Estate Tax Planning Tips for Single People
|Estate planning is an important part of your overall wealth management strategy, especially if you’re unmarried. Single parents may worry about who will care for their minor children and whether their surviving kids’ financial needs will be met until adulthood. Likewise, wealthy single people have less flexibility when it comes to shielding transfers from gift and estate taxes. |
Fortunately, under the Tax Cuts and Jobs Act (TCJA), estate tax issues are less of a concern. The exemption amounts have been temporarily raised, so you’re less likely to be hit with the federal estate tax. But you may need to update your existing estate plan to take advantage of the favorable changes.
Estate and Gift Tax Basics
The TCJA sets the unified federal estate and gift tax exemption at $12.92 million for 2023 (up from $12.06 million for 2022). The exemption amount will be adjusted annually for inflation from 2021 through 2025. In 2026, the exemption is set to return to an inflation-adjusted $5 million, unless Congress extends the larger exemption.
Taxable estates that exceed the exemption amount will have the excess taxed at a flat 40% rate. In addition, cumulative lifetime taxable gifts that exceed the exemption amount are also taxed at a flat 40% rate. Taxable gifts are those that exceed the annual federal gift tax exclusion, which is $17,000 for 2023 (up from $16,000 in 2022). If you make gifts in excess of what can be sheltered with the annual gift tax exclusion amount, the excess reduces your lifetime unified federal estate and gift tax exemption dollar-for-dollar.
Important: Some states also charge inheritance or death taxes, and the exemptions may be much lower than the federal exemption. Discuss state tax issues with your tax advisor to avoid an unexpected tax liability or other unintended consequences of an asset transfer.
Estates at or Below $12.92 Million
If your estate is valued at less than $12.92 million for federal estate tax purposes and you die in 2023, everything you own can be left to relatives and loved ones without any federal estate tax hit ($12.06 million in 2022).
But there are still reasons for you to create (or review) your estate plan. For example, if you have minor children, you need a will to appoint someone to be their guardian if you die. Or you might want to draft a will to designate specific assets for specific individuals. Likewise, if you’re concerned about leaving money to an individual who isn’t financially astute, you might want to set up a trust to manage assets that person will inherit.
From a tax perspective, any existing estate planning documents may now be outdated. The federal unified estate and gift tax exemption was much lower in prior years. (For example, it was $2 million for 2006 through 2008, $3.5 million for 2009 and $5.49 million for 2017.) Your old planning efforts may have been set up to make enough charitable donations to get the value of your estate down to the much-smaller estate tax exemption amount that applied in some bygone year.
Now that the unified exemption is much higher, you can leave a lot more to your loved ones and a lot less to charity without any federal estate tax hit. If that’s what you want to do, your paperwork may need to be updated.
Estates Over $12.92 Million
If you had died in 2010 — the one year that the federal estate tax was repealed — you could have left everything you own to relatives and loved ones and no federal estate tax would have been due even if you were a billionaire.
But it’s a different story now with the $12.92 million federal estate and gift tax exemption. You might want to change your estate planning documents to direct the executor to give away more to IRS-approved charities to get your taxable estate down to the current $12.92 million federal unified exemption.
Put another way, up to $12.92 million can be left to relatives and loved ones without any federal estate tax hit if you die in 2023. If you leave more, there will be a federal estate tax bill to pay. But the taxable value of your estate is reduced by donations that the executor of your estate is directed to make to IRS-approved charities. Of course, increasing charitable donations to avoid the estate tax means leaving less to your loved ones.
Smart Moves for Big Estates
Unmarried people with estates worth more than $12.92 million should consider planning strategies designed to lower their exposure to federal estate and gift taxes. For example:
Make annual gifts. Each year, you can make annual gifts up to the federal gift tax exclusion amount. The current annual federal gift tax exclusion is $17,000. Annual gifts help reduce the taxable value of your estate without reducing your unified federal estate and gift tax exemption.
For example, suppose you have two adult children and four grandkids. You could give them each $17,000 in 2023 (up from $16,000 in 2022). That would remove a grand total of $102,000 from your estate ($17,000 × six recipients) with no adverse federal estate or gift tax consequences. This strategy can be repeated each year, and can dramatically reduce your taxable estate over time.
Pay college tuition or medical expenses. You can pay unlimited amounts of college tuition and medical expenses without reducing your unified federal estate and gift tax exemption. But you must make the payments directly to the college or medical service provider. These amounts can’t be used to pay for college room and board expenses, however.
Give away appreciating assets before you die. In 2023, you can give away up to $12.92 million worth of appreciating assets (such as stocks and real estate) without triggering federal gift tax (assuming you have never tapped into your unified federal estate and gift tax exemption in prior years). This can be on top of 1) cash gifts to loved ones that take advantage of the annual gift tax exclusion, and 2) cash gifts to directly pay college tuition or medical expenses for loved ones.
Set up an irrevocable life insurance trust. Life insurance death benefits are federal-income-tax-free. However, the death benefit from any policy on your own life is included in your estate for federal estate tax purposes if you have so-called “incidents of ownership” in the policy. It makes no difference if all the insurance money goes straight to your designated beneficiaries.
It doesn’t take much to have incidents of ownership. For example, you have incidents of ownership if you have the power to:
Borrow against the policy,
Cancel the policy, or
Select payment options.
This unfavorable life insurance ownership rule can cause unsuspecting taxpayers to be exposed to the federal estate tax.
Important: The life insurance ownership rule is more likely to adversely affect single people. Why? Because the death benefit from a policy on the life of a married person can be left to the surviving spouse without any federal estate tax hit, thanks to the unlimited marital deduction privilege (assuming the surviving spouse is a U.S. citizen). In contrast, single people don’t have that privilege, leaving them without an easy way to remove life insurance death benefit proceeds from their taxable estates.
To avoid this pitfall, unmarried people with large estates can set up irrevocable life insurance trusts to own policies on their lives. The death benefits can then be used to cover part or all of the estate tax bill. This is accomplished by authorizing the trustee of the life insurance trust to purchase assets from the estate or make loans to the estate. The extra liquidity is then used to cover the estate tax bill. The irrevocable life insurance trust is later liquidated by distributing its assets to the trust beneficiaries (your loved ones). Then, the beneficiaries wind up with the assets purchased from the estate or with liabilities owed to themselves. And the estate tax bill gets paid with money that wasn’t itself subject to federal estate tax.
There are some important considerations, however.
If you move existing policies into the trust, you must live for at least three more years. If not, the death benefit will be included in your estate for federal estate tax purposes, as if you still owned the policies at the time of death.
When existing whole life policies are transferred into the trust, their cash values are treated as gifts to the trust beneficiaries.
In addition, you may need to consult your tax advisor to find ways to get the cash needed to pay the insurance premiums into the trust without adverse tax consequences.
The TCJA generally improves the federal estate tax posture of taxpayers for 2018 through 2025. But, to achieve optimal results and cover all your bases, you may need to meet with your tax and legal advisors to create or update your estate plan.