5 estate planning strategies to keep your money in the family

Danielle Nelson

If you’re single, you can have up to $5.45 million in assets before your heirs have to worry about paying a penny in estate taxes.

Knowing that, you might assume only the super wealthy need to worry about estate planning. However, financial planners say you’d be wrong to think planning is only necessary for the 1 percent.

“The bigger issue in estate planning for the majority of people is managing the step-up in basis on inherited assets and income taxes,” says Matt Anderson, a certified financial planner and vice president of The Wise Investor Group in Reston, Virginia.

The step-up in basis refers to how assets such as investment property and second homes are valued and taxed after a death and how taxes are levied against traditional IRAs and 401(k)s inherited by someone other than a spouse. 

What’s more, states may want their piece of the pie. “If you’re just looking at the federal [estate tax exemption] number, you might not realize your state has a lower limit,” says AJ Smith, managing editor of the finance site SmartAsset.com. New Jersey has the lowest exemption, with state estate taxes kicking in once assets exceed $675,000 per person – a number that’s not hard to reach for those who have been saving since early adulthood.

Meeting with an accountant and an estate attorney is the best way to sort through complex issues such as the step-up in basis for property. While you’re talking to the pros, ask them about the following five strategies. 

Danielle Nelson

Draw up a will.

It’s an obvious first step, but many people don’t even bother to draw up a will. In fact, a 2014 Rocket Lawyer survey of 2,048 adults found 64 percent of Americans don’t have a will. What’s more, 17 percent said they didn’t think they needed one.

However, without a will, your estate must be divided in probate court, a process that could leave your beneficiaries footing a big bill. “If your estate is not properly constructed, the only person that wins is the attorney,” says Sean P. Lee, co-founder of the financial education organization Retirement Elevated.

Check your beneficiaries.

Not all assets are disbursed through a will. Some accounts, such as retirement funds and life insurance policies, let owners name beneficiaries for that particular asset.

“You’d be surprised how many people have no beneficiary or a previous spouse listed,” Lee says. Without a named beneficiary, an account will need to go to probate court, where a judge will decide who gets the money.

It’s a good idea to review beneficiary information after every major life change, including the birth of children, marriage or divorce. As Smith says, “You want your money to go where you want it to go.”

Danielle Nelson

Set up a trust.

If you have a sizeable estate or are worried your heirs won’t be wise with your money, you can set up a trust and appoint a trustee to distribute your wealth.

Trusts can be set up in several ways, but irrevocable, or permanent, trusts may offer the most tax benefits. When money is put into an irrevocable trust, the assets no longer belong to you. They belong to the trust itself. As a result, the money cannot be subject to estate taxes. While a trustee ultimately controls the money, you can create stipulations on its use, and money can be distributed from a trust even while you are alive.

A trust does have to pay taxes on its income from dividends, interest and other sources, and the tax rates for trusts can be higher for individuals. For that reason, Anderson suggests people pay expenses from a trust, whenever possible.

For example, if you were planning to help your child with a down payment on a house, it may make more sense to transfer money from a trust rather than pull cash out of a different account. “Using money from a trust will cause income to be taxed at the beneficiary’s potentially lower tax rate, instead of the trust’s tax rate,” Anderson says. 

Because of the complex nature of trusts, you’ll want to consult with an estate attorney to determine how best to create one that meets your goals.

Convert traditional retirement accounts to Roth accounts.

Leslie Thompson, a certified financial planner at Spectrum Management Group in Indianapolis, says the biggest surprise for many people is that their traditional IRAs and 401(k)s are subject to income tax if passed to a beneficiary who is not a spouse. “People think just because they have $100,000 in an IRA, their beneficiaries are going to get $100,000,” she says.

In reality, that money is subject to income tax. Currently, those taxes can be spread over the life of the beneficiary, but that might change. 

“Both [political parties] are talking right now about potentially forcing people to take that money over a shorter period,” Thompson says. Instead of stretching payments – and taxes – over a person’s expected lifespan, some proposals call for IRAs to be cashed out, and fully taxed, in as little as five years. 

You can avoid leaving your beneficiaries with that tax bill by gradually converting traditional accounts to Roth accounts that have tax-free distributions. Thompson says her firm recommends clients make a series of conversions over several years. Since the amount converted will be taxable on your income taxes, the goal is to limit each year’s conversion so it doesn’t push you into a higher tax bracket. 

Danielle Nelson

Gift your money while you're alive.

One of the best ways to ensure your money stays in the family is to simply give it to your heirs while you’re alive. The IRS allows individuals to give up to $14,000 per person per year in gifts. If you’re worried about your estate being taxable, those gifts can bring its value down. The money is also tax-free for recipients.

A similar way to reduce your estate value is through charitable donations. As a twist on that idea, Thompson suggests setting up a donor-advised fund. This option would give you an immediate tax deduction for money deposited in the fund, and then let you make charitable grants over time. By naming a child or a grandchild as a successor for the fund, “it would keep the family involved in philanthropy,” Thompson says. 

Complex strategies and the ever-evolving tax code can make estate planning feel intimidating. However, ignoring it can be a costly mistake for your heirs, even if you don’t have a lot of money in the bank. “Estate planning needs to happen for everybody,” Lee says.

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