Federal estate taxes are also known by another term – the death tax. This is tax imposed on an estate by the federal government after someone passes away. There are also states that have their own estate tax as well as inheritance tax, but luckily Texas isn’t one of those at this time. (Full list can be found here at Does Your State Have an Estate or Inheritance Tax)
Estate taxes have a long history in the United States and there have been many periods of them being repealed and reinstated in history, beginning with a stamp tax in 1797, according to the IRS. In the early 1900 the estate tax rate was 10% and surged almost to 80% in the 40’s through the 70’s, but has since come down to the current rate of 40%. What this means is that estates that are over a certain value when someone passes away are taxed at a rate of 40% on the estate portion over the limit. Well, how much is that limit you might ask.
Currently, the amount of someone’s estate that is excluded from federal estate taxes is $11.58 million per person or a little over $23 million for a couple. For many people, that is nowhere near their projected net worth, but the catch is that the number can change. In 2001, that exclusion amount was only $675,000 per person and it is currently in motion to revert back to 2017 rates of $5.49 million per person with some inflation adjustment beginning in 2026. For some perspective, if you were to retire with $2.8 million at age 60, and the money grew by just 2.2% over 30 years, that would get you right up to the $5.49 million mark.
So if you are at the point of needing to plan, or you just want to be aware of your options in the future, here are 3 ways to help avoid federal estate taxes.
1) Give it Away
It may sound basic, but you can choose to give money away while you are alive as opposed to it all happening upon your death. If you give money to charities, that money is generally excluded from your estate when you pass. In addition, we have not only the multi-million dollar lifetime exclusion, there are also annual exclusions on top of this. You can give anyone you’d like $15,000 per year, per person, without having to do any IRS forms or hoops to jump through. So if you and your spouse want to give your child and their married spouse an annual gift, that could be $60,000 per year.
2) Get it Out of Your Name
This is similar to the first option of giving it away, but these options use tools that are available to you more than only writing a check, and most of them revolve around irrevocable trusts. Having a trust is fairly common as a way to keep assets out of probate, but many times those trusts are revocable living trusts. Irrevocable trusts are just that – irrevocable. You have to really be certain you want to move money into one because they are an entity all to themselves with different ownership and tax rules.
Charitable remainder trusts are one of the kinds of irrevocable trusts. The broad strokes of how these work is that you can set one up and fund it and then you or someone else can receive an income stream out of this trust for a period of time. At the end of the period or the life of the beneficiary, the remaining money all goes to the charity or charities of choice and you get to remove that money from your estate. These can be invested in investments or use an annuity inside of the trust and are sometimes referenced at CRATs or CRUTs as the abbreviation.
Another kind of irrevocable trusts are called grantor retained trusts. There are three types of these trusts and much of the difference between a GRIT, GRAT, and GRUT are the investments you hold within them. In all of these types, the grantor transfers funds into the trust and then the grantor is able to receive payment from it for a fixed amount of time. The payments received from the trust are excluded from their estate, but the balance is still included. These are very complicated and need an estate planning attorney really guiding you in the process and exploring all options.
3) Let Someone Else Pay Your Kids
Building on options 1 and 2, option 3 is where you use your annual exclusion and fund a life insurance policy within an irrevocable trust (also called an ILIT). Within an irrevocable trust, you set up a life insurance on yourself and create the beneficiaries however you’d like for your estate to pass. These too can be complicated in detail, but the general approach is you fund the life insurance policy with premium payments and each of these payments are seen as a gift to the beneficiaries. When you pass away, if the trust and insurance is properly set up, the death benefit pays to the trust and it is not included in your estate at the end. Because these are life insurance policies and can get more expensive the older one becomes, it can make sense to set these up earlier as opposed to later if you know that federal estate taxation will be an issue to contend with in the future.
So to recap, most people today will not have issues with federal estate taxes; however, there’s nothing to say that cannot change in the future and it is scheduled to be cut in half in 5 years. If you feel that your estate may fall into this range in the future, please reach out and let’s explore the right options for you and your family.
Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.