When it comes to estate planning, women have unique concerns. The fact is women live longer than men. That’s important for several reasons. First, you’ll not only need your assets to last longer, but you’ll also need to plan for potential incapacities due to declining health. Second, it means that if your husband or significant other dies before you, you’ll likely inherit their estate. Finally, though, it means that to a large extent, you will probably have the last word about the final disposition of all the assets you’ve accumulated during your relationship.
What is an estate plan? An estate plan is a map that reflects the way you want your personal and financial affairs to be handled in case of your incapacity or death. It is especially needed if you have minor children; your net worth exceeds the federal transfer tax exemption amount ($5,250,000 in 2013) or, if less, your state’s exemption amount; you own property in more than one state; financial privacy is a concern; or if you own a business.
Basic estate planning calls for:
- A health-care directive, where you decide who will be responsible for making sound decisions about your health when you are unable to.
- A living will that covers the types of medical treatment you would want, or not want, under certain circumstances.
- A durable power of attorney for health care (health-care proxy) that lets one or more family members or other trusted individuals make medical decisions for you.
- And, if you choose, a DNR (do not resuscitate) order that is a legal form, signed by both you and your doctor, that gives hospital staff permission to carry out your wishes.
There are also other legal devices that should be included in an estate plan to help others manage your property when you are unable to including; joint ownership, durable power of attorney and living trusts.
For high net worth taxpayers, a more assertive estate planning strategy may be a consideration in order to protect their assets from potentially excessive taxation. You’ll want to consider whether these concepts and strategies apply to your specific circumstances.
When you transfer your property during your lifetime, or at your death, your transfers may be subject to federal gift tax, federal estate tax, and federal generation-skipping transfer (GST) tax. (For 2013, the top estate and gift tax rate is 40%, and the GST tax rate is 40%.) Your transfers may be subject to state taxes.
Federal gift tax
Gifts you make during your lifetime may be subject to federal gift tax. However, not all gifts are subject to the tax. You can make annual tax-free gifts of up to $14,000 per recipient. Married couples can effectively make annual tax-free gifts of up to $28,000 per recipient. You may also make tax-free gifts for qualifying expenses paid directly to educational or medical service providers. And you can also make deductible transfers to your spouse and to charities. There is a basic exclusion amount that protects a total of up to $5,250,000 from gift tax and estate tax in 2013.
Federal estate tax
Property you own at death is subject to federal estate tax. As with the gift tax, you can make deductible transfers to your spouse and to charity, and there is a basic exclusion amount that protects up to $5,250,000 from tax in 2013.
The estate of someone who dies in 2011 or later can elect to transfer any unused applicable exclusion amount to his or her surviving spouse; a concept referred to as portability. The surviving spouse can use this decreased spousal unused exclusion amount (DSUEA), along with the surviving spouse’s own basic exclusion amount, for federal gift and estate tax purposes. For example, if someone dies in 2011 and the estate elects to transfer $5,000,000 of the unused exclusion to the surviving spouse, the surviving spouse effectively has an applicable exclusion amount of $10,250,000 to shelter transfers from federal gift or estate tax in 2013.
Federal generation-skipping transfer (GST) tax
The federal GST tax generally applies if you transfer property to a person two or more generations younger than you (for example, a grandchild). The GST tax may apply in addition to any gift or estate tax. Similar to the gift tax provisions above, annual exclusions and exclusions for qualifying educational and medical expenses are available for GST tax. You can protect up to $5,250,000 with the GST tax exemption in 2013.
Income Tax Basis
Generally, if you give property during your life, your basis (generally, what you paid for the property, with certain up or down adjustments) in the property for federal income tax purposes is carried over to the person who receives the gift. So, if you give your $1 million home that you purchased for $50,000 to your brother, your $50,000 basis carries over to your brother—if he sells the house immediately, income tax will be due on the resulting gain.
In contrast, in you leave property to your heirs at death, they get a “stepped-up” (or “stepped-down”) basis in the property equal to the property’s fair market value at the time of your death. So, if the home that you purchased for $50,000 is worth $1 million when you die, your heirs get the property with a basis of $1 million. If they then sell the home for $1 million, they pay no federal income tax.
Making gifts during one’s life is a common estate planning strategy that can also serve to minimize transfer taxes. One way to do this is to take advantage of the annual gift tax exclusion, which lets you give up to $14,000 to as many individuals as you want gift tax free in 2013. As noted above, there are several other gift tax exclusions and deductions that you can take advantage of. In addition, when you gift property that is expected to appreciate in value, you remove the future appreciation from your taxable estate. In some cases, it may even make sense to make taxable gifts to remove the gift tax from your taxable estate as well.
There are a number of trusts that are often used in estate planning. Here is a quick look at a few of them.
Revocable trusts. You retain the right to change or revoke a revocable trust. A revocable trust can allow you to try out a trust, provide for management of your property in case of your incapacity, and avoid probate at your death.
Marital trusts. A marital trust is designed to qualify for the marital deduction. Typically, one spouse gives the other spouse an income interest for life, the right to access principal in certain circumstances, and the right to designate who receives the trust property at his or her death. In a QTIP variation, the spouse who created the trust can retain the right to control who ultimately receives the trust property when the other spouse dies. A marital trust is included in the gross estate of the spouse with the income interest for life.
Credit shelter bypass trusts. The first spouse to die creates a trust that is sheltered by his or her applicable exclusion amount. The surviving spouse may be given interests in the trust, but the interests are limited enough that the trust is not included in his or her gross estate.
Grantor retained annuity trusts (GRAT). You retain a right to a fixed steam of annuity payments for a number of years, after which the remainder passes to your beneficiaries, such as your children. Your gift of a remainder interest is discounted for gift tax purposes.
Charitable remainder unitrusts (CRUT). You retain a stream of annuity payments for a number of years (or for life), after which the remainder passes to charity. You receive a current charitable deduction for the gift of the remainder interest.
Charitable lead annuity trust (CLAT). A fixed stream of annuity payment benefits a charity for a number of years, after which the remainder passes to your non-charitable beneficiaries, such as your children. Your gift of a remainder interest is discounted for gift tax purposes.
Life insurance plays a part in many estate plans. In a small estate, life insurance may actually create the estate and be the primary financial resource for your surviving family members. Life insurance can also be used to provide liquidity for your estate, for example, by providing the cash to pay final expenses, outstanding debts, and taxes, so that other assets don’t have to be liquidated to pay these expenses. Life insurance proceeds can generally be received income tax free.
Life insurance that you own on your own life will generally be included in your gross estate for federal estate tax purposes. However, it is possible to use an irrevocable life insurance trust (ILIT) to keep the life insurance proceeds out of your gross estate.
With an ILIT, you create an irrevocable trust that buys and owns the life insurance policy. You make cash gifts to the trust, which the trust uses to pay the policy premiums. (The trust beneficiaries are offered a limited period of time to withdraw the cash gifts.) If structured properly, the trust receives the life insurance proceeds when you die, tax free, and distributes the funds according to the terms of the trust.
Knowing what options are available and how each of these options can impact you and your financial plans are critical in making the right decisions. A financial professional can review your circumstances, help you sort through your options, and help develop a plan that’s right for you.