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What You Need to Know About Estate Taxes

October 27, 2020

Planning for what will happen to your wealth after you die is an important part of any financial plan, and estate taxes are at the top of that list. The main reason you need to plan ahead is so that you can guarantee that your money is going where you want it to go — namely, to the family members and philanthropic causes that matter to you.

What you don’t want is to give up your entire estate to the federal government in the form of taxes. We like to tell our clients that the government already has a plan for what happens to your assets after you die — if you want something else to happen, you need to come up with a plan of your own.

In this article, we’re going to unravel the ins and outs of the estate tax: the myths, the facts, and what you can do to make sure that your estate is distributed in a way that best reflects the things and people that you care about.

Does the Estate Tax Apply to You?

Surprisingly, the answer might be no. As of 2020, the estate and gift tax level is $11.58 million per individual and $23.16 million per married couple. If your combined estate with your spouse is worth $20 million, you can leave the whole thing to your children and not worry about the estate tax at all.

As such, less than a percent of American estates even fall under the purview of the estate tax. If the tax does apply to you, only the portion of your estate that exceeds the limit is taxed at the full rate of 40 percent. If your estate is worth $24 million, you’re only paying estate tax on the $840,000 that’s over the limit, which amounts to roughly $336,000 — not exactly pocket change, but only 1.4 percent of your total estate.

How Much You’ll Pay

Of the estates large enough to owe estate taxes in 2017, the effective tax rate that they paid was roughly 17 percent — far below the top statutory rate of 40 percent. There are plenty of claims floating around that you’ll give up nearly half of your money in taxes, but that’s unlikely to be true.

Expect the Unexpected

There’s a caveat to all this: estate taxes are subject to congressional oversight and can be changed fairly quickly. If you don’t die for another 40 years, the laws surrounding estate taxes could have changed drastically by then. In the last 20 years, the exclusion amount has risen from only $675,000 to $11.58 million, but it could drop again if political winds shift.

Similarly, the top tax rate has been as high as nearly 80 percent and as low as 20 percent in the last century. It could also change in the course of a year or two with an act of Congress, so it’s nearly impossible to predict what the tax picture will look like a few decades down the line.

You’ll also have to consider that each state has its own estate tax laws and exemptions. Connecticut’s exemption is currently $5.1 million, with a planned rise to $9.1 million in two years, while Massachusetts and Oregon are limited to only $1 million. If you plan to retire in another state than the one you live in now, that might play a factor in your decision.

Update Your Estate Plan Often

The upshot of all this unpredictability is that there are aspects of your estate plan that are complicated and difficult to parse, and you’ll need the help of an expert to help you sort through them. In addition, you should be updating your estate plan frequently — your financial advisor will keep an eye on your assets and the relevant laws and let you know about them, and you might need to update your plan to accommodate those changes.

For example, a new president and Congress could decide to cut the exclusion to $5 million and raise the top tax rate to 80 percent. It’s unlikely that a change would be so drastic, but it’s certainly possible. If you have a $20 million estate, your estate tax bill just went from zero to $12 million with one stroke of a pen, and you can be sure that your plans will change. Trusts will need to be set up, changes of ownership will need to happen sooner rather than later, and so on.

Start Planning Now

It’s never too early to start estate planning. The unexpected could happen at any moment and it’s best to be prepared so that you can ensure the security of your family and your legacy. That’s why it’s so important to talk to professionals like the advisors at First Western Trust Bank.

We’ll start by examining every aspect of your financial situation, from your income to the allocation of your funds. We’ll talk about the details of your personal goals and priorities — what you’d like to do with your money when you die, where it should be distributed, and what’s most important to you. Finally, we’ll make sure that you know what to expect in terms of the tax burden and how best to plan for what happens to your assets after your death. If you’re ready to start taking estate planning seriously, get in touch today.

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