The unified federal estate and gift tax exemption for 2019 is a historically huge $11.4 million, or effectively $22.8 million for married couples.
Even though these big exemptions probably mean that you are not currently exposed to the federal estate tax, your estate plan may still need updating to reflect the current tax rules.
You also have to consider the distinct possibility that today’s ultra-favorable estate and gift tax rules may be on life support. So, you may be exposed to the federal estate tax in the near future, even though you’re covered right now.
Finally, you may need to make estate planning changes for reasons that have nothing to do with taxes.
Here is some advice to heed whether or not you are “rich” enough to be worried about exposure to the federal estate tax. Year-end is a good time to conduct your estate planning self-check, so let’s get started.
Update your beneficiary designations
Many people don’t understand that a will or living trust document does not override beneficiary designations for life insurance policies, retirement accounts, and so forth. As a general rule, whoever is named on the most-recent beneficiary form will get the money automatically if you die, regardless of what your will or living trust document might say. So, if you’ve failed to update your beneficiary designations because you forgot or think it doesn’t matter because you have a will or living trust, you have a problem. For some real-life horror stories that illustrate the problem, see my earlier column.
Beyond just ensuring that your money goes where you want it to go, another advantage of designating beneficiaries is that it avoids probate — because the money goes directly to the beneficiaries you’ve named by operation of law. In contrast, if you name your estate as your beneficiary and then depend on your will to parcel out assets to your intended heirs, your estate must go through the potentially time-consuming and expensive process of court-supervised probate. Your intended heirs, those you intended to get little or nothing, and other interested parties can throw up objections and roadblocks during the probate process. It can get ugly.
Here’s a to-do list to avoid that ugliness.
Life insurance policies, annuities, IRAs and other tax-favored retirement accounts, employer-sponsored benefit plans
Fill out and turn in beneficiary designation forms to establish or change beneficiaries.
Bank and brokerage firm accounts
Fill out and turn in transfer on death (TOD) or payable on death (POD) form to establish or change beneficiaries.
529 college saving accounts
Fill out and turn in beneficiary change form if you want to change the account beneficiary.
Name secondary beneficiaries
Naming a primary beneficiary is not always enough. Name one or more secondary (contingent) beneficiaries to inherit if the primary beneficiary dies before you do. Sadly, this is a common occurrence, and you should take the possibility into account.
Update your property ownership
If you’re married and own property with you and your spouse named as joint tenants with right of survivorship (JTWROS), the surviving spouse will automatically take over sole ownership of the property when the other spouse dies. If you own property with a non-spouse as JTWROS, the surviving joint tenant will automatically take over sole ownership when the other joint tenant dies. If that’s what you intend, and you’ve already set up JTWROS ownership, great. Nothing to do here. But if that’s what you intend, and you’ve not yet established JTWROS ownership, please add this to your to-do list and get it done pronto. Visit your friendly local real estate attorney.
Key point: Perhaps the biggest advantage of JTWROS ownership is that it avoids probate. The property automatically goes to the surviving joint tenant without becoming embroiled in the potentially lengthy, contentious, and expensive process of probate.
Establish or update your will or living trust document
If you die intestate (without a will), the laws of your state determine the fate of your minor children and your assets. Yikes. So, unless you have an inordinate amount of faith in your beloved state legislature, you need a written will to make your wishes known.
In addition to a will, you may also want to set up a living trust to avoid probate.
The main purposes of a will are to name a guardian for your minor children (if any), name an executor for your estate, and specify which beneficiaries (including charities) should get which assets.
The guardian’s job is to take care of your kids until they reach adulthood (age 18 or 21 in most states).
The executor’s job is to pay your estate’s bills, pay any taxes due, and deliver what’s left to your intended heirs and charitable beneficiaries.
For wills, good do-it-yourself software is readily available online.
The living trust
Another basic estate planning goal is to avoid probate for the reasons mentioned earlier. That’s where the living trust comes in. Here’s how it works. You establish the living trust and transfer legal ownership of assets for which you wish to avoid probate, such as your main home and your vacation property. You should also have a so-called pour-over will drawn up. That document stipulates that assets that are not officially owned by the trust still belong under its umbrella. Things like your cars, your antique furniture, and your valuable baseball card collection.
In the trust document, you name a trustee to be in charge of the trust’s assets after you die, and you specify which beneficiaries will get which assets from the trust and when.
You can designate your attorney, CPA, adult child, faithful friend, or financial institution to be the trustee.
Because a living trust is revocable, you can change its terms at any time, or even unwind it completely, as long as you’re alive and legally competent.
For federal income tax purposes, the existence of the living trust is completely ignored while you’re alive. As far as the IRS is concerned, you still personally own the assets held by the trust. So, you continue to report on your Form 1040 any income generated by trust assets and any deductions related to those assets (such as mortgage interest on your home).
For state-law purposes, the living trust is not ignored. Done properly, it avoids probate. And that’s the goal.
When you die, the assets in the living trust are included in your estate for federal estate tax purposes. However, assets that go to your surviving spouse are not included, assuming your spouse is a U.S. citizen (thanks to the unlimited marital deduction privilege). But as I said at the beginning of this column, you probably don’t currently have to worry about any federal estate tax hit with today’s huge exemption. That said, keep reading.
Warning: If you set up a living trust, you must transfer legal ownership of the most important assets for which you wish to avoid probate (typically homes and other real property) to the trust for the trust to perform its probate-avoidance magic. Many people set up living trusts and then fail to follow through by actually transferring ownership. If so, the probate-avoidance advantage is lost unless your friendly estate executor can argue that the problem is cured by your pour-over will.
Recognize the estate Taxmageddon threat
The Tax Cuts and Jobs Act (TCJA) dramatically increased the unified federal estate and gift tax exemption from $5.49 million in 2017 to $11.4 million for this year, with inflation adjustments scheduled for 2020-2025. But the exemption is scheduled to revert back to the much-lower pre-TCJA level in 2026: about $6 million after inflation adjustments.
Depending on political developments, that could happen much sooner than 2026. And the exemption could be taken down way below the pre-TCJA level. To maybe only $3.5 million, or maybe lower, or maybe even completely eliminated.
This is the estate Taxmageddon threat, and it’s cause for concern if you have a healthy estate. One way to recognize the threat and hopefully disarm it is to make large tax-free gifts this year to whittle down your estate. Presumably, that will help insulate you against any later reduction in the unified federal estate and gift tax exemption. We hope.
If you wait until next year to make your big gifts, you are taking a risk. If a certain party seizes control in 2020, they might be emboldened to make a big reduction in the exemption that takes effect retroactively in 2020. It could happen. Probably not, but a certain amount of paranoia is justified. See my earlier column that covers the estate tax “clawback” issue.
The last word
Things change. You may acquire new assets, win the lottery, lose relatives to death, disown relatives, take them back, and gain children or grandchildren. Any of these events, and more, could require changes in your estate plan. Plus, the federal and estate and gift tax rules have proven to be unpredictable. Not to mention state death tax rules. For all these reasons, you should review your estate plan. Like now. If you wait, it could be too late. If you pass away, your current estate plan with all its flaws, or your completely missing estate plan, will be locked in.