By Eric J. Seidman, CPA
Not everyone possesses a complex or taxable estate, and a significant number of taxpayers will leave behind far less than the federal lifetime exemption. However, regardless of the level of assets one expects to bequeath, there are several smart measures one should take to ensure a smoother estate experience for the eventual administrators. Some of these tips may seem more common than savvy, but they are equally as vital. As you consider mapping out your estate plans, be certain to consult an attorney on these matters because all situations differ.
Update Your Will
This may seem like a simple, obvious step, but you may be surprised to learn that a significant number of individuals pass away either without a last will and testament or with one that has not been updated in quite some time. Outdated wills may reference relationships that no longer exist (ex-spouses) or do not recognize current relationships that had not existed at the time of its creation (children, grandchildren, etc.). Some may be missing specific, desired bequests, which come out of the estate before the balance is distributed to beneficiaries. Whenever something important changes, it is critical to update this document. The will is the governing document when it comes to estates.
It is important to stay on top of who is listed as a beneficiary on your financial accounts. Beneficiaries are often added to accounts when established, but if an individual remains at the job offering that account for a long period, or with a brokerage institution for a long time after an account was opened, it is quite easy to overlook this aspect of estate planning. There have been countless instances where a retirement account beneficiary was not changed post-divorce, and the ex-spouse still had a claim to the assets. This can be worked out legally after the fact, but it does add to the legal cost of estate administration, reducing the amount to bequeath. There is also the possibility that an account was opened prior to any relationships being established, in which case the beneficiary may simply be listed as “Estate.” As we'll get into below, that could have significant tax implications.
Probate or Nonprobate
Not all assets are required to be probated. However, assets that immediately transfer into an estate are required to go through the probate process and, in Pennsylvania, be reported on the inheritance tax return. But not all assets have to transfer into the estate. For example, a 401(k) plan that had defaulted to the estate as the 100% beneficiary could be modified so the beneficiaries mirror the will. In this case, the 401(k) balance gets distributed directly to the beneficiaries and is not subject to probate or inheritance tax. Based on the size of the asset and the differing inheritance tax rates depending upon the type of relationship, this could save a significant amount of tax. Alternatively, assets could be treated as joint with rights of survivorship, where the balance transfers automatically to the account's co-holder.
The term “trusts” is broad and can cover a lot of things, but consider two options: a trust established under the will or one created in advance into which certain assets are transferred while the individual is alive. A trust may be established under the will to pass assets without going through the probate process. While a will frequently names an executor, the trust document would name trustees and include various provisions on how certain assets are to be administered. These are frequently established in the case of minor children.
Consider an unmarried parent of two children under the age of 18. Should the parent pass away, it may be of benefit to include the creation of a trust under which someone of majority age determines how and when the minor children are bequeathed or distributed assets.
An individual can also create a charitable remainder unitrust (CRUT) during his or her life. A CRUT allows an individual to pass an asset out of the estate and into a trust during his or her lifetime. Not only does this reduce the taxable estate, but, because this type of trust is established to eventually benefit charitable organizations, there also is an income tax deduction available in the year the contribution is made.
Estate planning can be complicated, but it is crucial to do so during one’s life. Even some simple steps can help ensure a smoother estate administration when one passes away. Few relish addressing their mortality and thinking about what happens when they are gone, but not doing so may result in their goals not being carried out and their estate assets being reduced while the courts determine how to best administer everything.
Eric J. Seidman, CPA, is with Wouch, Maloney & Co. LLP in Horsham, Pa. He is a member of PICPA’s CPA Image Enhancement Committee and Greater Philadelphia Chapter Federal Taxation Committee.
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