Under current law, the IRS imposes an estate tax on any amounts over an exemption of $15 million per individual. For married couples, the exemption amount is effectively $30 million with proper planning. If your heirs inherit more than that, the top tax rate is as high as 40% on assets they may receive after you die.
That can be a painful tax bill for your heirs — especially if your assets are illiquid, because they may be forced to borrow money to pay the estate tax or sell assets at fire sale prices.
If you believe estate tax may apply after your death, you can take steps now to minimize your heirs’ exposure to estate taxes.
1. Start a strategic gifting program
You don’t have to wait until you die before you allow your heirs to enjoy the benefits of your substantial estate. You can give them an advance on your will! You can give as much as $14,000 per beneficiary without triggering any tax problems.
You can give away more than this, of course, but amounts in excess of the gift tax exclusion will count against the lifetime limits under the gift tax. Make sure you speak with your tax advisor about managing exposure to lifetime gift taxes and generation-skipping transfer taxes. Every dollar you get out of your taxable estate <i>now</i>, however, will reduce your eventual estate tax bill.
Note: Married couples can “double up” their gifts for a total of $28,000 per beneficiary.
2. Contribute to section 529 college savings plans
Have college-bound children, grandchildren, nephews and nieces? You may be able to save significant amounts on estate taxes while providing in advance for their education. Assets transferred to 529 plans for loved ones are not included in your taxable estate.
3. Convert Traditional IRAs to Roth IRAs
When you convert a traditional IRA to a Roth IRA, you pay income taxes on the amount transferred. But by getting the income taxes out of the way that someone would likely pay anyway, you get that income tax money out of your taxable estate.
You can also take advantage of this concept by rolling 401(k), simplified employee pension and SIMPLE balances into IRAs and then converting, if eligible. Note that a recent Tax Court ruling limits you to executing one IRA rollover per year.
4. Create an irrevocable life insurance trust
By holding assets within an irrevocable trust — and living at least three years thereafter — you move them out of your taxable estate. And by using that trust to hold life insurance, you can turn relatively modest amounts of capital into a potentially much larger asset that transfers to heirs tax-free at the death of the insured.
Final word
Recent changes to the tax code have many advisors rethinking estate tax planning. Because of changes to the capital gains tax rate and how capital gains are treated when assets are passed on to heirs, some steps that were common only a few years ago are now irrelevant and, in some cases, could be counterproductive.
It’s important to review your estate plan periodically with your tax and insurance professionals and make sure your existing plan reflects current law.
