At the writing of this blog (12/27/2012 @ 12:57pm CST) all signs show we are heading over the “fiscal cliff”. This is going to mean big changes to the tax code and big tax increases, on top of taxes created by the PPACA that are set to go into effect in 5 days. It’s important to educate yourself on all the changes; I can help explain the effect on the death tax.
The Death Tax, also known as the Estate Tax, is a tax on the assets passed on after death. This applies to most wealth transfers other than those between spouses (ex. when a spouse dies the assets go directly to the living spouse with no tax). During the Bush Administration, the Estate Tax was set at a 35% rate with a $5 million exemption. (Ex. $10 million estate, $5 million passes with no tax, the other $5 million is taxed at 35% or $1.75 million in taxes). President Obama has proposed a 45% rate with a $3.5 million dollar exemption as a part of the fiscal cliff talks, which is now looking unrealistic. The worst case scenario looks to be happening, if no agreement on the Fiscal Cliff is reached, the Estate Tax will reset to 55% with a $1 million dollar exemption.
This new rate and exemption (not to mention the uncertainty) is creating problems for people with even modest estates. High and even medium net-worth households are now looking for a way to move money out of their estate in order to prevent a majority of their estate from going to the government. For some people with non-liquid assets, like family farms and family businesses, this task is increasingly difficult, for people with liquid assets it can be much simpler.
One approach we have taken with our clients is moving “pass-on” cash into a life insurance policy. If you (or your parents) have money in a CD or other low-yielding investment and that money is just meant to pass on to heirs, it can be beneficial to put it in a single premium life insurance policy. If structured correctly, the death benefit will be passed on tax free and the assets in the policy will not be counted in the estate. These policies can also have riders that will allow the insured to utilize part of the death benefit to pay for long-term care needs, if needed. The policies have very low risk, many of the policies allow the owner to cancel the policy anytime and receive 100% (or more) of the original investment back. This method will also instantly increase the amount of money being passed on. The increase is based on the age when you take out the policy. As an example, a 62 year old male could invest $50,000 and have an instant death benefit of $100,000 or more.
Early gifting should also be considered as a part of your estate plan. If you have trusted family members, you can gift up to $14,000 (starting in 2013) per person tax free. (ex. John and Mary have 2 married sons. John could give $14,000 to each of his sons and their spouses [$14,000 x 4 = $56,000]. Mary could do the same, meaning they could move $112,000 out of their estate each year, tax free. This money can be early inheritance or held in accounts for John and Mary to use if needed (would have to be gifted back).
It’s never too early to create an estate plan, and a properly constructed estate plan will save you and your family money and headaches. This is especially true if your estate includes a business or farm. Be sure to assemble a trusted team consisting of a Lawyer, Accountant, Financial Advisor and an Insurance Specialist. Develop a plan and communicate it with your heirs. As the saying goes “in order to be rich, you have to stay rich”. The Estate Tax is the biggest obstacle for families trying to stay rich.