Of Man's Estate

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You also want to make certain that heirs have the means to pay the estate tax without taking an IRA distribution. If the estate does not include enough liquid assets to cover the tax bill, consider a life-insurance policy that pays when the second spouse dies. That's when the bulk of your estate gets handed down. Such a policy should be put in the heir's name and funded through annual tax-free gifts.

Elementary, of course, is that married couples should take full advantage of the lifetime exemption--that one-time $675,000 exclusion from estate taxes mentioned above. For non-IRA assets, you may need a credit shelter trust to divide assets. But if the bulk of your estate is IRA savings, simply divide the IRA money into two accounts--one for the full value of the lifetime exemption and the other for what remains. Generally, you should let the smaller IRA pass to heirs at the death of the first spouse, using that spouse's lifetime exemption. When the surviving spouse dies, heirs get the second IRA, using the second spouse's lifetime exemption. If the second IRA is greater than the lifetime exemption, that's where a second-to-die life-insurance policy kicks in to cover the estate tax. Generally, the policy should be for about half the value of the second IRA.

For more complicated estates there are more complicated solutions. The goal in each case is to get assets out of your estate, driving the estate value as close as is practical to the lifetime exemption. The easiest way is through annual gifting. Married couples can give away up to $20,000 a year ($10,000 for singles) tax free to as many people as they like. Paying tuition is tax free and does not count against the annual gift limit. If you have highly appreciated stock, that can be given to charity at market value, and the charity does not pay tax on the embedded capital gain.

If you own a lot of stock that you expect will rise a great deal before you die, consider gifting the stock up to the annual gift limit. "Do it early, before the value goes up," says Karen Goldberg, a tax lawyer with accounting firm Grant Thornton. "That way you keep future appreciation out of your estate."

Here are three other common ways to reduce your estate:

QUALIFIED PERSONAL RESIDENCE TRUST This lets you get a primary residence or vacation home out of your estate. You place it in trust but retain the right to live there for a set number of years. After the term expires, you presumably move to Florida. But you can also elect to rent the house as long as you like. You must survive the original term, though, or the house gets thrown back into your estate. The advantage: when you set up the trust, it amounts to a gift at discounted value. A $1 million house in a 10-year QPRT counts only as $379,320 against your lifetime exclusion. The discount applies because heirs who receive the house don't get to use it for 10 years.

GRANTOR RETAINED ANNUITY TRUST This lets you fund an annuity that will pay you at a market rate, but with any excess returns remaining in the trust and passing to heirs outside your estate. A typical example would be someone planning to sell a family business within five years. You set up a GRAT with low-priced pre-sale stock. The GRAT pays you back the equivalent of about 8% a year, based on current rates. But actual returns are likely to be far higher when the company is sold. The excess returns stay out of your estate.

FAMILY LIMITED PARTNERSHIP This lets you give away assets at a discount, making your annual gifts or lifetime exclusion go further. A typical example would have you place shares of a family-owned business in the partnership and then give away shares of the partnership. But flps can hold any asset, including publicly traded shares. Just retain full control of the partnership with sole discretion over when to sell any assets held by the partnership. The irs then discounts the value of the assets in the partnership by up to 40%, as they are illiquid to the general partners. In this way, a married couple could gift, say, $20,000 of partnership stock (staying at the annual tax-free gift limit) with an underlying value of $28,000. Good deal.

Thinking about death is painful. But you can lessen the pain for your heirs if you think of ways to beat the taxman now.