When you die, where do you want your money to go?
Your spouse? Your kids? Your grandchildren? A favorite charity?
How about…the federal government?
I’ve helped a lot of clients think through their estate plans over the years, and I’ve seen a lot of wills and beneficiary forms. Not once have I seen “Internal Revenue Service” written on either document as a specified beneficiary. And yet, most people end up leaving a portion of their estate to the federal government – sometimes a hefty portion, at that.
In this context, Uncle Sam is like the not-so-fun uncle who shows up at the funeral asking for a piece of the inheritance. Nobody invited him, but that doesn’t stop him from demanding his “fair share.”
It’s difficult to keep Uncle Sam out of the picture entirely, but with careful planning, you can ensure that more money goes to the people and causes that you truly care about.
This is especially true – and especially critical – for those with estates that exceed $15 million ($30 million for a married couple), which is the current value of the estate tax exemption. Why? Because forty cents of every dollar above that amount goes to, you guessed it, Uncle Sam.
To illustrate, let’s take the example of a married couple who die with a $50 million estate. To keep things simple, we’ll say that the entire estate is sitting in cash in a bank account, and the couple had done no planning besides a simple will leaving their assets to their children.
Now, let’s assume the same couple’s estate was $100 million.
As you can see, the greater the size of the estate, the greater the share Uncle Sam receives (both in absolute dollar terms and in percentage terms). Clearly, the greater the amount of wealth involved, the more important estate tax planning becomes.
For the vast majority of the population, this would appear to be a non-issue. After all, the $15 million exemption amount means that the estate tax only impacts a tiny percentage of the population.
However, even if you don’t have a $15+ million estate, you still might be at risk of leaving more to Uncle Sam than you think.
For example, maybe your current estate is “only” $5 million, or one-third the exemption amount. If you’re 80+ years old, you probably won’t have to worry about estate taxes. However, if you’re 40, 50, or even 60 years old, your portfolio may have decades of compounding growth ahead of it, in which case it is entirely possible that you will one day be faced with an estate tax problem. This is especially true if you own a high-growth asset like a privately held business or equity compensation from your employer, or if you are due to receive a large inheritance. In cases like these, the odds of exceeding the estate tax exemption later in life become even greater. Shifting some of the growth of these assets to entities outside of your estate, like trusts, may result in significant long-term tax savings.
Even for smaller estates that will never be subject to the dreaded 40% estate tax, there is still room for Uncle Sam to lay claim to a portion of the assets. Specifically, pre-tax IRA and 401(k) plans will eventually face required distributions to the listed beneficiaries, and those distributions will be taxed as ordinary income. With the passage of the SECURE Act in 2020, for non-spouse beneficiaries, inherited IRAs must now be fully distributed within 10 years of the account owner’s date of death, accelerating the taxable income realized by the beneficiaries. For example, if someone were to leave $1 million in an IRA to their daughter, it’s not unreasonable to assume that the daughter would have to pay $200k or more in income taxes over that 10-year span – equal to 20% or more of the value of the account.
In summary, if you have an estate in excess of the $15 million exemption amount, you should waste no time in talking to your financial and tax advisors about strategies to mitigate your future estate tax liability. If you’re not quite there yet, but your estate is projected to grow beyond the exemption amount over the next couple of decades, you should start considering your planning options. And if the value of your estate is nowhere close to $15 million, there may still be some steps that you can take to minimize your beneficiaries’ income tax bill.
The goal is not to reduce your inheritance taxes to zero. That kind of aggressive tax planning tends to involve unnecessarily complex planning vehicles and may lead to legal trouble. Instead, the goal should be to take prudent steps to minimize future estate and income taxes using savvy, conventional planning strategies in a way that makes sense for your specific situation.
That way, when Uncle Sam shows up to the funeral, you’ll be expecting him. And, more importantly, he won’t walk away with more than you intended.
And Now For Something Completely Different…
In case you missed it, the mile world record – which had stood for 27 years – was recently smashed by Josh Kerr. A mind-boggling performance (starts at the 3:10 mark)!
The information offered is provided to you for informational purposes only. Robert W. Baird & Co. Incorporated is not a legal or tax services provider and you are strongly encouraged to seek the advice of the appropriate professional advisors before taking any action.