Tax reform may impact your estate plan

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With the changes made by the Tax Cuts and Jobs Act of 2017, my wealth is nowhere near the heightened exemption amount. So, I don’t need to worry about an estate plan, do I?

The increased exemption amount may change how an estate plan is structured, but it does not alleviate the need for planning!

The increased exemption amount may change how an estate plan is structured, but it does not alleviate the need for planning! Consider the following:

  • What if you become incapacitated?

  • Are you married?

  • Do you have children?'

  • Do you have children with special needs or who are still minors?

  • Do you have a clear objective as to how and who you want assets to be distributed when you pass?

Federal tax exemption is not permanent

Every individual taxpayer is allowed to transfer a certain amount of assets (during their lifetime or at death) to someone else free of estate tax. This amount is referred to as the “lifetime exemption," and is $11.7 million for 2021 (per individual)¹. It is important to consider how your estate plan may be affected as a result. This increased exemption amount is scheduled to sunset at the end of 2025¹, at which time the exemption would revert back to the previous limits.

State estate tax exemptions differ from federal

Attention also must be given to planning in specific states that continue to have a separate state estate tax. Illinois, for example, happens to be one of the states that have a different estate tax exemption than the federal exemption amount. There can be gaps between the federal and state estate tax exemption, for example:

  • Federal estate tax exemption: $11.7 million 

  • Illinois state estate tax exemption: $4 million

  • Massachusetts state estate tax exemption: $1 million

In Illinois, that is a gap of over $7 million dollars if you pass before 2026. There are planning strategies that can address the gap between the state and federal exemption amounts.

Trusts provide clear direction and help avoid probate

A trust can be a powerful planning tool. During one’s lifetime:

  • The grantor retains full power of the assets in the trust

  • The trust is not treated as a separate tax entity for income tax purposes

  • The trust is revocable

In the event the individual becomes incapacitated, the named successor trustee would take over the administration of the trust assets, including distributing funds to the individual, his/her spouse, and their dependents pursuant to the terms of the governing instrument.

Upon the grantor’s death, the trust becomes irrevocable. The terms of the trust provide the “control from the grave,” which directs how assets are distributed or retained in trust for their family members, charitable organizations, or other individuals. While individuals may not feel it is necessary for assets to be retained in trust, consider the following:

  • Trust assets allow you to help direct how beneficiaries will manage the assets

  • Assets retained in the trust for some period of time help allow for creditor protection

  • Assets in trust may not be includable in the beneficiary’s estate

  • Retaining the assets in a trust may aid in preserving assets for the beneficiary’s lifetime

  • Trust assets can provide for beneficiaries with special needs without disrupting government aid

Trusts can ensure that your beneficiaries have access to funds

It is imperative to understand how the beneficiaries of your estate may differ depending on the exemption amount. Do your current documents have provisions that will result in the funding of a family trust upon your passing? If so, who are the beneficiaries of that family trust?

One basic estate planning strategy is to provide for what is sometimes referred to as an A/B Trust (Family and Marital Trust). The family trust typically is funded with the allowable and unused exemption amount at your passing, while the balance of the estate is typically allocated to a marital trust. Some family trusts provide benefits and distribution provisions for both the surviving spouse and the grantor’s children, while the marital trust is held solely for the benefit of the surviving spouse.

Will naming a broader class of beneficiaries in the family trust limit your spouse’s access to funds during his or her lifetime? Given the increased exemption amount, will all the individuals you have intended to provide for after your passing receive the funds you intended them to receive?

What if I die without a will or trust?

If your assets are held in your individual name with no beneficiary designation, not in joint title, and with no will, the assets will be distributed pursuant to the intestacy laws of the state you live in. In the event your assets pass pursuant to your will and you have no living trust, they will be distributed as provided in the document, but may be subject to state probate proceedings. The probate process may be worth avoiding; it can lead to unnecessary costs that could otherwise be avoided with the execution of a living trust. In addition, a will is a public document, whereas a trust is private. In summary:

  • Assets would pass by “intestate”

  • Assets would pass through probate

  • Assets could pass by beneficiary designation

  • There is a potential for court appointed guardians and/or conservators

What if my spouse remarries?

If assets are held jointly with your spouse, upon one’s passing the assets would be held for the surviving spouse. Sounds great, right? What if the surviving spouse remarries and does not retain any of the assets for your surviving children? Having an estate plan is not only a tax planning vehicle, but also a way to ensure you and your loved ones are provided for in the manner you desire.

Still don’t think you need an estate plan?

As your wealth advisor, we are here to help facilitate the appropriate conversation with counsel and discuss what planning strategies may be appropriate for your family. And if you do already have an estate plan, it is advisable that these documents be reviewed every 3-5 years with your attorney.

1 https://www.kitces.com/blog/final-gop-tax-plan-summary-tcja-2017-individual-tax-brackets-pass-through-strategies/

2 http://illinoisattorneygeneral.gov/publications/estatetax.html

3 https://www.mass.gov/service-details/estate-tax-overview

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