Estate planning priorities: Take inventory. - Blog Popular Bank

03.22.2022 /

Estate planning priorities: Take inventory.

This is Part 2 in a three-part blog series that highlights key aspects of the estate planning process.

There are many estate planning strategies, including some that are implemented inter vivos (during life), such as making gifts, and others post-mortem (after death), such as disclaimers. Before choosing which strategies are right for you, familiarize yourself with the basics of estate planning, which can then help you identify important priorities to consider.

Gather and analyze the facts.

Gather and analyze the facts to help you get a full picture of your financial makeup. The following questions may help you accomplish this. If they are not easy to answer, you may have to make some estimates based on reasonable assumptions and expectations.

Information regarding your financial makeup:

  • What is your current income?
  • What is your income likely to be in the future?
  • How much do you spend each year?
  • What are your expenses likely to be in the future?
  • What are your current assets and debts?
  • Are your assets currently owned solely or jointly?
  • What estate planning strategies have you already implemented?

Family information:

  • Who are the family members you intend to benefit?
  • What are the needs of each family member?

What other important factors do you need to consider?

Decide what your goals and objectives are in light of your circumstances and in light of the factors that may affect your estate. The primary factors that may affect your estate are your beneficiaries, taxes, probate, liquidity and incapacity.

1. Taxes

One of the largest potential expenses your estate may have to pay is taxes, which may include federal transfer taxes, state death taxes and federal income taxes.

Federal transfer taxes.

The federal transfer taxes include (a) the federal gift tax and estate tax and (b) the federal generation-skipping transfer (GST) tax.

Federal gift tax.

Gift tax is imposed on property you transfer to others while you are living. You need a basic understanding of how the gift tax system works to minimize gift tax liability. Under the gift tax system, in 2021 you are allowed a $11,700,000 lifetime applicable exclusion amount that reduces your gift and estate tax liability (any [basic] applicable exclusion amount you use during life effectively reduces the amount that will be available at your death). Also, you are currently allowed to give $15,000 per donated gift tax free under the annual gift tax exclusion (the annual gift tax exclusion is indexed for inflation, so this amount may change in future years). Further, certain other types of transfers can be made gift tax free. You need to understand what these types of transfer are and how they work to take full advantage of them.

Federal estate tax.

Generally speaking, estate tax is imposed on property you transfer to others at the time of your death. You need a basic understanding of how the estate tax system works for several reasons:

Saving your property for your beneficiaries.

Estate tax rates could reach as high as 40 percent in 2021, which means that a large chunk of your estate may go to the federal government instead of your beneficiaries. If you want to preserve your estate for your beneficiaries, you’ll need to know how to minimize estate tax with respect to your property.

Reducing estate tax liability.

Under the estate tax system, you are allowed an applicable exclusion amount that reduces your estate tax liability. Also, there are exclusions, deductions and other credits available that allow you to pass a certain amount of your estate tax free. You need to understand what these exclusions, deductions and credits are and how they work to take full advantage of them.

Providing for the payment of estate tax.

Generally, estate tax must be paid within nine months after your death. To avoid depriving your beneficiaries of what you intend for them to receive, you should provide that specific and sufficient assets be set aside and used for this purpose. In addition, these assets should be sufficiently liquid to pay these expenses when they are due.

Planning for estate tax expense.

Although calculating estate tax can be complex, you should estimate what the amount of your estate tax may be (if any), so that you can arrange to replace that wealth.

GST tax.

The GST tax is imposed on property you transfer to an individual who is two or more generations below you (e.g., a grandchild or great-nephew). Not surprisingly, the IRS wants to levy a tax on property as it is passed from generation to generation at each and every level. The purpose of the GST tax is to keep individuals from avoiding estate tax by skipping an intermediate generation. A flat tax rate equal to the highest estate tax then in effect is imposed on every generation-skipping transfer you make over a certain amount. You are allowed a GST tax exemption of $11,700,000 in 2021. Currently, some states also impose their own GST tax. Check with an attorney or your state to find out what may be subject to your state’s GST tax, and how and when to file a state GST tax return.

State death taxes.

You should be aware of what the death tax laws are in your state and how they may affect your estate. There are three types of state death taxes: (1) estate tax, (2) inheritance tax, and (3) credit estate tax (also called a sponge tax or pickup tax). Some states also impose their own gift tax and/or GST tax.

Estate tax.

State estate tax is imposed on property you transfer to others at your death, much like federal estate tax. The state estate tax calculation for most states is similar to the federal calculation.

Inheritance tax.

Unlike estate tax, the inheritance tax is imposed on your beneficiary’s right to receive your property. Tax is due on each beneficiary’s share of your estate. Beneficiaries are grouped into classes (generally based upon their familial relationship to you) and are taxed accordingly. Although inheritance tax is due on each heir’s share of your estate, it’s your personal representative who writes the check from your estate to pay it.

Credit estate tax.

Some states impose a credit estate tax (also referred to as a sponge tax or pickup tax).

Tip: Most states that imposed a credit estate tax have “decoupled” from the federal system (i.e., they’re imposing some form of stand-alone estate tax).

Tip: The federal system allows a deduction for state death taxes for the estates of persons dying in 2005 and later. Prior to 2005, a credit was available.

Federal income taxes.

In the estate planning context, you should be aware of three federal income tax considerations:

Income taxation of trusts.

If your estate plan includes the use of a trust, you need to know that a trust may be an income tax-paying entity. The trustee may be required to file an annual return and pay income taxes on trust income.

Decedent’s final income tax return.

Your personal representative or surviving spouse has the duty of filing your last income tax return that covers the tax year ending on the date of your death.

Income taxation of your estate.

Your estate is considered a separate income taxpaying entity. Your personal representative must file and pay income taxes on any income your estate receives (e.g., interest from bonds, or dividends from stock).

2. Probate

Probate is the court-supervised process of proving, allowing and administering your will. The probate process can be time consuming, expensive and open to public scrutiny. Avoiding probate may be one of your most important goals. To develop a successful avoidance strategy, you’ll need to understand how the probate process works, how to estimate probate costs and what is subject to probate.

3. Liquidity

Estate liquidity refers to the ability of your estate to pay taxes and other costs that arise after your death from cash and cash alternatives. If your property is mostly nonliquid (e.g., real estate, business interests), your estate may be forced to sell assets to meet its obligations as they become due. This could result in an economic loss or your family selling assets that you intended for them to keep. Therefore, planning for estate liquidity should be one of your most important estate planning objectives.

4. Incapacity

Planning for incapacity is a vital yet often overlooked aspect of estate planning. Who will manage your property for you when you can no longer handle these responsibilities? You need to ask and answer this question because the consequences of being unprepared may have a devastating effect on your estate and loved ones. You should include plans for incapacity as a part of your overall estate plan.

It’s not too late to begin your estate planning process.

Connect with a Popular Private Banker today and take the next step toward creating an estate plan that benefits you and your family.

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