Archive for December, 2010

Editors Note: This story was updated on 7/08.

Everything you own is considered part of your estate when you die. To grasp the importance of planning for the distribution of your worldly goods, consider all the things that influence what happens to them.

1. The role of probate

This is the procedure by which state courts validate a will’s authenticity, thereby clearing the way for the executor to collect and pay debts, pay taxes, sell property, distribute funds and carry out other necessary tasks involved with settling an estate. The process can be slow and expensive, and probate fees can absorb 3% to 7% of the estate’s assets. And if there is a “will contest,” costs will skyrocket.

Mindful of criticism and the spread of devices designed expressly to keep assets out of the grip of probate courts, most states have adopted a streamlined procedure for small estates, with informal procedures requiring little court supervision. Sometimes all that’s necessary is for the appropriate person to file an affidavit with the court and have relevant records, such as title to property, changed. Formal probate, in which major steps along the way are supervised by the court, is commonly reserved for large estates.

Not all of your estate has to go through probate. Among the items exempted from probate — but not necessarily from taxes — are life insurance payable to a named beneficiary, property left in certain kinds of trusts and assets such as homes and bank accounts held in joint tenancy with right of survivorship.

2. Joint ownership

Property jointly owned with a right of survivorship — the form that is commonly used by married couples but can be employed by any two people — automatically passes to the other owner when one owner dies. Tenancy by the entirety, another form of joint ownership, can apply only to married couples and isn’t recognized in all states. The pluses and minuses of joint ownership are discussed in detail later. For now, suffice it to say that it is an important estate-planning tool.

3. Federal estate and gift taxes

Despite all the attention given to the federal estate tax, few estates ever actually owe it. By one estimate, for example, the estates of fewer than 15,000 people who died in 2007 were large enough to trigger the much-vilified tax. For 2008, the first $2 million of an estate is tax-free, so only taxable estates larger than that have to pay the tax; the tax-free level rises to $3.5 million on January 1, 2009. Because the federal levy on taxable estates is a flat 45%, the $1.5-million increase in the exemption will save hundreds of thousands of dollars for the wealthiest who die in 2009.

As the law now stands, the estate tax is scheduled to disappear in 2010, then come back to life in 2011 with a skimpy $1-million exemption and a top rate of 55%. This will not happen. Instead, sometime in 2009 (no doubt near the end of the year), we expect Congress will approve estate-tax-reform legislation.

And we have an increasingly clear idea of what that legislation will look like because we know the positions of John McCain and Barack Obama, one of whom will almost certainly be president come January 20, 2009. Neither of the presumptive presidential candidates supports allowing the estate tax to disappear in 2010. And neither wants it to return with a vengeance in 2011.

The main points still to be negotiated are the top estate-tax rate and the exemption amount. Obama would extend 2009’s $3.5-million exemption into the future and hold the top rate at 45%. McCain favors a $5-million exemption and a 15% maximum rate. These positions give you the parameters for next year’s reform.

Under current law, married couples who leave their assets to their spouse can avoid tax on the entire estate of the first spouse to die, no matter how much it’s worth. This is called the marital deduction. But if the first spouse dies without fully using his or her exemption, the remaining amount is wasted. Both McCain and Obama support making the exemption portable. Thus, if one spouse were to die, the unused exemption would simply pass through to the survivor, effectively allowing a $7-million estate-tax exemption for a couple under Obama’s proposal, and a $10-million exemption under McCain’s plan. (Couples can effectively double their exemption now, but doing so often demands complex estate planning. Making the exemption portable would greatly simplify their financial planning.)

If your estate is likely to approach or surpass the taxable level, one way to reduce the estate-tax hit is to give away assets before you die. You can give away up to $12,000 a year to as many recipients as you wish without incurring what’s called a gift tax. (For married couples, the limit is $24,000 per recipient.) The gift tax is designed to prevent people from giving away too much of their wealth to prospective heirs and thus escaping the estate tax entirely. Current law allows you to give away up to $1 million during your lifetime tax-free, above and beyond those $12,000 annual tax-free gifts.

There is no limit on gifts between spouses and no limit on the marital deduction described above. This means that, with proper estate planning, the marital deduction and the estate-tax exclusion can be used to pass estates of any size from one spouse to the other without incurring federal estate tax. To make sure that you take full advantage of this opportunity and to minimize estate taxes upon the death of the second spouse, consult with an experienced estate lawyer familiar with the laws of your state.

4. State inheritance taxes

Until 2005, all 50 states and the District of Columbia had an estate tax, too: a so-called pickup tax, which applied only to estates owing the federal tax. The pickup tax didn’t actually increase the amount an estate owed but simply used a tax credit to channel revenue to your state rather than to the federal treasury. In 2005, though, the federal credit disappeared and so did the state’s pickup tax. So far, about 20 states have changed their laws to impose an estate tax, sometimes on estates small enough to avoid the federal levy.

Eight states–Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania and Tennessee–also levy an inheritance tax, which is paid by the beneficiary rather than the estate. In all states, transfers of assets to a spouse are exempt from the tax. In some states, transfers to children and close relatives are also exempt.

Adapted from Kiplinger’s Practical Guide to Your Money, by the editors of Kiplinger’s Personal Finance magazine (Kaplan Publishing. Copyright 2005 The Kiplinger Washington Editors, Inc.) Available wherever books are sold or direct at

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