By Anne-Lyse Wealth, WCI Contributor
Estate planning, the process of organizing your affairs in the event of your death, can be a sensitive topic. But it’s a necessary step to follow for most adults.
According to findings from a recent Gallup poll, less than 50% of Americans have a will in place to specify how they would want their assets and estate handled in the event of their passing. As a result, the estate tax is one of the problems your estate beneficiaries may have to deal with in estate planning.
Here's what you need to know about the estate tax and different strategies to avoid it.
What Is the Estate Tax?
Estate tax, sometimes called the death tax, is the tax that an estate must pay if the size of the estate exceeds the tax exemption amount. As of 2023, the estate tax exemption amount is $12.92 million for an individual and $25.84 million for a married couple (in 2022, it was $12.06 million for an individual). Any estate valued below this amount will be exempt from federal estate taxes. Most states don't have estate taxes, except for 13 states, including Massachusetts, New York, and Connecticut. In addition to the estate tax, some states, like Maryland, also have an inheritance tax, meaning the person who receives an asset has to pay taxes on it.
The estate's executor is responsible for ensuring that any federal or state estate-related taxes are paid. That's why it's important to select the executor of your estate carefully.
Strategies to Avoid Estate Tax
There are several strategies to consider to avoid estate tax. Here are a few.
One way to reduce estate tax is by transferring your assets while you are alive through gifting. Every year, a person can donate $17,000  while a couple can donate $32,000 to a non-charity recipient without incurring any taxes. Any amount gifted above the threshold over the course of a year would be subject to the gift tax. However, it's an option to consider if you don't want your beneficiaries to be taxed on their inheritance. If your estate is below the tax exemption amount, your estate should not have to be responsible for estate tax. But if your estate is worth more than $12.92 million, then you might want to consider progressively gifting your relatives or loved ones to reduce the future estate tax amount.
Donating to Charity
It's possible to lower your estate tax liability by transferring your estate to charity through a charitable lead trust or a charitable remainder trust (CHR). Through a charitable lead trust, you can donate to charity, via an irrevocable trust that you'd set up, and reduce the overall value of your estate (and thus the estate's tax liability). In addition, after a time period expires or upon your passing, the balance left in the trust that didn't go to the charity would be transmitted to your estate beneficiaries after incurring applicable taxes.
A charitable remainder trust allows you to transfer investment or appreciating assets, such as stocks or real estate, to an irrevocable trust. It allows you to earn income on that asset through annual payments and reduce your tax liability while you're alive, as earnings from a CHR are exempt from federal taxes. Upon your death, the trust balance will go to charity.
It's important to note that by definition, irrevocable trusts are not supposed to be updated once put in place. As such, any modification would have to be made with the agreement of the trust's beneficiary.
Purchasing Life Insurance
If you are concerned about the liability of having your beneficiaries pay an estate tax, an option to consider is purchasing life insurance that will cover you, even if it's just a portion of the estate tax. The older you are, the more expensive life insurance gets, so it's something to consider sooner rather than later.
It's also important to note that proceeds from life insurance are usually not taxable. However, in some cases, if the beneficiary is an estate rather than an individual, life insurance proceeds can be subjected to estate taxes.
Another step to avoid having life insurance be subject to an estate tax is to create an irrevocable life insurance trust. This trust would be transferred to a beneficiary, and thus your life insurance death benefits would be excluded from your estate.
If you currently live in a state with an estate tax, you may want to explore relocating to lower the tax liability for your loved ones. Few states have an estate tax, so you have plenty of options to choose from. Heirs may also want to consider if their state has an inheritance tax, where the recipient is actually taxed.
Given the high estate tax exemption, very few people will have to worry about estate tax. However, it's important to know your options if you have an estate higher than the estate tax exemption, whether it's now or in the future.
Have more questions about estate planning or protecting your assets? Hire a WCI-vetted professional to help you sort it out.
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