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Your Estate and Retirement Plans May Need Revising After New Tax Law
The $1.35 trillion Tax Relief Act of 2001 makes sweeping changes in the rules regarding estate taxation, gift taxes, retirement savings, education IRAs, and more. Given this altered landscape, you would be well advised to review your estate, retirement savings and other financial plans with a qualified elder law or estate planning attorney or financial planning specialist.
Tweaking Estate Plans
As we have reported in an earlier article, the estate tax exemption will gradually rise to $3.5 million in 2009, after which the estate tax will be completely eliminated for at least the year 2010. At the same time, the maximum tax rate on estates, which currently stands at 55 percent, will be reduced to 45 percent by 2007.
Current estate plans may need to be fine-tuned so that they take advantage of the increase in the exemption over the next 9 years. For example, if your estate plan allocates a specific dollar amount to a credit shelter trust, this amount will need to be revised if you are to take advantage of the rising exemption. On the other hand, if your plan uses a "formula clause" to determine how much is to be allocated to a credit shelter trust, the clause could now end up shifting too much to the trust, depending on the size of your estate.
While better-off families may benefit from estate tax repeal, those inheriting property could still wind up paying a hefty capital gains tax bill. At the same time that the estate tax is repealed, "carryover basis" rules will replace the current "step-up basis" rule regarding inherited property. Heirs who inherit property after repeal will generally no longer be permitted to step-up the income tax basis of the property to the fair market value at the date of the decedent''s death. Instead, they will carry over the decedent''s income tax basis. If the heirs sell the property, this will usually result in an increased capital gains tax.
The new law does allow U.S. citizens or residents to increase the basis of the decedent's property by up to $1.3 million, and property passing to a surviving spouse can receive up to a $3 million basis increase. This means that after estate tax repeal, the focus of estate planning will shift to the effective use of the allowable basis increase, as well as to income tax planning.
The role of life insurance in estate planning will also change with estate tax repeal. Policies taken out solely to pay the tax on an estate will no longer be needed, and it may be advisable to sell such policies when the estate tax is repealed. In addition, irrevocable life insurance trusts, most of which are established to protect the proceeds from estate tax, should be reevaluated in light of repeal.
The exemption for generation-skipping transfer (GST) tax will rise along with the estate tax exemption to $3.5 million in 2009, and then will be eliminated the following year. This means that if your estate plan includes a GST, it should be reexamined.
Surprisingly, Congress did not repeal the gift tax at the same time it planned for the eventual repeal of the estate tax. Like the estate tax exemption the gift tax exemption will rise to $1 million in 2002, but will not increase further.
Retirement Planning Changes
As previously reported, the new tax law will allow Americans - especially older workers - to contribute more to tax-deferred retirement plans like traditional IRAs and Roth IRAs. In light of the opportunities for considerably more tax-sheltered retirement savings, you may want to revise your retirement savings plan.
Education IRAs, which currently allow contributions of only $500 a year, will expand in 2002 to allow contributions of up to $2,000 each year. For the first time, such IRA funds can be used to cover elementary and secondary school costs as well as college.
Finally, rates for taxpayers in the four tax brackets will begin falling starting July 1. They will gradually drop to 25, 28, 33 and 35 percent starting in 2006. This means that taxpayers should look into deferring income so that it can be taxed at the lower rates as well as taking advantage of any available deductions to offset income taxed at the higher rates.