The New Year brings major changes in many estate plans. Not only has there been the biggest year-to-year increase in the federal estate tax exemption (from $2 million to $3.5 million), but the change comes at a time when the values of many estates have declined, due to the housing and stock market slumps.
As a result, every estate plan should be reviewed to make sure it is still relevant and that surviving spouses do not end up receiving much less than they thought. In addition, advisers must be aware of potential higher state estate taxes in states that have uncoupled from the federal estate tax system.
Let’s start with the higher estate tax exemption. A married couple now has $7 million of estate tax protection if the estate plan is set up to take advantage of each spouse’s $3.5 million exemption. The increase should eliminate estate tax for millions more families who would have been subject to the tax when the exemption was lower.
This paves the way for larger IRA amounts to pass to children and other beneficiaries, free of estate tax. Although most spouse beneficiaries can inherit an unlimited amount of property through the marital deduction, leaving everything to a spouse is not always the best move, especially for larger estates that could be subject to estate tax when the second spouse dies.
The same $3.5 million exemption applies to the Generation Skipping Transfer (GST) tax, which makes the stretch IRA more powerful. Beginning in 2009, we can leave more of our IRA or Roth IRA, free of any GST tax, to grandchildren. Their longer life expectancies will allow the IRA to grow tax-deferred or even tax free (with a Roth IRA) for greater wealth build-up, over time, in stretch IRAs.
While the higher federal estate tax exemption is good, it could trigger two bad things: A spouse could receive less or there could be an increase in state estate taxes.
If a client is married and set up a typical credit shelter trust estate plan (also known as a bypass trust), that plan should be reviewed. Under this type of estate plan, amounts up to the federal estate exemption go to the credit shelter trust and any excess goes directly to a spouse or to a marital trust for the spouse’s benefit.
In a perfect estate plan, each spouse would use their entire exemption amount, paying the lowest possible estate tax after both spouses die. But many estate plans have credit shelter trusts set up when the exemption was $2 million or even $600,000. Under those plans, assets up to the amount of the federal estate exemption are placed in the credit shelter trust, which means $3.5 million now will be placed in that trust, leaving the surviving spouse with much less than expected, or nothing.
The will and estate plan should be revised, either to state a specific amount that should go to the credit shelter trust or to divide the property so that the spouse receives the amount that he or she desires. IRAs that are part of a credit shelter estate plan also should be examined to see how much of the IRA your client would want to pass to the non-spouse beneficiaries (or a credit shelter trust) and how much should go to the surviving spouse.
One strategy to put the surviving spouse in control is by building a disclaimer into an estate plan. The spouse would inherit everything and disclaim the amount not needed. Amounts disclaimed up to the federal and/or state estate tax exemption amount would then pass to contingent beneficiaries free of estate taxes.
Today, more than 20 states are uncoupled from the federal estate tax system. These states have gone their own way, taxing estates of lower values. They generally chose to remain at the exemption effective under prior law. In New York, for example, an estate of $3.5 million will be exempt from federal estate tax. But since the state’s estate exemption is only $1 million, the estate would trigger a New York estate tax of $254,911 (up from $107,391 in 2008).
The same disclaimer strategy could work here as well, where everything is left to the spouse, who can then disclaim the amount that will pass free of any state estate tax.
Ed Slott, a certified public accountant in Rockville Centre, N.Y., created the IRA Leadership Program and Ed Slott’s Elite IRA Advisor Group to help financial advisers and insurance companies become recognized leaders in the IRA marketplace. He can be reached at irahelp.com.
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