Death of a Spouse: Financial Steps You Should Take

Proper estate planning can help to increase the size of your estate, whether large or small. Its basic purposes are to (1) choose how your property will be distributed after your death, (2) help assure that your property will be distributed in an orderly and efficient way and (3) minimize taxes.

This Financial Guide gives you a road map to the estate planning process. It will help you to get started: to provide for your heirs, to lessen the administrative burden on your survivors, and to understand what you'll have to do to minimize estate and income taxes. It will enable you to approach your attorney and other professional advisors with a clearer idea of what the process should entail.

The Overall Picture

What is your "estate?" Simply stated, it includes everything you own at your death minus your debts. However, some rather tricky rules apply, which may bring back into the estate assets you've given away, or thought you'd given away.

Most estates do not need to pay the federal estate tax, in many cases because you can leave an unlimited amount to a surviving spouse without having it being subjected to federal estate tax (i.e., the bequest provides a marital deduction). In 2023, there is an exemption of $12,920,000 (up from $12,060,000 in 2022) per individual before the federal estate tax kicks in. The nearly doubling of the exemption amount is due to tax reform legislation passed in December 2017. In 2026, however, the estate tax exemption amount reverts to the 5 million exemption amount (indexed for inflation) that that went into effect in 2011. State inheritance taxes, which vary from state to state, must also be considered in addition to federal estate tax.

In November 2019, the Department of Treasury and Internal Revenue Service (IRS) issued final regulations regarding increased gift and estate tax exclusion amounts in effect from tax years 2018 through 2025. The final regulations state that individuals who take advantage of the increased gift and estate tax exclusion amounts will not be impacted adversely after tax year 2025 when exclusion levels are scheduled to revert to pre-2018 TCJA levels.

In addition to the two primary estate planning tools, wills, and trusts, there are other essential tools you should consider such as:

• The postmortem letter to your spouse and survivors,
• Living wills,
• Life insurance,
• Disclaimers,
• Lifetime gifts, and
• Powers of attorney.

State estate taxes. States had death taxes (i.e. estate and/or inheritance taxes) long before there was a federal estate tax. Today, twelve states and the District of Columbia impose an estate tax while six states have an inheritance tax:

Estate Tax

• Connecticut
• District of Columbia
• Hawaii
• Illinois
• Maine
• Maryland
• Massachusetts
• Minnesota
• New York
• Oregon
• Rhode Island
• Vermont
• Washington

Inheritance Tax

• Iowa
• Kentucky
• Maryland
• Nebraska
• New Jersey
• Pennsylvania

Many state death taxes are loosely based on the federal estate tax model. In some cases, the amount subject to the state death tax is the same dollar amount that is also subject to federal estate tax. In other states, estate taxes at death are independent of the federal estate tax and apply whether or not a federal estate tax applies. While the federal estate tax rate was made permanent (indexed for inflation), state death taxes are often subject to change.

Gift tax. The lifetime gift tax exemption is $12.92 million ($25.84 million joint) in 2023.

Gifts (apart from the annual exclusion of $17,000 per donee in 2023 ($16,000 in 2022) are applied against the $12.92 million exemption so that gift tax is due when their total exceeds that exemption amount. If the estate tax is still in existence when the donor dies, the estate will include prior taxed gifts and prior untaxed gifts counted against the $12.92 million exemption. If an estate tax results because the estate at death plus these prior gifts exceeds the estate tax exclusion amount applicable in the year of death, that tax is reduced by prior gift tax payments.

Some states impose gift taxes.

Under the estate/gift tax scheme now applicable, gift tax can result in situations where there would be no estate tax if assets of the same value had been held at death. Gifts that bring the gift total above the lifetime exemption should be made only on the specific advice of a tax professional.

Gift tax is continued after estate tax repeal as a device to limit asset transfers designed to avoid income tax.

Income tax after estate tax repeal. Assets acquired upon another person's death usually take a tax basis to the heir equal to the asset's fair market value on the date of death. Thus, for example, if a person bought 1,000 shares of stock at $10 a share and died when the shares were worth $50 a share (a $40,000 unrealized gain), his or her heir takes the shares at a total basis of $50,000. The heir can sell the shares for $50,000, free of income (capital gains) tax.

Fair market value basis at death is usually a step up in basis although the basis is stepped down at death where value has fallen below cost. Basis step-up by which most inherited assets escape most capital gains tax has been justified as a kind of compensation for the possible exposure of the entire asset (not just the unrealized gain) to the estate tax, whether or not estate tax was actually imposed. The theoretical reason for step-up in basis is reduced if there is no estate tax. The step-up in basis was retained by the Tax Cuts and Jobs Act of 2017.

Complex estate planning for making use of this surviving step-up in basis is possible, but your professional tax adviser's view of the prospects for estate tax repeal should govern whether such planning should be done now.

