Does a Beneficiary have to Pay Taxes on 401(k)? – Annapolis and Towson Estate Planning

There are many complicated rules for inheriting assets in the form of retirement plans, workplace plans and Individual Retirement Accounts (IRAs), says a recent article titled “How Much 401(k) Inheritance Taxes Will Really Cost You” from The Madison Leader-Gazette. Any assets passed from one person to another in the form of a 401(k) are taxable. You’ll want to be prepared.

How are Inherited 401(k)s Taxed?

The inheritance rule for 401(k) tax usually follows the same path as the rules used when making contributions or withdrawals to tax deferred retirement plans. When a person dies, their 401(k) becomes part of their taxable estate.

This means that any taxes due on earnings not paid during the person’s lifetime need to be paid.

Traditional 401(k) plans are funded with pre-tax dollars. This is great for the saver, who gets to defer paying taxes while they are working. When they retire, withdrawals are taxed at their ordinary income tax rate, which is typically lower than when they are working.

There is an exception with Roth 401(k)s, where contributions are made with after-tax dollars and qualified withdrawals are tax free.

How the IRS taxes an inherited 401(k) depends on three factors:

  • The relationship between the account owner and the heir
  • The age of the heir
  • How old the account owner was at the time of death.

Who Pays Taxes on an inherited 401(k)?

The beneficiary who inherits the 40(k) is responsible for paying the tax. They are taxed at the heir’s ordinary income tax rate. This could push the heir into a higher tax bracket.

What Should I Do with an Inherited 401(k)?

If your spouse was the original owner, you may leave the money in the plan and take regular distributions, paying income tax on the withdrawals. You may also roll it over into your own 401(k) or to an IRA. This allows the money to continue to grow tax free, until withdrawals are taken.

Can I Avoid Taxes on an Inherited 401(k)?

The only way to avoid taxes on inherited 401(k) would be to disclaim the inheritance, at which point the 401(k) would be passed to the contingent beneficiary. If you don’t need the money, don’t want the tax headaches, or would rather see it go to another family member, this is an option. Most people pay the taxes.

Planning For Taxes When Creating an Estate Plan

Talk with one of our experienced estate planning attorneys about your taxable assets and how to manage the tax liabilities to your heirs. There are numerous tools to address these and related issues. Your heirs will be grateful for your foresight and care.

Reference: The Madison Leader Gazette (July 29, 2022) “How Much 401(k) Inheritance Taxes Will Really Cost You”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

Actress Helen McCrory Leaves Money in Trust – Annapolis and Towson Estate Planning

Late British actress Helen McCrory left her entire $1 million estate in the name of her husband and actor Damian Lewis and their two children. The will states that the Harry Potter star had put her money into a trust.

Her will appointed Damian as one of the trustees of the 125-year-long fund – along with HM the Queen’s bankers Coutts – with the power to make payments out of the trust to himself and the other beneficiaries.

SK Pop’s recent article entitled “What was Helen McCrory’s net worth at the time of her death?” reports that her children, Manon (15), and Gulliver (14), along with any future grandchildren, have been named beneficiaries.

McCrory, who last starred in Netflix’s Peaky Blinders, died in April 2021 after secretly battling breast cancer for years. She was 52 and had been married to Lewis since 2007.

Her net worth was combined with her husband’s and was around $25 million at the time of her death.

In 2017, Helen was awarded an OBE for her services in drama. McCrory  was most remembered for playing Aunt Polly, the Shelby family matriarch in Netflix’s crime drama series Peaky Blinders. She died during the filming of the show’s final season.

She also starred as Narcissa Malfoy in the Harry Potter film series and played roles in Skyfall and the 2006 film The Queen.

McCrory received many accolades during her lifetime, including a BAFTA award for Streetlife (1995), a Broadcasting Press Guild Award for North Square and a Golden FIPA at the Biarritz International Festival of Audiovisual Programming.

The National Theatre’s artistic director Rufus Norris said she was “unquestionably one of the great actors of her generation.”

McCrory and Lewis made contributions during the pandemic and helped raise $1.8 million for Feed NHS.

Her actor husband was the Emmy Award-winning star of Band of Brothers, Homeland and Wolf Hall.

Reference: SK Pop (July 23, 2022) “What was Helen McCrory’s net worth at the time of her death?”

