Common Mistakes & Misunderstandings

Create a Last Will and Testament. People today continue to pass on without a Will, allowing their State of Domicile to determine which heirs receive what property. It is commonly assumed that the surviving spouse will inherit the entire estate; however, the spouse's share often differs, when there is no Will. Additionally, if no heirs survive the decedent, then the entire estate is taken by the State of Domicile. To protect your assets, it is imperative to create a Last Will and Testament.

Use the Unified Credit. A costly misconception is that a Will is not necessary if the property is held jointly with a spouse. Unfortunately, this thinking results in a $435,000 or more minimum increase in taxes for estates valued at $2 million or more. The Unified Credit is a deduction of $345,000 of first spouse to die, which everyone is eligible (except non-citizens and nonresident aliens). The Unified Credit allows you to pass on $1 million to someone other than your spouse or to a non-citizen spouse without being taxed, saving your estate $345,000. It is possible to use this credit to transfer significant amounts of wealth during your lifetime or after your death with proper estate planning.

Life Insurance Proceeds Are Not Immune from Taxation. The owner of a life insurance policy has full management authority of that policy, such as changing the beneficiaries or borrowing against the policy's cash value. If the decedent owned the policy, then all of the proceeds to the beneficiaries are subject to estate taxes. To avoid the policy being taxed, ownership must be in the name of another individual or entity, such as an irrevocable life insurance trust. If in the name of another person, you have no authority over the policy. With a trust, however, you retain full authority and avoid the estate tax burden.

IRAs and Pension Plans Are Not Immune from Taxation. All deferred compensation plans, such as IRAs and pension plans, are subject to taxation as part of a decedent's estate. All distributions are subject to income tax upon receipt, and the value of the plan(s) is subject to estate tax, which can be as much as 55 percent. For example, if you have deferred compensation plans totaling $2 million, your estate may incur approximately $800,000 in income taxes and $660,000 in estate taxes - leaving only $540,000 to your heirs. With proper estate planning, the tax burden may be eliminated or reduced significantly.

Avoiding Probate Does Not Guarantee No Taxation on the Estate. Many people believe that if they place the bulk of their wealth into life insurance policies, IRAs, pension plans, annuities, and property held jointly with rights of survivorship then they will void the after-death tax burdens. Though these investment vehicles generally are not subject to probate, they may be subject to federal and state taxation, as shown in the above two paragraphs. Contact an attorney to take advantage of estate planning strategies.

The $1.5 Million Generation-Skipping Tax Exemption Does Not Take Assets from Your Heirs. Only one percent of individuals take advantage of this tax exemption, yet it provides an umbrella of protection for assets designated for children and grandchildren. It protects these assets from divorce, taxation, and any actions or claims against your estate. Be one of the one percent and use the generation-skipping exemption to protect your estate assets.

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