Be prepared for estate tax changes
For people nearly or newly retired with potentially decades ahead of them to watch their assets grow, estate taxes are a huge concern, especially if Congress decides to revise the rules.
The generous gift and estate tax exemption, rising to $11.7 million in 2021, may be on the chopping block. The exemption is set to expire at the end of 2025 — that is, if political and fiscal pressures don’t lead to a change sooner.
The large exemption has lulled many people into thinking they shouldn’t worry about estate taxes, says Martin Shenkman, an estate and tax planning attorney in New York. But “anybody with wealth needs to plan,” says Shenkman, citing looming deficits that could hasten a change in the exemption amount.
The federal gift and estate tax is currently 40% on amounts over the exemption, and some states also levy an estate tax. You can reduce a potential estate tax by reducing the size of your estate. Here are ways to do so:
Leverage the annual gift tax exclusion.
Every year, anyone can give anyone else a gift up to the annual gift tax exclusion amount — $15,000 in 2021. Couples can give up to a total of $30,000 to an individual. Go over this amount and you’re required to file a gift tax return, with any amount in excess applying toward your
lifetime exclusion.
A 529 college savings plan can help you remove money out of your estate even faster. You can contribute five year’s worth of gifts to a 529 plan — $75,000 for an individual, $150,000 per couple in a single year. Be aware that you won’t be able to make gifts to the 529 beneficiary for five years. And if you die within that time, a prorated amount applies to your estate.
Use up your lifetime exemption early.
If you think gift and estate tax limits are heading lower, use up your lifetime gift exclusion now, suggests Eric Bronnenkant, head of tax for Betterment. “If you have an asset you think will appreciate and want to leverage today’s exclusion because you’re concerned it’s going lower, the IRS has given guidance that indicates you won’t be penalized for using up your exemption while you’re alive,” he says.
What happens if you use up the exclusion and the lifetime exemption amount isn’t lowered? You’ll still benefit because there is less in the estate that can be taxed when you die. There’s a trade off, however: The cost basis of gifted assets carries over to the person receiving the gift. “If you were going to end up being below the estate tax exemption in either scenario, you may be better off holding onto the asset until death so [your heirs] can benefit from the step-up in basis,” Bronnenkant says. Plus, you’ll have more security in case you need the money.
Pay expenses directly. Another way to save on future estate taxes is to write checks for someone else’s medical expenses or education from preschool through graduate school. These payments don’t count toward the annual exclusion or the estate tax exemption, provided the checks are written directly to the health care provider or school, Bronnenkant says. “You can keep writing checks all day long, and it reduces the taxable estate while making someone else very happy they don’t have to pay,” he says.