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Some States Have Tough Estate and Inheritance Taxes – Annapolis and Towson Estate Planning

For now, most people don’t have to be scared of federal estate taxes. In 2022, only estates valued at $12.06 million or more for an individual ($24.12 million or more for a married couple) need to pay federal estate taxes. Even better for the very wealthy, there’s no federal inheritance tax for heirs who reside in such lofty economic brackets, notes the recent article titled “States with Scary Death Taxes” from Kiplinger.

By definition, estate taxes are paid by the estate and based on the estate’s overall value, while inheritance taxes are paid by the individual who inherits property, assets, or anything else of value. This isn’t to say “regular people” don’t need to worry about death taxes. We do, because states have their own estate taxes, and a few still have inheritance taxes.

A number of states eliminated estate taxes in the last ten years or so, in an effort to keep retirees from leaving and heading to places like Florida, where there’s no estate tax. However, a dozen states and the District of Columbia still have estate taxes, six states have an inheritance tax and one has both an estate and inheritance tax: Maryland.

Here’s how some state taxes look in 2022:

Connecticut has an estate tax, with an exemption level at $7.1 million. However, there is no inheritance tax. The Nutmeg state is the only state with a gift tax on assets gifted during one’s life.

The District of Columbia has an estate tax, with an exemption level of $4 million.

Hawaii’s estate tax exemption level is $5.49 million., one of the higher state estate tax exclusions, and is not adjusted for inflation.

Illinois’s estate tax is $4 million, but there’s no inheritance tax. It’s known as one of the least taxpayer friendly states in the country for retirees.

Iowa is phasing out inheritance taxes, but this doesn’t take effect until 2025. In the meantime, there’s no estate tax, and if the estate is valued at less than $25,000, there’s no inheritance tax. No taxes are due on property inherited by a lineal ascendent or descendent, but for other family members, the taxes range from 8%—12%.

There’s no estate tax in Kentucky. However, depending upon your relationship to the person who died and the value of the property, the inheritance tax is 4% to 16%.

Maine has an estate tax exemption of $5.87 million, but no inheritance tax.

Maryland’s has both an estate tax exemption of $5 million and a flat 10% inheritance tax (on transfers to individuals who are not direct relatives (e.g. – cousins, nephews, friends, etc.)

Massachusetts has no inheritance tax and a $1 million estate tax exemption.

Minnesota has a low estate tax exemption of $3 million. Any taxable gifts made three years prior to death are included.

New York, New Jersey, Rhode Island, Oregon, Vermont and Washington have no inheritance taxes, while Pennsylvania has no estate tax but does have an inheritance tax.

It’s not necessary to move purely to avoid estate or inheritance taxes. An experienced estate planning attorney uses strategic tax planning as part of an estate plan, minimizing tax liability and preserving assets.

Contact our office to schedule a preliminary call with one of our experienced estate planning attorneys to review your estate plan and determine whether there are strategies to reduce or eliminate estate or inheritance taxes.

Reference: Kiplinger (July 29, 2022) “States with Scary Death Taxes”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

What’s the Most Important Step in Farm Succession? – Annapolis and Towson Estate Planning

There are countless horror stories about grandchildren in tears, as they watch family farmland auctioned off because their grandparents had to liquidate assets to satisfy the taxes.

Another tale is siblings who were once in business together and now do not talk to each other after one felt slighted because they did not receive the family’s antique tractor.

Ag Web’s recent article entitled “Who Gets What? Take This Important Estate Planning Step” says that no matter where you are in the process, you can always take another step.

First, decide what you are going to do with your assets. Each farmer operating today needs to be considering what happens, if he or she passes away tonight. Think about what would happen to your spouse or your children, and who will manage the operation.

The asset part is important because you can assign heirs to each or a plan to sell them. From a management perspective, farmers should then reflect on the wishes of your potential heirs.

Children who grew up on the farm will no longer have an interest in it. That is because they are successful in business in the city, or they just do not have an interest or the management ability to continue the operation.

After a farmer takes an honest assessment, he or she can look at several options, such as renting out the farmland or enlisting the service of a farmland management company.

Just remember to work out that first decision: What happens to the farm if I am dead?

