The inheritance you leave could still be eaten away by taxes
and expenses. Here are five strategies to avoid that. If you’re single, you can
have up to $5.45 million in assets before your heirs have to worry about paying
a penny in estate taxes. Knowing that, you might assume only the super wealthy
need to worry about estate planning. However, financial planners say you’d
be wrong to think planning is only necessary for the 1 percent.
The step-up in basis refers to how assets such as investment
property and second homes are valued and taxed after a death and how taxes are
levied against traditional IRAs and 401(k)s inherited by someone other than a
spouse. Meeting with an accountant and an estate attorney is the best way
to sort through complex issues such as the step-up in basis for property. While
you’re talking to the pros, ask them about the following five strategies.
Draw Up a Will
It’s an obvious first step, but many people don’t even
bother to draw up a will. In fact, a 2014 Rocket Lawyer survey of 2,048
adults found 64 percent of Americans don’t have a will. What’s more, 17 percent
said they didn’t think they needed one. However, without a will, your estate
must be divided in probate court, a process that could leave your beneficiaries
footing a big bill.
Not all assets are disbursed through a will. Some accounts,
such as retirement funds and life insurance policies, let owners name
beneficiaries for that particular asset. It’s a good idea to review beneficiary
information after every major life change, including the birth of
children, marriage or divorce.
Set up a Trust
If you have a sizeable 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. 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.
A trust does have to pay taxes on its income from dividends,
interest and other sources, and the tax rates for trusts can be higher for
individuals. For that reason, Anderson suggests people pay expenses from a
trust, whenever possible. For example, if you were planning to help your
child with a down payment on a house, it may make more sense to transfer
money from a trust rather than pull cash out of a different account. 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.
Retirement Accounts to Roth Accounts
Leslie Thompson, a certified financial planner at Spectrum
Management Group in Indianapolis, says the biggest surprise for many people is
that their traditional IRAs and 401(k)s are subject to income tax if passed to
a beneficiary who is not a spouse. In
reality, that money is subject to income tax. Currently, those taxes can be
spread over the life of the beneficiary, but that might change. Instead
of stretching payments – and taxes – over a person’s expected lifespan, some
proposals call for IRAs to be cashed out, and fully taxed, in as little as five
You can avoid leaving your beneficiaries with that tax bill
by gradually converting traditional accounts to Roth accounts that
have tax-free distributions. Thompson says her firm recommends clients make a
series of conversions over several years. Since the amount converted will be
taxable on your income taxes, the goal is to limit each year’s conversion so it
doesn’t push you into a higher tax bracket.
Gift Your Money While
One of the best ways to ensure your money stays in the
family is to simply give it to your heirs while you’re alive. The IRS allows
individuals to give up to $14,000 per person per year in gifts. If you’re
worried about your estate being taxable, those gifts can bring its value down.
The money is also tax-free for recipients.
A similar way to reduce your estate value is through
charitable donations. As a twist on that idea, Thompson suggests 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. By naming a child or a grandchild as a successor for the fund, “it would
keep the family involved in philanthropy,” Thompson says.
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.
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