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Wills

A will is the foundation of good estate planning and it's critical to obtain competent legal help when drafting a will. A will that is poorly drafted or does not dot every legal "i" and cross every legal "t" can be the cause of endless trouble for your survivors.

Do not keep original copies of your will in a safe deposit box. Instead, keep them in a fireproof safe at home and give copies to your attorney and your executor as well.

Many people believe they do not need a will, but there are many good reasons, other than saving estate taxes, for having a valid and updated will.

Why You Need a Will

There are five basic reasons to prepare a will:

1. To Choose Beneficiaries. The laws of the state in which you live determine how your property will be distributed if you die without a valid will. For example, in most states, the property of a married person with children who dies intestate (i.e., without a will) generally will be distributed one-third to his or her spouse and two-thirds to the children, while the property of an unmarried, childless person who dies intestate generally will be distributed to his or her parents (or siblings if there are no parents). These distributions may be contrary to what you want. In effect, by not having a will, you are allowing the state to choose your beneficiaries. Further, a will allows you to specify not only who will receive the property, but how much each beneficiary will receive. You may also wish to leave property to a charity after your death, and a will may be needed to accomplish this goal.

2. To Minimize Taxes. Many people feel they do not need a will because they believe their taxable estate is below that taxable amount for federal estate tax purposes. However, your taxable estate may be larger than you think. For example, life insurance, qualified retirement plan benefits, and IRAs typically pass outside of a will or of estate administration. But these assets are still part of your federal estate and can cause your estate to go over the threshold amount. Also, in some states, an estate becomes subject to state death taxes at a point well below the federal threshold. A properly prepared will is necessary to implement estate tax reduction strategies.

Periodically reviewing your estate plan is advisable to take into account the changes in estate and gift tax rules, as well as rules on items that affect the size of your estate including retirement and education funding plans. Amounts subject to estate tax, and estate and gift tax rates, are scheduled to change periodically in future years.

3. To Appoint a Guardian. Your will should name a guardian for your minor children in the event of your death and/or the death of your spouse. While naming a guardian does not bind either the named guardian or the court, it does indicate your wishes, which courts generally try to accommodate.

4. To Name an Executor. Without a will, you cannot appoint someone you trust to carry out the administration of your estate. If you do not specifically name an executor in a will, a court will appoint someone to handle your estate, perhaps someone you would not have chosen. Obviously, there is an advantage, as well as peace of mind, in selecting an executor you trust.

5. To Establish Domicile. You may wish to firmly establish domicile (permanent legal residence) in a particular state, for tax or other reasons. If you move frequently or own homes in more than one state, each state in which you reside could try to impose death or inheritance taxes at the time of death, possibly subjecting your estate to multiple probate proceedings. To lessen the risk of this, you should execute a will that clearly indicates your intended state of domicile.

You should review your will every two or three years, or whenever your circumstances change. Changes that warrant revising your estate plan might include:

• Divorce,
• Having a child,
• Having children move out of the house,
• Acquiring a large asset,
• Selling a large asset, or
• A change in the tax laws.

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Trusts

Today, trusts are not just used by the very wealthy, people with a wide range of income levels use them as estate planning tools too, despite the fact that trusts are complex and costly to set up and run, and require a higher level of services from an attorney than a will does.

What is a Trust?

A trust owns its own property (holds the title). When it is set up, the trust appears on official papers and records as the legal owner of any property that is placed into it. The trust's principal is the property that the trust owns, as distinguished from the interest or dividends earned by that property. The terms of the trust dictate who will get the benefit of the income from the trust property, how long the trust will last, and so on.

The trustee is the person or entity whose job it is to administer and manage the trust: make investment decisions, pay taxes, make sure the terms of the trust are carried out, and take care of the trust's property. Generally speaking, the trust must pay income tax on any of its undistributed interest or other income.

There are basically two types of trusts:

• An irrevocable trust is a separate entity, for both legal and tax purposes, and pays its own taxes. The irrevocable trust cannot be revoked or changed.
• A revocable trust is not considered a separate entity for tax purposes, although it may be considered a separate legal entity. The revocable trust can be changed or revoked (taken back) by the creator of the trust.

Another way to categorize trusts is the living (or inter vivos) trust, which is set up by a living person, or a testamentary trust, which is created by a will.

What is a Trust Used For?

A trust can be used for many worthwhile purposes:

1. Giving property to children.
2. Reducing estate taxes.
3. Leaving assets to a spouse.
4. Providing for life insurance used to pay estate tax.

