“We don’t need estate planning. We’re not wealthy enough to owe estate tax.”
The first half is a misunderstanding. The second half is probably correct, and that is exactly why the first half costs families money.
The federal estate tax is not most people’s problem
The federal estate tax applies only above an exemption amount high enough that the large majority of estates never owe a dollar of it. If you have been avoiding planning because you pictured a tax bill at the end, that is most likely not your issue.
It is worth knowing the exemption is not permanent. Congress has adjusted it repeatedly, and scheduled changes have been written into law before and then altered. If your estate is anywhere near the threshold, this is worth monitoring with an advisor rather than assuming today’s number holds.
State taxes are a different conversation
Some states impose their own estate tax, often with a substantially lower threshold than the federal one. A handful impose an inheritance tax, which is assessed on what a beneficiary receives and sometimes varies with how closely related they were to you.
Where you live matters, and so does where you own property. A second home in another state can pull that state’s rules into your plan.
The tax that reaches ordinary families: inherited retirement accounts
This is the one worth understanding properly.
Money in a traditional IRA or 401(k) has never been taxed. When your heirs withdraw it, it is generally taxable income to them.
And under current rules, many non-spouse beneficiaries must empty an inherited account within roughly ten years rather than stretching withdrawals across a lifetime. Spouses generally have more favorable options, and certain beneficiaries, including some minor children, disabled or chronically ill individuals, and those close in age to the account owner, may be treated differently.
The practical effect: if your child is in their peak earning years, a large inherited account may have to come out during exactly the decade their own income is highest, stacked on top of their salary.
That does not mean the inheritance is a bad thing. It means the sequencing is worth planning. Options to discuss with your advisors can include Roth conversions during your lifetime, which pay the tax at your rate instead of theirs; naming different assets to different beneficiaries based on their tax situations; and leaving retirement assets to charity while leaving other assets to family, since a qualified charity generally does not pay income tax on those funds.
Capital gains and the step-up in basis
Property that passes at death often receives a step-up in basis, meaning the heirs’ basis becomes the date-of-death value. A house bought for $90,000 and worth $400,000 can pass to children who then sell it with little or no taxable gain.
Giving that same house away during your lifetime generally does not produce that result. The recipient may take your original basis, and the gain surfaces when they sell.
This is the mathematics behind why the do-it-yourself probate shortcuts backfire. The transfer saves a probate filing and can cost far more in capital gains.
Where life insurance fits
Insurance is the liquidity tool in all of this.
It gives the estate cash. Taxes, debts, final expenses and the cost of maintaining property all come due before anyone inherits. Without cash, families sell assets quickly, which usually means selling them cheaply.
It funds buy-sell agreements. An agreement that your business partner will purchase your interest is only as good as the money behind it.
It equalizes inheritances. When one child inherits the business or the farm, insurance can give the others a comparable share without forcing the asset to be split or sold.
While you’re looking, check the basics: is the coverage amount still right, when does a term policy expire, does employer coverage end with the job, and are the beneficiary designations current? A policy naming an ex-spouse is one of the most common errors we find.
A word of caution about anything you read, including this
Tax rules in this area change regularly, thresholds adjust, and the right answer depends on your state, your assets and your beneficiaries’ circumstances. Treat articles as a map of the questions, not a source of the answers.
Let’s look at what actually applies to you
Call us or send a message to schedule a free estate planning consultation, and we’ll work through which of these reach your family and what can be done about them.
Visit www.heritancelaw.com to get started.
