Estate planning is a critical component of a comprehensive financial plan. It involves deciding how your assets will be distributed upon your death or incapacitation. Furthermore, estate planning includes aspects such as tax minimization strategies, asset protection, and charitable giving. As you navigate the complexities of tax and financial planning for estate planning, a wealth manager or financial planner can offer invaluable assistance to optimize your financial strategy for future generations.
This article builds upon our series on financial planning, following our other guide, What is a Financial Plan, and How Do I Make One?
Table of Contents
- The Importance of Estate Planning
- Key Components of an Estate Plan
- Estate Tax Rates and Limits in 2023
- Strategies for Minimizing Estate Taxes
- The Role of Wealth Managers and Financial Planners in Estate Planning
The Importance of Estate Planning
Without a proper estate plan, your assets may be distributed according to federal and state law, which may not align with your wishes. Moreover, inadequate planning can cause legal disputes among your heirs, and potentially subject your estate to unnecessary taxes and probate fees.
Key Components of an Estate Plan
A comprehensive estate plan consists of several key components, including wills and trusts, power of attorney, healthcare directives, and beneficiary designations. Each of these elements serves a distinct purpose, ensuring that your assets are distributed according to your wishes and that any necessary decisions regarding medical care or guardianship are appropriately addressed.
Will and Trusts
A will is a legally-binding document that outlines your wishes regarding the distribution of your assets after your passing, allowing you to designate an executor to administer your estate and a guardian for any minor children. Having a will is crucial, as it enables you to dictate how your assets will be allocated upon your passing. Without a will, the distribution of assets would be determined by the laws of your state, which may not align with your preferences.
Trusts, on the other hand, are legal entities that can be used to manage and distribute assets to the beneficiaries of an estate. There are many different types of trusts, each designed to address specific estate planning needs. Some common types of trusts used in estate planning include:
- Revocable Living Trusts: This type of trust can be altered, amended, or revoked by the trustor during their lifetime. The trustor retains control of the assets and can even act as the trustee.
- Irrevocable Trusts: Unlike revocable trusts, these cannot be changed or terminated without the permission of the trust’s beneficiary. These trusts can remove assets from the estate, potentially reducing estate taxes.
- Charitable Trusts: These trusts allow the grantor to leave assets to a charity of their choice, often reducing the estate’s tax burden.
- Special Needs Trusts: These trusts are designed for the benefit of individuals with physical or mental disabilities. They provide for the individual’s needs without disqualifying them from government assistance, such as Medicaid.
- QTIP Trusts (Qualified Terminable Interest Property trusts): These allow a surviving spouse to receive income from the trust’s assets for the rest of their life. The remainder of the trust’s assets can then be passed to other beneficiaries (such as children from a previous marriage) upon the surviving spouse’s death.
- Bypass Trusts: These allow married couples to maximize their estate tax exemptions. Upon the death of the first spouse, the assets are moved into the trust, with the income generated by the trust benefiting the surviving spouse.
While trusts are often thought of as financial products available only to the wealthy, almost anyone can create a trust, and it can lead to many financial advantages for estates of all sizes.
Power of Attorney and Healthcare Directives
Power of Attorney (POA) is a legal document that grants a designated individual the authority to make decisions related to your property, finances, or medical care on your behalf, should you become incapacitated. This document allows your financial matters and personal well-being to be handled by someone you trust, with the goal of providing peace of mind in the face of uncertainty.
Healthcare directives, also known as advance directives or living wills, are legal documents that allow you to specify your preferences regarding medical care in the event that you become unable to make decisions for yourself. These documents may include instructions for end-of-life care, organ donation, and the appointment of a healthcare proxy to make medical decisions on your behalf.
Estate Tax Rates and Limits in 2023
The estate tax, also referred to as the death tax, is levied on an heir’s inherited portion of an estate if the value of the estate exceeds certain limits. Federal, state, and inheritance taxes have different rates and limits, which are important to understand for estate planning purposes.
For 2023, the federal limit on the estate tax is $12.92 million, meaning that no estate tax is owed on estates worth less than that amount. For estates worth more than $12.92 million, the estate tax is calculated on a tier system ranging from 18% to 40%.
For example, if an estate at the time of death is worth $13 million, taxes would be levied on the difference of $13 million and $12.92 million, meaning $80,000. $80,000 would be taxed at 26% plus an additional base tax of $13,000, bringing the total tax bill to $33,800.
Here’s a table showing the estate tax rates for 2023
|Taxable Amount||Base Tax||Estate Tax Rate|
|$0 to $10,000||$0||18%|
|$10,000 to $20,000||$1,800||20%|
|$20,000 to $40,000||$3,800||22%|
|$40,000 to $60,000||$8,200||24%|
|$60,000 to $80,000||$13,000||26%|
|$80,000 to $100,000||$18,200||28%|
|$100,000 to $150,000||$23,800||30%|
|$150,000 to $250,000||$38,800||32%|
|$250,000 to $500,000||$70,800||34%|
|$500,000 to $750,000||$155,800||37%|
|$750,000 to $1,000,000||$248,300||39%|
|$1,000,000 or greater||$345,800||40%|
State-level Estate Tax Rates
In 2023, twelve US states, and Washington, DC, impose their own estate tax. Below is a list of those states, as well as the estate value at which the estate tax kicks in:
|State||2023 Estate Tax Threshold|
Notice that many states start levying estate tax at amounts below where the IRS starts. Depending on the size of an estate, this could be a reason for many high-net-worth individuals to consider relocating to no estate tax-free states later in life, such as Florida.
