While it may seem like a long way off, estate planning is the best way to ensure your assets are distributed the way you want. But while you may want certain family members to receive certain aspects of your estate, you also don’t want to leave them with a large tax bill. Many parts of your estate are taxable but there are ways you can avoid some of these taxes.
The step-up in basis is how certain assets like investment properties and second homes are valued and taxed following your death. It also refers to how taxes are levied against traditional IRAs and 401(k)s that you leave to someone other than your spouse. These five tips will ensure that you leave as much of your estate as possible to your family.
Draw a Will
Creating a will is an effective way of ensuring that your estate is distributed as you wish and that your family doesn’t have to go through trouble with your estate following your death. While many people do create wills, a majority of Americans leave their estate unprotected. A 2014 survey by Rocket Lawyer found that 64 percent of Americans don’t have a will. Of that 64 percent, 17 percent said they didn’t think that they even needed a will.
If you don’t create a will to state how you want your assets divided, the estate will go to probate court and a judge will make the decision for you. Apart from not having your say on how your estate is divided, it could also end up with your beneficiaries getting stuck with a large bill.
Know Your Beneficiaries
While a will can solve many potential disagreements with your estate, not all assets will be distributed through your will. Certain accounts like retirement funds and life insurance policies are passed on differently. Rather than being put into a will, these accounts allow the owners to name beneficiaries for each asset that will receive the asset upon your passing. If you decide not to name a beneficiary for any of these accounts, they’ll go to probate court and a judge will make the decision on who receives the account. For this reason, it’s important to review your beneficiaries after every major life change.
Set Up a Trust
If you have a sizable estate or you don’t believe that those you’re leaving your assets to are capable of responsibly managing what they’re left, you can set up a trust which will allow you to appoint a trustee that will distribute your assets. A trust can be set up in many different ways but an irrevocable trust, or permanent trust, offers the most tax benefits. When you put your assets into this type of trust, the assets of the trust no longer belong to you but to the trust itself. Because the money doesn’t belong to an individual, it’s not subject to taxes.
While the trustee will be in control of the money, you will be able to set certain stipulations for how the money will be distributed or how it will be used. Even while you’re alive, you’ll still have the ability to distribute the money. If you decide to create a trust, you will have to pay taxes on the income it receives from dividends, interest, and other sources and these tax rates can be higher than tax rates on individuals. For this reason, it’s recommended that you pay certain expenses from the trust whenever possible.
Converting Traditional Retirement Accounts to Roth Accounts
If you pass your traditional IRA or 401(k) on to someone other than a spouse, income taxes will be levied on those accounts. Currently you can spread the tax out over the lifespan of the beneficiary but politicians are considering forcing people to take that money over a shorter period. Some proposals would force people to cash out IRAs, fully taxed, in as little as five years.
A good way to avoid leaving your beneficiary with a tax bill is to gradually convert those traditional accounts to Roth accounts which allow for tax-free distributions. An important tip for making these conversions is to limit each one so that you don’t risk changing tax brackets.
Gift Your Money While You’re Alive
Another good way to transfer money to family members following your death is to gift it to them. The IRS allows individuals to gift up to $14,000 per person per year. Doing this can lower the tax burden on beneficiaries as these gifts are tax-free for recipients.
When you hand your assets down to family members following your death, some of those assets will be taxed. These tips will ensure that your beneficiaries get taxed as little as possible and your money goes to those that you want. If you’re looking to create your own estate plan, come see the professionals at France Law Firm.