If you have more than $1 million in assets, an important deadline is fast approaching to take advantage of some of the most generous estate tax rules of the past century. Until December 31, 2012, the rules say, it is possible to transfer up to $5.12 million of your estate (and twice that amount for couples) free of federal tax. Next year, unless the sharply divided Congress extends the current rules or enacts new ones, the lifetime exemption drops to just $1 million. The federal estate tax on assets over that limit would spike from the current 35% tax rate to 55%, and that’s not even including estate taxes imposed by individual states.

What to do: If you have a small estate (substantially under $1 million), you don’t need to take action, because any new legislation is unlikely to require your estate to be taxed unless it grows substantially. But if your estate is larger than that, consider making gifts to loved ones of up to $5.12 million in assets by year-end and/or transferring up to that amount to an irrevocable trust.

How irrevocable trusts work: They are legal agreements that allow you to transfer your assets so that they are no longer part of your estate. Those transferred assets can range from stocks, bonds and real estate to your life insurance policy and shares in your business. Any future gains on those assets also escape the estate tax. You choose the trustee—typically a spouse or other relative, a friend or a bank (which may charge an annual fee of $3,000 to $5,000 or more, or 1% of the value of the assets). You also designate the beneficiaries and the specific terms of the trust, such as when the beneficiaries get control of the assets. How much you transfer to the trust will depend on your own future financial needs, because once transferred, those assets are no longer yours to directly control or withdraw. Example: If you transfer stocks and bonds, the trust owns the investments. The trustee decides when to sell them if at all and how to reinvest or distribute the assets.

Among the advantages of using a trust: The assets are protected from creditors and divorce settlements.

If parting with assets makes you feel vulnerable or fearful that you will someday need the money, consider doing the following…

Put only non-income–producing assets, such as investments in land and works of art, in the trust rather than more liquid assets such as stocks.

Create a qualified personal residence trust (QPRT), which allows you to give your home to beneficiaries at a discount to current market value and transfer future appreciation in the home’s value free of taxes. You are allowed to remain in the house for a defined period of time.

Typical cost to create an irrevocable trust: $5,000 and up, depending on the complexity of your estate plans. It can take one to two months to draft the proper legal documents and do appraisals and valuations of businesses and properties.

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