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Estate Planning 301: Taxes Are The Key To Extend The Life Of Your Assets

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Lisa Richmond-Kirby

Lisa Richmond-Kirby

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When done right, estate planning is a gift to your loved ones. After your passing, your estate plan makes dividing your estate a less stressful (and costly) process. But as you prepare to leave your legacy to others, there’s a particular threat you must address - the effects of taxation during the transfer of your estate.

If not adequately planned for, the wealth you’ve taken a lifetime to accrue can be diminished significantly by taxes. Here are five ways you can be proactive in preventing unnecessary taxation on your estate and heirs.

Understanding Current Federal & State Tax Laws

The 2017 Tax Cuts and Jobs Act (TCJA) bumped the federal estate tax exemption up significantly. For 2021, the exemption is $11,700,000 per person. If your estate exceeds the federal tax exemption, the overage will be taxed at 40%. 

It’s important to note that the TCJA will phase out in 2025, meaning the federal estate tax exemption is set to resume pre-TCJA rates (adjusted for inflation). There is a possibility that future legislation could affect this tax exemption as well.

With the rate at a historical high and uncertainty regarding future changes, there’s still time left in 2021 to take advantage of this exemption. Consider sitting down with your estate planning attorney and CPA to discuss the possibility of utilizing a lifetime portion of this exemption amount before rates change.

How Does the Estate Tax Exemption Impact Married Couples?

Say Jane and Joe Smith have accumulated a significant amount of wealth. If Joe were to die in 2021 and leave everything to his wife, Mrs. Smith could file an estate tax return and receive Joe’s unused exemption. Joe never gifted to children or grandchildren, as he left everything to his wife. Jane, the surviving spouse, now has a lifetime federal estate tax exemption of $23,400,000 (both individual’s $11.7 million exemption) for 2021.

If Joe had gifted his children money before his passing, Jane would receive an exemption amount lesser than what had already been gifted. If the couple had three children and each received $1 million in gifts, Joe’s remaining lifetime exemption would have been $8.7 million.

What About State Estate & Inheritance Tax Laws?

In addition to the federal estate tax, some states have their own estate or inheritance tax. South Dakota, for example, does not have estate taxes.

Exemption levels and tax rates vary greatly state-by-state. If you own out-of-state property or are considering moving elsewhere, this is something you will want to review carefully with your trust officer and estate planning attorney.

Strategizing Your Beneficiary Selection

Who you choose to be the beneficiary (or beneficiaries) of your estate can significantly impact potential tax obligations. Designating a spouse, for example, as a beneficiary for certain assets may be more tax-efficient than selecting a friend or other relative. One important instance of this is transferring an IRA, especially with recent changes that will impact the inheritor.

The End of the Stretch IRA

The SECURE Act removed what was commonly known as the “stretch IRA.” If you inherit an IRA and do not qualify under the exemptions, you are required to withdraw the remaining amount within ten years. With a traditional IRA, this has the potential to put a significant tax obligation on the beneficiary, as they’ll be required to pay taxes on the withdrawn amount.

This is where being strategic with your beneficiaries can be crucial. There are a few exemptions to this rule, they include:

 

  • Surviving spouse
  • Those who are disabled or chronically ill
  • Minors
  • Those who are less than ten years younger than the originator

With the required minimum distribution age (RMD) recently raised from 70 ½ to 72, you have more time than ever to consider a Roth conversion. With this strategy, you convert all or a portion of your traditional IRA to a Roth IRA, creating tax-free withdrawals both in retirement and for beneficiaries who inherit the account.

Maximize Your Gift-Giving

If you’re able, consider giving portions of your estate during your lifetime. You may make tax-exempt gifts up to $15,000 individually or $30,000 per married couple annually. This gift tax exclusion is per receiver, not donor. You are not limited to the number of people you give to annually, as long as the gift is under $15,000 per person.

For example, Brenda and Kenneth Miller have decided to start distributing their estate now to reduce tax obligations after their passing. The Millers have four daughters, each is married, and each couple has three children. For those keeping track, that’s 20 family members. In one year, the Millers could give up to $600,000 to their family (20 family members x $30,000 each). If Brenda and Kenneth gifted the same amount each year for five years, they would have reduced their estate by $3 million.

Alternative Gifting Opportunities

If you’re looking for other ways to gift before your passing, certain gifts offer unlimited lifetime exemptions.

According to the IRS, these include:

  • Donations to qualifying charities
  • Political donations
  • Direct payments to medical facilities on behalf of someone else
  • Direct payments to colleges and educational institutions on behalf of someone else

Leveraging the Right Trust

Trusts can be an effective, tax-efficient estate planning tool. With eliminating the “stretch,” IRA discussed above, restrategizing the use of trusts for non-spousal beneficiaries is becoming a more popular choice.

A Charitable Remainder Trust, for example, may be a suitable alternative for those looking to bypass the recent IRA distribution criteria when leaving assets for loved ones.

Trusts are beneficial for several reasons. The grantor can determine when the assets are distributed, who oversees them, and the criteria met before they can be distributed. This type of control can provide the grantor’s heirs with ongoing financial support and tax-efficient distribution without overwhelming them with too much responsibility before they’re ready for it.

Your trust officer can help you leverage several types of trusts during the estate planning process. These include (but are not limited to):

  • Spousal lifetime access trusts (SALT)
  • Bypass trusts
  • Special needs trusts
  • Charitable remainder trusts
  • Insurance trusts

Considering a Corporate Trustee

A corporate trustee is a third-party entity responsible for managing and distributing funds from a trust. Corporate trustees take on the fiduciary duty of overseeing trusts, along with all necessary actions - record-keeping, investing, filing tax returns, etc. Banks or financial institutions typically have the resources and personnel required to devote time and care to effectively managing a trust.

If you haven’t considered it before, working with a corporate trustee provides multiple benefits. Work with your trustee to develop the terms that you’re comfortable with without causing family conflicts. A corporate trustee provides professional support beyond your lifetime, working with your loved ones to establish a tax-efficient distribution strategy. 

Working With First Dakota Wealth & Trust

Please reach out to any of your local Wealth & Trust Officers at First Dakota National Bank with any questions you may have. We are here to help South Dakota families and beyond develop a tax-focused estate planning strategy!

Disclaimer

First Dakota Wealth & Trust is the fiduciary investment department of First Dakota National Bank with trustee powers to serve clients during their lifetime, during incapacity, and after death. We help clients develop a financial roadmap to help simplify their financial future.

Please note that neither First Dakota National Bank nor First Dakota Wealth & Trust Department or its employees provides tax or legal advice. This is intended for informational purposes and is not intended to constitute legal or tax advice. Please consult your attorney and/or tax professional for advice related to your specific situation.