The estate tax returned to a state of flux with Congress voting last week to extend the Bush era estate limit for another year. While this is a positive development for anyone who unfortunately has to deal with the death of a loved one in the next year, the overall impact of this decision will most likely include more estate planning uncertainty.
For the next year, the estate tax exemption remains at $5 million and the taxable portions of estates are taxed at 35 percent. After 2013, all bets are off.
Sadly, this puts those who are trying to better plan for their demise in a rough position. The latest proposal suggests the tax exemption will be lowered to $1 million while the rate of the taxable portion will rise to 55 percent. Without a doubt, there's a huge chasm between the current exemptions/rates and the proposals. Does a senior optimistically plan for the $5 million exemption or look to a much pricier reality with the exemption at merely $1 million?
Politics aside, the real winners here are estate planning attorneys and life insurance companies. Wealthy individuals can and should consult with a tax attorney when planning how to distribute their assets when they die. It's a smart practice that can often save their descendants from paying extra thousands of dollars in taxes. Life insurance policies, purchased specifically to pay estate taxes, are a common part of estate planning as the proceeds are used to pay taxes and hopefully enable individuals to pass on as much of their estates as possible to heirs and other beneficiaries. Note that failing to properly plan for estate taxes might mean that assets which a senior would like to pass on to heirs might have to be liquidated in order to pay the tax.
To tackle the current situation, here's what seniors and retirees need to do:
Assess your estate. Look at your overall estate and what you will be passing on to your heirs. Are you prepared to pay 55 percent tax on anything above $1 million? For example, let's say you are a senior who owns a $500,000 home outright and has $1 million in other assets. If the estate tax shifts back to previous levels, this senior will have to pay 55 percent of $500,000 (the amount above the exemption) which equals $275,000 in estate taxes. If the person in this example is anything like most Americans, having to concede more than a quarter million dollars to the government is not a prized option. We recommend consulting with a professional, and likely purchasing some life insurance that will help cover the roughly 18 percent "tax burden" that will fall upon the heirs.
Review your existing life insurance policy, particularly if you purchased one for estate taxes years ago. The insurance industry is constantly changing, and in many instances, policies purchased a few years ago may be expensive and outdated. If you are worried about estate taxes, consider purchasing additional insurance but also review existing policies. In some instances, older policies can be sold today and the funds can be used to purchase more appropriate coverage at much better rates. Life insurance remains a go-to option to pay estate taxes because it can be purchased now and the premium costs will likely be less than the payout.
Keep a close eye on this issue. If the $5 million "death tax" ceiling stays the same, (which I personally doubt due to the division in Congress), there will be a large group of Americans whose total estates will fall under that $5 million threshold. If these individuals have purchased insurance to pay higher amounts of taxes, they will then be "over insured." Rather than letting these policies lapse (a common occurrence), they should consider a life settlement as a means to secure additional value from these assets. I was recently interviewed about this on Varney & Co. on the Fox Business Network.
The estate tax debate is far from over. While it may not reach a fever pitch until after the election, any senior with assets in excess of $1 million should closely follow proposed changes, as they will impact hundreds of thousands of Americans and potentially generate millions of dollars in tax costs.