Hey guys, it’s Finance Fridays, and this is kind of related to last week’s post, Inheritance Tax. Today I’m going to be talking about Estate Tax.

Stock Photo from: Pixabay

Ok, first things first.

Before we get in too deep here, I want to make something clear.

For the majority of people (and doctors), it is unlikely that you will need to pay an estate tax. 

The figure I see tossed around is that only 0.2% (2 out of 1000) of us will ever need to pay Estate Tax.

First of all, the federal estate tax only triggers for estates worth more than $5.49 million in 2017. Let’s just round up to $5.5 million.

Make no mistakes. That’s a lot of money… today.

Wait a second, isn’t “your number” $5 million? That’s pretty close…

You’re absolutely right!

However, my plan isn’t to save $5 million for retirement and then just keel over and die. I’m going to be using that $5 million over the course of my (hopefully) lengthy retirement. By the time of my passing, I will almost certainly be below the number to trigger estate Taxes. This exemption number continues to rise, and will probably be well over $10 million by the end of my retirement.

To give you an example, the number was $1.5 million for 2004 – 2005, and it’s $5.49 million this year.

Ok, can you run some numbers?

Sure.

Like I said, it’s unlikely, but it’s important to be aware of things. While I imagine that the number to trigger estate tax will continue to go up, you can’t predict how the tax laws will change.

So let’s say you pass away and you have an estate worth $6.49 million. You trigger the federal estate tax which is currently set at $5.49 million. So $1 million of your estate will be taxed.

The federal tax rate is 40%. Yes, forty.

So the $1 million excess is taxed $400,000. The $6.49 million estate is knocked down slightly to $6.09 million. Obviously, the more you have to leave, the more you have to pay in taxes.

So let’s say you instead of $6.49 million, your estate was worth $10.49 million. So you will have to pay 40% taxes on the $5 million excess which is:

$2 million dollars

So your $10.49 million estate is knocked down to $8.49 million.

Hey, your heirs aren’t starving with an inheritance that large, but either way, no one wants to pay taxes if they can avoid it (legally), right?

 Wait a second, what if I’m married?

If you’re married, then for tax purposes your estate is considered one entity and as a couple your exemption doubles from $5.49 million to $10.98 million.

Here’s the thing though, the surviving spouse must elect to take the portability of the Deceased Spousal Unused Exclusion (DSUE) amount within 9 months of the decedent’s death. You can ask for a 6 month extension though. The form that needs to be filed is Form 706, for those interested found at irs.gov.

Now you can imagine that almost $11 million in an estate may be difficult to accrue, but remember that we don’t know how taxes will change. Also, your parents may (unexpectedly) leave you more money than you think on their passing. If you then add on years of compound interest and an increase in the value of any property you own, the possibility of triggering an estate tax is still unlikely, but plausible.

Wait.. what about state estate taxes?

Oh yes, I referred to those in my prior post about inheritance tax, which is a “state-only” thing.

Like the inheritance tax, not all states have a state estate tax. The list in alphabetical order is: (from Nolo.com)

• Connecticut
• Delaware
• District of Columbia
• Hawaii
• Illinois
• Maine
• Maryland
• Massachusetts
• Minnesota
• New Jersey (repealed for deaths as of January 1, 2018)
• New York
• North Carolina (repealed for deaths as of January 1, 2013)
• Ohio (repealed for deaths as of January 1, 2013)
• Oregon
• Rhode Island
• Tennessee (eliminated as of January 1, 2016)
• Vermont
• Washington

Do you see a trend? The trend is to repeal (end) state estate taxes. We’ll see if this continues or not.

It’s worth mentioning that state estate taxes have their own exemption amounts.

Example:

Your estate is worth $5 million, and doesn’t trigger the $5.49 federal estate tax. However, let’s say you live in Massachusetts which only has a $1 million dollar exemption. You will then pay taxes on the remaining $4 million.

To be quite honest, I’m not exactly sure what happens in the event that you trigger both federal and state estate taxes. This may be state dependent related to what the state exemption is.

I was told to get whole life insurance in order to avoid estate taxes… what do you think?

When you go to buy your life insurance (which should be term), the insurance agent may try to convince you to buy whole life insurance. Usually, they will explain that whole life insurance isn’t taxed.

This is true. It’s not taxed.

However, whole life insurance is mixing insurance with investing. Basically you are having the insurance company invest your money for you and they return a certain amount to you. The yields that you will see will always be lower  than any real world yields if you had simply invested the money yourself because the insurance company takes their cut. 

Remember this, the only way you “win” (financially) with life insurance companies is if you DIE EARLIER THAN THEY EXPECT. There are a ton of tables and statistics to make sure that even if they lose money on you, they will make money on 9 other “yous” to cover their loss.

Also, I must reiterate that the likelihood of you needing to pay taxes on your estate are low. However, if you believe that there is a strong possibility that you will leave more than the exemption (state or federal), then the better way to minimize taxes is to create a trust.

Also… people have brought something called the “Infinite Banking Concept” and its “Bank on Yourself” mantra to my attention, which utilizes Whole Life Insurance. That deserves its own post, and is for another time. Spoilers: I don’t like it, and don’t recommend it.

A trust?

Yea. Previously trusts were just for the super rich. However, there are a lot of good reasons to consider creating a trust, with estate taxes and avoidance of probate being some of the important ones. There are lot of different kinds of trusts and they can become very complex very quickly. However, it’s outside the scope of this post, so I will talk more about trusts in my post next week.

TL;DR

Having to pay estate taxes (federal or state tax), is pretty low (0.2% of the population).

However, it’s good to be educated on what could happen.

You never know if tax laws will change or if you will receive a windfall.

This combined with compound interest and increased equity in your home over time, make the possibility of triggering estate tax still unlikely, but plausible.

Don’t buy whole life insurance.

Stay tuned next week where I talk about trusts.

In the near future, I’ll also talk about the “Infinite Banking Concept” and its “Bank on Yourself” mantra.  Spoilers: I don’t like it, and don’t recommend it.

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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