Many people postpone planning their estates, not wishing to confront issues of mortality; or, it may be that they believe the subject so complex that no amount of effort will yield any useful results. They may shrug their shoulders and say “I’ll let my kids worry about it”, not realizing the significant burden they are imposing on the next generation and the likelihood that far greater tax liabilities will be incurred by doing nothing.Estate planning should not be considered a process impossible to understand and not worth the time spent. Much can be achieved with a few hours of work. The result will be that the burden on the next generation will be greatly lessened and the taxes imposed at death may be substantially reduced.
Writing a Will
What is a will? It is simply a statement of what you want done with whatever you own at the time of your death. It can be as simple as a letter of instructions. The important points are that it must clearly be a direction of what is to be done, and it must be signed and dated. In some states, there may be more required in the way of formalities, but generally this is what is needed to ensure that your assets go where you want them to go. It’s probably a better idea to have a formal will drawn up, and for this you should consult a lawyer. While there are sample form wills available on computer programs and in the local pharmacy, this is too important a project to have it done without expert advice. A will drawn up by a lawyer will add some more formal language, but it will cover issues that you might not have thought of on your own, such as who will be your executor, the person who carries out the terms of your will, and who will be the guardian of minor children.
Will Substitutes
Not everything you own will necessarily pass by will. Certain assets may contain their own provisions determining where they go upon your death. A good example of this is life insurance. The proceeds of life insurance will go the persons you name as your beneficiaries, on a document that is kept on file with the insurance company. Similarly, the beneficiary of any pension or profit-sharing plan benefits, or individual retirement account benefits, will be the persons you name on a beneficiary designation form filed with the plan administrator or financial institution holding the IRA.Many people own property in joint names. Typically, a home owned by two people will be owned jointly, and this also occurs quite often with bank accounts and brokerage accounts. For most joint accounts, except those called “tenancies in common”, the survivor will be entitled to the entire value of the asset when one of the owners dies.These will substitutes must be reviewed to determine where the assets covered by them will go. They must also be considered along with the will to obtain a picture of the entire estate plan, where all of your assets will end up.
Death and Taxes
Most people pay federal and state income taxes during their lives, generally every year, and the Form 1040 and the tax rates are well known. Less well known is the fact that both the federal government and, in many cases, the state government will impose taxes at death on the value of all that the decedent owned. That is, even if you have paid income taxes on what you have accumulated during life, it will be subject to tax again at death.Federal estate taxes have changed significantly in recent years. In 2011, the federal estate tax will be imposed at a flat rate of 35%. There is an exemption of $5,000,000 before the tax is imposed, increased to $10,000,000 for married couples. Assets up to that amount may be passed free of federal estate tax. This may seem like a sufficiently high number to avoid tax in almost every case, but the tax is imposed on the value of IRAs and other retirement accounts, the value of your home, and the proceeds of life insurance policies, in addition to stocks and bonds, bank accounts, and all other assets. The threshold may be exceeded when the these assets are totaled.Federal estate taxes have another very important offset: you may leave any amount to your spouse with no imposition of federal estate taxes on the transfer. Thus, it is possible to avoid all or nearly all tax on the death of the first spouse, simply by leaving everything to the survivor. This may not be the disposition you want of all of your assets, but it is a valuable deduction that can assist in planning to minimize taxes.The combination of the estate tax exemption and the marital deduction can produce very significant reductions, or the elimination, of federal estate tax. By using trusts set up under a will, it is possible to provide for the survivor and pass on to the next generation the maximum amount possible under the federal tax system.Many states still impose death taxes of their own. Pennsylvania imposes an inheritance tax on the assets owned at death, to the extent they do not pass to the surviving spouse. New Jersey exempts transfers to the surviving spouse and descendants. Florida imposes no inheritance tax, as do a few other states. It’s important to review what your state death tax liability would be in your state of residence. By the way, what is your state of residence? Some people live most of the time in one state, but try to claim they are actually residents of another state, like Florida, to avoid inheritance taxes. This is a technique that must be carried out with careful planning, to avoid claims by two (or more) states that taxes are owed to it. Planning Techniques to Lower Tax Liability
There are a number of techniques that may be employed to reduce the burden of death taxes. First, you can give assets away during your lifetime to family members. In doing so, you should be aware of the possible imposition of federal gift tax. The gift tax is similar to the estate tax, with the same rates and threshold exemption. In addition, you may give up to $13,000 per year (in 2011) to any number of persons without incurring gift tax or using up any of the lifetime exemption. If your spouse joins in the gift, the $13,000 exemption is doubled. Gifts beyond these amounts use up part of your lifetime exemption and, if large enough, can result in the payment of gift tax currently.
In conclusion: Plan ahead
There is no substitute for thinking about the disposition of your assets, both during your life and afterward. The process of estate planning takes some time, but the reward is usually substantially reduced tax liability, and almost always a clearer idea of what one has and what will happen to it. The certainty and peace of mind this process can lead to justifies taking time and expending the effort to be prepared for the inevitable. You and your family and friends will benefit in many ways.