Why Review Your Estate Plan Regularly

BY CINDY YOUNGCOURT

It would be nice to do estate planning just once. For the majority of people, their wealth transfer plans don’t necessarily change over time, so they often see no need to revise their existing estate documents.

However, the tax rules for estates and wealth transfers do change on a regular basis. In light of recent estate tax law changes, it’s advisable for clients to meet with their financial representative and an estate planning attorney to review their documents.

I recommend that clients review their estate plans every three years, but certain life events such as marriage, divorce, death, birth and adoption may necessitate a more frequent review of your documents.

If your most recent estate plan documents were executed before 2018, you should schedule a review as soon as possible. That’s because there were substantial changes to the estate plan tax exemption in 2018. Your estate plans may be designed for a tax schedule that is no longer applicable.

What’s the estate tax exemption? 

Federal law stipulates how much of your wealth can be passed to your heirs with no federal estate tax.  The current exemption amount for 2020 is $11,580,000 for a single person. And thanks to portability between spouses, the exemption for a couple is double this amount.

That’s great news for most of us. If you have less than $11 million in assets, your beneficiaries won’t pay any federal estate taxes on their inheritance. If you have more than the current exemption amount, these assets will be taxed by the IRS at 40%.

Why do I recommend reviewing estate documents drafted prior to 2018? Just consider how much estate taxes and the estate tax exemption has changed in 20 years. Before the 2018 increase, the estate tax exemption amount $5,490,000 per person. Ten years earlier, the exemption amount was even lower at $2,000,000. Over that limit, estates were taxed at 45% at the federal level. (See the table at right.)

Imagine 1997 when the estate tax exemption was less than $1 million and the federal estate tax rate was 55%. Many more people were subject to estate taxes back then, and their wealth transfer plans were drawn up for that different time.

Should you bypass the bypass?

Many older estate plans for married couples include a bypass trust that’s funded after the death of one spouse by the amount of the estate tax exemption. Money in the bypass trust goes to the surviving spouse and never incurs federal estate taxes, even on any potential earnings.

For example, let’s say Jim and Jane Smith, a hypothetical married couple, drafted their estate plans in 2001. At the time, the estate tax exemption was $675,000, so the couple included a bypass trust in their estate document to avoid a big estate tax bill. Jim Smith died in 2011 with an estate worth $2,800,000. The bypass trust for Jane was funded with the entire amount of her husband’s estate because it qualified for the full estate tax exemption (which was $5 million in 2011.) Jane used money from the bypass trust for income and living expenses while the account appreciated in value.

Let’s assume Jane Smith died six years later in 2017. The bypass trust was worth $4 million at the time of her passing and was not subject to federal estate taxes. That’s great for her heirs, but even without a bypass trust, there would be no estate taxes because the total value of her estate was less than the 2017 exemption amount of $5,490,000.

But the Smiths made a major tax mistake by not updating their documents. The assets in the bypass trust avoided estate tax, but they did not qualify for the step-up in cost basis for capital gains when Jane passed away. After Jim died, his $2,800,000 grew to $4 million in the bypass trust for Jane. When Jane dies, her heirs’ tax basis is $2,800,000, not $4 million. So when the heirs sell these assets, they pay capital gains taxes on difference in tax basis—in this case, $1,200,000 of the assets are sold on the day they are inherited, which could be capital gains taxes of $240,000 instead of $0. If the assets had been transferred to Jane’s heirs without the bypass trust, they would get the step-up in basis to $4 million and could potentially avoid paying any capital gains taxes.

(Keep in mind, these tax rates are for assets in non-qualified accounts, as qualified accounts do not get a step up in basis.)

This is a good lesson in why it’s important to review estate plan documents on a regular basis—not every year, but often enough to make sure your plans are suited for your intentions under current tax law. That’s why I recommend every three years at a minimum.

Start your estate plan review.

If exemption amounts and bypass trusts sound confusing, don’t fret—they certainly can be. Estate planning would be complex even if tax laws and exemption amounts never changed.

Comprehensive financial planning includes regular reviews of your estate documents and tax laws, along with conversations with you to better understand the financial and personal dynamics of your family. Together, we partner with a skilled estate planning attorney to make sure your estate documents are drafted according to your exact wishes and minimize potential income, estate and capital gains taxes.

Please reach out and see how we can help you.