It is National Estate Planning Awareness Week - were you aware? Why is this week so significant? According to a recent study conducted by Caring.com, nearly two-thirds of all Americans do not have an estate plan in place. National Estate Planning Awareness Week was established in 2008 with the aim of educating Americans about the importance of estate planning and how it contributes to financial well-being.
Estate planning can be a complex process that people often put off, which can have costly tax impacts on their estates. To ensure that your estate plan is effective and tax-efficient, it's never too early to start and seek guidance from a qualified estate planning attorney or tax professional.
Here are some of the common tax mistakes often made in estate planning:
1. Failing to account for estate and gift taxes
One common mistake that many individuals make in planning for the future is overlooking the potential impact of federal and state estate and gift taxes. These taxes can have a significant effect on the value of your estate that will be passed on to your heirs.
Fortunately, there are several strategies that can help alleviate the burden of estate taxes.
- You may not know that you can gift $17,000 tax-free annually. Consider gifting assets annually under the $17,000 threshold to reduce the overall value of your estate prior to death. This can potentially reduce the amount of estate tax owed.
- Second, trusts can be a valuable tool for protecting your assets while still providing for your heirs. By utilizing trusts, you can safeguard specific assets from estate taxes and ensure that they are distributed according to your wishes.
- Additionally, it's important to take advantage of the gift and estate tax exemption, discussed further in section 3. This exemption allows you to pass a certain amount of wealth to your heirs tax-free. By structuring your estate plan to maximize the use of this exemption, you can significantly minimize the impact of estate taxes on your estate.
2. Failing to consider Capital Gains and Income tax consequences
Income tax and capital gains implications have to be considered as part of your overall estate plan. Many people overlook the fact that selling appreciated assets within an estate can trigger capital gains taxes. Additionally, many people don’t realize that distributions to beneficiaries are taxed to them as income. However, with proper planning, you can minimize these tax consequences.
Here are some areas to focus on:
- Capital gains taxes may apply when you sell appreciated assets within your estate, such as stocks, real estate, or collectibles. These taxes are based on the profits made from the sale and can vary depending on factors like the duration of asset ownership.
- One effective strategy to minimize capital gains taxes on your estate is to utilize a stepped-up basis. This adjusts the value of assets in your estate to their fair market value at the time of your death, effectively reducing or even eliminating capital gains tax liability for your heirs when they sell the assets.
- Another strategy is gifting appreciated assets to loved ones, transferring the capital gains tax liability to them. This can be beneficial if they are in a lower tax bracket or can take advantage of tax deductions.
- Donating assets to charitable organizations not only avoids capital gains taxes but also supports causes you care about.
3. Failing to plan prior to changes to the Unified Credit in 2026
Currently, an individual can give a total of $12.92 million dollars away during their lifetime and after death tax-free. This is doubled for married couples, amounting to almost $26 million dollars. This is called the Unified Credit and is currently the highest it has ever been. However, due to impending changes in tax law, this amount will decrease dramatically to roughly $5.5 million dollars in 2026.
This change in tax law will have substantial impacts on anyone with assets in excess of $5.5 million. Acting prior to 2026 means that you can take advantage of the high Unified Credit and use gifting as a strategy to the maximum effect.
Ways that individuals can take advantage of the Unified Credit include:
- Gifting assets to trusts, so that any appreciation is not subject to estate taxes upon death. By utilizing gifting as the transferral method, you avoid taxation normally associated with selling assets.
- Gifting assets to family members can allow you to take advantage of the Unified Credit and provide for family members during your lifetime.
4. Insufficient planning for business succession
If you're a business owner, it's important to have a clear succession plan in place to avoid any complications or tax issues when you transfer your business. Creating a thoughtful business succession plan can ensure a smooth transition for your business and minimize any tax liabilities.
When it comes to planning for the succession of your business, there are several key factors to consider:
- Identify a successor who has a deep understanding of your company's operations, vision, and values. By carefully selecting and preparing a successor in advance, you can ensure a seamless transition and maintain the continuity of your business.
- Establish a clear plan for transferring ownership and control of the business. Outline the specific steps and timeline for the transfer, taking into account any legal and financial considerations that may arise.
- Understand the potential tax implications of the transfer. Without proper planning, the transfer of a business can trigger significant tax liabilities for both owner and successor.
- Regularly review and update your business succession plan as circumstances change. Business dynamics, family dynamics, and tax laws can all evolve over time, so it's important to make any necessary adjustments to your plan to ensure its effectiveness.
5. Believing trusts are only for the super-wealthy.
Trusts can be incredibly valuable tools for business owners, providing individuals with greater control over how their assets are distributed and potentially offering tax savings when their estate transfers to their heirs. By establishing a trust, you can ensure that your assets are managed and distributed according to your specific wishes, even after you pass away.
There are many benefits to including trusts in your estate plan, that may include:
- Minimizing estate taxes. This allows business owners and high-net-worth individuals to maximize the value they can pass on to their loved ones.
- Providing asset protection and privacy by keeping assets separate from your personal estate, safeguarding them from creditors and legal disputes.
