The prospect of estate planning can seem overwhelming, but don't put it off. Having an estate plan is crucial to ensuring your money and assets go to your intended heirs.
The good news is your family probably won't have to worry about paying estate taxes. In 2021, you'd have to die with assets exceeding $11.7 million to trigger the estate tax, although there is a proposal in Congress that would cut the exemption in half.
Most estates would still be exempt from this tax even with a $6 million exemption though. "That impacts such a tiny percentage of the population," explains Benjamin Trujillo, a senior advisor in the Compardo, Weinstroer, Conrad & Janes office of financial planning firm Moneta. While some people worry about how the estate tax affects family farms and small businesses, provisions in the law help shield them from big tax bills, Trujillo says.
The bad news is that avoiding estate tax is only one of your worries. Heirs may be responsible for paying federal income taxes on some assets and retirement accounts, and if you don't plan correctly, your money could end up in the hands of an ex-spouse or creditor.
"(You) want to make sure (your) stuff goes to the right people," says Patrick Simasko, elder law attorney and wealth preservation specialist at Simasko Law in Mount Clemens, Michigan. That means everyone can benefit from estate planning.
Meeting with an accountant and an estate attorney is the best way to sort through this complex issue, but here are some estate planning tips to get you started.
— Draw up a will.
— Check your beneficiaries.
— Set up a trust.
— Convert traditional retirement accounts to Roth accounts.
— Gift your money while you're alive … but wisely.
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Draw Up a Will
Writing a will is the most basic of estate planning strategies. This document stipulates how your assets will be divided after your death.
It's an obvious first step, but many people don't even bother to draw up a will. In fact, only about 33% of people say they have a will, according to the 2021 Estate Planning and Wills Study that surveyed 2,500 Americans, published by Caring.com. Of those who don't have a will, 34% say it's because they haven't gotten around to it.
Without a will, your estate will be divided in probate court, meaning someone else decides who gets your money. Having a will doesn't mean your heirs avoid probate though. They still need to go through the court system to have the will reviewed and confirmed as valid.
"It's a slow and expensive process," explains Craig Kirsner, president of Stuart Estate Planning Wealth Advisors in Coconut Creek, Florida. It could take six months to two years to probate a will, and then it becomes a public document that anyone can read and review. For these reasons, those seeking a quick and private way to transfer wealth should consider other estate planning strategies.
Check Your Beneficiaries
One way to avoid probate court is to have beneficiaries named for your assets. Some accounts, such as retirement funds and life insurance policies, let owners name beneficiaries who will receive that particular asset.
"In some states, you can even do beneficiary deeds," Trujillo says. These make it easy to transfer property to someone else upon your death. Other accounts may also be set up with transfer-on-death provisions, and this is the cheapest and easiest way to pass assets to heirs.
Since a beneficiary or TOD designation trumps anything written in a will, it's a good idea to review beneficiary information after every major life change, including the birth of children, marriage or divorce.
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Set Up a Trust
If you have a sizable estate or are worried your heirs won't be wise with your money, you can set up a trust and appoint a trustee to distribute your wealth. A trust may make the most sense if you are leaving more than $250,000 in assets to any one person, Kirsner says.
Trusts can be set up in several ways, but irrevocable, or permanent, trusts may offer the most tax benefits. When money is put into an irrevocable trust, the assets no longer belong to you. They belong to the trust itself. As a result, the money cannot be subject to estate taxes. While a trustee ultimately controls the money, you can create stipulations on its use, and money can be distributed from a trust even while you are alive.
"My clients want to keep their money in their family bloodline as long as possible," Kirsner says. To achieve that, a dynasty trust can be used to ensure that money is passed from one generation to the next and protected from divorces, lawsuits and creditor claims.
Because of the complex nature of trusts, you'll want to consult with an estate attorney to determine how best to create one that meets your goals. An attorney who specializes in trusts may charge $3,000 to $6,000, but Kirsner says "you get what you pay for."
Convert Traditional Retirement Accounts to Roth Accounts
Those with traditional 401(k) or IRA accounts could inadvertently leave their heirs a big tax bill. "IRAs are terrible for estate planning," Trujillo says.
Regular income tax must be paid on distributions from all traditional retirement accounts. In the past, nonspousal heirs such as children had the option to stretch those distributions over their lifetime, effectively reducing the total taxes due. But now, heirs other than spouses must withdraw all money from an account within 10 years. If the account balance is large, that could require significant distributions that may be taxed at a higher rate.
If you're looking for how to pass money to heirs tax free, that may be accomplished by converting traditional accounts to Roth accounts. The converted amount is subject to regular income taxes, but withdrawals — either by you or your heirs — are tax free. What's more, with tax rates at near historic lows, it may be better to pay taxes on the money now rather than later.
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Gift Your Money While You're Alive … But Wisely
You might not have to worry about estate tax planning if you simply give away your money while you're alive. As of 2021, the IRS allows individuals to give up to $15,000 per person per year in gifts. If your goal is avoiding estate tax, those gifts can bring its value down. The money is also tax-free for recipients.
However, be careful about giving away assets that appreciate in value, such as stocks or a house, which receive a step-up in basis when part of an estate. That means the taxable amount of an asset is adjusted upon the owner's death and, as a result, it may be beneficial to transfer certain assets after death rather than before. Speak to a tax professional for guidance in this area.
Married couples can use a spousal lifetime access trust to gift a large amount of money from one spouse to the other. This irrevocable trust can be used to move cash out of an estate while still keeping funds accessible. "There are some risks involved," Trujillo says, "(but) using a trust is the best way to make an efficient transfer."
Another way to reduce your estate value is through charitable donations. Rather than giving a one-time gift, consider setting up a donor-advised fund. This option would give you an immediate tax deduction for money deposited in the fund and then let you make charitable grants over time. A child or grandchild could be named as a successor in managing the fund as well.
Complex strategies and the ever-evolving tax code can make estate planning feel intimidating. However, ignoring it can be a costly mistake for your heirs, even if you don't have a lot of money in the bank. Talk to a professional to see if these estate planning strategies may be right for you.