Once you work with an experienced estate planning attorney to create this basic framework, make a habit of reviewing it regularly.

You should, at a minimum, review the plan every two to three years and make changes based on tax or circumstance changes.

Reference: Ag Web (August 1, 2022) “Who Gets What? Take This Important Estate Planning Step”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

Pay Attention to Income Tax when Creating Estate Plans – Annapolis and Towson Estate Planning

While estate taxes may only be of concern for mega-rich Americans now, in a relatively short time, the federal exemption rate is scheduled to drop precipitously. Estate planning underway now should include consideration of income tax issues, especially basis, according to a recent article titled “Be Mindful of Income Tax in Estate Planning, Particularly Basis” from National Law Journal.

Because of these upcoming changes, plans and trusts put into effect under current law may no longer efficiently work for income tax and tax basis issues.

Planning to avoid taxes has become less critical in recent years, when the federal estate tax exemption is $10 million per taxpayer indexed to inflation. However, the new tax laws have changed the focus from estate tax planning to coming tax planning and more specifically, to “basis” planning. Ignore this at your peril—or your heirs may inherit a tax disaster.

“Basis” is an often-misunderstood concept used to determine the amount of taxable income resulting when an asset is sold. The amount of taxable income realized is equal to the difference between the value you received at the sale of the asset minus your basis in the asset.

There are three key rules for how basis is determined:

Purchased assets: the buyer’s basis is the investment in the asset—the amount paid at the time of purchase. Here is where the term “cost basis” comes from.

Gifts: The recipient’s basis in the gift property is generally equal to the donor’s basis in the property. The giver’s basis is viewed as carrying over to the recipient. This is where the term “carry over basis” comes from, when referring to the basis of an asset received by gift.

Inherited Assets: The basis in inherited property is usually set to the fair market value of the asset on the date of the decedent’s death. Any gains or losses after this date are not realized. The heir could conceivably sell the asset immediately and not pay income taxes on the sale.

The adjustment to basis for inherited assets is usually called “stepped up basis.”

Basis planning requires you to review each asset on its own, to consider the expected future appreciation of the asset and anticipated timeline for disposing the asset. Tax rates imposed on income realized when an asset is sold vary based on the type of asset. There is an easy one-size-fits-all rule when it comes to basis planning.

Estate planning requires adjustments over time, especially in light of tax law changes. Speak with your estate planning attorney, if your estate plan was created more than five years ago. Many of those strategies and tools may or may not work in light of the current and near-future tax environment.

Reference: National Law Review (July 22, 2022) “Be Mindful of Income Tax in Estate Planning, Particularly Basis”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

How Do I Contest a Will? – Annapolis and Towson Estate Planning

As a beneficiary of a will, if you do not agree with how the assets are being distributed, you may have grounds for contesting the will. MSN’s recent article entitled “Contesting a Will? You Might Not Need a Lawyer” says to do this you must have a legitimate legal reason to challenge the will, such as one of the most common arguments:

  • Lack of mental capacity. If the person making the will (the “testator”) was not “of sound mind,” he or she may not understand their decisions. The testator must be able to understand what they own, who their natural heirs are and what they are giving and to whom.
  • Fraud, undue influence, or forgery. Some people are tricked into signing a will, are forced to create a will under duress, or have their signature forged.
  • Multiple wills. In this situation, the one that was made most recently is often the one that the courts will decide is valid. However, wills created immediately before death may be contested due to undue influence, lack of mental capacity, or other reasons.
  • The state requirements are not met. Every state has specific requirements as to what must be in a will, the way in which it is signed, and the number of witnesses required. If these elements are not met, then the will may not be valid.
  • Location. Some states may not recognize wills created in another state.

To contest the will, you must have legal standing, which means you must meet one of these requirements:

  • A prior will designates you as a beneficiary;
  • The current will designates you as a beneficiary;
  • You are the beneficiary of a more recent will made after the one in question; or
  • You would be an heir if there was no will, and the state’s laws of intestacy were applied.

Your attorney will next file a petition in the state probate court where the estate is under probate. This tells the probate court and the estate that you are contesting the will. If your case is not settled, it goes to court where you will make your argument as to why the will should be changed. The court will decide the outcome of your case.

