If estate taxes and estate planning haven't been top of mind for 2023, now might be the time to start thinking about them.
It's true that most people are not concerned about the so-called death tax—only people with taxable estates worth more than $12.92 million for single people and $25.84 million for couples in 2023 will need to think about tax implications. But the 2017 Tax Cuts and Jobs Act (TCJA), which increased the lifetime exemption for estates, will phase out at the end of 2025, meaning the estate tax exemption could revert to about half its current level.
Additionally, it's important to pay attention to state-level laws, as numerous states have estate and/or inheritance tax thresholds that are much lower than the federal government's lifetime exemption.
Beyond estate taxes, if you haven't made a will or considered things like health care proxies and durable powers of attorney, as well as revisiting beneficiary designations or transfer on death (TOD) instructions to ease the transfer of certain assets at your passing, the beginning of the year is a great time to think ahead and start this crucial part of financial planning.
Here are 6 things to consider.
How the estate tax could affect you
1. The 2017 Tax Cuts and Jobs Act (TCJA) The TCJA made some changes to income and estate taxes. These changes will sunset at the end of 2025. And without further legislation in Congress, the federal estate tax exclusion will revert to its pre-TCJA level, which could be around $7 million after inflation adjustments.
2. Rising property values Fueled by demand for work-from-home space and low mortgage rates during the early part of the pandemic, property values have marched steadily upwards since 2019. While the housing market has softened in recent months, if you've owned your home for some time, it's possible your equity has increased, and such increases now and in the future may push the fair market value of your total estate past federal or state estate and inheritance tax exemptions.
3. Consider state-level estate and/or inheritance taxes More than a dozen states impose estate and/or inheritance taxes at values that are often lower than the threshold established by the federal government. Massachusetts and Oregon, for example, both tax estates over $1 million. Think about your home, your cars, retirement accounts, life insurance, and the appreciation of your assets, and it all starts to add up. "People should be aware of what's going on at the state level," says David Peterson, head of wealth planning at Fidelity. "Between real estate values and retirement money in workplace plans, it's very likely that estate or inheritance taxes in some states will affect a lot of people."
What you can do to help lower the value of your estate
4. Consider gifting The annual gift tax exclusion for 2023 increased to $17,000 from $16,000 in 2022. That means you can give up to $17,000 to as many people as you like each year without incurring any gift tax liabilities. Married couples can use gift-splitting to give up to $34,000 without the gift being considered taxable. The gifts can also help reduce the value of your estate, without using up your lifetime gift and estate tax exemption.
When developing a gifting plan, it's worth thinking about not just the value of your estate now, but what the value of your estate could be in the future, accounting for such things as the potential growth of your retirement accounts over the course of years. "Your individual forecast for where your assets will be at end of life can help you decide what you'll do today to take advantage of that annual exclusion," Peterson says.
Here are some other details to keep in mind about gifting.
- If you give above the annual exclusion limit to any single person, you will reduce the available amount of your lifetime exemption, and the amount available upon your death to reduce your estate tax liability. It's good practice to file an IRS Form 709 when using an annual gifting strategy. But if you give more than your annual limit, it's necessary to keep track of the amount, because the excess will reduce your lifetime exemption.
- Gifts are considered anything of value. Usually the value of gifts is easily determined, using the fair market value on the date of the gift. However, certain gifts may require a formal valuation, such as artwork. In most cases, if tax is owed, the donor pays the tax.
- Generally, gifts to a spouse, political organizations, charitable organizations (subject to certain income limitations during life based on the type of gift given), tuition or medical care for someone else paid directly to the providers, are exempt from gift taxes.
5. Fund a 529 or custodial account If there are children or grandchildren in your life, funding an education account for them can also reduce the value of your estate. While lifetime contribution limits to 529 accounts are set by states, you can contribute up to $17,000 annually without triggering the gift tax. And once inside the account, the money is not considered part of your estate. You can also accelerate 5 years worth of annual gifts for a total of up to $85,000 per person, per beneficiary in 2023 without incurring gift taxes.1 However, after that, you won't be able to make gifts under the annual exclusion to the same beneficiary for the subsequent 4 years without triggering the gift tax. Note: If the donor dies within 5 years of making the accelerated gift, the value of the gifts attributable to the years after the owner dies will be brought back into the donor's estate.
Following the passage of the SECURE 2.0 Act, starting in 2024 up to $35,000 in 529 assets can be converted or deposited into a Roth IRA owned by the 529 beneficiary without facing this tax penalty. There are some stipulations; for example, the 529 plan must be held for the designated beneficiary for at least 15 years and annual conversions can't exceed the annual Roth IRA contribution limit. Also, the amount of 529 account funds converted to a Roth IRA may not exceed the aggregate amount contributed to the 529 plan account (including earnings on those contributions) within 5 years of the Roth IRA conversion distribution date.
