Published July 28, 2021
A phenomenon described by economists and financial planners as “the Great Wealth Transfer” has begun. The oldest members of the baby boomer generation are now in their early 70s and will begin transferring their wealth to the succeeding generations over the next 30 years.
The generations on the receiving end—Gen Xers and Millennials—will have to learn how to manage and grow the wealth they inherit. One particular aspect is critical to resolve before the “wealth transfer” happens—minimizing the costs of inheritance.
Even those who manage to write a will generally forget something when planning their estate, the costs of probate and how their heirs will pay for those costs.
Probate is the process of proving a will is valid, inventorying estate property, having it appraised, paying any debts or taxes, and distributing the remaining property according to the terms of the will (or according to state law, if there is no will).
Unless the estate assets were put in trust fund or conveyed directly through property or accounts with joint rights of survivorship, the estate will pass through probate. Unfortunately, probate generally tacks on both time and expense, depending on the estate, both can become significant.
Probate costs can include court costs, personal representative fees, attorney’s fees, accounting fees, appraisal and business valuation fees, bond fees, and other miscellaneous fees.
These fees can amount to around 3-8% of the value of the estate, not including any applicable estate, income, or inheritance taxes. And if the estate does not have enough cash to cover probate fees, taxes, and liabilities, some of the estate assets may need to be sold in order to pay the necessary fees.
One way to avoid the problem of probate costs is by setting up a trust. If most estate assets are made trust assets, then the probate process can be significantly minimized. There are costs to setting up and administering the trust, but those costs are generally much lower than what you would pay in probate costs and taxes.
Another way to potentially avoid probate is by setting up accounts as payable on death with your heir as the recipient, or by putting the heir on the title of the property and giving them joint rights of survivorship. You do not need to do this with retirement accounts or life insurance policies, since these will pass directly to the account beneficiary.
Probate costs can also be avoided by gradually gifting your estate ahead of time to members of your family. A gift of up to $14,000 per year, per recipient, can be given without having to pay the gift tax.
Another option for managing probate costs is making it easy for heirs to access cash. One way of doing this is setting up a life insurance trust. This allows the death benefit of the life insurance policy to be distributed by a trustee and can be set up to allow the trustee to use proceeds to pay for any estate taxes or fees.
An irrevocable life insurance trust, or ILIT, can be set up if the value of the life insurance policy would make estate assets surpass the federal estate tax threshold (currently estates worth more than $5.49 million must pay estate taxes when the owner of the estate dies). The assets held in an irrevocable trust are not counted as estate assets, and thus estate taxes can be avoided in some cases by putting life insurance policies and other assets in an irrevocable trust.
There is an additional element to consider if you are looking to reduce the cost of inheritance: where you live and where your property is located.
You may just think about climate and cost of living when choosing where to make your retirement abode. However, if you plan on leaving an inheritance behind, you should also consider state inheritance and estate taxes.
There are fourteen states (plus the District of Columbia) that have their own estate tax and six states with an inheritance tax. Two states (Maryland and New Jersey) have both. Some states are also more friendly than others when it comes to charging state income tax on retirement income. For those about to retire who have the option of relocating, consider how much it will cost you or your heirs in taxes if you choose to retire in a particular state.
If you or your parents have made plans for the estate already, you may not be finished. Transferring estate assets through a will may add undesirable costs and complications that you did not anticipate when you wrote your will. Plan today and you will be able to avoid those costs later so that the “Great Wealth Transfer” is a happy bonus for heirs rather than a stressful burden.
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