Insights for Your Journey

Have you recently learned that you could lose 40% or more of your hard-earned wealth to estate taxes? Federal estate tax, state estate tax, and income tax can take a substantial bite out of your wealth, leaving less for those you love.

But though estate taxes can be high, the federal estate tax exemption – the amount you can pass tax free – is also at an all-time high…for now. Tax reforms proposed last fall would have cut this tax free exemption by 50% or more. So, what can you do to take advantage of the all-time high exemption and reduce your estate tax bill?

Let’s look at an overview of the estate tax, exemption, and what you can do now.

 

What is the federal estate tax and the estate tax exemption?

Let’s start with a simple overview of the federal estate tax and the federal estate tax exemption.

  • The estate tax is a tax on your accumulated wealth assessed by the federal government when you die.
  • The tax starts at 18% on your first taxable $10,000 and climbs to 40% on taxable assets over $1 million.
  • Your first $12.06 million passes tax-free, called your “federal estate tax exemption”. Each spouse gets an exemption, so married couples can pass $24.12 million before owing any federal estate tax.
  • The exemption is “portable” which means your unused exemption transfers to your spouse if you are married.
  • Many states add an additional estate tax. In our home state of Washington, your first $2.193 million passes tax free and remaining assets are taxed at up to 20%. This article focuses on the federal estate tax only, but a complete plan should account for state estate taxes, too.

 

The 2022 exemption is the largest in history, but it won’t last.

The 2022 federal estate exemption is at an all-time high, increasing from $600,000 in 1997 to $12.06 million today. Here’s a look at how this exemption has changed over the years.

This all-time high exemption limit is unlikely to last. Tax reform proposals in 2021 aimed to reduce the exemption to approximately $6 million as early as the start of 2022. They also sought to limit some of the most effective strategies to avoid estate taxes. Though these proposed reforms were not passed, current law will automatically reduce the exemption to approximately $6 million at the end of 2025.

 

Are you at risk of owing estate taxes today?

How big is your potential estate tax bill? You can use our calculator to find out. If you have an estimated estate tax bill that makes you uncomfortable, then evaluating the use of your exemption is a good idea.

 

Much of today’s exemption is a ‘use it or lose it’ opportunity.

As we discuss in Plan by Default vs. Plan by Design, everyone has an estate plan by default…the government’s plan. Doing nothing means accepting their plan for your assets, which is fine for many. But is it fine for you? What’s the potential cost to your loved ones if you wait? Let’s look at two examples:

  • If your estate is $10 million, you’re under the current exemption and you wouldn’t owe any estate tax today. But if the exemption reduces from $12 million to $6 million (as it’s scheduled to in 2026), your estate tax bill could jump to $1.6 million or more.
  • If your estate is $35 million today, you’re already facing nearly $9.2 million in federal estate tax. If, however, the exemption went from $12 million to $6 million before you used it, you’re looking at a total federal estate tax bill of nearly $11.6 million.

 

Don’t I have to die to use the exemption? What can I do now?

You can use your $12.06 million exemption at death or during your life through gifts, which can be far more effective in many cases. This is in addition to the $16,000 gift limit you can give to each person each year.

So why would you give during your life instead of at your death? Two reasons:

  1. You lock in today’s all-time high estate tax exemption. We’ve already looked at the potential cost of waiting. If you give $12 million today and the exemption reduces to $6 million in future years, your full gift is already out of your estate and exempt from estate tax. But if you wait and the exemption is reduced, you’re now limited to that lower exemption and will pay more in tax.
  2. Save tax on future growth. If you give away $12 million today, live for another 20 years, and your gift earned 5% per year, the initial $12 million would grow to nearly $32 million. The $20 million in growth would be outside your estate and not subject to estate tax when you die, saving up to $8 million in taxes.

 

If I give it away, don’t I lose it? What if I need those funds?

There are a wide variety of ways you can make gifts for estate tax purposes and maintain some level of income or access to these assets during your life. Your estate and financial planning team can help you weigh these options when considering substantial gifts.

For more, read Out of Your Estate, Not Out of Reach.

 

Want to learn more about how to use your exemption and reduce estate taxes?

In How Do I Reduce Estate Taxes?, we detail a 5-step process to reduce your potential estate tax bill. You’ll want to be prepared to answer three questions:

  1. How much do I need in my retirement nest egg? These are the funds you need to enjoy life without worry. Once your nest egg is secure, attention can shift to reducing estate taxes.
  2. Do I want to make gifts to charity when I pass? Nothing passes to charity unless you make special provisions, so you’ll want to consider specific causes you care about and make sure funds are set aside in your estate plan.
  3. What impact do I want to make on my family? Some want to leave unrestricted funds to future generations, while others want to direct funds toward specific uses like education. Consider including the kids and grandkids in the discussion. These future generations will ultimately be the stewards of your wealth and it can help to invite them into your long-term legacy vision.

 

I’m ready to get started…but where do I start?

Your plan to reduce taxes and pass more to loved ones will require a team of financial, legal, and tax professionals, but a conversation with a comprehensive financial planning team, like ours at Alterra, is a great place to start. Before you have wills and trusts drafted, you’ll want a clear, coordinated action plan for the big picture.

Whatever your goals, the time to act is now. You don’t want to rush this process, but the all-time high estate exemption is an opportunity not to miss and it could be reduced anytime. With a clear plan and a coordinated team, you’ll be on your way to reducing loss to estate taxes and passing more to the people and causes you care about!

Alterra Advisors does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance.

Alterra Advisors - Josh Whelan

Grant Monson

CFP®, CLU®, ChFC®
Partner, Financial Advisor

About the Author

Grant grew up on a working wheat farm in eastern Washington. Today, he credits his family – who still manage the farm – for preparing him to build a business serving others. His vision to lead Alterra is built on relentless dedication to the success of his clients and the team – his extended family.

Grant’s dad says that he hasn’t worked a day in his life because “it isn’t work when you love what you are doing.” When combined with his mom’s view that “helping others should be part of every day”, Grant’s view of financial planning comes into focus. Alterra Advisors is very much a reflection of Monson family values.

Grant earned a bachelor’s degree in business and a master’s in economics at Washington State University. He launched his own financial advising practice over a decade ago, an entrepreneurial quest has become one of the most impactful things in Grant’s life. He loves coordinating the complex financial lives of business owners, bringing a depth of understanding that is rooted in his family’s own experience.

The “Alterra” name was coined by joining the Latin roots “alter”, the origin of the word “altruism” with “terra” meaning earth or land. This name reflects the company philosophy of “clients before profits” and providing firmly grounded advice.

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