A way to keep family members from fighting over an estate is add a no-contest clause into the will. This disinherits anyone who challenges a will, if their challenge fails. In order words, if you do not win your challenge, you get nothing from the estate.

Reference: MSN (May 30, 2022) “Contesting a Will? You Might Not Need a Lawyer”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

When Should I Hire an Estate Planning Attorney? – Annapolis and Towson Estate Planning

Kiplinger’s recent article entitled “Should I Hire an Estate Planning Attorney Now That I Am a Widow?” describes some situations where an experienced estate planning attorney is really required:

Estates with many types of complicated assets. Hiring an experienced estate planning attorney is a must for more complicated estates. These are estates with multiple investments, numerous assets, cryptocurrency, hedge funds, private equity, or a business. Some estates also include significant real estate, including vacation homes, commercial properties and timeshares. Managing, appraising and selling a business, real estate and complex investments are all jobs that require some expertise and experience. In addition, valuing private equity investments and certain hedge funds is also not straightforward and can require the services of an expert.

The estate might owe federal or state estate tax. In some estates, there are time-sensitive decisions that require somewhat immediate attention. Even if all assets were held jointly and court involvement is unnecessary, hiring a knowledgeable trust and estate lawyer may have real tax benefits. There are many planning strategies from which testators and their heirs can benefit. For example, the will or an estate tax return may need to be filed to transfer the deceased spouse’s unused Federal Estate Unified Tax Credit to the surviving spouse. The decision whether to transfer to an unused unified tax credit to the surviving spouse is not obvious and requires guidance from an experienced estate planning attorney.

Many states also impose their own estate taxes, and many of these states impose taxes on an estate valued at $1 million or more. Therefore, when you add the value of a home, investments and life insurance proceeds, many Americans will find themselves on the wrong side of the state exemption and owe estate taxes.

The family is fighting. Family disputes often emerge after the death of a parent. It is stressful, and emotions run high. No one is really operating at their best. If unhappy family members want to contest the will or are threatening a lawsuit, you will also need guidance from an experienced estate planning attorney. These fights can result in time-intensive and costly lawsuits. The sooner you get legal advice from a probate attorney, the better chance you have of avoiding this.

Complicated beneficiary plans. Some wills have tricky beneficiary designations that leave assets to one child but nothing to another. Others could include charitable bequests or leave assets to many beneficiaries.

Talk to an experienced attorney, whose primary focus is estate and trust law.

Reference: Kiplinger (July 5, 2022) “Should I Hire an Estate Planning Attorney Now That I Am a Widow?”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

What Is a Marital Trust? – Annapolis and Towson Estate Planning

Marital trusts have multiple benefits for beneficiaries, including asset allocation and tax benefits.  They are worth looking at in your estate plan.

Forbes’ recent article entitled “Guide To Marital Trusts” says that a marital trust is an irrevocable trust that allows you to transfer a deceased spouse’s assets to the surviving spouse without paying any taxes. The trust also protects assets from creditors and future spouses that the surviving spouse may encounter.

When the surviving spouse dies, the assets in the trust are not included as part of their estate. That will keep the taxes on their estate lower.

There are three parties involved in setting up, maintaining and ultimately passing along the trust, including a grantor, who is the person who establishes the trust; the trustee, who is the person or organization that manages the trust and its assets; and the beneficiary. That is the person who will eventually receive the assets in the trust, once the grantor dies.

A marital trust also involves the principal, which are assets initially put into the trust.

A marital trust doubles the couple’s estate tax exemption limit, especially when almost all assets are owned by one spouse. Estate tax refers to the federal tax that must be paid on someone’s estate after they die. The estate tax limit is how much of an estate will be tax-free. In 2022, the estate tax limit is $12.06 million, which means utilizing a marital trust would essentially double that amount to $24.12 million. Therefore, about $24 million of a couple’s net worth would be shielded from estate taxes by taking advantage of a marital trust.

A marital trust is also beneficial because it can provide income to the surviving spouse, tax-free.

Only a surviving spouse can be a beneficiary of a marital trust. When the surviving spouse dies, the trust will then be passed on to whomever the first spouse’s will or trust governs.

If keeping wealth within your family after you die is important, then a marital trust is an estate planning tool that will make certain that individuals outside of your family do not have access to the wealth. You can put a variety of assets into a marital trust, including property, retirement accounts and investment accounts.

