When a loved one dies, there are many things to worry about, from planning the funeral to deal with your own emotions. As always, however, money is an important part of the calculation of life when dealing with a recently deceased family member. When they pass away, your family will have to deal with their money, assets, and debts. And if they have a large enough estate, you’ll likely have to worry about estate and inheritance taxes. However, there are things you can do now to limit the amount that ends up being subject to these taxes, so your family can use more of your assets to build their lives. For help with property taxes or any other financial planning issue, consider work with a financial advisor.
Understand the difference between estate tax and inheritance tax
First make sure you know the difference between property tax and inheritance tax. An estate tax, sometimes called a “death tax,” is money collected by the government on the estate of a recently deceased person before passing on to their family, friends, and other beneficiaries. There is a federal estate tax, while some states also levy their own estate taxes.
Whereas, inheritance tax is levied on money after it is passed on to the heirs. Money may be subject to both inheritance and estate taxes. There is no federal inheritance tax, but some states do tax inheritance.
The rules for these inheritance taxes vary from state to state. Sometimes inheritance tax is only imposed based on the state in which the heir lived, although it can also affect the state in which the deceased person lived. Even the condition of the property, such as a house, you inherit can affect the situation.
There are many strategies to reduce both taxes. For more information on potential property tax breaks, check this post.
Strategies to avoid inheritance tax
If you think you will receive an inheritance upon the death of a loved one, the first thing you should do is check the laws in both the state you live in and the state they live in. If both states don’t tax inheritance, you’re clear. Whenever your loved one passes away, there is nothing for you to worry about. You may have to settle for property taxes, but you won’t have to pay anything for any of the money you actually get.
However, if there are inheritance taxes to consider, there are a few things you can do to reduce your tax burden. Remember that some of these steps will require advance planning and cooperation with the person leaving your estate. So, if you believe you will receive an inheritance, think ahead and talk to a family member about the most efficient way to transfer money.
Arrange to receive money as a gift
If you are receiving an inheritance from an elderly relative, consider talking to them about receiving a portion of it as a gift before they pass away. Currently, the annual gift tax limit is $15,000, so one person can give up to $15,000 to one person per year without tax.
Let’s say your grandmother told you she would leave you $45,000 in her will. If, instead of willingly giving you this amount, she gave you $15,000 a year for the three years before her death, the money would not be subject to inheritance tax. In addition, you can Invest it into stocks or index funds and ended up with more money by the time she actually passed away. If it makes your loved one feel better, you can even promise not to touch the money until they leave.
Use Alternative Valuation Dates
Not all inheritance is cash, as many receive assets, including homes and other real estate. Generally, the value of the property used for inheritance tax purposes is the date of death. However, if the estate is also subject to estate taxes, using a later date – usually six months after death – may be an option. This can lead to lower property values and, therefore, a smaller tax burden.
Buy a payable-on-death (POD) life insurance policy
If you set up a payable upon death of life insurance policy, your beneficiaries will not owe any taxes on the money they receive upon your death. They can use this money to pay any applicable inheritance or estate taxes. Again, this will require some tough planning ahead of time.
Change your place of residence
This may seem like a drastic step, but for some, it can make sense. Remember, not all states tax inheritance and there is no federal inheritance tax. If you’re in a place in your life where you can move, opening a store in a state with no inheritance tax can save you or your beneficiaries a decent amount of money.
bottom line
Inheritance tax is levied on money after it has been transferred to an heir. Most states have no inheritance tax and no federal inheritance tax. That said, even if you live in a state with inheritance taxes, you can take some steps to minimize the portion of your inheritance that will be seized by the state.
While estate planning can lead to some tough conversations, it will ultimately put your family in a much better position once you’ve passed. In fact, inheritance tax planning can be just as important as writing a will or setting up a trust.
Estate planning tips
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If you or a loved one need help reducing your inheritance or estate tax burden, consider work with a financial advisor. Finding a qualified financial advisor is not difficult. SmartAsset’s free tool connects you with up to three financial advisors in your area and you can interview the right advisors for you for free to decide which one is right for you. If you are ready to find an advisor who can help you achieve your financial goals, start right now.
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If you are doing your own estate planning and retirement, you should be fully prepared. SmartAsset offers you lots of free online resources that can help you plan for the future. For example, check our retirement calculator.
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