Stanley - The 2002 Tax Act

What it means to your estate plan in 2003

As just about everyone knows by now, Congress made major changes to the federal estate and gift tax in 2002. Some of the media hype about the new tax law may have led you to believe that you can put your estate plan on hold. The truth is more complicated. There are at least three reasons for revisiting your wills, trusts and tax planning strategies in 2003.

What the tax law did and didn't do

Despite some claims to the contrary, the 2002 act didn't exactly repeal the federal estate and gift taxes. Instead, under the 2002 act the estate tax remains in essentially its 2002 form until 2009. Then, in 2010 the estate tax is repealed but only for those individuals who die in 2010. Unfortunately, for those who die in 2011 the estate tax returns with a vengeance, unless Congress makes the repeal permanent between now and the end of 2010. In an era of fast-shrinking budget surpluses and increases in defense spending, many experts think that Mohammed Ali's return to the ring is more likely.

What the 2002 act did do was increase the estate tax exclusion to $1 million in 2003 and gradually increases it to $3.5 million in 2009. Also, the top estate tax rate decreases gradually from 55 percent until it reaches 45 percent in 2007.

Something the 2002 act didn't even pretend to do was repeal the gift tax. Granted, the gift tax exemption is increased to $1 million in 2002, but unlike the estate exemption, the gift tax exemption remains locked at that level. The rate decreases that apply to the estate tax also apply to the gift tax; however, beginning in 2010, the top gift tax rate will be the same as the top income tax rate. Right now, that rate is slated to drop to 35 percent by then.

What it means in 2003

First, the increase in the estate tax exemption to $1 million makes it imperative that you have your wills and trusts reviewed by an estate planning professional. Here's why:

Under the old law, a common approach was for each spouse to leave the other the least amount of property necessary to reduce estate taxes to zero after taking into account the exemption. But the increase in the exemption under the 2002 Act can have unexpected results. Take the example of the individual who has a $2 million estate and a marital bequest that is tied to the exemption amount. Unless the formula in the will or trust is adjusted, the spousal bequest is much less under the act, eventually dropping to zero than it would have been under the old law. Chances are this is not the intended result.

A more palatable approach might be to change your will or trust to leave the surviving spouse an amount not to exceed the exemption amount in a given year. Using this approach, the surviving spouse receives the entire $2 million estate beginning in 2006, reduced only by specific bequests to children and others.

Second, if you are skeptical about permanent repeal of the federal estate tax, you should continue or begin making gifts to family members. One reason for making gifts is that you are allowed to transfer $10,000 per year per individual for any reason free of gift taxes. Better yet, the value of the gifts and all future appreciation is removed from your estate. That saves you estate taxes in the long run.

But, it's like a sale at Bloomingdale's the sooner you start, the more you save. A modest $10,000 annual gift for 10 years growing at 6 percent transfers $131,808 out of your estate and saves $59,314 in estate taxes (assuming a 45 percent tax rate). Start today and make the same gift for 20 years and you transfer $367,856 out of your estate and save $165,135 in estate taxes. What are you waiting for?

Third, if your estate isn't large enough to take advantage of the $3.5 million estate tax exemption slated for 2009, why not do something today to enlarge it? For example, why not purchase enough life insurance to fund (or partially fund) the estate tax exemption. In fact, if you really want to please your life insurance agent, why not buy enough life insurance to fund both your exemption and your spouse's exemption? That's right, come 2009, you and your spouse can each pass $3.5 million to children and grandchildren free of estate tax $7 million if you have it. Only life insurance can guarantee that the money is available when you need it.

But the catch with life insurance is that you have to be in reasonably good health to get it and the premium increases with age. That's why you need to take action in 2003. Chances are you'll never be healthier than you are today and premiums will never be lower.

The bottom line

The Tax Act of 2002 didn't eliminate the need for estate planning. Instead, it created new opportunities for those who seize the day. Have your attorney review your will. Continue or implement a family giving program. Talk to your life insurance agent about buying enough life insurance to take advantage of the tax breaks Congress has offered. It's as simple as one, two, three.

Sharon Stanley is a representative of The Prudential Insurance Co. of America in Cape Girardeau. (334-2603 )