Do You Need to Worry About Estate Taxes?

If you believe the estate tax is only for the rich, be advised: Contributing about $433 per month to a 401(k), at 8% compounded monthly, would give you more than $1 million after 35 years - and, under some circumstances, $200,000 or more owed in federal estate taxes.

Currently, anywhere from 37% to 55% of assets over $675,000 when you die can be lost to federal estate taxes, unless you leave this money to a surviving spouse or charity. A spiraling real estate market, growing retirement plan assets, and rising stock prices are all helping make more Americans subject to taxes on their estates. Therefore, it may be smart to watch for ways to help protect your heirs' inheritance ahead of time.

Beyond the "Rich Man's Tax"

The good news is that Congress offered some relief to heirs and taxpayers in 1997, with the minimum amount of assets subject to the estate tax gradually increasing from $600,000 at that point to $1 million ($2 million for couples) in 2006.

Some critics dismiss the estate tax as a rich man's burden. Yet, it's the modestly well-off that stand to gain the most from this change. Partly because "the rich" know who they are - and therefore set up appropriate tax shelters - the richest estates (those worth more than $20 million) currently pay less in taxes (about 12.6%) than smaller estates, which generally pay rates of about 14.8% to 18.1%.

Should You Rest Easy?

This relaxation in the estate tax laws may not mean you can be more lenient in your own tax planning, even as many Americans enjoy the possible effects of these changes. How you plan for these changes will depend on factors such as your age, asset size, and overall financial situation.

For example, if you don't expect your assets to exceed the $1 million mark by a wide margin when you die, then the expense of estate-tax planning may not save much in the long run. And, if your spouse is still alive, in most cases one of you can inherit most of the assets estate-tax free when the other one dies.

But if you do expect your assets to exceed $1 million by a wide margin when you die and/or your spouse has passed away, the gradual hike in the estate tax threshold won't help you much, especially if you are still in your peak earning years. In addition, a number of states currently impose their own estate taxes on assets of as little as $100,000. These states include Connecticut, Delaware, Indiana, Iowa , Kansas, Kentucky, Louisiana, Maryland, Montana, Nebraska, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oklahoma, Pennsylvania, and South Dakota. In these cases, you may want to make some tax-saving moves regardless of federal estate tax limits.

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