Families: Of Man's Estate

You may have heard whispers about a movement in Congress to eliminate the so-called death tax, the amount the Federal Government lifts from your estate before heirs get what's coming to them. Nice thought. Estate taxes can be whoppers. The maximum rate--on estates over $3 million--is 55%. Even the lowest rate is stiff: 37% on everything you're unable to shelter.

Estate taxes are essentially a levy on savings that have already been taxed, triggered by the money passing from one generation to the next. That smacks of double taxation, and Republicans have said they'd like to put an end to the practice. But it's doubtful that any bill to that effect will survive this year. Any such change would be viewed as a tax break for the millionaire set. Washington insiders say President Clinton would veto it in a heartbeat.

So whether you're planning your estate or helping Mom or Dad, you may as well figure on the strategies out there. Remember, bad planning can turn a $3 million estate into ready cash of just $200,000.

Say you leave behind $1 million in real estate and $2 million in an IRA. The estate tax comes to about $1 million, allowing for standard deductions and exemptions. But your estate will owe an additional $800,000 right away if heirs take the IRA as a distribution rather than leaving it intact to continue growing tax free. What might force such a distribution? If no beneficiary is named on the IRA and you are past age 70 1/2 at the time of death, it automatically gets liquidated, with taxes due. But even if you've named a beneficiary, he or she might need a distribution to pay the $1 million estate tax. Remember, the only non-IRA asset in this case is illiquid real estate. Result: $1.8 million of a $2 million IRA goes to the taxman. A small part of that may ultimately be recovered through various deductions. But poor planning can devastate an estate. No question about it.

There are three broad areas of estate planning: trusts and gifts to reduce an estate, planning distributions from IRAs and other retirement accounts to minimize the tax, and basics like a will. Let's take them in reverse order.

It's worth noting that 97% of the population will never owe a dime in estate tax. The lifetime exemption this year and next is $675,000 per person and goes to $1 million in 2006. Married couples can easily shelter twice that amount--sums most people only dream of. Meanwhile, virtually everyone can benefit from a written will, a living will and a durable power of attorney. With each, the idea is to keep potential disputes out of court, where legal costs eat into your heirs' good fortune.

"Most wills are too simple," warns Martin Shenkman, a New York tax attorney and estate planner. "You should ask 'what if' to the point you don't care anymore." Who gets what in the event of a child's death or divorce is a key consideration. A living will designates someone to make health-care decisions should you become unable to. A durable power of attorney designates someone to make legal and financial decisions should you become unable to.

These documents are essential to any estate plan. But think twice before giving one of your children durable power. That grants the authority to do things like change IRA beneficiaries. If two children fight and only one has durable power, the other could get cut out. Grant joint durable power, or go outside the family.