How to Prevent Getting Hit With Inheritance Taxes

(beeboys/Shutterstock)

Receiving an inheritance can be considered a great blessing. Even though you will be missed, your heirs will be glad that you named them as a beneficiary. If you have not made any preparation to cover or prevent inheritance taxes, your beneficiaries will discover that they will not get nearly as much as they hoped.

Preparing to pass on your estate and avoid inheritance taxes is a part of good estate planning. These taxes are taken out of your beneficiaries’ distribution.

Here are some ways to get your estate ready to change hands without the dreaded inheritance tax.

Write a Will

You need to be aware that writing a will cannot help your estate escape taxes. Having one is a good idea, because if a probate court is needed, it will direct the court by revealing your intended beneficiaries.

One of the few options available to avoid estate and inheritance taxes is to will your estate to your spouse. In most places, it will enable your estate to pass legally to your spouse without taxes.

Gift Your Assets Before You Pass On

Probably the best and cheapest way to pass your assets to your beneficiaries is to gift it to them. When you do this, there is no tax on the money passed to them. Any profit made from the money is taxable, such as interest.

If you have a large estate, you can reduce the size of it in advance by giving your assets away. Doing so reduces the size of your estate and means that any required inheritance tax will be less.

In 2022, FinanceBuzz says you are allowed to give away up to $16,000 to any person and to as many people as you want. Your spouse can also give away the same amount, making it possible to give away up to $32,000 to the same person. The limit will be raised in 2023, to $17,000 per person.

There is a limit to how much the government will let you give away. It is called the lifetime gift and estate tax exemption. In 2022, you can give away up to a total of $12.06 million. In 2023, the total amount of gifts you can give away in your lifetime is $12.92 million.

The exemption limit is going to be reduced in 2025 down to $5.49 million. So, if you want to reduce more of your estate without inheritance taxes (and fewer estate taxes), you want to give it away while the limit is much higher.

Inheritance Tax-Exemption Limits

There is no federal inheritance tax, but six states have one. States with inheritance tax place exemptions that enable some of the estate to pass to the heirs without any taxes. Smaller estates may not pay any inheritance taxes.

In some cases, the percentage tax on the inheritance depends partly on how close you are to the deceased. Investopedia mentions, for instance, that Kentucky exempts immediate family members, but everyone else only has an exemption of either $500 or $1,000. The tax ranges from 4 percent to 16 percent, depending on the size of the estate.

Another state—New Jersey—exempts charities as well as immediate family members. Siblings, sons, and daughters-in-law are exempt up to $25,000, and the tax ranges from 11 percent to 16 percent, dependent on the estate’s size and their relationship.

Put All Your Assets Into a Trust

A trust can enable your assets to go directly to your beneficiaries without going through probate court. Lawyers need to create them correctly to avoid legal complications later and extra costs.

There are two kinds of trusts, but one is safer. A revocable trust allows you to put assets into it and later remove them if you want. You retain control. This one is not as safe as the other from taxes because everything in it is under your control—therefore, part of your estate. The only option to keep the assets safe from taxes is to put into your will that the assets in your revocable trust be placed immediately into an irrevocable trust after your death.

The other kind of trust—an irrevocable trust—puts assets in the trust under the hand of a trustee. Generally, assets in an irrevocable trust are no longer under the control of the person creating the trust—the grantor. The Federal Deposit Insurance Corp. says that the exception is when the grantor arranges for a “retained interest.” In that case, the circumstances that require the assets to return to the grantor’s control must be prescribed.

Minimize Retirement Account Distributions

Inheritances will often include a retirement account. The money from a distribution is taxable, except for money from a Roth IRA. A spouse can spread the distributions over their lifespan, but others do not have that option. They must distribute all the funds from a retirement account within 10 years.

TheBalance mentions one option that may prevent the 10-year requirement. Converting the money to a Roth IRA can bypass it because it has no required minimum distribution requirement.

Buy Life Insurance

An excellent way to pass assets without them having to pay taxes is to buy a life insurance policy and name them as beneficiaries. The Internal Revenue Service says that there is no life insurance inheritance tax and the proceeds do not need to be reported on your tax forms. Any interest earned from the policy will need to be reported.

If you do not have enough assets, or you do not want to divide property between heirs, a life insurance policy can equalize your assets. Of course, you must remember that a life insurance policy is only of value after you die.

The above tips enable you to know how to prevent inheritance taxes from eating away at your inheritance. The sooner you take action and ensure your inheritance will be passed on successfully to your beneficiaries intact, the more you will enjoy your retirement and your plans for your loved ones.

The Epoch Times Copyright © 2022 The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.