Estate Planning For Newbies, Part1: What It Is And Why It's Important

Estate Planning For Newbies, Part1: What It Is And Why It's Important  Estate planning is nothing more than being tax-efficient, so your heirs get as much as possible. In this post we'll learn how much tax our heirs will need to pay, what the allowable deductions are, and what options are available to handle the estate tax.
With All Souls day (and Halloween) around the corner, I figured it's not a bad time to broach a topic that starts with death. Well ok, there never is a good time but I figured I might as well be in season.

Like investing, estate planning is usually thought of as something just for rich people. But that's not really the case.

Did you know that if you die, your surviving family will need to pay the government up to 20% of what you left them? 

The government taxes pretty much everything where money changes hands. And handing over hard-earned money to your heirs (usually the surviving spouse or children) is subject to taxes too.

Estate planning is nothing more than being tax-efficient, so your heirs get as much as possible.

Why is that important for ordinary folks like us? It's not like we've got several mansions and millions of cash to leave behind, right? 

Well, you might be surprised. Let's take a look at this example

Let's say Juan has a small, modest house worth 2M today. That's not necessarily a large house; there are 1-room condo units more expensive than that. And he's got an old car worth 200k in it's current condition. Similar to the house, that's not an especially nice car either. And let's say he's also got 100K in savings that he wanted to split among his 4 remaining children. And let's assume his wife passed away already.

That's not the picture of a wealthy guy. But if Juan did pass away, without doing any kind of planning or preparation, the BIR might be asking his heirs to pay Php168,000 just for receiving their inheritance.

And to make that more interesting, his heirs can't legally use his 100K savings because it's frozen until the estate tax is paid.

That's just crazy, right? And if it's not settled within the allotted time, there are even penalties imposed; so the amount just gets larger.

Essentially, that's why we need to have even a rudimentary estate plan. Even some simple or minor preparation can help a lot.

So, how do we prepare?
  1. Know how much (and what exactly) you're leaving behind. That way you have an idea how large the tax might be and what the best approach might be.
  2. Know the deductions. Yes, thankfully there are deductions. So your entire estate is not really taxed. In the example above, it's quite possible that in reality Juan's heirs can get away with very minimal estate taxes due. But since our BIR is very "motivated", it's better if we know just what those deductions are. Just in case they "forget" to tell us...
  3. Estimate how much the estate tax could be. To do this: compute for your net worth, apply the deductions (see allowable deductions list below), and look at where it falls on the tax table (shown below as well, for convenience).
  4. Write a Will. Your last will and testament is more for your family/heirs. It might help with probate costs, but that's a very complicated topic. Fitz has a nice article on his site about the basics of writing a Will.
  5. Find and choose the best way to deal with the tax. For which there are several:
    • Get Life insurance
    • Setup a Living Trust
    • Donate or Gift your assets to your heirs while alive (though still subject to Donor's tax)
    • Sell your assets to your heirs while alive (though still subject to capital gains tax)
    • Setup a corporation and transferring shares of stock to your heirs
In the next post, we'll discuss the different ways to deal with the estate tax. For now, we'll just go over the estate tax bracket and what the allowable deductions are.

From BIR's website, here's the estate tax table (Effective January 1, 1998 up to Present). If the Net Estate is:


Over But not Over The Tax
Shall be
Plus Of the Excess Over
P 200,00.00 Exempt
P200,000.00 500,000.00 0 5% P 200,000.00
500,000.00 2,000,000.00 P 15,000.00 8% 500,000.00
2,000,000.00 5,000,000.00 135,000.00 11% 2,000,000.00
5,000,000.00 10,000,000.00 465,000.00 15% 5,000,000.00
10,000,000.00 1,215,000.00 20% 10,000,000.00


Allowable deductions:
a)   Funeral Expenses (RA 8424 - 5% of gross estate but not exceeding P 200,000)
b)   Judicial expenses of the testamentary/intestate proceedings
c)   Valid claims against the estate
d)   Claims against insolvent person
e)   Unpaid mortgages/indebtedness
f)    Unpaid taxes
g)   Casualty losses
h)   Property previously taxed or vanishing deductions
Requisites:
  • Present decedent must have died within five (5) years from date of death of prior decedent or date of gift
  • The property with respect to which the deduction is claimed must have formed part of the gross estate situated in the Philippines of the prior decedent or taxable gift of the donor
  • The property must be identified as the same property received from prior decedent or donor or the one received in exchange therefore
  • The estate taxes on the transmission of the prior estate or the donors tax on the gift must have been finally determined and paid
  • No vanishing deduction on the property or the property given in exchange therefore was allowed to the prior estate
i)    Transfer for public purpose
j)    Share of surviving spouse
k)   Medical expenses - those incurred by the decedent within one (1) year prior to his/her death which shall be substantiated with receipts (NOTE: Amount allowable as deduction depends on the law prevailing at the time of death of the decedent).
l)    Family Home - fair market value but not to exceed P1,000,000.00
m)  Standard Deduction - an amount equivalent to P1,000,000.00 (applicable only for death occurring after the effectivity of RA 8424 which is January 1, 1998.)
n)  Amount received by the heirs under Republic Act No. 4917 (applicable only for death occurring after the effectivity of RA 8424 which is January 1, 1998) - This law essentially states that money received by the heirs from the deceased's employers (from a retirement plan) is not subject to tax. Like any law, there are conditions and such. Learn more about RA#4917 here: http://www.lawphil.net/statutes/repacts/ra1967/ra_4917_1967.html


Disclaimer: This post is purely for informational purposes. It's still best to consult a lawyer to properly prepare your estate plan.

Read more: The 6 different ways to prepare for estate taxes.

If you likes this post, please subscribe to my feed, like me on Facebook, circle me on Google+, or follow me Twitter @thePFApprentice. It's free, you won't miss new posts, and you'll also get my free ebook: the Super Savings Guide.

Enter your email address for your free subscription





photo credit: lucyfrench123 via photopin cc

4 comments:

  1. Hi Carlos,

    Great article, but don't you think so that taxes like this should be modified to reflect whatever we currently have in the Philippines? These numbers are actually from the 80s and they don't necessarily reflect the same purchasing power that we have right now. Maybe we can ask Miriam Defensor to make a pick-up line on this. Anyways, kudos for this very informative post! :)

    ReplyDelete
    Replies
    1. Thanks!

      Did you mean that the thresholds were set in the 80s? And should therefore be raised to reflect the current, equivalent standard of living that 200,000 (for example) had back then? If so, I'm inclined to agree.

      Delete
  2. I read somewhere in an academic paper that the BIR does not bother to look into your cash hoard, but only into your real property hoard.

    That is one instance among many instances on how law in the country is NOT observed regularly and with 'consent' from the government.

    For example, and correct me if I am wrong, government officials are supposed to NOT be into money making undertakings as a general rule, because all their working hours of every working day should be occupied productively for the country, and in fact they should divest all their business undertakings or profitable undertakings during their employment in the government.

    But this law is not being observed at all.

    Consider that Vilma Santos Recto governor of Batangas is into advertising on radio for some commercial products; and correct me if I am wrong, attorneys who are congressmen and senators continue to practice their attorney profession.

    And the government and also the citizenry all to all appearances don't give a damn about it.

    ReplyDelete
    Replies
    1. All true...

      I would be interested in that academic paper though. And all possibly "strategic", similar paper :)

      However, it's possible that is true only because of the banking privacy rules. In general I think they can't just go snooping into banks to see how many accounts and how much money you really have. You'd have to cross some level of suspicion or run afoul of anti-money-laundering rules first.

      I guess real property holdings are more accessible to them.

      Delete