Most clients know that if they have a net worth above a certain level, they are subject to federal estate tax. However, many clients do not realize that even if their net worth is far below the federal threshold, they still may need to plan for New Jersey Estate Tax. The New Jersey Estate Tax kicks in for single people or married couples with net worth over $675,000. There is no exemption for assets left to children; those assets are fully taxed. There is also no exemption for the value of your home, retirement accounts, or life insurance, so it is easy to hit the $675,000 threshold very quickly.
In addition to the federal Estate Tax and New Jersey Estate Tax, there is also a New Jersey Inheritance Tax. The New Jersey Inheritance Tax is a completely separate tax from the New Jersey Estate Tax and has its own separate rules. For instance, the New Jersey Inheritance Tax applies even if your net worth is below $675,000. However, unlike the New Jersey Estate Tax (which fully taxes inheritances you leave to your children), the Inheritance Tax exempts inheritances left both to spouses and to children. For that reason, for married couples with children the New Jersey Estate Tax usually ends up being a bigger issue than the Inheritance Tax. On the other hand, for the unmarried and/or childfree, the situation reverses and New Jersey Inheritance Tax is the far bigger problem.
The good news is that there are many strategies to reduce both New Jersey Estate Tax and federal estate tax (as well as New Jersey Inheritance Tax if it apples). Here are a few:
- Credit Shelter Trusts. These are also sometimes called bypass trusts. For married couples, a credit shelter trust is one of the easiest forms of planning. It effectively allows a married couple to shield $1.35M from New Jersey Estate Tax rather than the standard $675,000. [For details on the mechanics of credit shelter trusts, click here.]
- Irrevocable Life Insurance Trusts (ILITs). This is a very straightforward estate tax planning strategy. If you hold any life insurance policies, they are by default included in your taxable estate at your death. An easy way around this is to form an Irrevocable Life Insurance Trust (or ILIT). By holding the policy within an ILIT, upon your death the life insurance proceeds pass to your spouse, children, or other loved ones completely free of all federal and New Jersey Estate Taxes. Through use of a so-called Crummey provision, you can even continue to pay the policy premiums from your own funds with no adverse tax consequences.
- Completed Gift Access Trusts (CGA Trusts) and Dynasty Trusts. This is a special type of Spousal Lifetime Access Trust, or SLAT, that leverages the large difference between the federal estate and gift tax thresholds and the New Jersey Estate Tax threshold. With a CGA Trust, you can make tax-free gifts into a trust. The assets gifted into the trust, as well as any growth in the funds gifted to the trust, generally pass to your loved ones completely free of estate tax and inheritance tax upon your death. Even better, if you need to use the funds while still alive, the CGA Trust provides an "escape valve" which allows you to get the funds back from the trust. It is the closest thing to a best of both worlds situation in estate tax planning. CGA Trusts can also be set up as Dynasty Trusts, in which case the assets in trust will be exempt from estate tax not only at your death, but also at the death of your children, grandchildren, great-grandchildren, and further down the line, literally forever.
- Private Annuities. Through use of a private annuity, you can prevent your assets from being subject to estate tax when you die, all while still being able to access a steady stream of income while alive. Like a CGA Trust, it's as close as you can get to a "best of both worlds" situation.
These are just a few death tax planning strategies. There are many more depending on your specific situation. If you have any questions about the three death taxes applicable to New Jersey residents and how to plan for them, feel free to contact me.
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