As currently structured, the tax system in this country levies an estate tax of up to 55 percent, with minimal deductions, on monies passed down from one generation to the next. There is no plan in sight for lessening this insidious erosion of your assets through multigenerational estate taxation. In fact, if anything, the government is considering decreasing the allowable exemptions and thereby depleting your estate even further.

If your estate is worth $50 million, after taxes your children will inherit only $22.5 million. And your grandchildren will receive only $10,125,000 after the estate taxes are deducted from the remainder. In only two generations, everything you have worked so hard to earn and protect will be depleted by almost 80 percent. Clearly, if $50 million is not sufficient to ensure financial security for future generations, $10 million, which may seem like a tidy inheritance, will provide even less security after it suffers similar depletion.

Let's assume, to make things easy, we live in a world of 10 percent interest. Ten million dollars currently producing $1 million before taxes and $666,000 after income taxes becomes about $5 million after estate taxes. In turn, that $5 million will produce $500,000 to be shared by your children before income taxes and $300,000 after income taxes. Your grandchildren will all share an inheritance of only $2.5 million from your original estate. This will generate approximately $250,000 before income taxes and $166,000 after income taxes, based on current assumptions. The security you thought you had provided is quickly dissipated as your grandchildren are left with only 20 percent of your original estate; the missing 80 percent has been given to the government in just two generations.

Bleak as this picture seems, it can get even worse.

Even if your estate is worth $10 million, it is probably not very liquid. Chances are you have some money in property and investments but a lot of your capital tied up in the family business. Nonetheless, estate taxes are due on the total value of your entire estate within nine months. If your family does not have $5 million immediately available in cash to pay your estate taxes, they may have to sell the business. Even if you do have other liquid assets, your heirs may suffer a significant additional loss if those have to be sold to cover taxes. The other remedy is for them to borrow the money, which could put an added burden on the business.

If I were to tell you there is an investment opportunity, stock, bond, or municipal fund available that would give you a guaranteed rate of return sufficient to reduce your estate taxes by up to 90 percent—and that it would pay its guaranteed return the very next day if required—you would clamor for the details and be eager to participate.

Unfortunately, no such investment, stock, bond, or muni exists. But there is one way, and only one way, to accomplish this financial miracle—through life insurance.

For one reason or another, many of you may draw back at the mention of life insurance. Perhaps you've been advised against it by experts in other fields who don't fully comprehend the wondrous uses it offers. Perhaps you don't understand the tremendous leverage and tax advantage it represents. Perhaps you were once turned off by an overzealous insurance salesperson or an unknowledgeable stockbroker. Or maybe in the past you didn't want to face your own mortality.

Properly used, life insurance represents a guaranteed investment with returns of 2 to 1 to as high as 40 to 1, and it can be income- and estate-tax free.

Of course the actual return amount will vary based on your age, health, method of insurance, and the carrier(s) you choose. But for the average older person, $1 million could easily produce a $10 million tax-free return.

In a comparable situation, you would have to make over a $32 million profit on your investments or business—which would produce $21 million after income taxes—to result in approximately $10 million after estate taxes. In other words, a $1 million life insurance policy does the work of $32 million.

Think about it in terms of the earlier example: If your estate is worth $50 million, 55 percent will be lost to estate taxes when you die. Life insurance can reduce the amount of that loss to only 10 percent.

If you and your wife purchase a last-to-die type of life insurance policy for $2,750,000 under which both of you are insured and the proceeds are paid upon the second death, your heirs can receive, based on your averaged age of 60, a return of $27.5 million—10 times your investment—tax free.

So while the government still takes its 55 percent share of your estate—$27.5 million—your family receives that same amount back from the life insurance company that insured you. Your estate passes on to your heirs virtually intact. The bottom line is: Either your children will pay the entire amount in the future or you can pay it now—at a 90 percent discount.

Remember, all this was accomplished using only 5 percent of your total estate value. Fully 95 percent remains available for you to invest or spend. Of your original $50 million estate, $42,250,000 remains for you to use in making an even greater fortune. Meanwhile, a mere 5 percent—$2,750,000—provides a guarantee of financial security for your heirs and for your business, whether it is needed tomorrow or 25 years from now. At younger ages, it is possible to structure a policy that will provide a 20 to 1 return, meaning that enough insurance can be purchased to pay the tax liability of $27.5 million for only $1,125,000.

The next step is for your heirs to do the same thing. They purchase a life insurance policy on the estate they have inherited from you, now worth $47,250,000. Assuming they reach an average age of 60, for $2,598,750 they can purchase $25,987,500 worth of insurance, which will cover their estate tax costs. Your original $50 million estate passes to your grandchildren at $44,651,250 ($50 million less the $2,750,000 cost of your insurance and less the $2,598,750 cost of your children's insurance), as opposed to the vastly depleted sum of $10,125,000.

With an estate of $10 million, you can expect to pay 50 percent in estate taxes. But with a guaranteed 10 to 1 return on an investment in a life insurance policy, based on current assumptions, you can pay the total $5 million tax assessment using only $500,000. At age 60, that $500,000 will purchase a policy worth $5 million.

Often an accountant or other financial planner will refer to an internal rate of return when establishing the value of a given financial program. But you cannot really apply that concept to this approach because you do not know if you will die tomorrow, five years from now, or 30 years from now. An internal rate of return is a means of calculating time into the return on an investment. But to do so you must make certain assumptions, one of which concerns the amount of time over which the investment will mature to its full potential. But you are never guaranteed that you'll survive long enough to realize what may be considered a significant rate of return. What if you die tomorrow?

We had one major client with substantial insurance who died recently within six months of his purchase. The internal rate of return meant nothing. It's an uncomfortable thought, but unfortunately the possibility always exists. The investment you made that has not had time to mature will be worth approximately its original amount, while the life insurance policy you purchased will realize its full potential immediately.

Barry Kaye of Barry Kaye Associates in Los Angeles specializes in wealth creation and preservation. He founded the Wealth Creation Centers, a nationwide network. Excerpted from Save a Fortune on Your Estate Taxes. Copyright �(c) 1993, Barry Kaye. Published by Business One Irwin, Homewood, IL.

Estates of the famous

Used with permission: Your Estate Research Service �(c) 1990,
Dearborn Financial Publishing Inc., Chicago. All rights reserved.