Even with a lot of advice from financial advisors, and some considerable work on protecting capital gains, some unlucky households can find that unanticipated rules on state tax laws can still take a huge bite out of retirement assets. Some households considered middle-income or middle-net-worth by analysts are now choosing to "vote with their feet" when it comes to estate tax rules.
Central to this issue is a vast discrepancy between federal estate taxes, and the tax rules in some dozen or so U.S. states, many of them in the Northeast. Around the New Jersey/New York area, and in other parts of the country, residents of some states face estate taxes at the state level that can kick in at $1 million or less. That's in contrast to a federal $5.34 million exemption on estate taxes.
State tax differences
More than half of all U.S. states don't collect state taxes at all beyond what the federal estate tax laws provide for. Of those that do, there's been some ping-ponging back-and-forth . For example, four states cut estate taxes in 2010: Illinois, Kansas, North Carolina, and Oklahoma. However, in two of those states, Illinois and North Carolina, the taxes came back the next year.
A list of estate taxes around the country circa 2013 shows that New Jersey has traditionally imposed the most heavy-handed tax, with a low exemption of $675,000, with Rhode Island next in line at just less than $1 million. However, there is the very important disclaimer that these state laws are changing over time, and changing fairly quickly. New reporting on how state officials handle estate and inheritance taxes is showing that many state governments, including New York's administration, are moving quickly to repeal some of the tax burdens for those with net worth from $1 million-$5 million, or, in other words, in the huge gap between federal and state exemptions.
Handling unfriendly state tax laws
In the face of these radically different kinds of taxation, some high-net-worth or middle-net-worth families are moving where the best tax exemptions are. For example, professionals at financial planning offices report many New York and New Jersey residents are simply heading for sunnier southern vistas, moving south to Florida. This kind of strategy isn't too different, in a way, from the migration of college-bound and newly emancipated minors looking to get state residency for higher education purposes. It's just happening at a different phase of life -- and in some cases, will save a family a lot more money.
Another choice is to create a spousal trust for money, which can help delay some of the tax, and eliminate other portions of it. However, according to The New York Times, a lack of "portability" in New York and New Jersey is complicating the issue. Because the federal law includes portability, a lot of those who are planning for retirement can be seriously confused about the tax laws in their state, where they may not be able to take advantage of exemptions or tax advantages without a specific document being drawn up.
Clear-eyed thinking about estate taxes
Again, all of this relies on public awareness. As an individual approaches retirement, he or she can gift money up to specific federal and state limits, create a trust or other shelter, or establish residency in another state. But it's important for that person to be well-informed and well-advised, to know what each kind of move entails. For instance, some who have vague ideas of moving out of state may find that they haven't really met the criteria for a tax-free residency at the time that they try to navigate the financial paperwork. There's a greater idea here, which is that those handling retirement investment need to think carefully about their assets, and know about the context of the state-by-state battle for higher estate tax exemptions.
Take control of your taxes
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Justin Stoltzfus is a contributor to WiserAdvisor.