Dealing With Estate Taxes Is Now Easier

As the final days of 2010 were counted down, you may recall that Congress and the President enacted the 2010 Tax Relief Act.

While not much changed on the income and capital gains tax front, a lot changed on the federal estate tax front!

In one fell swoop, it made estate planning for most of our Relaxing Retirement members much simpler.

To refresh your memory, estate taxes are levied at your death on your assets above a certain amount.

Effective in 2011, each of us can pass on up to $5 million without any estate tax.  After that, your heirs will pay a 35% estate tax or more.  This alone is promising news.


However, the provision that most particularly impacts our members is a brand new concept called “portability of the estate tax exemption”. What exactly does this mean?

It means a husband and wife can leave their federal estate tax exemptions to each other. The first spouse to die can automatically leave his/her $5 million estate tax free exemption to the surviving spouse, so the surviving spouse will have a $10 million exemption.

No longer do you have to create “credit shelter trust” estate plans to make full use of each of your exemptions.

This makes estate planning much easier, especially when most of your assets are in IRAs.


Let me give you a very simple, clean-cut example.  This will take a moment to clarify, but please bear with me because it’s all good news:

Don and Betsy are married with three children. Don’s only asset is a $5 million IRA, and Betsy’s only asset is her $5 million IRA.

With $10 million of combined assets, they obviously want to make sure they take full advantage of their estate tax exemptions, so the full $10 million can eventually pass to their three children with no federal estate tax.

Without portability of the estate tax exemption, the only way they could have taken advantage of their exemptions was for the first spouse to die NOT to leave his or her $5 million IRA to the surviving spouse. Under the old way of saving estate taxes for a married couple, we would tell Don not to name Betsy as beneficiary of his IRA!

If he did, Betsy would wind up with $10 million of assets and only $5 million of exemption!

Under the old way of estate tax planning, the only way Don could make use of his federal estate tax exemption would be to leave his IRA either directly to the children or to a “credit shelter” or “bypass” trust for the life benefit of Betsy.

Leaving the IRA directly to the children could be a good tax move, but most members in my experience don’t like that because it takes money away from the surviving spouse.

Leaving the IRA to a credit shelter trust for the surviving spouse seems to protect the surviving spouse financially, and it definitely saves estate taxes for the children by keeping the IRA out of the surviving spouse’s estate.

However, on the flip side, it causes a huge loss of income tax benefits. There is no spousal rollover and no “stretch or inherited” IRA payout over the children’s life expectancy.

Instead, the entire IRA gets dumped out into the credit shelter trust over the single life expectancy of the surviving spouse, a much shorter period of time.

Prior to the new Tax Act, members like Don and Betsy’s situation had to make a hard choice: Do we go for the income tax benefits of the spousal rollover by leaving the IRA outright to the surviving spouse, even though that costs extra estate taxes by wasting the first spouse’s estate tax exemption?

Or, do we save estate taxes by leaving the benefits to a credit shelter trust but give up on the long term deferral that would otherwise be available via the spousal rollover?

Thanks to the new law, you no longer have to make that particular hard choice.

Instead, Don can leave his $5 million IRA outright to Betsy and still leave her his $5 million estate tax exemption. They can now get the income tax savings of long-term deferral of distributions via the spousal rollover, without having to waste one spouse’s estate tax exemption to get it. When Betsy later dies, she will have a $10 million IRA and a $10 million estate tax exemption!

Two Caveats

First, this will be the law of the land until the end of 2012.  After that, it’s up in the air. (Nothing worse than laws that “sunset”!)

Second, this doesn’t negate my recommendation to have a revocable living trust.  I still strongly recommend it for probate avoidance and estate management reasons so don’t take this to mean that you shouldn’t have created living trusts.  They still have significant benefit.