There are many techniques for avoiding the estate tax, some of which are complicated and expensive to implement. However, there are some very simple steps one can take to avoid, or at least minimize, the estate tax. First, what most people do not realize is that everything you own at the time of your death, including life insurance, is part of your taxable estate. Many are under the misconception that life insurance is not taxable. While it is not income taxable, the death proceeds become part of one’s taxable estate. If one transfers the ownership of the insurance to be another person (other than one’s spouse) or a life insurance trust, the value of the death proceeds is removed from one’s estate. Of course, you need to be very careful about transferring the ownership to another individual, as there are liability and control issues, which are avoided by creating a life insurance trust.
Everyone is permitted to gift up to $16,000 per year (which is the annual exclusion amount for 2022) to as many people as one likes, without it having an adverse tax effect. If you are married, that means you can remove $32,000 from your taxable estate by making just one gift. If you have several children and/or grandchildren, you can use this gifting to make a large reduction in your taxable estate. Care should be taken, however, when gifting to children or grandchildren, because they must be over the age of 18 to receive monies outright. This annual exclusion can also be used to fund 529 college plans.
The gift tax laws also permit one to make gifts in unlimited amounts for education and medical purposes, provided those gifts are made directly to the medical provider or facility and educational institution.
Taking larger than required minimum distributions from one’s retirement account is also an excellent way of reducing one’s estate. Of course, income tax will need to be paid on the withdrawal, but the reality is that when one passes, the beneficiary will need to start taking withdrawals and paying the tax. Either way, income tax must be paid, but if paid by the donor, it reduces the estate..