You can also contribute to a custodial account, known as Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts. While such accounts are the property of the beneficiary once you set one up, the assets are considered part of the donor's estate until the beneficiary is no longer a minor and takes control of them.
6. Think about charitable giving It can feel great to make charitable donations to support philanthropic causes you care about. And if your spouse, family, or other beneficiaries don't need the money, donating to a qualified charity can help you with your tax planning in the year you're donating, while also potentially lowering the value of your estate. For example, if you itemize deductions on your annual income tax return you can contribute to a donor-advised fund (DAF) and may receive an income tax deduction for the year in which you contributed to the DAF. From an estate tax perspective, assets left to a qualified charity upon death are deducted from a decedent's taxable estate. You can also donate long-term appreciated securities, such as stocks, bonds, and mutual fund shares held a year or longer, and deduct their fair market value without having to pay the capital gains tax. Charitable contribution deductions are subject to adjusted gross income (AGI) limits depending on the receiving charity and what you donated.2
Make an estate plan, even if you don't think you need one
Next, get your paperwork in order. An estate essentially is any money, assets, or possessions you own, regardless of their value, at your death. "Many people think estate planning is only for wealthy people. They rationalize, ‘I don't have that much money,'" Peterson says. "But everybody has an estate, and if you don't plan for it, your state does it for you without your input."
Generally, if you pass away without a will, beneficiary designations, or proper titling, the state where you die has intestacy laws that direct the transfer of your assets, and you and your family will have little control of the process. Your estate will also wind up in probate, which is your state or jurisdiction's court-supervised process of distributing a deceased person's assets. That can be both time-consuming and costly for family at a time when they should be focused on the loss of a loved one. Probate is also a public process, and in many cases probate records are available for anyone to inspect. There may be ways to avoid probate by naming beneficiaries, through titling, and using trusts, but you will need to thoughtfully implement these to ensure your wishes are carried out.
- Designate beneficiaries . Start with this low-hanging fruit. Having a beneficiary is the smoothest way to transfer assets. Most financial accounts, such as 401(k)s and IRAs, ask you to designate one or more beneficiaries. This is typically a simple process that can be accomplished with your financial provider, in many cases online. If your financial institution doesn't prompt you to designate a beneficiary, or doesn't have that functionality online, call or email them to ask how you can add one. Without a beneficiary, IRS rules usually require that inherited retirement accounts be distributed on an accelerated basis, which could force distributions over a 5-year period and result in increased income tax liabilities for beneficiaries, says Michael Christy, regional vice president of advanced planning at Fidelity. Good to know: The beneficiary you name for these accounts will also take precedence over who you name in your will.
- Asset titling . The manner in which you own your assets, including real estate and brokerage accounts, is also a critical component of your estate plan. Typically, assets can be owned individually, jointly with a spouse or someone else, or as tenants in common. Individually owned assets will transfer to the named beneficiaries, if any, upon the account owner's passing. Jointly owned assets and accounts generally pass to the surviving joint owner upon one joint owner's death. Finally, assets owned as tenants in common rely on the probate process to transfer the interest of one deceased tenant. In other words, the interest does not pass by beneficiary designation or joint ownership. You should work closely with your attorney and financial professional to ensure your assets and accounts are properly titled and aligned with your overall estate planning goals.
- Then move on to creating essential documen ts. These include a will, which names an executor who will carry out the provisions of the will and identifies the beneficiaries of an estate and guardians for any minor children. Also consider planning for incapacity by creating a durable financial power of attorney and a health care proxy. With a durable financial power of attorney, you can designate a person to manage your financial affairs when you can no longer do so for yourself. Similarly, a health care proxy (or power of attorney) will specify who can make medical decisions about your care on your behalf when you can no longer communicate them yourself. This is usually paired with a living will, which allows you to indicate to your health care proxy the type of end-of-life care that you want to receive and, equally important, the type of care you do not want to receive.
- You might also consider creating a revocable trus t. There are many different types of trusts, but it is common for estate plans to include a revocable living trust. Such a trust can be created while you are alive, and it can be amended or revoked at any time. It allows the person who created the trust (the grantor) complete access and control of trust assets during their lifetime. Upon their death, the trust becomes irrevocable and includes instructions about how trust assets should be managed and distributed. Revocable trusts are often paired with a will that directs all probate assets to pass into the trust (commonly known as a pour-over will) for management and ultimate distribution to beneficiaries. Good to know: After creating a trust, you should request that your attorney provide you with guidance on how to "fund" your revocable trust. A funding letter from your attorney will direct you on which assets should be titled in the name of the trust and which assets should remain owned individually. Revocable trusts are flexible and can be funded with many different types of assets, with one primary exception being retirement accounts.
Between tax considerations, wills and other estate documents, there's a lot involved. Don't try to go it alone. Seek the help of tax, legal, and financial professionals who can assist you in drafting your estate plan.
You can find out more about estate planning in Viewpoints: 5 steps to create an estate plan.