Because it is not a popular topic, many people are unprepared (financially, of course for purposes of this topic) for their parents' or their own demise. The estate tax exemption for 2002 is $1,000,000 and while that may sound extremely large for a lot of individuals, many others are stunned to realize that their estates easily exceed that amount when they include life insurance proceeds, retirement accounts and their personal home.

The value of your estate is probably much greater than you realize, and the resulting state and federal taxes which will have to be paid by your descendants can be staggeringly high. If your estate consists of non-cash assets such as a home, family farm or business, it may have to be sold in order to pay the taxes, which can exceed 50% depending on the state in which you live and the value of your assets.

Although you cannot completely eliminate estate and inheritance taxes, there are steps you can take to reduce the impact somewhat. Most of these options can be quite complicated, so we will just briefly touch on them in this discussion.

Irrevocable Trust

This may be the most popular method of avoiding or lowering estate taxes for extremely large estates. By transferring your assets into an irrevocable trust, you can defer estate taxes until your descendants liquidate the assets of the trust. It is also possible that your descendants liquidate the assets of the trust. It is also possible that your descendants could pass the trust on to their descendants without paying estate taxes if they maintain the assets untouched. Of course, one potential problem with irrevocable trusts is that you must transfer your assets out of your name and into the trust. This may not be an attractive option if you are still relatively young or in good health and plan to live for many more years.

AB Trust

An AB Trust can be an excellent option to lower estate taxes for married couples. Generally, if one spouse dies and leaves the bulk of his or her estate to the other spouse, the estate tax exemption ($1,000,000 for 2002) dies with the decedent. When the other spouse dies and leaves all of the assets (we'll use $3,000,000 for this example) to the children, they will be left with a tax bill of $1,000,000 (assuming a taxable estate of $3,000,000 less the $1,000,000 exemption times an estimated 50% state and federal tax rate).

With an AB Trust, however, each spouse could establish a trust and place $1 million of their assets into part A and the remainder of their assets into part B. When the first spouse passes away, his or her trust is willed to the heirs with part A being exempt from taxes. The trust can remain intact until the second spouse passes on. At that time, both trusts can be liquidated by the heirs and the $1 million exemption is doubled to $2 million and the resulting estate tax using the same assumptions above is reduced to $500,000 - a savings of $500,000!

Second To Die Life Insurance

Another popular option for married couples with non-cash assets is the second to die insurance policy. It really offers no tax savings, but it can prevent your heirs from having to sell the family farm or business to pay the estate taxes. A second to die policy is simply a life insurance policy that is held in your descendants' names (or an irrevocable life insurance trust) and pays them cash after both spouses have passed on. Of course, the premiums on the policy could be more than your heirs save on their taxes, so it is wise to be careful when considering this option.

There are, as always, many other options you can consider to decrease or defer estate and inheritance taxes. The rules are considerably more complicated than what we have presented above. The tax savings than can be gained, however will often be in the tens or hundreds of thousands of dollars and is well worth the small amount of time and expense it will take now to prepare for the inevitable.