A marital trust is one legal tool to consider using when planning for a blended family.

Reference: Forbes (June 30, 2022) “Guide To Marital Trusts”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

Addressing Vacation Home in Another State in Estate Planning – Annapolis and Towson Estate Planning

Many families have an out-of-state cabin or vacation home that is passed down by putting the property in a will. While that is an option, this strategy might not make it as easy as you think for your family to inherit this home in the future.

Florida Today’s recent article entitled “Avoiding probate: What is the best option for my out-of-state vacation home?” explains the reason to look into a more comprehensive plan. While you could just leave an out-of-state vacation home in your will, you might consider protecting your loved ones from the often expensive, overwhelming and complicated process of dealing both an in-state probate and an out-of-state probate.

There are options to help avoid probate on an out-of-state vacation home that can save your family headaches in the future. Let’s take a look:

  • Revocable trust: This type of trust can be altered while you are still living, especially as your assets or beneficiaries change. You can place all your assets into this trust, but at the very least, put the vacation home in the trust to avoid the property going through probate. Another benefit of a revocable trust is you could set aside money in the trust specifically for the management and upkeep of the property, and you can leave instructions on how the vacation home should be managed upon your death.
  • Irrevocable trust: similar to the revocable trust, assets can be put into an irrevocable trust, including your vacation home. You can leave instructions and money for the management of the vacation home. However, once an irrevocable trust is established, you cannot amend or terminate it.
  • Limited liability company (LLC): You can also create an LLC and list your home as an asset of the company to eliminate probate and save you or your family from the risk of losing any other assets outside of the vacation home, if sued. You can protect yourself if renting out a vacation home and the renter decides to sue. The most you could then lose is that property, rather than possibly losing any other assets. Having beneficiaries rent the home will help keep out-of-pocket expenses low for future beneficiaries. With the creation of an LLC, you are also able to create a plan to help with the future management of the vacation home.
  • Transfer via a deed: When you have multiple children, issues may arise when making decisions surrounding the home. This is usually because your wishes for the management of the house are not explicitly detailed in writing.
  • Joint ownership: You can hold the title to the property with another that’s given the right of survivorship. However, like with the deed, this can lead to miscommunication as to how the house should be cared for and used.

Plan for the future to help make certain that the property continues to be a place where cherished memories can be made for years to come. Talk to a qualified estate planning attorney for expert legal advice for your specific situation.

Reference: Florida Today (July 2, 2022) “Avoiding probate: What is the best option for my out-of-state vacation home?”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

What’s Involved with Being a Trustee? – Annapolis and Towson Estate Planning

There is an old saying that the two best days in a boat owner’s life are the day they buy their boat and the day they sell it.

Forbes’ recent article entitled “How To Be An Effective Trustee” says that a similar notion applies to being a trustee – it is an honor to be named and then a huge relief when it is over. That is because being a trustee is difficult.

Remember that a trust is a fiduciary relationship in which one party (the trustor) gives another party (the trustee) the right to hold title to property or assets for the benefit of a third party (the beneficiary). Trusts are created to provide legal protection for the trustor’s assets, to make certain those assets are distributed according to the wishes of the trustor, and to save time, reduce paperwork and, in some cases, avoid or reduce inheritance or estate taxes.

Being a trustee requires knowledge about a wide range of topics, including:

  • The trustee’s fiduciary duties, which include loyalty, impartiality, duty of care, protection of trust property, enforcement of claims and the duty to inform and account to beneficiaries, among others (violation of these duties exposes the trustee to liability).
  • Understanding the details of the trust, like the specifics of the distribution instructions.
  • Investments and the ability to engage and monitor investment managers.
  • Administrative matters, such as record keeping and principal and income accounting.
  • Estate planning, trusts and the basics of the estate, gift and generation skipping taxes.
  • Income tax, including how trusts are taxed both by the federal government and the state.

A trustee must also be able to productively communicate and work with the beneficiaries on their financial wellness and distribution needs, which is an area that can be full of conflict.

It is a daunting list. Talk with an experienced estate planning attorney to discuss your situation in detail.

Reference: Forbes (May 31, 2022) “How To Be An Effective Trustee”

 

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys