Getting to retirement with a fat nest egg is a big accomplishment: All those years of toil and saving finally pay off.
If you are exceedingly fortunate and plan to pass on a big inheritance to your children or a charity, you still have one big retirement-planning mission remaining: protecting a chunk of your wealth from disappearing into the coffers of state and federal government.
Depending on where you live, achieving that goal can be difficult, or relatively easy. In fact, 33 states have no estate or inheritance taxes.
And pity the poor residents of the alleged “Free State” — Maryland levies both types of taxes.
The full list of such states, and the District of Columbia, in each category is as follows:
States with estate taxes
- District of Columbia
- New York
- Rhode Island
States with inheritance taxes
- Iowa (The tax was repealed this year, and will phase out through 2024.)
- New Jersey
Estate taxes versus inheritance taxes
Your estate is taxed based on the total value of everything you own at the time of your death, minus deductions. This is known as your “gross estate.” According to Nolo:
“The gross estate includes all of the obvious assets, like your real estate and bank accounts, plus some that aren’t so obvious — for example, the proceeds of a life insurance policy that the deceased person owned.”
By contrast, inheritance taxes depend on who inherits your assets. For example, taxes may not be due if your spouse inherits your assets, but taxes might be due if the assets go to your children or someone more distantly related to you.
If you live in one of the states on the two lists above, don’t panic. Estate taxes typically are assessed only if your assets exceed a certain level, such as $1 million. And some states have much higher thresholds.
As for inheritance taxes, rates typically are modest if you leave your assets to close relatives. For example, Nolo says that in Nebraska, close relatives who inherit $40,000 or less face no taxes, and just 1% is charged on assets over that amount left to those family members.
However, taxes of 13% will be due in Nebraska on amounts above $15,000 left to more distant relatives, and 18% will be due on amounts above $10,000 that you leave to others, such as nonrelatives or organizations.
Avoiding these taxes
The higher exemption levels associated with most states’ estate and inheritance tax systems are not much solace to people with very large estates who hope to pass down their cash.
So, what can you do if you are in that fortunate circumstance? You could move to a new state or accept your fate, while taking solace in the knowledge that the 2017 federal tax legislation significantly raised the exemption levels for federal estate taxes.
For the 2021 tax year, federal estate taxes will not apply to your estate unless your assets exceed $11.7 million — then, the tax applies only to the amount above $11.7 million.
Just be aware that recently, there has been chatter among politicians about reducing that exemption level sharply, which could result in a much bigger tax bill for some.
Creating a trust is another option for those concerned about a tax bite. Trusts are often used to bypass estate taxes, as Money Talks News founder Stacy Johnson details in “Ask Stacy: I’m Afraid to Leave an Inheritance for My Kids — What Should I Do?”
For more tips on protecting your assets from taxes, check out “8 Documents That Are Essential to Planning Your Estate.” And if you’re looking for a good deal on the estate documents you need, head over to the website of Money Talks News partner Rocket Lawyer.