You have carefully planned your Will provisions for distribution of your estate at your death, thought about and designated your primary and contingent beneficiaries on the 401(k)'s, IRA's, and managed to build a comfortable investment portfolio. You aren't what you would consider ?really rich?, so Estate Taxes shouldn't be a worry for you or heirs, or should they?
One estate tax surprise that could be waiting for heirs has to do with what is referred to as ?incidents of ownership? in life insurance coverage.
If you have a group life policy (many working adults do for hundreds of thousands of dollars because of the ease of payroll deduction to pay premiums) you have direct ownership of the policy privileges. You control to a certain extent the amount of coverage, based on what you qualify for and the maximum amount the insurer selected by your employer allows. You also control the beneficiaries listed.
Most people accept that in virtually all cases the life insurance proceeds are paid at the death of the insured to beneficiaries free of income tax. But, when calculating the value of an estate, the total of the group life insurance proceeds will be included in the total value of the estate potentially pushing assets over the Estate Tax exemption amount, creating an estate tax bill on what would have otherwise been completely tax free proceeds.
This estate structuring error could be compounded if the deceased also had substantial amounts of private life insurance in force outside of any employer group plans that they were both the insured and owner of the policy.
Another common surprise trigger for families occurs in regards to estate taxes at the death of the second spouse when all the home equity, possessions, IRA proceeds, life insurance proceeds and assets transferred to the remaining spouse with no tax bills being triggered at the first death. Now the assets of the remaining spouse have grown quickly, and potentially compounded the problem.
What do you do now that you are not certain if a problem exists or not? It is time to consult with trained professionals. They will help you and your attorney as needed, to determine what the estimated value of your total estate is with the addition of life insurance proceeds after confirming how you have ownership and beneficiaries structured. Together, they can assist you in structuring a comprehensive Estate Plan to compliment your will provisions, distribution desires and guide you in implementing changes to minimizing or eliminate Estate taxes altogether for your heirs.
You may need to do some strategic cash gifting to heirs or charity, complete some policy ownership changes, perhaps a policy replacement is in order to update coverage, perhaps a policy sale to a heir, you may need to change some or all beneficiaries, you may need to create a trust or two, the plan for your household will be a unique solution tailored to your specific situation.
Will you really save much by changing anything already in place that seems to be working OK right now? Doesn't an attorney and an insurance professional cost a lot for these things? It depends on perspective versus reality. If you consider that every dollar that is subject to estate taxes could be levied an approximate 50% Estate tax, would you spend a few thousand dollars to keep three times that amount away from the IRS? Would you do it for five times? What if your actual planning result number was 20+ times? The potential tax savings multiple for your situation is something you need to know.
Surprise! It is also possible that those 401(k)'s you have will not be subject to just around a 50% Estate tax.
Suppose that $100,000 in 401(k) proceeds over your Estate Tax exemption will now pass to your adult daughter at your death. She is not able to just roll them into her name like you did as a spouse, and she must take them in a lump sum. Well, as beneficiary, she must include these in her taxable income. If this bumps her to the 28% Federal Income Tax Bracket, and she lived in Kansas for example, she could add an additional 6.45% State income tax liability as a result of receiving the proceeds in her taxable income. That $100,000 account just lost around $34,450 to income taxes, and the deceased estate owes about $50,000 for Estate taxes and the daughter received the proceeds, the Estate didn't!
This is how you can allow the government to legally and painfully tax any retirement account to around 84.45%, or more, with the signing of a death certificate if you don't do a little planning first!