Personal Finance Essentials
Estate Planning and Taxes
Without an Estate Plan, the Government Decides How Much
of Your Wealth Survives to the Next Generation
Estate planning is not just for the wealthy. Everyone has an estate – the total value of everything you own minus your debts – and everyone benefits from a plan for how it will be distributed.
The Estate Tax and Why Planning Matters
Federal estate tax applies to the value of your taxable estate above a certain exemption. For those whose estates exceed that threshold, the rates can be substantial. The more wealth you have when you die, the more the government collects. Effective planning can reduce or eliminate this tax through strategies such as lifetime gifting, trusts, charitable giving and proper structuring of assets.
The cost of not planning can be immense. Wealth that spans multiple generations tends to diminish rapidly through estate taxes at each transition. A significant estate that is not carefully structured can be substantially reduced within three or four generations – not through poor investments, but through the repeated application of estate taxes at every transfer.
Gift Taxes
Federal law limits how much you can give to any one person in a single year before triggering the gift tax. Amounts above the annual limit reduce your lifetime estate tax exemption and require filing a gift tax return. You can give unlimited amounts to your spouse without triggering the gift tax, but those assets remain part of your combined estate.
One important caution: some people try to give assets away to reduce their estate or to qualify for Medicaid. Under federal gift tax rules, transfers to any one person above the annual limit are restricted. And attempting to shift assets to qualify improperly for Medicaid is both ineffective and, under federal law, potentially illegal – Congress has made it a felony for advisors to assist in asset-shifting strategies designed to circumvent Medicaid’s rules.
Step-Up in Basis at Death
When you inherit an investment, your cost basis for tax purposes is generally the fair market value of that investment on the date of the original owner’s death. This is called a step-up in basis. If the investment had risen significantly in value, the step-up eliminates any capital gains taxes that would otherwise have been owed on that appreciation.
This is one of the most valuable benefits in the tax code. It means that holding appreciated investments inside a taxable account, rather than selling them during your lifetime, can result in substantial tax savings for your heirs. Annuities do not benefit from this rule: if you die owning an annuity, your heirs inherit the account balance along with the deferred tax liability on all the accumulated gains.