Little-known pension tips to avoid inheritance tax (2024)

FAQs

What is the best trust to avoid estate tax? ›

One type of trust that helps protect assets is an intentionally defective grantor trust (IDGT). Any assets or funds put into an IDGT aren't taxable to the grantor (owner) for gift, estate, generation-skipping transfer tax, or trust purposes.

Place assets within a trust.

Another commonly used inheritance tax loophole is placing your assets within a trust. Your estate will not include these assets and therefore they avoid inheritance tax. Trusts are a great way to leave behind part of your estate to somebody who is too young to handle their affairs.

Shift money to a nontaxable account.

You will pay taxes as you make the transfer, but your money will then grow tax-free, and you will pay nothing in retirement when you withdraw. You may want to stretch those transfers over several years, so you avoid jumping yourself into a higher tax bracket.

Strategies to transfer wealth without a heavy tax burden include creating an irrevocable trust, engaging in annual gifting, forming a family limited partnership, or forming a generation-skipping transfer trust.

Grantor retained annuity trust (GRAT): A GRAT is a type of irrevocable trust. You can transfer assets to the trust while getting an annuity payment. If the assets in the trust appreciate enough, you can pass that excess value to your heirs with little or no tax.

The trust fund loophole lets you transfer assets to your heirs without paying the capital gains tax. High-income earners pay the highest capital gains tax rate. So, the loophole benefits them most. Politicians frequently try to close the loophole.

Most relatively simple estates (cash, publicly traded securities, small amounts of other easily valued assets, and no special deductions or elections, or jointly held property) do not require the filing of an estate tax return.

A payer must withhold 20% of an eligible rollover distribution unless the payee elected to have the distribution paid in a direct rollover to an eligible retirement plan, including an IRA.

How much of my pension is taxable federal? ›

Pensions: Pension payments are generally fully taxable as ordinary income unless you made after-tax contributions. Interest-Bearing Accounts: Interest payments are taxed at ordinary income rates, but municipal bond interest is exempt from federal tax and may be exempt from state tax.

Some states have inheritance taxes, but California is not one. However, it's essential to be aware that even though there is no inheritance tax in California, there may still be federal estate tax to consider.

A gift tax is a government tax imposed on those who give money or property to others in exchange for nothing (or less than total value). There is typically a tax-free gift limit to family members until a donation exceeds $15,000 (jumping up to $16,000 in 2022). In these instances, the IRS is usually uninvolved.

Irrevocable trusts

The assets move out of your estate, and the trust pays its own income tax and files a separate return. This can give you greater protection from creditors and estate taxes.

Using an irrevocable trust allows you to minimize estate tax, protect assets from creditors and provide for family members who are under 18 years old, financially dependent, or who may have special needs.

Asset protection: A properly designed trust can also protect the assets in it from creditors, predators and failed marriages. In addition, a properly designed trust can protect the assets in it from long-term care and nursing home costs.

The downside of irrevocable trust is that you can't change it. And you can't act as your own trustee either. Once the trust is set up and the assets are transferred, you no longer have control over them, which can be a huge danger if you aren't confident about the reason you're setting up the trust to begin with.