Estate Taxes and Portability

Good Morning Relaxing Retirement Member,

As we’ve all experienced, there are very few certainties in the world.

One of them is that governments will always find ways to collect taxes from you.

During your lifetime, they do so in abundance through income, capital gains, sales, and real estate taxes to name a few.

However, as we discussed last week, taxes may also be levied on gifts you make and/or on the value of your accumulations after you pass away.

In other words, even after a lifetime of paying dozens of taxes, the federal government (and the state of Massachusetts) then taxes your heirs on what remains.

In tax year 2016, the amount that each of us can pass on without federal estate taxes is $5.45 million.

That $5.45 million credit exemption has grown over the years from zero, to $600,000, to $1 million on up.

After that, your heirs will pay a 35% estate tax or more to the federal government. (However, on the state level in Massachusetts, that threshold is still only $1 million.)


When it comes to calculating the amount that your heirs will owe, a little known provision that most particularly impacts our Relaxing Retirement members is a concept known as “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 $5.45 million estate tax free exemption to the surviving spouse, so the surviving spouse will have a $10.90 million exemption.

No longer do you have to create "credit shelter revocable 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.

A Real Life Case Study

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

Ben and Bertha are married with three children. Ben’s only asset is a $5.45 million IRA, and Bertha’s only asset is her $5.45 million IRA. (Please don’t be blindsided by the simplicity or the values used. I’ve chosen them to make a very important point.)

With $10.90 million of combined assets, they obviously want to make sure they take full advantage of their estate tax exemptions, so the full $10.90 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 who passes away NOT to leave his or her $5.45 million IRA to the surviving spouse.

Under the old way of saving estate taxes for a married couple, we would tell Ben not to name Bertha as beneficiary of his IRA!

If he did, Bertha would wind up with $10.90 million of assets and only $5.45 million of exemption!

Under the old way of estate tax planning, the only way Ben 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 Bertha.

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 this current tax policy, members like Ben and Bertha 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 current law, you no longer have to make that particular hard choice.

Instead, Ben can leave his $5.45 million IRA outright to Bertha and still leave her his $5.45 million estate tax exemption.

They can now get the income tax savings of long-term deferral of distributions with the spousal rollover, without having to waste one spouse’s estate tax exemption to get it. When Bertha later dies, she will have a $10.90 million IRA and a $10.90 million estate tax exemption!

** For all of us who live in Massachusetts, your state estate tax exemption is only $1 million so proper planning is even more important.

Committed to Your Relaxing Retirement,

Jack Phelps

The Retirement Coach
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(The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advic