With the establishment of a historically high $5 million federal estate tax exemption (indexed for inflation), many taxpayers believe they do not have to plan for their estates. But federal estate taxes are only one aspect of estate planning. It’s critical to have the right documents in place and plan for potential state estate taxes where applicable.
Here are five ideas that investors may want to consider when planning for the future of their estates.
1. Review estate planning documents and strategies
It is critical for investors to plan for an orderly transfer of assets or for unforeseen circumstances such as incapacitation. Strategies to consider include proper beneficiary designations on retirement accounts and insurance contracts, wills, powers of attorney, health-care directives, and revocable trusts.
2. Plan for potential state estate taxes
While much attention is focused on the federal estate tax, certain residents need to know that many states have estate or inheritance taxes. A number of states have “decoupled” from the federal estate tax system. This means the state applies different tax rates or exemption amounts. A taxpayer may have net worth comfortably below the federal tax exemption, but may be well above the state exemption. It is important to consult with an attorney on specific state law and potential options to mitigate state inheritance or estate taxes.
3. Evaluate whether to transfer wealth during lifetime or at death
The unified lifetime exemption amount ($5,430,000 for 2015) for gifts and estates provides flexibility for taxpayers to decide whether to transfer wealth while living or at death. Lifetime gifting shelters appreciation of assets post-gift from potential estate taxes, helps heirs now, and utilizes certain valuation discounts available through such strategies as family limited partnerships. Transferring assets at death allows individuals to maintain full control of property while living and benefit from the step-up in cost basis at death.
4. Consult with an attorney to explore complex wealth transfer techniques
Individuals and families with significant wealth, especially within non-liquid assets such as real estate or closely held businesses, may benefit from a range of more complicated strategies to efficiently transfer wealth. Examples include grantor trusts, family limited partnerships, and dynasty trusts. Recently, these trusts have come under heightened scrutiny by lawmakers, which could prompt restrictions on how these strategies are implemented. It may be prudent to examine these options while they are still viable alternatives.
5. Evaluate a Credit Shelter Trust (CST)
A properly designed CST will shelter appreciation of assets from the estate tax after the death of the first spouse. However, since the portability provision allows a surviving spouse to utilize the unused exemption amount of a deceased spouse is permanent, is trust planning actually necessary? There are still some benefits for using a CST, including protection of assets from potential creditors, spendthrift protection to prevent wasteful spending by trust beneficiaries, planning for state death taxes, and preserving the “generation-skipping exemption,” which is not portable. Investors need to understand that certain costs and effort are required to establish the trust while the portability provision does not require any special planning. Also, assets transferred to a trust at the death of the first spouse do not receive a step-up in cost basis at the death of the second spouse.
Investors should consult with a legal and tax expert. Personal circumstances vary widely, so it is also critical to work with a professional who understands an individual’s specific goals and situation. For additional information and strategies, explore “Ten income and estate planning strategies for 2015.”
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