Inheritance Tax Rates
While estate tax is paid by the estate, inheritance tax is paid by the beneficiary (or the person who inherits the assets).
There is no federal inheritance tax in the United States, but there are six US states that impose inheritance taxes:
|State||2023 Inheritance Tax Threshold|
|Iowa||0 to 15% (Phasing out Jan 1, 2025)|
|Kentucky||4 to 16%|
|Maryland||Up to 10%|
|Nebraska||1 to 18%|
|New Jersey||11 to 16%|
|Pennsylvania||0 to 15%|
Similar to the state-level estate taxes, it could be important to consider relocating to a more tax-friendly state, depending on the size of the estate in question.
Strategies for Minimizing Estate Taxes
There are several strategies that can be employed to minimize estate taxes, with the goal that your beneficiaries receive the maximum amount of your estate. These strategies include gifting and annual exclusions, charitable donations and trusts, setting up trusts for tax reduction, and life insurance trusts.
If you have substantial assets that you wish to offset from estate taxes, you might be interested in setting up a charitable trust. Forming a trust will allow you to support a cause important to you, and it will allow you to take assets away from your personal estate and into an entity.
There are generally two types of charitable trusts to consider: a charitable lead trust and a charitable remainder trust:
- A charitable lead trust allows you to contribute regular payments to a charity during your lifetime, with the remainder going to you and any beneficiaries of the trust.
- A charitable remainder trust allows you and any beneficiaries to receive payouts from the trust over your lifetime, and distribute the remainder of the trust assets to the designated charities upon your death.
Gift Tax Exemption
As of 2023, the maximum tax-free gift limit is $17,000 per recipient per year. By making annual gifts within these limits, you can help reduce the overall value of your estate. This, in turn, reduces the potential estate taxes your beneficiaries may face. Gifting can be a great way to reduce estate taxes, but it is important to understand the rules and regulations that apply. Make sure to consult with a qualified tax professional.
Charitable Remainder Unitrusts (CRUTs)
A CRUT is an irrevocable trust that distributes a yearly income from its assets to the donor, with the remainder going to a charity. An individual with significant equity compensation can utilize a CRUT to sell their stocks, avoiding immediate capital gains tax. The stocks are transferred to the CRUT, sold by the tax-exempt trust, and then reinvested. This approach allows the recognition of capital gains tax to be spread out over time, and the donor also receives a charitable income tax deduction.
Charitable Lead Annuity Trusts (CLATs)
A CLAT provides fixed annual payments to a charity for a specified term, with the remaining assets then going to the donor’s heirs. This is a strategic move for those with substantial equity compensation anticipating significant asset appreciation. It facilitates the removal of future asset appreciation from the estate, thereby reducing potential estate taxes. Although the wealth passed on to the heirs could be considerable, the value of the gift for tax purposes is diminished due to the charitable annuity payments.
Family Partnerships and LLCs
Family Limited Partnerships (FLPs) and Limited Liability Companies (LLCs) are common vehicles for consolidating family wealth, managing assets, and reducing estate taxes. These entities can also provide some protection from creditors. Make sure to consult with legal counsel when creating entities to fully understand the liabilities and protections of each structure.
Qualified Personal Residence Trust (QPRT)
A QPRT allows you to give away your house or vacation home at a great discount for gift tax purposes. You would transfer the title of your home to the QPRT, making it no longer part of your estate, but retain the right to live in the home for a certain number of years. If you live to the end of the period, the home, plus any appreciation in value over the period, passes to your heirs with no estate tax consequences.
Generation-Skipping Transfer Tax (GSTT) Strategies
The GSTT is an additional tax that applies to transfers to grandchildren and lower generations that exceed the GSTT exemption of $12.92 million for the 2023 tax year. Trusts like a Dynasty Trust or a Generation-Skipping Trust can protect assets from estate taxes for several generations.
The Role of Wealth Managers and Financial Planners in Estate Planning
A wealth manager or financial planner can advise you on how to build a financial plan that meets your unique wants, goals, and wishes. They can help you make informed decisions and assist in formulating strategies to minimize tax liabilities.
Harness Wealth Can Help
Estate planning is a critical aspect of financial planning that endeavors to ensure your wealth is effectively managed according to your wishes. By incorporating tax and financial planning strategies and engaging with skilled financial professionals, you can aim to minimize your tax liabilities, strive to maximize your wealth, and leave more support in place for your spouse, children, and other loved ones. At Harness Wealth, our wealth managers and financial planners are well-versed in estate planning. If you need help planning your financial future, get started with Harness Wealth today.