How Insurance Can Be Used to Offset Estate Tax
Q: A recent column touched on the strategy of buying an insurance policy to cover estate taxes. Can you explain more about this and how it works? --S.P . L.
A: The concept is actually quite simple, but the execution must be flawless to achieve the desired end, advises Gregg Ritchie, a partner with the accounting firm KPMG Peat Marwick in Los Angeles.
The goal is to buy enough insurance on the life of the benefactor to cover the estate taxes on the property left to his heirs or family trust. To do this, you obviously must have an accurate estimate of the size of the estate and the probable tax bite, a calculation you will need a tax attorney or accountant to help you make. The next step is to buy an insurance policy on the benefactor for that amount, naming the heirs or an irrevocable trust as the beneficiaries.
But there’s one more important point to cover to make sure that the insurance policy does not wind up in the benefactor’s estate and compound the tax bite. The issue is: Who owns the insurance policy? If the deceased is judged to “own” the policy, its proceeds are included in the estate. To avoid this determination, the policy should be purchased by the irrevocable trust or the heirs--and not the benefactor.
If the benefactor purchases the policy and retains control over it, Ritchie says, the proceeds will be taxable to his estate even though he never changes the beneficiaries or any other features of the policy. Ritchie says the benefactor can provide the money for purchasing the policy by giving his beneficiaries gifts of up to $10,000 per year to cover the premium. This way the beneficiaries buy the policy but are not burdened by the expense.
Obviously this strategy is designed for what are euphemistically known as “high net worth individuals,” or rich people, since $600,000 of an individual’s estate can be given away tax-free.
A Formula to Compute the Yield of a Stock
Q: I am trying to figure out how to compute the yield of the utility company shares that I own. I bought 450 shares at once several years ago and have added about 300 more shares over the years through the company’s dividend re-investment program. There must be some sort of formula that I can use to evaluate how well my money is working for me. --Q.M.
A: Yes, and the formula is a fairly simple one--if you have kept track of the paper work from each of your dividend reinvestments.
First, add up your total investment in the stock--the initial purchase plus each re-invested dividend. Next, divide that total by the number of shares you hold. This gives you an average per-share cost. Now divide your average per-share cost into the stock’s annual dividend, a figure available in newspaper listings or on your most recent statement from the company. This will give you the average annual yield on your holdings.
Tax Break Hinges on Home-Purchase Date
Q: My wife and I plan to sell our home next year and make our vacation home our primary residence. Can we defer taxation on our profits from the sale by designating our vacation home the replacement residence? --V.E.
A: Your strategy will work only if you bought your vacation home within two years of the sale of your primary residence. If you bought your vacation home more than two years before the sale, then it is not considered a replacement residence, and you will be required to pay taxes on the sale of your residence. However, if you are over age 55, you might consider using your one-time exclusion of $125,000 in home sale profits.
Insurance Annuity Can Be Converted
Q: I have an annuity with a troubled insurance company. I would like to get my money out and put it into a mutual fund that I can manage myself. Can I do this without incurring any problems? I certainly feel that I can invest my money better than an insurance company. --J.E.H.
A: Whether you can do a better job investing than your insurance company remains to be seen, but you certainly have the right to switch your money out of your annuity and into a mutual fund, says Thomas Gau, a Torrance financial planner.
If your annuity is part of an individual retirement account, Keogh or other retirement plan, Gau says you can simply roll the proceeds over into a self-directed IRA that you will invest in one or more mutual funds. If your annuity is not connected to a retirement plan, Gau says you should transfer your annuity funds to a mutual fund account through what is known as a 1035 exchange in order to preserve your tax-deferred status.
In either event, you should be aware that you could face a surrender penalty for early withdrawal of your annuity proceeds.
NOTE: A reader recently wondered what he should do with his newly rediscovered stock certificates for Financial Corp. of America, a bank holding company that filed for bankruptcy nearly three years ago and whose principal assets have long since been parceled out by federal regulators to other thrift operations. We advised that the stock is probably worthless, but a reader offers a faint glimmer of hope. A bankruptcy settlement fund of about $50 million is being disbursed to a large number of claimants. Although the deadline for filing a claim against FCA has long since passed, it may still be possible to assert an interest. Contact Security Litigation Claims Center, 1115 Magnolia Ave., Larkspur, Calif. 94939. The phone number is (415) 461-0410.
