Estate-Tax Planning: Not Just for the Super Wealthy

Estate-tax planning may seem like a concern only for the very wealthy since the first $5.12 million of an estate ($10.24 million for a married couple) is currently exempt from federal estate tax.
But some states, like New York, Massachusetts and Oregon, offer only a $1 million exemption for state estate taxes, which can put a sizable dent in a relatively modest-sized estate.
And unless Congress acts, the federal exemption for both estate and gift taxes will revert to $1 million in 2013. If that happens, millions of estates will suddenly become subject to taxation.
One powerful tool for cutting estate taxes while giving to charity is a charitable lead annuity trust, or CLAT. A CLAT can let you boost your charitable giving and cut income, gift and estate taxes while earning a reasonable rate of return.
Here’s how it works. The donor first contributes assets to this irrevocable trust, which lasts a certain period, for instance, 10 years.
The trust then pays a fixed annual amount, or annuity, to a charity. The IRS sets the minimum payout rate — currently an ultra-low 1% of assets — each month. At the end of the term, any remaining assets pass to non-charitable beneficiaries, such as your children.
A historically low 1% hurdle rate makes a CLAT very attractive.
Establishing a CLAT could result in a taxable gift, which would reduce your gift-tax exemption. The gift amount equals the value of the “remainder interest” that’s expected to pass to your heirs when the trust ends.
You can avoid this by establishing a CLAT with a remainder interest that is projected to have a value of zero at the end of the trust term. This is called a “zeroed-out CLAT.” To accomplish that with a 10-year CLAT, you’d have to distribute more than 10% of the assets originally contributed to the trust every year.
But your family members won’t be left out in the cold if the assets in the trust significantly outperform the IRS rate.
Let’s say you set up a 10-year zeroed-out CLAT and put $1 million in it. Assuming an 8% rate of return and given the current 1% IRS rate, at the end of 10 years, the trust will be worth $629,404. All of it will go to your beneficiaries gift-, estate- and income-tax free. Meanwhile, you’ve given a total of $1,055,821 to your favorite charity or charities.
A CLAT is one of several types of trusts that can help reduce the bite of state and federal estate taxes.
Estate-tax planning is complex, and whether a CLAT or another type of trust would make sense for you depends entirely on your circumstances and goals.
Read more:
Shomari Hearn, CFP, is vice president of Palisades Hudson Financial Group, a wealth-management firm. He heads the firm’s Fort Lauderdale, Fla., office and can be reached at
Palisades Hudson ( is a fee-only financial planning firm and investment advisor headquartered in Scarsdale, N.Y., with $1 billion under management. It offers estate planning, insurance consulting, retirement planning, cross-border planning, business valuation and appraisal, family office and business management, tax preparation, and executive financial planning. Branch offices are in Atlanta and Fort Lauderdale, Fla.