Leaving a financial legacy for your heirs requires you to make some big decisions. You may not want to leave all of your money to your children, but you also may not know exactly the best way to leave a portion of your assets to a charity or other beneficiary.
Estate planning is a vital part of your overall financial plan, so don’t neglect this aspect of managing your finances and start thinking about what you want to leave to who now. A carefully crafted estate plan can prevent possible misunderstandings between your heirs and minimize any estate taxes that might be assessed. (For more, see: Estate Planning: 16 Things to Do Before You Die.)
Keeping the Tax Man At Bay
Regardless of who you leave your money and other assets to, you need to do everything in your power to minimize estate taxes. These taxes can take a heavy toll on the size of your estate if your net worth is above a certain amount. Here are several things that you can do to keep your estate tax bill as small as possible.
- Charitable gifts – Any assets that you gift to charity will be excluded from your taxable estate. As long as the recipient is a qualified 501(c)3 organization, then you will pay no estate tax on your donation. There is no limit on the amount that you can donate to charity. If you choose to leave your entire estate to charity, then you will pay no estate tax.
- Disclaimers by beneficiaries – Include stipulations in your will and trusts that allow your beneficiaries to disclaim part of all of their inheritance in favor of leaving it to a charity. This can be a tax-efficient way to allow beneficiaries to choose to donate to a charity if they so desire.
- Charitable lead trusts – This type of trust will provide an income stream to a charity of your choice while you are living. The income-producing assets that you used to fund the trust can then be passed on to your children or other beneficiaries. You will need to decide at what age you want your beneficiaries to receive this asset. You can also structure this trust to be a maximum zeroed-out charitable lead trust, which will eliminate any possible income or estate taxes for your heirs. (For more, see: Choosing the Right Charitable Remainder Trust.)
- Charitable remainder trusts – This strategy allows you to make a large donation now and receive a substantial income tax deduction equal to the value of the assets that you donate within certain limitations. You will receive a stream of income from the trust while you live, and the assets in the trust will pass to the charity upon your death.
- Annual lifetime gifts – You are allowed to gift a certain amount of assets to another person each year without incurring gift or estate tax. If you take advantage of this provision, you can substantially reduce the amount of your taxable estate over time and provide financial aid to your current beneficiaries. Friends and relatives are good targets for this type of gifting strategy.
- Q-TIP trusts – This type of trust allows you to bequeath a stream of income from the trust to your spouse after you are gone and then have the assets in the trust pass to an irrevocable beneficiary, which can be a charity. This is a good way to provide for your spouse and still ensure that the assets in the trust go to the beneficiary of your choice.
The Bottom Line
If you are going to owe taxes when your estate is passed on, now is the time to implement a strategy to minimize or eliminate this expense. There are many ways to reduce your taxable estate while providing a gift to a worthwhile cause. For more information on estate planning, consult your financial advisor. (For more, see: Estate Planning: Charitable Trusts.)