- Easing the burden on your loved ones when you pass. Trusts bypass probate, resulting in faster and more private asset transfer to beneficiaries without court interference.
Different types of trusts serve different purposes, and a sophisticated estate plan will be custom-tailored to your individual needs. To determine the best trust for your specific goals and needs, it's highly recommended that you consult with an experienced estate planner or tax professional.
6. Not keeping an estate plan up to date
As your life changes, it's important to make sure your estate plan is aligned. Failing to regularly update your plan can lead to unintended consequences and not accurately represent your wishes and financial situation. By being proactive and reviewing your estate plan during significant life events, you can ensure that it remains relevant and effective for your needs.
Significant life events should trigger a review of your plan:
- Marriages and divorces are important life events that can have a big impact on your estate plan. When you get married, you might want to include your spouse as a beneficiary or make adjustments to your current beneficiaries. In the case of a divorce, you may want to alter your estate plan to reflect your new wishes.
- The arrival of new family members or the loss of loved ones are moments that call for a thorough review of your estate plan. A new child or grandchild may mean including them as beneficiaries or setting up trusts to safeguard their inheritance. On the other hand, the passing of a loved one may require adjustments to your plan, like updating beneficiaries or modifying the distribution of assets.
- If you experience a significant increase or decrease in your assets, it might be necessary to review your distribution strategies or consider additional tax planning. Additionally, changes in tax laws can directly impact your estate plan. By staying updated on any legislative changes, you can ensure that your plan remains compliant and takes full advantage of available tax benefits.
7. Choosing the wrong executor or trustee
It is important to carefully consider the individuals you choose as executors or trustees for your estate. An executor is responsible for carrying out your estate plans, while a trustee manages any trusts you have established.
For instance, an inexperienced executor may struggle with the complexities of the probate process or make decisions that result in unnecessary taxes. Likewise, an untrustworthy trustee may not act in the best interests of the beneficiaries or mishandle the assets held in trust.
What to look for in an executor or trustee:
- Consider their level of financial and legal knowledge, organizational skills, and ability to communicate effectively with beneficiaries and other professionals involved in the estate planning process.
- Have an honest conversation to understand their willingness to take on these responsibilities and assess their overall character and integrity.
- It is also advisable to have a backup executor or trustee in case your first choice is unable or unwilling to fulfill the role. This ensures that your estate will be properly managed, even in unforeseen circumstances.
8. Believing you are too young to plan
Often, young people believe that they have no need to start planning their estate. It’s viewed as a problem that can be put off for a decade or two. The reality is that anyone with assets and loved ones needs an estate plan, regardless of the value of those assets. Estate planning should be viewed not only as a financial tool, but also as a protective measure for the loved ones you will leave behind. Having an estate plan in place ensures that your affairs are in order, no matter when it might become necessary.
Conducting sophisticated estate planning before you acquire wealth is also one of the most effective ways to grow generational wealth. By planning for future wealth, you can utilize appropriate tax savings strategies to ensure that your wealth can be passed to future generations.
9. Failure to leverage tax-advantaged accounts
When it comes to estate planning, tax-advantaged accounts like IRAs, 401(k)s, or HSAs are a foundational strategy. Failing to take advantage of these accounts can lead to unnecessary taxation and a decrease in the value of your estate.
Here are some effective approaches to maximize the benefits of tax-advantaged accounts:
- Optimize beneficiary designations: By carefully considering the tax implications for each individual, you can maximize the tax benefits. High-income earners may face higher tax rates upon withdrawal, while lower-income earners may have the opportunity to pay less in taxes.
- Plan distributions strategically: Strategic planning of distributions from multiple tax-advantaged accounts can minimize the tax burden on beneficiaries and help preserve more of your estate.
- Explore tax advantages for charitable giving: Utilizing tax-advantaged accounts for charitable donations can provide significant tax advantages. For instance, a qualified charitable distribution (QCD) enables you to transfer funds directly from your traditional IRA to a qualified charitable organization, reducing your taxable income and satisfying your required minimum distribution (RMD). This can be particularly beneficial for high-income earners or those seeking to minimize the impact of income tax on their estate.
10. Choosing the wrong professionals to help plan your estate
Your estate plan should ideally be one important part of a larger financial and tax savings strategy. When selecting your team of professionals, look for advisors who:
- View your business and personal goals holistically.
- Are willing to communicate with the other professional advisors in your life.
- Are up-front regarding expectations and fees associated with their services
- Have ample knowledge and experience to understand relevant laws and regulations, and ensure that your plan complies with every single one.
We understand that estate planning may not be the most pleasant topic to think about. However, considering all the hard work you've put into building something for your family, it's your responsibility to get the necessary assistance to pass on as much of your acquired assets as possible. To avoid any costly mistakes, collaborate with experienced estate planners, attorneys, and tax advisors. They possess the expertise needed to guide both individuals and business owners through the complexities of estate planning, identify opportunities for tax savings, and ensure that all legal requirements are fully met.
If you have questions about the tax readiness of your estate plan, we can help. Set up a time to talk with our team.