Real Estate and You!

Q: I am a widow. I have inherited my husband's 401(k) and have an IRA in my name. Once I die, are they subject to Rhode Island's inheritance tax if my total estate, including the 401(k) and IRA, is worth more than $675,000? Or do they go to my heirs tax-free?

-- L.G., East Greenwich

A: They will pass directly to your heirs, outside the Probate Court process.

But they will be counted as part of your estate for purposes of calculating any estate tax that may be due.

That's the summary. Following are some details:

Probate: After you die, most of the assets you leave behind will pass to your heirs or beneficiaries only after a court procedure, known as probate.

However, certain assets -- such as an IRA, 401(k) or similar retirement-saving plan -- can pass directly to your named beneficiaries, outside the probate process.

That way, they'll avoid the potential delays, costs and publicity that can be associated with the probate process, said Angela M. Thomson, former head of the Rhode Island chapter of the Financial Planning Association, a trade group for financial planners and others.

To ensure that this happens, check with the financial institution that oversees each such retirement account, to see that there's a beneficiary form in place, and that the form is up to date. (Please see the June 11 MoneyLine for more details on the importance of beneficiary forms.)

You might also consider transferring the 401(k) account directly to an IRA. That'll give your beneficiaries more investment flexibility. They'll also have more of an opportunity to stretch out mandatory withdrawals, giving the account more time to grow, Thomson said in an interview at Coastal Financial Planning Inc., her fee-only financial-planning firm in Lincoln.

Death Tax: In general, if the value of all your assets exceeds a certain amount -- a certain "threshold" -- it may be slapped with a death tax -- also known as the estate tax -- at both the federal and Rhode Island level.

The threshold for the federal death tax is $2 million for this year, and is scheduled to move higher in future years.

Rhode Island's death-tax threshold is $675,000 and is not scheduled to change. It has been fixed at $675,000 since 2001. Had it been indexed to rise with inflation, it would be at about $773,330 today, a government inflation calculator shows.

All the assets in your retirement accounts are counted toward these thresholds. "They are counted as assets for purposes of calculating any Rhode Island estate tax that may be due," Thomson said.

The person handling your estate will have to add up the value of all your retirement accounts, along with the value of all your other assets -- such as real estate, jewelry, collectibles, stocks, bonds and cash, said Robert J. Sclama, former head of the federal and state tax committee of the Rhode Island Society of Certified Public Accountants.

If the total value exceeds $675,000 (after deducting debts, funeral costs and certain other expenses), Rhode Island will bite off a chunk of your estate to cover the death tax; your beneficiaries will get the remains.

In general, "The [death] tax is borne by the estate, not by the individuals receiving the property," Sclama said in an interview at his office in North Providence, where he runs his own tax-consulting and financial-planning practice.

Rhode Island Threshold: The National Federation of Independent Business (NFIB), which represents small and independent businesses in Rhode Island and other states, says that the Rhode Island estate tax should be eliminated. Short of that, the threshold should be indexed to inflation.

"The Rhode Island estate tax should be indexed so that it gradually increases to reflect the increase in the value of assets, particularly real estate," the NFIB says.

"This tax is money that should go [to] heirs and small, family-owned business and not the state, so that relations are not forced to sell off their parents' life work to fill the coffers of government. . . . Death [should] not be a taxable event. . . .," the NFIB says.

Other points:

If you're married and you pass your entire estate to your spouse upon your death, there'll generally be no estate tax due. But when the surviving spouse dies, the tax can be triggered.

You can take a number of steps to reduce or even eliminate the impact of the death tax, especially the Rhode Island death tax. For example, Rhode Island has no gift tax, so if you give away some assets while you are alive, you can reduce the size of your estate. However, you must plan carefully. Be sure to consult a professional who can tell you which techniques best suit your circumstances.