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. For 2020, the exemption amount jumps to $11.58 million ($23.16 million for married couples). Even though fewer clients are exposed to the federal estate tax due to these exemptions, their estate plans may still need updating to reflect current tax rules and other changing realities.
Clients also should consider the distinct possibility that today's generous exemption may be on life support along with the relatively reasonable (by historical standards) 40% federal estate and gift tax rate, depending on how the 2020 election turns out. Some clients who are fully sheltered right now might find themselves exposed to the federal estate tax in the near future. Finally, clients may need to make estate planning changes for reasons that have nothing to do with taxes.
This outline provides some estate planning advice for all clients, regardless of whether they are "rich" enough to be worried about the federal estate tax. Year-end is a good time to conduct estate planning checkups.
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 the individual dies, regardless of what his or her will or living trust document might say. Individuals who have failed to update their beneficiary designations for whatever reason have a problem.
Beneficiary Check-up To-do List
Following is a to-do list that can be used to avoid issues surrounding beneficiary designations.
For life insurance policies, annuities, IRAs and other tax-favored retirement accounts, and company benefit plans, fill out and turn in beneficiary designation forms to establish or change beneficiaries.
For bank and brokerage firm accounts, fill out and turn in Transfer on Death (TOD) or Payable on Death (POD) forms to establish or change beneficiaries.
For Section 529 college saving accounts, fill out and turn in beneficiary change forms to change the account beneficiary.
Naming a primary beneficiary is not always enough. Name one or more secondary (contingent) beneficiaries in case the primary beneficiary dies before the client.
Check property ownership. If you are married and own property with your spouse 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. Important 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 probate process.
Establish or Update 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. So, unless you have an inordinate amount of faith in the state legislature, a written will is needed to make your wishes known. In addition to a will, you may want to set up a living trust to avoid probate.
The main purposes of a will are to name a guardian for one's minor children (if any), name an executor for one's estate, and specify which beneficiaries (including charities) get which assets. The guardian's job is to take care of the kids until they reach adulthood (age 18 or 21 in most states). The executor's job is to pay the estate's bills, pay any taxes due, and deliver what's left to the intended heirs and charitable beneficiaries.
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. You establish the living trust and transfer legal ownership of assets for which you wish to avoid probate, such as your main home and vacation property. You also should 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, antique furniture, and valuable collections would fit in this category.
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 spouse, adult child, faithful friend, attorney, CPA or financial institution to be the successor 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 the taxpayer is alive and continues to report income on Form 1040 generated by trust assets and any deductions related to those assets (such as home mortgage interest). For state law purposes, the living trust is not ignored. 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).
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. 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 the estate executor can argue that the problem is cured by the client's pour-over will.
Future Potential Estate Tax Changes
The Tax Cuts and Jobs Act (TCJA) dramatically increased the unified federal estate and gift tax exemption from $5.49 million for 2017 to $11.4 million for 2019 and $11.58 million for 2020, with inflation adjustments scheduled for 2021-2025. However, 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. This is definitely a cause for concern for individuals who have healthy estates. One way to recognize the threat and hopefully disarm it is to make large tax-free gifts this year or next year to whittle down the estate. Presumably, that will help insulate you against any later reduction in the unified federal estate and gift tax exemption.
NOTE - State death taxes and related issues have not been addressed in the above outline.
Things change. Your may acquire new assets, lose relatives to death, and/or have children or grandchildren. These events, and more, could require changes in your estate plan. For all these reasons, you are encouraged to review your estate plans at the beginning of the year.