Why Everyone Should Have an Estate Plan
Estate plans can save your loved ones a lot of time, effort, and potentially a lot of money. You don’t have to be uber wealthy to benefit from estate planning. Anyone can save their loved ones time and confusion by setting up a will and passing on most assets outside of the probate process.
Estate planning can be especially useful to those in Washington State, where estate taxes kick in at a much lower threshold than at the federal level. Many of those in Washington who own their own homes and have retirement assets may find their estate subject to tax.
Estate Planning Basics
Last Will and Testament
The last will and testament is a legally binding document that communicates a person’s final instructions for how their money, property, and other assets should be handled after death. This also gives you a chance to list out what (and where) all your assets and liabilities are at so it’s easier for your beneficiaries to account for everything.
For those with minor children, the will also provides them the opportunity to choose a personal guardian.
What makes a will legal? It must be typewritten and you must be at least 18 and of ‘sound mind.’ The will must name at least one executor and must be dated and signed in front of two witnesses over 18 who are not beneficiaries of the will.
If you have no will in Washington State, a state appointed administrator will distribute your assets according to Washington State Succession Laws. These laws give your estate to your “closest” living family or relatives.
Probate is the legal process that occurs after a person passes away. During probate, your assets are identified, all debts and estate taxes are paid, and fees for lawyers, appraisers, and for court filings are paid before the remaining estate property is distributed to inheritors.
In Washington State probate generally takes between 6-12 months with 4 months being the minimum time to give creditors the chance to make a claim against the estate.
Given the time and cost of probate it’s generally best to pass along most assets outside of the probate system.
Most common major estate assets such as retirement or investing accounts and property can be passed on without going through probate. It just requires proper planning and preparation. Retirement and investment accounts give the option to list beneficiaries to whom the account will pass upon death. Other accounts such as checking and saving accounts can utilize pay-on-death designations to achieve the same outcome.
You can establish a living trust which allows you to retain full control over your trust property while you live. After death the property in the trust is quickly transferred to beneficiaries. By retitling assets such as your home or other property in the name of the trust you can pass these assets to your beneficiaries outside the probate system.
Washington State Estate Tax
Washington State currently has the highest top estate tax rate in the nation (tied with Hawaii at 20%). The state has an estate exclusion amount in 2021 of $2,193,000. This means that assets up to that limit are not subject to any estate tax. Then a graduating estate tax rate kicks in between 10-20%:
If you’re married your assets will transfer to your spouse tax free, however your exemption is not portable to your spouse in Washington State (unlike the federal estate tax exemption). Let’s say a husband and wife have an estate worth $5M and the husband passes away without any estate planning. The wife will not have to pay any taxes on the husband’s half of the estate. However, when she later passes she will have a taxable estate of over $2.8M ($5M estate less her $2.193M exemption).
How could the couple above have lowered their taxable estate? They could have established a credit shelter trust, also known as an A/B trust or bypass trust. Most wills in Washington State for couples with estates over the exemption amount will include a provision allowing for creation of such a trust. The surviving spouse is typically the trustee and may receive income from the trust for life with the proceeds of the trust going to the beneficiaries upon the surviving spouse’s death. Thus when the second spouse passes away, the $5M estate will receive two exemptions.
Here’s the difference in estate taxes for the two situations:
|No Estate Planning||Credit Shelter Trust|
|Washington Estate Tax||$361,050||$61,400|
Thus by setting up a credit shelter trust the hypothetical couple would save nearly $300K in estate taxes.
Federal Estate Tax
Following the passage of the Tax Cuts and Jobs Act of 2017, the federal estate tax exclusion amount doubled. In 2021 that exemption amount is $11.7M, meaning that only ultra high net worth individuals currently have to worry about federal estate taxes as a married couple can pass along an estate of over $23M tax free.
The process for keeping spousal portability is simpler for federal estate tax purposes. When one spouse passes you file form 706 (US Estate Tax Return) with the IRS which preserves the deceased spouse’s exemption for the future if property passes to the surviving spouse.
The higher federal estate tax exemption will reset to lower levels in 2025 without any changes to the law. Furthermore, the Biden administration has proposed taxing capital gains upon death (currently you don’t have to pay capital gains taxes at death and your beneficiaries receive a step up in tax cost basis to the fair market value). These will be important things to watch going forward for estate planning purposes.
Living Wills (Aka directive to physicians or health care declaration)- a legal document in which you state your wishes about life support and other kinds of medical treatments
Power of Attorney -This is where you name someone to handle your financial matters and/or medical decisions in the event you become incapacitated
There are a lot of emotionally charged aspects of estate planning that people may want to think about. Creating a will is a good chance to have a discussion with beneficiaries about family heirlooms or other items with significant emotional significance. There may be hurt feelings over other issues as well such as who was chosen as the executor.
Some may have unique planning needs when one or both spouses have children from a prior marriage. There’s also issues one must consider when they don’t trust their beneficiaries with large sums of money or if one’s beneficiaries are underage. Many of these challenges can be addressed through proper planning and different trusts can be established to aid in these circumstances.
There’s also other tax saving options for those with larger estates such as charitable giving and reducing an estate through gifts under the annual exemption amount. Currently you can give up to $15K to an individual each year without it counting towards your estate or gift exemptions. Such annual giving can help reduce the future tax burden on larger estates.
While estate planning can seem complex, it is so helpful to your beneficiaries to have a listing of all your assets and debts and know your wishes for your estate. Helping pass along your assets and avoid some of the headaches of probate during a difficult time for your beneficiaries through proper estate planning is a wonderful gift you can give them.
Scott Caufield, CFA, CPA