While many people hope to leave their family a tidy inheritance, you’re probably not intending for a big share to go to old Uncle Sam.
But a proposal in President Joe Biden’s tax plan and 2019 changes to inheritance rules may see the IRS taking a larger piece of your assets.
However far along you are in your retirement planning, here’s what you can do to ensure more of your estate goes to the people you want it to.
How estate taxes are handled
Many Americans won’t owe a federal estate tax, which some critics call a “death tax.” As of this year, the only households that have to worry about that are the estates valued at and above $11.7 million.
However, about a dozen states still levy this type of tax on a person’s estate before it gets distributed per the individual’s will.
But even if you don’t live in one of those states, that doesn’t mean your estate isn’t going to be taxed. It just means instead of being taxed before your estate is disbursed, your beneficiaries will owe the government a cut once they receive their inheritance.
A proposed change could impact your estate
President Joe Biden is reportedly considering a change to tax law that would impact how much of your estate your heirs get to keep.
Usually, when you inherit an asset and decide to sell it, you only have to pay taxes on the gains from when you got it rather than how much it has appreciated since it was originally purchased.
This is known as the step-up basis.
Let’s say a parent bought a house for $40,000 the year before their child was born. When they died decades later, it was worth $150,000. By the time their child gets around to selling it, it’s worth $200,000. With the step-up basis, you’d only pay tax on that $50,000 difference between what it was worth when you inherited it and its value when you sold the asset.
Getting rid of the step-up basis would mean you’d owe taxes on $160,000 — which is how much the home appreciated in value from the time it was purchased.
How the rules have changed recently
As of Jan. 1, 2020, the federal government has done away with Stretch IRAs.
Stretch IRAs used to allow beneficiaries who inherit an individual retirement account (IRA) to defer paying taxes on the full value of the account. Instead, you only had to withdraw the required minimum distributions for a number of years.
Meanwhile, the IRA’s value would continue to grow and ensure the beneficiary gets a larger payout after taxes when you finally withdraw the full amount.
The changes mean if you inherit an IRA from anyone other than your spouse, you’ll have to withdraw the full amount within 10 years of the original owner’s death. Failing to do so will result in paying a penalty of 50% of what was supposed to be distributed.
What you can do to reduce these effects
With both the above changes potentially in place, a lot of more of your estate is likely to land in the government’s coffers.
Fortunately, there are a few ways to plan now to help ease the tax burden on your loved ones.
1. Get life insurance
It’s an uncomfortable topic, but locking in an affordable life insurance policy is an important part of estate planning.
And you can draw from your taxed accounts to pay for a universal indexed life insurance policy to have your death benefit paid out tax-free to your beneficiaries — it’s a win-win.
2. Set up a Roth IRA
Not all retirement accounts work the same way.
Traditional IRAs won’t have you paying tax until you start withdrawing funds. But with Roth IRAs, you’ll contribute money after tax, meaning you and your beneficiaries can make withdrawals tax-free when the time comes.
3. Give some of your money as a gift
The federal government offers a $15,000 gift tax exclusion, which means you can give individual loved ones that amount each year without either of you having to pay tax on it.
If you don’t need the funds, there’s no reason you can’t give your grandkids money for school tuition or help your daughter with a down payment on a house.
As long as you don’t exceed the $15,000 limit, you’ll be able to share some of your wealth with your loved ones and watch them enjoy it.
Other ways you can set your family up for success
Even if your estate is fairly modest, you have a few options to give it a little boost before you plan to pass it on to your heirs.
Don’t leave them with the burden of debt. If you owe money when you die, your creditors can collect it from your estate. Make sure your family doesn’t have to deal with that by managing what you owe now through a lower-interest debt consolidation loan.
Find more savings in your budget. You may be overspending on your car insurance policy by more than $1,000 a year. Trim a few hundred from your monthly budget just by shopping around for a better rate. And while you’re dealing with insurance, shave another few hundred from your expenses by comparing offers on home insurance.
Keep growing your assets. Even if you don’t have much experience or a whole of lot cash to invest in the stock market, you can still see solid returns just from investing your “spare change.”. Those pennies will soon turn into profits your family can rely on for years to come.