17 Dec How can I avoid the inheritance tax for my nephews?

Q. I’m trying to plan my estate. I have three nephews I want to give everything to but I don’t want them to have to pay the inheritance tax. Is there any way to avoid the tax?
— Uncle

A. We’re glad you’re trying to plan ahead.

You do have some options, but it will take some planning. Let’s start at the beginning.

The New Jersey inheritance tax is a tax levied on certain transfers from a deceased person to a beneficiary, depending on that beneficiary’s relationship to the decedent, said Samantha Rocco, an attorney with Einhorn. Barbarito, Frost & Botwinick in Denville.

There are four classes of beneficiaries: Class A, C, D and E. Class B was eliminated in the 1960s, she said.

“Nieces and nephews are Class D beneficiaries,” Rocco said. “Generally, a bequest of $700,000 or less to a Class D beneficiary is subject to a 15% inheritance tax and any amount in excess of $700,000 is subject to a 16% inheritance tax.”

There are, however, exceptions to this general rule.

One exception is that proceeds of a life insurance death benefit payable to a named beneficiary, or beneficiaries, are not subject to the New Jersey inheritance tax.

She offered this example. Let’s say Joan Smith dies, leaving $100,000 in cash to her nephew. The nephew’s inheritance will incur a 15% inheritance tax. This means that of the $100,000 bequest, a $15,000 tax will be imposed ($100,000 * 15%). The net amount the nephew will receive is $85,000 ($100,000 minus the $15,000 inheritance tax).

Now, let’s instead, imagine that Joan designates her nephew as the beneficiary of her life insurance policy, which has a death benefit of $100,000, rather than giving him $100,000 in cash. Because life insurance death benefit proceeds are paid to a named beneficiary, the proceeds are exempt from New Jersey inheritance tax and thus, the nephew will inherit the entire $100,000, Rocco said.

In that case, no inheritance tax will be incurred, she said.

Rocco noted that certain specifically-delineated pensions are also exempt from the New Jersey inheritance tax. Namely, per NJAC Section 18:26-6.14, “all payments at death under the Teachers’ Pension and Annuity Fund, the Public Employees’ Retirement System of New Jersey, and the Police and Firemen’s Retirement System of New Jersey, and such other State, county, and municipal systems as may have a tax exemption clause as broad as that of the three major State systems addressed in this section . . . are exempt from the New Jersey transfer inheritance tax.”

Rocco said another effective way to minimize the amount of New Jersey inheritance tax is to begin gifting assets during one’s lifetime, whether outright or in trust.

This won’t be right for everyone as some people may not be able to afford it during their lifetimes, she said.

With respect to gifting during one’s lifetime, it’s important to note that under the law, gifts made within three years of death are considered to be “given in contemplation of death.”

“Gifts given in contemplation of death are subject to inheritance tax, even though the individual was alive when the gifts were made,” Rocco said. “To rebut this presumption, one must convince the New Jersey Division of Taxation that the gifts made within three years of death were not gifts given in contemplation of death.”

So if you leave your estate to your nephews, unless your estate is solely composed of life insurance policies designating your nephews as beneficiaries or one of those pension plans, an inheritance tax will be incurred, Rocco said.

Also note that your will can address the issue of who will pay the inheritance tax.

“The two chief options are your residuary estate — the amount left over after your liabilities and specific bequests, if any, are satisfied — will pay for the inheritance taxes, which will reduce the amount each nephew receives, or each nephew can pay his own portion of the inheritance tax due.”

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This story was originally published on Dec. 17, 2021.

NJMoneyHelp.com 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.