Retiree Portfolio Estate Planning in Flux

The enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) contained estate taxation provisions that may reduce the need for detailed estate planning for many. Unfortunately, due to a sunset provision built into the EGTRRA, those rules will revert to current law in 2011 unless a future Congress chooses to extend or modify them. Given this uncertainty, it is important that we all remain flexible and alert to potential changes in this area.

Format for Printing

Format for printing

Request Reprints


By David Braze (TMF Pixy)
November 5, 2001

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) has given most of us some great opportunities to save on taxes as well as increase our retirement savings. Unfortunately, given its complicated phase-in and phase-out features, the EGTRRA has also made our personal financial planning a more challenging effort. That's because now, perhaps more than ever, we must be alert to the opportunities and pitfalls this legislation presents.

The best way to do that is to remain informed. Over the past few months my colleague Roy Lewis (a.k.a. TMF Taxes) and I have written a number of columns highlighting the issues involved. In fact, Roy wrote seven consecutive columns on the issues involved starting with his missive of June 1, 2001. All are worth your review, and can be found in the tax column archives.

For this column, though, let's look at one of the more ambiguous changes enacted by the EGTRRA, that of estate taxes. Estate planning is important at any time in your life, a fact we highlight in Step 11 of Retirement Planning: Keep It in the Family. But the EGTRRA has made such planning even more important in the near term. While seemingly attractive on the surface, the EGTRRA revisions have further complicated an already complex issue.

Currently, those with estates subject to potential taxation must seek detailed legal advice to use a combination of marital deductions, trusts, and gifting to minimize federal estate taxes. Under the EGTRRA, these planning devices may or may not be needed. To see why, let's take a quick look at what the law provides for today as opposed to what is scheduled to happen under the recently enacted EGTRRA.

In the absence of appropriate estate planning, under today's law federal estate taxes kick in when a person dies and leaves an estate that has a value of more than $675,000. While this may seem like a large sum to many, keep in mind that your estate includes the value of everything you own. When you total the value of your home, car, investments, retirement plans, and the face value of life insurance on policies you control, it is quite easy for many of us to have an estate that exceeds today's exempted amount.

Indeed, that's a major reason why an earlier Congress provided for an increase in the exempted portion of a decedent's estate by enacting the Taxpayer Relief Act of 1997 (TRA 97). The EGTRRA is another attempt by Congress to reduce the bite of estate taxes. Here's what the estate exemption and top marginal tax rates look like under TRA 97 (today's law) and EGTRRA.

    Estate Exemption and Top Marginal Tax Rates

Year    TRA 97       EGTRRA Estate    Top Marginal
       Exemption       Exemption        Tax Rate
2001   $675,000       Not applicable      55%
2002   $700,000       $1,000,000          50%
2003   $700,000       $1,000,000          49%
2004   $850,000       $1,500,000          48%
2005   $950,000       $1,500,000          47%
2006   $1,000,000     $2,000,000          46%
2007   $1,000,000     $2,000,000          45%
2008   $1,000,000     $2,000,000          45%
2009   $1,000,000     $3,500,000          45%
2010   $1,000,000     Tax Repealed        None
2011   $1,000,000        ????             55%

Note that under the EGTRRA there will be a steady increase in the exempted estate between 2002 and 2009. That favorable result is combined with a reduction in the maximum possible marginal estate tax rates from 55% today to 45% in 2007, an additional boon to those with large estates. And for those in that category, from their heirs' perspective the best year for them to die seems to be 2010. In that year, estate taxes are scheduled for a full repeal, so the heirs of those who die with large estates in that year will see no federal estate taxes at all. Think many folks will plan for that? Sounds like a job for Dr. Kevorkian to me.

Note that the situation changes in 2011. The EGTRRA estate taxation provisions disappear entirely, and we revert to the estate taxation provisions found in TRA 97! That's because the Congress, using the smoke-and-mirrors approach it often employs when dealing with taxation and budget issues, inserted a sunset provision into the EGTRRA that ends all changes enacted in that law, to include those pertaining to estate taxation. This was done to ensure the various provisions within the EGTRRA would comply fully with the provisions of the Congressional Budget Act of 1974. Thus, unless a future Congress chooses to extend the estate taxation aspects of the EGTRRA (to say nothing of all the others), we will be back to those found in TRA 97.

As the Congress was developing the new estate tax provisions, many in the financial planning community foresaw the potential elimination of involved estate planning procedures for all but the super-wealthy. But reality reared its ugly head with the insertion of the sunset clause in the EGTRRA. Now, that prospect is far from certain. Unless something happens between now and 2011, the need for detailed estate planning will remain. Sure, we will see two presidential and five congressional elections between now and then, so anything can happen. Still, it's unlikely the estate taxation aspects of the EGTRRA will remain as they currently are. And that means that we must review our estate planning frequently to ensure we adapt our plans to fit the law as it evolves.

A conservative approach may be to view the TRA 97 provisions as those most likely to survive in future years. Alternatively, there continues to be broad support in Congress for relief in this area; therefore, it may also be reasonable to project the EGTRRA estate exemption and marginal rates scheduled for 2008 ($2 million and 45%, respectively) will be allowed to stand. Certainly, there is no way to know for sure. In this author's opinion, a full repeal of estate taxation appears highly unlikely. Conversely, I think a further increase in the estate exemption amount coupled with a reduction in the top taxation rate is likely. Only time will tell whether I am right.

But even if estate tax repeal survives as scheduled under the EGTRRA, there will still be ample need for many folks to look at this issue carefully. Reasons other than tax avoidance may dictate the development of plans, wills, and trusts that specify how assets will pass to heirs. These reasons may include the gradual distribution of assets to a spendthrift heir. Or perhaps there is a need to protect a beneficiary's assets from creditors. Or maybe there is a disabled beneficiary for whom continuing care must be arranged. Regardless of what happens, estate planning should remain a facet of everyone's overall financial plan.

What should you do in light of these impending changes? That's easy. Review where you are in your estate planning. Does your will do what you want it to in distributing your assets at death? Are your beneficiary designations for life insurance, retirement plans, and IRAs up-to-date? Are your major assets (i.e., investment accounts, homes, cars) titled appropriately? How will your estate be affected by the estate exemption amounts over the next 10 years? Answering these questions and amending your plans accordingly will ensure your family or other heirs will obtain the maximum benefit when you depart this world.

Remain flexible and pay attention to what will surely happen over the next decade. When Congress next changes the rules -- and don't doubt it will -- amend your estate plans once again to conform with the new rules as they become effective. In short, consider your estate planning a short-term effort that should be reviewed often, at least once every five years. That's the only way you will be able to guarantee that those you wish to have your property on your death get it, and suffer the least possible loss in those assets due to the payment of estate taxes and probate fees.

That's it until next week. In the meantime, post away on the Retirement Investing or Retired Fools boards.

Best to all...Pixy

The Motley Fool may be all about investors writing for investors, but Dave Braze is all about retirement. The countdown to his third retirement now stands at 25 days. Maybe he'll get it right this time.