Trying to beat the inheritance tax

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Q. I have one daughter and two nieces – I practically raised them. I want them to share my estate equally. I know the inheritance tax can make that hard, so what strategies can I use to make it even?
— Auntie Mom

A. There are some strategies you can use to save these transfers from the tax man.

First, let’s cover how your assets will be taxed.

Even though New Jersey has repealed its estate tax as of Jan. 1, 2018, it still has an inheritance tax, said Roy Williams, president and founder of Prestige Wealth Management in Flemington and Millburn.

He said the inheritance tax is imposed on transfers of assets to certain classes of beneficiaries, including nieces and nephews.

“The tax rate on transfers to nieces and nephews is 15 percent,” he said. “The only exception is if the bequest is less than $500, in which case there is no tax. If you leave a niece or nephew $500 or more, there is tax on the entire amount.”

Williams said it’s important to note that the tax is also imposed on almost all transfers whether they’re probate or non-probate.

A probate transfer is an asset that passes under your will such as a house or bank account that you own in your name alone, he said, while a non-probate transfer is something that passes outside of your will such as a joint bank account or a retirement account.

“This means that if you name your nieces as beneficiaries of your IRA or 401(k), there will a 15 percent tax due on the amount they receive,” he said. “This is also true despite the fact that when they withdraw money from the IRA, in most cases, they will have to pay income tax on the withdrawal.”

Williams said there are a few transfers that are exempt from the tax. An important one is life insurance paid to a named beneficiary. So if you name your nieces as beneficiaries of your life insurance, they won’t have to pay any inheritance tax on the proceeds of the life insurance.

In general, the person receiving the asset is liable for the tax, Williams said. This can be a burden if the asset they are receiving is not liquid, such as real estate.

In that case, he said, the beneficiary might have to sell the property in order to raise the money to pay the tax. For example, if you leave your house worth $300,000 to a niece or nephew, they would be liable for inheritance tax of $45,000 which is due eight months after the date of death.

Williams said one solution is to state in your will that all taxes are paid from the residue of your estate.

“This is a common provision in a will, and in your case, it would mean that all of the inheritance tax would be paid before any assets are distributed to your beneficiaries,” he said. “Your daughter would get less than what she might otherwise inherit, but basically you would be treating all three beneficiaries the same.”

You will need to be sure that you have sufficient assets flowing through your estate to pay the tax, Williams said, and this might require some planning. But if you want to realize your goal of treating all three beneficiaries equally, planning is exactly what you’re going to have to do.

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This post was first published in January 2018. presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.