How do death taxes affect financial planning?

On Behalf of | Aug 24, 2021 | Estate Administration |

When thinking about estate planning, many people do not take into account what taxes may apply to their assets after they are gone. Careful planning can prevent death taxes from taking a substantial amount out of the estate.

It is important for New Jersey residents to know that their state is one of six that has an inheritance tax. Estate planners in Somerset County and elsewhere may be wise to get up to date on all federal and state laws when reviewing their portfolios as they plan for the future.

What are estate and inheritance taxes?

Both estate and inheritance taxes are death taxes, but the main difference is who will pay them. For estate tax, it comes from the net value of the estate assets once all liabilities are subtracted. With inheritance taxes, however, it is the beneficiaries of the estate who must pay a tax on the value of the individual bequests.

All states once had an estate tax, and an applied federal tax credit offset them based on each state’s rates. Amendments to federal law eliminated the credit, resulting in a repeal by many states of their estate taxes. Moderate to smaller estates are not liable for the federal estate tax, however, which only applies to estates that are valued at more than $11.7 million.

How does the New Jersey inheritance tax affect my bequests?

Although New Jersey no longer has estate taxes, the inheritance tax remains unchanged. Ranging from 11% to 16%, estate planners would be prudent to find ways of minimizing the effect that this tax will have on their beneficiaries after they are gone.

Beneficiaries or transferees fall into different classifications, depending on their relationship to the deceased:

  • Class A: spouses, children, grandchildren and grandparents and others are exempt
  • Class C: siblings, sons- and daughters-in-law are exempt on the first $25,000, then graded from 11% to 16%
  • Class D: nieces, nephews, friends and others must pay from 15% to 16%
  • Class E: religious or not-for-profit entities, charities and others are exempt

To avoid significant estate and inheritance taxes, it is important to consider smart estate- planning tools that minimize the tax burden that the surviving family will have to pay. Some of these strategies include setting up a trust, gifting up to $14,000 per year, or converting an IRA to a Roth or making a life insurance trust for a non-exempt beneficiary. It can help to plan ahead, as there may be a look-back period of three years.