In estate planning circles you hear a lot of talk about “avoiding the estate tax” and “gaining estate tax efficiency.” There are those patriotic Americans who may question this mentality, feeling as though they are more than willing to assume their fair share of the tax burden.
This is an admirable stance, but the operable term here is “fair share.” Let’s explain by way of a very simple example. Let’s say you start to put away a portion of your paycheck when you are in your early twenties and you do so your entire life. Between income tax and payroll tax you may have been left holding about $60 out of every $100 you earned before you went to the bank to make your savings account deposits.
So forty years down the line your saving have accumulated considerably and they are sitting safely in the bank. There is no way that this money can be taxed because it is an after-tax remainder that you were able to hold on to through your thrift. But, when you die, this money suddenly becomes taxable as it is passed along to your heirs. The current rate of the estate tax is an incredible 35%. Now if your children who inherit the money never spend it and pass it on to their children, it will be taxed yet again, and this can go on and on.
Few would call this steady and harsh asset erosion a “fair share,” which is why many people choose to create generation skipping trusts as a way to keep the hard earned money in the family. The way these vehicles work is that you fund the trust and name your grandchildren as the beneficiaries rather than your children. Your children can benefit from the assets placed into the trust, but they don’t own them. When your children die, the second generation inherits the principal and the estate tax is due on just one transfer rather than two.