This post is part of the one day blog event “The Spectrum of Personal Finance.” In this event, Brian of My Next Buck, will discuss 8 different emotions and relate them to personal finance. Here at Free Money Finance we will be looking at Death. To view the rest of the event look at the bottom of the page to see the other blogs hosting articles.
In the coming weeks we are going to hear more and more stories coming from Congress discussing the death tax. For those that don’t know, the death tax, more appropriately known as the “estate tax”, is a tax on wealth being transferred (i.e. inherited) from one generation to the next upon the death of the owner. The estate tax has always been dubbed as a tax on the uber rich, but if Congress doesn’t make some changes in the near future, this will be a tax on anyone with taxable wealth of over $1 million beginning in 2011.
Unfortunately, $1 million sure can’t buy what it used to, especially if you plan to retire someday. It is likely that a lot of us will shoot for nest eggs well over the million dollar exemption by the time we reach retirement, making our wealth eligible to be taxed at an alarming rate of 55% upon our deaths.
Don’t Plan on Dying in 2011
This topic does have a sense of morbidity about it. It’s really not cool to think about an appropriate time to die. Then again, with the way the taxes are currently set up, dying in 2009 vs. 2010 vs. 2011 could mean millions of extra dollars in taxes for dependents. Here are those three years’ exemptions and maximum tax rates:
- 2009 - $3.5 million; 45%
- 2010 – No exemption, 0% (tax repealed)
- 2011 - $1 million; 55%
If an individual with a net worth of $3.5 million dies in 2011 compared to 2010, the individual’s family would pay $1.375 million in additional taxes. Regardless of your political affiliation, I think it’s safe to say that no one would want to pay an extra $1.4 million in taxes on January 1st 2011 compared to $0 on December 31st 2010.
Why You Should Care
The $1 million exemption limit that will go into effect in 2011 may sound like a fair amount. After all, a million dollars is a lot of money. For those that have worked hard and accumulated wealth over the years to afford retirement, and for those that have helped their parent’s estate plan, this could mean that a bulk of hard earned money could be going to the Fed’s coffers instead of your family’s.
It’s never too early to worry about these issues. At the age of 25 I plan on saving, investing, and growing my wealth to a nest egg that greatly exceeds $1 million. I would hate to put 40 years of work into building my wealth, only to see 55% of anything in excess of $1 million be taken away from my dependents by the government.
If you are a small business owner, you have to be even more concerned as a lot of small businesses get liquidated as a means for families to pay the estate taxes of the deceased. Speaking of liquidation, if your assets are tied up in real estate and other non-liquid investments, beware that those assets are likely to be sold promptly to pay off these taxes. Many families lose their businesses and even their homes because the majority of the owner’s assets are not liquid.
What Can You Do About It?
While estate taxes are going to be unavoidable in the future, it’s in the best interest of you and your dependents to take a few steps NOW to minimize the effect of the tax on your wealth. Here are a few things you can do today to plan for tomorrow:
- Make lifetime gifts (up to the point of hitting a gift tax) – You can give up to $13,000/year per recipient without paying any tax. You can also pay someone’s medical bills, tuition or give to charity without paying tax. This reduces the size of your estate and the eventual tax bill.
- Create an irrevocable trust – These trusts allow you to “remove” ownership of the assets held inside the trust (usually cash, investment assets, a business). Therefore you are technically removing the assets from your taxable estate. Furthermore, the grantor is also relieved of the tax liability on the income generated by the assets in the trust.
- Create a Living Trust with “A-B Provisions” – This trust is complex, but in short, it allows you to pass your estate onto your heirs, while still allowing your spouse to have full access to the funds. The funds will not be transferred to the heirs until the spouse passes. However, the tax bill is for the original amount of the grantor’s estate, which means any appreciation in value of the estate will not be taxed.
- Set up and Transfer a life insurance trust – A life insurance trust exists to own a life insurance policy. If the owner of the policy transfers ownership of a life insurance trust to a beneficiary, the proceeds will be completely free of estate taxes.
- Go see an attorney and an estate planner – This stuff is complicated and an attorney can help you sort through all of the fine print and possibly come up with some more creative ways to mitigate your estate tax liabilities.
Keep an eye out over the coming weeks as the estate/death tax starts to make more news. It is unlikely we will see a repealing of the tax for 2010, but it is possible that new legislation will be passed that may impact your estate plans. Pay attention and meet with your financial advisors to ensure that your family is taken care of with or without you.For further reading of the Spectrum of Personal Finance Event, please see:
- Fear at Bargaineering
- Hope at Budgets are Sexy
- Avarice at Consumerism Commentary
- Willpower at Debt Free Adventure
- Death at Free Money Finance
- Compassion at Get Rich Slowly
- Love at Mrs. Micah
- Rage at Poorer Than You