If your state has an inheritance tax, you should have an idea how it will be paid when you pass away.
Financial institutions may not withhold the tax before the inheritances are paid, and if there won’t be enough in the residue of your estate to pay the tax, you need some options.
Nj.com’s recent article entitled, “How can I be sure the inheritance tax is paid when I die?” says that, while it’s admirable to try to avoid trouble for your executors, there’s a simple solution.
The article suggests that you can remove all beneficiary designations from your financial accounts. This planning technique has some merits but, as a general rule of thumb, it is best to name either an individual(s) or trust as the beneficiary to these types of accounts. While there may be an issue of who pays the estate taxes, there is also the issue of who ultimately inherits the asset to factor into this decision. That is, the option to remove all beneficiaries from your financial accounts may not be a prudent one, especially if you fail to execute a Last Will and Testament during your life. In this case, where there is no death beneficiary and no Will, these assets are distributed in accordance with your state’s intestacy statute. If, for example, you wanted your favorite niece to inherit your IRA but failed to name her as the death beneficiary to the account, and failed to execute a Will, and if you died without a spouse, parent or children, your living sibling(s) would inherit this asset. The state’s design and not yours will govern the distribution of these assets. If you do implement this strategy, it is advisable to have a properly executed Last Will and Testament at a minimum.
To understand this general rule of naming/not naming a beneficiary, assuming that you have executed a Last Will and Testament, a review of how the beneficiary designation works after death is helpful.
When you add individuals as death beneficiaries to your financial accounts, you create what is called a nonprobate asset, or an asset that is not distributed pursuant to your Will and, in the case, where the benerficiary(ies) are individuals, the assets are distributed to these individuals outright soon after death. Alternatively, if you name the beneficiary of these accounts as the estate or fail to name any individual beneficiary, these assets become probate assets that are distributed in accordance to your Last Will and Testament. Your Last Will and Testament will have a tax apportionment clause that may state that any estate taxes owed are paid by the residuary beneficiaries or require each beneficiary, residuary or one that has received a specifc bequest, to pay their proportionate share of the tax liability. A third option, other than to name invdiduals or the estate, is to name the death beneficiary of these accounts as the trustee of your living trust. The tax provision of the trust will then guide who or what classes of beneficiaries pay any estate taxes, as well as whether these assets are distributed outright at death or held in trust for a period of time or subject to certain conditions.
It is important to discuss with an estate planning attorney the issue of whether you have a potential taxable estate at your death, whether these taxes are paid by a group or all of your beneficiaries, whether your documents can provide estate tax minimization language and opportunities, and whether a Last Will and Testament or Living Trust is the better estate planning document to achieve these objectives.
Reference: nj.com (May 5, 2020) “How can I be sure the inheritance tax is paid when I die?”