NJ Estate Tax - Case Study $2M

In New Jersey, tax planning and estate planning can be very important.  I'd like to show you a good representation of what a plan can do for a married couple with $2,000,000 in assets.  Let's assume that the couple has $800,000 of life insurance, a house worth $400,000, retirement accounts of $200,000, brokerage assets of $350,000, and $50,000 of other miscellaneous assets.  Let's also assume that they are both citizens and they have two young children from their marriage.

Without a will, everything will go to the survivng spouse, free of tax. However, on the death of the surviving spouse, there will be NJ Estate Tax of about $100,000.  Moreover, the two children would each receive $950,000 outright at age 18 and there would be no clear guardian named.

The biggest tax mistake most people make is that they leave everything outright to the surviving spouse.  The reason that this can be a tax mistake is because New Jersey allows each person to pass on $675,000 to their children (and grandchildren) before it taxes the estate.  If you do not use this $675,000 exemption, you lose it.  So the best way to preserve this tax exemption is to avoid giving the $675,000 outright to the surviving spouse and giving it to the surviving spouse and children in a trust.  Sometimes you will hear this referred to as a Bypass Trust, a Credit Shelter Trust or even a Family Trust.

Another big tax mistake most people make is to own life insurance on their own lives.  Most people think that life insurance passes to their heirs free of tax.  This is not true.  It is not subject to income tax or inheritance tax, but it IS subject to the Federal Estate Tax and to the NJ Estate Tax.  Usually the best way to avoid an estate tax on the payout from a life insurance policy is to have an Irrevocable Life Insurance Trust (also known as an ILIT) own the policy on the life of the insured.

So, knowing all this, let's come back to our couple.  The first thing that our couple should do is move the life insurance into a life insurance trust.  (It would be even better to have the trust buy a new life insurance policy because if you transfer a policy in to an ILIT, there will not be any tax benefits for 3 years.)

The second thing our couple should do is create Wills (or revocable living trusts).  In New Jersey, with most traditional couples, on the death of the first spouse, we will typically send the first $675,000 into a Bypass Trust for the benefit of the surviving spouse and the children.  (The $675,000 is really based upon a formula to allow the maximum amount possible to go into the this trust before there is a tax.  It various by state and also by the tax law at the time of the death of the first spouse.)  

If the first spouse to die owns more than $675,000, than that can either go outright to the surviving spouse or in a Marital Trust.  This is up to the couple to decide based upon how much they want to protect this money from creditors and future spouses.  Upon the death of the surviving spouse, everything that is in the name of the surviving spouse and everything that is in the trust for the surviving spouse gets combined and sent to the children.  If the children are young, we usually recommend that it goes to them in trust until they reach a more appropriate age.

Now that we have the plan in place, we must retitle the assets so that the plan will be effective. You see, a Will that states the first $675,000 goes to a surviving spouse in trust is useless unless the first spouse to die actually owns $675,000.  In our situation above, the house is most likely owned by husband and wife jointly, meaning it goes automatically to the surviving spouse outright regardless of what the Will says. Additionally, the life insurance and retirement accounts will most likely name the the surviving spouse as beneficiary.  For most couples, retitling the assets typically means moving the life insurance into the ILIT, preparing a new deed and otherwise moving assets around between the couple.   There is usually not much you can do with the retirement accounts.

The end result of this plan is that we will have moved $800,000 into a life insurance trust, reducing the taxable estate to $1,200,000.  The balance will be divided roughly equally between the husband and wife.  On the first to die, we send as much as we can into the Bypass Trust, utilizing their NJ Estate Tax exemption.  In this scenario, on the death of the second person, we will have reduced the NJ Estate Tax from $100,000 to $0. 

Another benefit to all this planning is that it can make the estate administration much easier and less costly.  In this econcomy, it is important to make things easier especially when you own real estate.  If you owe estate or inheritance taxes at the time of your death, a tax lien automatically attaches to the property and you will not be able to sell it with a clear title until the taxes are paid. 

Social Security Statements

You may have noticed that you did not receive a Social Security statement recently.  A little more than a year ago, the SSA stopped mailing paper statements out in a cost savings move.  All is not lost however, as you can go online to get your earnings history and information on estimated benefits at:  https://www.socialsecurity.gov/mystatement/

Keeping up to date with what you are entitled to is an important part of your financial plan and your estate plan.  If you haven't done so yet, you should go ahead and create an online account with the Social Security Administration so that you will be able to access your earnings history.

Thank you to Ken Weingarten at Weingarten Associates, L.L.C. for bringing this important information to my attention.