Gift Planning: Using Insurance

If you're shopping for a tax-saving, lifetime gift plan for your family, you may find that giving away your insurance is a smart idea. First, take a look at the conventional approach, using some round numbers. You give, say, £50,000 in stocks to your two youngsters. The dividends paid on the stocks come to £2,000 a year. Each child gets taxed (in the £2,000 low bracket) - and you pay less tax yourself. If, for example, your taxable income is around £35,000, you save nearly £1,000 a year.

Besides, you cut your estate by £50,000, plus income that would have piled up. If these two total, say, £60,000 - and you leave a taxable estate of £100,000 or more - your family saves at least £15,000 in estate tax. Not only do you save estate tax - you can avoid gift tax, too.

But suppose that you have good reason for not wanting to part with your shares of stock. This is the rub for many a man - and it's the point where some of them decide to drop the whole gift-plan idea. Unless you give other income-producing property, you can't pick up your yearly income tax savings - but there is a way you can preserve the estate tax advantage, which may be more vital anyway: Use your life insurance as the gift property. Say that you own a £100,000 life policy and assign full ownership in it to your youngsters, or your wife. Again, this can automatically cut your eventual estate - by £100,000. To use round figures, if your remaining taxable estate turns out to be £100,000, the insurance transfer saves your family £30,000 in estates taxes. And usually there is no gift tax problem. Remember that when you assign the policy you aren't giving away anything like £100,000. For example, if you're age 50 and have been paying premiums for 10 years, the cash value is roughly £16,000 to £18,000, depending on whether the policy pays dividends.

The point is that, for tax purposes, the gift is well below your own personal lifetime exemption from gift tax, which is £30,000 (£60,000 for you and your wife). Also, this is apart from the £3,000-a-year gift tax exclusions that permit you and your wife together to give two children £12,000 yearly. So usually you can give the life policy tax-free. For comparison, if you give £100,000 in securities to your two youngsters (joining with your wife), the gift tax would be about £2,000. Thus a gift of life insurance allows you to maintain your securities intact, and at the same time, avoid any current tax as you cut a large slice from your taxable estate.

And there's a third point to weigh: If today you give securities that have appreciated in value since you purchased them, generally your family members assume your own original tax basis - so when they sell, they pay capital gains tax on the full measure of profit. Pending tax law changes that could come about by 2006 - if you hold the securities and your children inherit them at your death, their tax basis is the current value of the securities at the time your estate is settled.

Providing for the future of children by giving them good common stocks is a fast-growing practice, and probably you are well aware of two prime advantages: (1) built-in inflation protection for the child's benefit, and (2) income tax savings affecting the whole family. But what you may not be up on is the best way to carry out the plan. A "custodian account" may be your answer. A few years ago, the formal trust was about the only practical way to set up such a stock plan for a child. But this means the selection and appointment of a trustee, the expense and bother of drafting formal trust agreements, and the cost of accounting, etc. Today the streamlined "custodian account" can be a smart alternative to a trust, in some cases.

The plusses: First, the idea is simple, workable. Opening a stock account for your child takes only a few minutes in your broker's office. You just register the stocks in your own name - or in another family member's name (see below) - "as custodian for the benefit of...," your child. Generally, as custodian, you can sell the stocks, reinvest the proceeds, and reinvest the income, year to year. There are a few limitations under the law - for example, the custodian can't legally use the child's money to buy stocks on margin. But these restrictions are not usually too burdensome.

Now, consider tax breaks. First, all states get the same treatment from the Internal Revenue Service in Washington, regardless of differences in state laws. And here is the prime tax advantage: As long as you use your own money, and not custodian-account money, to support the child (this being your legal obligation), the annual income from the custodian account is taxed to the child. That is, he files his own return each April, and pays tax in his own bracket.

This may mean a very low tax - or none at all. Another plus is the fact that even though you may serve as custodian of a large income-producing account, in your child's name, you still retain your tax exemption for the child - as long as he's under 19, or remains a full-time student.

There is one possible drawback - it may or may not cloud the whole idea. With a custodian account, when the child reaches majority, the property is turned over to him. Today, most states have nailed down age-18 majority laws. This means that the account principal would be turned over to a person of somewhat tender years - in the minds of some parents, that is. With a trust, this, of course, isn't the case.

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Joint Ownership: Often An Attractive Snare

Owning property jointly with your wife or husband - that is, listing yourselves as co-owners - may be a convenient and harmless way to handle a family checking account. But if you carry the idea much further, you are inviting serious trouble. The real difficulty begins when joint ownership is used as a short-cut substitute for long-range estate planning. That's because joint ownership gives you little or no flexibility. You forfeit your chance to direct the final disposition of your property. And in the long run it can be costly.

Here's an example of how costly: Where there's an estate of, say, £300,000 moving from husband to widow to grandchildren, the difference between effective... see: Joint Ownership: Often An Attractive Snare