Why Estate Planning Isn't Just for the Rich

Dice on paper

By Kelly LaVigne, JD

Even if you are not a member of the 1%, the inheritance you leave could still be eaten away by taxes and expenses if you do not have a solid plan in place. Estate planning is not something only the rich need to worry about. Here is a brief overview of some estate transfer strategies that may help you leave more to your heirs:

Estate or Inheritance Tax?

States vary in their approach to taxing an inheritance. Your state may either have an inheritance tax (paid by beneficiaries) or an estate tax (paid by the deceased's estate). As of January 1, 2016, 14 states and the District of Columbia imposed an estate tax while six states have an inheritance tax. Maryland and New Jersey had both, but on October 14, 2016, New Jersey repealed the estate tax. The elimination became entirely effective on January 1, 2018. (For more, see: read Getting Started on Your Estate Plan.)

Generally, whether estate or inheritance tax applies depends on who pays the tax. Inheritance tax is paid by beneficiaries. Estate tax is paid by the deceased’s estate. Also, note that which beneficiaries pay inheritance tax may vary. For example, in New Jersey the inheritance tax does not apply to spouses, children, and other exceptions, but does apply to siblings, nieces, nephews and some other categories.

Establish Power of Attorney

One of the most important initial steps in estate planning is establishing power of attorney - designating someone to act on your behalf in case of incapacity. It should be noted that every power of attorney expires at death. Any investing transactions after death would need to be executed by the estate’s executor.

A durable general power of attorney gives broad powers to a person or organization (known as an agent or attorney-in-fact) to act on your behalf. These powers may include handling financial and business transactions, buying life insurance, settling claims, operating business interests, making gifts and employing professional help.

You need to ensure the durable general power of attorney specifically allows for the tax basis planning action, including the flexibility to reduce income taxes and create better tax basis results. For example, it would be helpful to execute a durable general power of attorney which specifically permits the agent to convert a traditional, SEP, or Simple IRA, to a Roth IRA, or to make pre-mortem decisions that increase the tax basis for heirs.

It may be that a Roth IRA conversion can save income and estate taxes if the original traditional, SEP or Simple IRA, owner converts to a Roth IRA while in a lower tax bracket compared to a higher tax bracket in retirement or if the income taxes paid on a Roth IRA conversion reduce the estate size by the amount of the taxes paid.

Another estate tax planning strategy that may be helpful is the gifting of assets with unrealized losses. The original basis of the property is transferred with the gift. If the property gains in value and is later sold for more than the fair market value (FMV) at the time of the gift, the original basis can be used to offset any gains and the recipient of the gift may not have to pay any tax - or only pay a reduced amount - due to the transferred cost basis. Another more straightforward strategy could be to sell the asset for a loss and gift the proceeds. (For more, see: 3 Secrets You Didn’t Know About Estate Planning.)

Depreciated Property

If you are thinking about gifting a piece of rental property to a family member, there are a couple of ways to consider doing this. If the depreciated property is gifted, the existing basis goes with it. Conversely, if depreciated property is inherited, there is a step-up in basis (a readjustment of the value of the property for tax purposes upon inheritance. When an asset is passed on, its value is typically more than when the original owner acquired it). Depreciation starts at the full market value at death.

For most people, managing the step-up in basis on inherited assets and income taxes is one of the major issues in estate planning. Another major issue is control.

Married Couples

Now that the exclusion amount for a married couple can reach over $22 million (provided the correct forms are filed in a timely manner), it could be easy to assume that estate planning for a married couple is not very complicated. In some cases this may be true, but that would be neglecting the prevalence of second (or multiple) marriages and blended families.

When each partner brings assets to a marriage and there are children - especially adult children - from previous unions, it may be important to assure that each partner’s heirs receive family assets. This could lead to the creation of qualified terminable interest property (QTIP) trusts that provide for the surviving spouse but leave the remainder to the kids from previous marriages. This may be a difficult subject to navigate at first, but could eliminate hard feelings and possible legal action later.

Clearly, there are many important decisions that need to be made as part of the estate planning process. Failure to adequately prepare could have a significant effect on the inheritance you provide to beneficiaries, be they family members, business interests or charitable organizations. To better understand these estate transfer strategies and decide on your best course of action, it's important to discuss them with a qualified estate planning attorney and your tax advisor. (For more, see: 5 Ways to Mess Up Estate Planning.)

Disclaimer: Please remember that converting an employer plan account to a Roth IRA is a taxable event. Increased taxable income from the Roth IRA conversion may have several consequences including (but not limited to) a need for additional tax withholding or estimated tax payments, the loss of certain tax deductions and credits, and higher taxes on Social Security benefits and higher Medicare premiums. Be sure to consult with a qualified tax advisor before making any decisions regarding your IRA. It is generally preferable that you have funds to pay the taxes due upon conversion from funds outside of your IRA. If you elect to take a distribution from your IRA to pay the conversion taxes, please keep mind the potential consequences, such as an assessment of product surrender charges or additional IRS penalties for premature distributions. This content is for general educational purposes only. It is not, however, intended to provide fiduciary, tax or legal advice and cannot be used to avoid tax penalties; nor is it intended to market, promote, or recommend any tax plan or arrangement. Allianz Life Insurance Company of North America, Allianz Life Insurance Company of New York, their affiliates, and their employees and representatives do not give legal, tax advice. Clients are encouraged to consult their own legal, tax, and financial professionals for specific advice or product recommendations.

This article was originally published on Investopedia.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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