Estate Planning: A Proper Transfer

6) Beneficiary Designations: Life insurance, annuities, qualified retirement plans, IRAs, non-qualified deferred compensation benefits, and transfer on death (TOD) designations of non-qualified investment accounts all pass to the designated beneficiary and will not be subject to probate. The designated beneficiary may be an individual or a trust.

7) Joint Tenancy with Right of Survivorship (JTWROS): This undivided interest in property passes automatically by operation of law to the surviving joint owner and will not be subject to probate.

8) Tenancy in Common: This undivided interest in property owned in a sole name (individually) with other tenant-in-common owners passes according to specific directions in the will of the deceased or by the intestacy laws of the state if there is no will. The tenant-in-common interest is probate property and final distribution must be approved by the Probate Court.

9) Qualified Disclaimer: If the recipient of any type of property executes a qualified disclaimer within nine months of the death of the owner of probate property, the property in question will instead pass to the remaining beneficiaries of a probate estate. For life insurance, annuities, qualified retirement plans and IRAs, the property in question will pass to the contingent beneficiary when the designated primary beneficiary disclaims. Sometimes a “double disclaimer” needs to take place in order for the disclaimed property to be transferred to the desired heir.

Each and every asset owned by a deceased individual must pass through one of the property transfer methods described here. Financial professionals should record and update an accurate asset inventory for their clients that lists current value, asset title, and whether the asset will pass through the probate court process or not. 

State estate taxes and IRD income taxes

Also, certain states have state estate taxes that must be paid. Generally, states that “de-coupled” from the federal estate tax system so they could continue to levy death taxes on their deceased residents have progressive state death taxes ranging from about 5 percent up to 16 percent, depending on the size of the taxable estate. There is currently a federal estate tax deduction for any state death taxes actually paid. If the “sunset” of the current federal estate tax law takes place as scheduled on December 31, this federal estate tax deduction will automatically revert to a federal estate tax credit as it existed prior to 2005.

States that remained “coupled” to the federal estate tax system currently have no state death taxes at all since the phase-out of the “pick-up” state death tax credit in 2005. However, if the “sunset” of the current federal estate tax law takes place as scheduled on December 31, these “coupled” states will automatically be “re-coupled” to the federal estate tax system and will receive an amount of federal revenue sharing in the form of the so-called “pick-up” estate tax according to the Credit for State Death Tax Table of IRC Section 2011. Thus, “coupled” states like Florida, Texas, and California will once again “pick-up” a share of estate taxes as they did prior to 2005. Financial professionals should advise their clients whether or not state death taxes may be part of their planning picture again depending on whether their state is a “de-coupled” state or a “coupled” state.

Finally, financial professionals should advise their clients whether or not there will be any post-death income taxes on certain financial assets. This post-death income is known as “income in respect of decedent” (IRD). Two major types of financial assets affected by this post-death IRD tax are qualified retirement plans (i.e., IRA and 401(k)s) and the deferred gain amount in excess of the cost basis for non-qualified deferred annuities. Plan beneficiaries of these assets will report the receipt of these post-death taxable amounts as ordinary income on their own federal and state personal income tax returns. There are certain options available under the Internal Revenue Code and Regulations to spread out the IRD post-death taxation over a number of years after the account owner’s death if desired. Generally, these rules allow up to five years as a post-death distribution option or, conversely, a post-death distribution option over the life expectancy of the beneficiary. Smaller accounts may opt for the five-year plan whereas larger accounts may find the life expectancy method more suitable to their needs. Clients should consult their financial professionals and tax advisors to explore these post-death “inherited” IRA or “inherited” non-qualified annuity distribution options.