Giving property to children. People generally do not want to give property to a minor child outright because of the financial risks involved (e.g., the child could squander it). Many people give property to a minor through a trust. The trust's terms can be written so that the child does not get outright ownership until he or she has achieved a certain age so that the child receives only the income from the trust property until that time. Another way to give property to a minor is via the Uniform Gifts to Minors Act or Uniform Transfers to Minors Act. These provisions, which apply in most states, provide for a custodianship over property given to a minor.

Reducing estate taxes. As noted earlier, if you leave everything to your spouse, it passes free of federal estate tax. However, when your surviving spouse dies, anything in his or her estate over the exclusion amount (also called "exemption amount") would be subject to estate tax. The exclusion amount for 2023 is $12,920,000. The credit shelter trust or bypass trust is used to shelter up to the exclusion amount from the estate tax.

Wills may be drafted to leave a bypass trust an amount equal to the exclusion amount in the year of death, rather than a specific dollar amount. However, because amounts change, review of the estate plan may be needed to keep the desired balance between what the spouse is to get and what trust beneficiaries are to get.

Leaving an asset to a spouse. The marital deduction trust allows the first spouse to die to place estate assets in a trust for the surviving spouse, instead of leaving them to him or her outright. If the legal requirements are met, the estate gets the marital deduction, but can still preserve assets for heirs other than the surviving spouse. Typically, the income of such trusts will go to the surviving spouse for life and the principal will go to children. All of the income must go to the surviving spouse for the trust to qualify for the marital deduction. It must be paid out at least once a year. The spouse may have some access to the principal. When the second spouse dies, the property is included in his or her estate for estate tax purposes.

Pay estate tax. Complex and expensive arrangements, life insurance trusts are usually used to finance future estate taxes on an estate that contains a business interest or real estate.

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Postmortem Letters

Does anyone but you know where your tax records and supporting tax documents are located? How about deeds, titles, wills, insurance papers? Does anyone know who your accountant is? Your lawyer? Your broker? If you pass away without leaving your heirs this information, it will cause a lot of headaches. Worse than that, part of your estate may have to be spent in needless taxes, claims, or expenses because the information is missing.

The postmortem letter is an often overlooked estate planning tool. It tells your executors and survivors what they need to know to maximize your estate such as the location of assets, records, and contacts. Without the postmortem letter, you risk losing part of your estate's assets because necessary documentation cannot be located.

Related Guide: Please see the Financial Guide: POSTMORTEM LETTER: How To Prepare It And What To Include.

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Livings Wills

A living will, which is sometimes called a health care proxy, makes known your wishes as to what medical treatment or measures you want to have if you become incapacitated and unable to make the decision yourself. It tells family and physicians whether you want to be kept alive through mechanical means or whether you would prefer not to have such means used. If there is no living will, this decision is left up to the family, or the physicians, to decide. Stating your preference in a living will take some of the burden off of family members and decreases the stress in an emergency.

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Life Insurance

The main purpose of life insurance is to provide for the welfare of survivors. But life insurance can also serve as an estate planning tool. For example, it can be used to finance the payment of future estate taxes or to finance a buy-out of a deceased's interest in a business. It can also be used to pay funeral and final expenses and debts.

If the decedent owns the policy, the proceeds will be included in the estate and subject to estate tax. However, if the decedent gives away all incidents of ownership in the policy, and names a beneficiary other than the estate, the proceeds will not be included in the estate.

Related Guide: Please see the Financial Guide: LIFE INSURANCE: How Much And What Kind To Buy

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Disclaimers

The disclaimer is a way for an heir to refuse all or part of the property that would otherwise pass to him or her, via a will, intestacy laws, or by operation of law. An effective disclaimer passes the property to the next beneficiary in line.

With a properly drawn disclaimer, the property is treated as if it had passed directly from the decedent to the next-in-line beneficiary. This may save thousands of dollars in estate taxes. The provision for a disclaimer in a will and the wise use of a disclaimer allows intrafamily income shifting for maximum use of the estate tax marital deduction, the unified credit, and the lower income tax brackets.

Disclaimers can also be used to provide for financial contingencies. For example, a beneficiary can disclaim an interest if someone else is in need of funds.

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Lifetime Gifts

The annual gift tax exclusion provides a simple, effective way of cutting estate taxes and shifting income. You can make annual gifts in 2023 of up to $17,000 ($34,000 for a married couple) to as many donees as you desire. The $17,000 is excluded from the federal gift tax so that you will not incur gift tax liability. Further, each $17,000 you give away during your lifetime reduces your estate for federal estate tax purposes.

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Government and Nonprofit Agencies

• Army and Air Force Mutual Aid Association (www.aafmaa.com)
  An organization that provides information on officers' benefits and estate planning
  Tel. 800-336-4538
• Navy Mutual Aid Association (www.navymutual.org)
  This veterans' benefit organization provides information for Navy, Marine Corps, Coast Guard, Public Health, and NOAA personnel
  Tel. 800-628-6011

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