The Tax Cut And Jobs Act doubled the estate tax exemption in 2018 to $11,180,000 for an individual. This jump was much higher than any increase in the past.
In 2019, the estate tax exemption increased to $11,400,000 and for 2020, the estate and gift tax exemption goes up to an eye-popping $11,580,000 per person.
Meanwhile, the top federal estate tax rate remains at 40%, down from 55% in the late 1990s. The annual gift exclusion amount remains the same at $15,000 for 2020.
If you plan to die, there is no better time to die than right now. Your heirs will thank you. Take a look at the historical gift tax exemption amounts and estate tax rates per person in the chart below.
How The Estate Tax Exemption Works
The gross value of your estate must exceed the exemption amount for the year of your death before estate taxes become due. Even then, only the value over the exemption is taxable.
For example, let’s say you die with $21,580,000 in 2020. Given the estate tax exemption about is $11,580,000, you will pay a top federal estate tax rate of 40% on $10,000,000, or almost $4 million.
The first $1 million over the federal estate tax exemption amount will pay $345,800 in federal estate taxes. The subsequent $9 million will pay a 40% marginal estate tax rate, which would equal $3,600,000. Therefore, $3,600,000 + $345,800 = $3,945,800 in federal estate taxes for an estate that is $10 million above the federal estate tax exemption amount.
Paying such a large estate tax to the government seems like a waste when you could have donated more to charity or spent more on yourself and your loved ones while still alive.
The annual gift tax exclusion amount is $15,000 for 2020, and will likely go up to $16,000 by 2022 to account for inflation. In other words, every individual can gift $15,000 a year to an unlimited amount of people without the amount going against your estate.
In other words, if you project your estate to surpass the estate tax exemption limit, or your estate is already far above the estate tax exemption limit, it is much better to give individuals the max annual gift tax exclusion amount now. Otherwise, you’ll be paying $6,000 in taxes for every $15,000 you don’t give away.
You can also look into creating a Grantor Retained Annuity Trust or GRAT for your offspring. A GRAT is a way to have any gains of an asset above a certain level determined by the IRS to be tax-free upon transfer.
The Exemption is Transferrable
The government also allows you to transfer any unused portion of your exemption to your spouse if you’re married. This is called “portability”. If your estate is worth $10 million, you’d have $1.18 million of your exemption left over to give to your spouse in 2019.
Presumably, she inherited most if not all of that $10 million in property from you via a revocable living trust so this allows her to pass that property to her heirs tax-free. This type of generational wealth transfer helps ensure the wealthy stay wealthy, with covenants in place on how to spend the inheritance.
Five Things Every Rich Person To Do
1) Estimate when you will die. The median life expectancy is roughly 78 for men and 81 for women. You must make a best guess as to when you plan to die in order to properly plan for your estate transfer. If you don’t like when you plan to die, do things to help elongate your life. Being wealthy enough to worry about paying estate taxes means you’ve won the lottery. Therefore, your goal should be to try and live as long as possible. Time is your most valuable asset.
2) Estimate your wealth. The longer you live, the more wealth you can accumulate. Not only must you estimate your future wealth, you must also estimate what future estate exemption amounts and estate tax rates will be. You’ll be surprised at how much wealth you will create with diligent savings and even modest returns due to the power of compounding.
3) Estimate how much more you can give. By having a rough estimate of your life expectancy and your wealth, you can better plan for how much more you can spend on yourself and family and give to charity. Dying with millions of dollars beyond the estate tax limit is truly a waste of money. You could have lived an even better life by working less or spending more to help others instead of giving 40% of the overage to the government.
One common strategy to utilize for estate tax liability is life insurance. You can even set up a life insurance revocable trust so it doesn’t count toward your estate exemption amount. If a large part of your estate includes a business you don’t want to sell to pay for estate taxes, then using life insurance or other liquid assets is a solution.
4) Pay attention to politics. While Republican death tax foes hope to make the doubled exemption permanent, Democratic presidential hopefuls say they’ll bring it back to its 2009 level of $3.5 million, with a graduated tax rate up to 77%, compared to today’s flat 40% rate. Stay up to date on the latest tax laws. The Tax Cut and Jobs Act is to expire in 2025, but who knows what will happen based on the presidential election outcome.
5) Stay on top of your finances like a hawk. Nobody cares more about your money than you. I recommend signing up for Personal Capital, the web’s #1 free wealth management tool to get a better handle on your finances. After you link all your financial accounts, you can get a great holistic view of your entire net worth. From there, you can run their Retirement Planning calculator to forecast your future net worth and cash flow needs. The forecasts are based on your real expenses and income history, which is why it’s so powerful. Once you’ve reached a 90%+ confidence level, you can then better plan for more efficient consumption smoothing.
Here’s a snapshot example of some estimated income events and spending goals.
Here’s a snapshot of what you ultimately want to achieve. You want to be in good or great shape. In the example below, you can afford to spend $6,100 more than expected during your retirement years and still reach your estate planning goals. The Personal Capital Retirement Planner truly is one of the best free tools you should use to stay on top of your finances.
I hope everyone lives a long and wonderful life. Planning for the future is not only good for you, but it’s a selfless act for the people and charitable organizations you care about the most. There’s no rewind button in life. Don’t let ignorance or laziness get in the way of living your best life possible!
About the Author: Sam started Financial Samurai in 2009 as a way to make sense of the financial crisis. He proceeded to spend the next 13 years after attending The College of William & Mary and UC Berkeley for b-school working at Goldman Sachs and Credit Suisse. He owns properties in San Francisco, Lake Tahoe, and Honolulu and has $810,000 invested in real estate crowdfunding.
In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income, partly thanks to his investments in real estate crowdfunding. He spends time playing tennis, hanging out with family, consulting for leading fintech companies and writing online to help others achieve financial freedom.