It is important to ensure that your beneficiaries receive the maximum amount of your accumulated assets, while minimizing exposure to avoidable tax liabilities. Image: Zerbor/Shutterstock.com
By: Austin Costello, CFPThe federal estate tax exemption has undergone dramatic changes over the past two decades. In 2001, estates exceeding $675,000 faced federal estate tax rates up to 55%. Today, the exemption stands at $13.99 million per person for 2025. This remarkable increase has completely changed how people need to think about their estate plans.
This shift means that very few estates now face federal estate tax, a significant change from the early 2000s when many middle and upper-middle-class families were affected.
However, with the federal estate tax exemption now at an all-time high, older trusts may no longer serve their original purpose and could even harm your heirs.
How Federal Tax Policy Changes Affect Estate Planning
Federal employees in the early 2000s faced significant estate tax exposure under much lower exemption thresholds. In 2001, estates exceeding $675,000 faced federal estate tax rates up to 55%. This threshold was easily reached with just a family home, Thrift Savings Plan balance, and federal benefits in many areas across the country.
The current exemption is over 20 times higher than it was in 2001. However, many estate plans created during the low-exemption era remain unchanged, potentially creating new tax burdens for federal employee families through the loss of step-up in basis benefits.
Understanding the ‘Step-Up in Basis’
The step-up in basis is a valuable tax rule that can save heirs significant money when they inherit assets. Here’s how it works:
When someone passes away and leaves property to their heirs, the value of that property for tax purposes is reset to its fair market value at the time of inheritance, rather than what it was worth when originally purchased. This means if the property has grown in value over the years, heirs won’t owe capital gains taxes on that increase.
For example, if a parent bought a house for $100,000 and is worth $500,000 when their child inherits it, the child’s “basis” for tax purposes becomes $500,000. If the child sells it for $500,000, there are no capital gains taxes. But without the step-up, the child would owe taxes on the $400,000 increase.
Trust Structures and Step-Up in Basis Rules
Estate planning can feel overwhelming, especially as laws and your personal circumstances change over time. Understanding which trust arrangements preserve or eliminate step-up benefits is crucial for federal employees evaluating their estate plans:
Trusts That Preserve Step-Up in Basis:
- Revocable Living Trusts: Assets remain in the grantor’s taxable estate, ensuring step-up benefits while providing probate avoidance and asset organization benefits.
- Irrevocable Trusts with Retained Interest: When grantors retain income rights, property use, or other beneficial interests, assets may remain includible in the estate for tax purposes, preserving step-up benefits.
Trusts That Eliminate Step-Up in Basis:
- Irrevocable Life Insurance Trusts (ILITs): Designed to exclude life insurance proceeds from taxable estates, these trusts typically do not provide step-up benefits on trust assets.
- Bypass or Credit Shelter Trusts: These preserve the estate tax exemption of the first spouse to die but exclude assets from the surviving spouse’s estate, eliminating the second step-up opportunity.
- Grantor Retained Annuity Trusts (GRATs): Created to transfer appreciation to beneficiaries while minimizing gift tax exposure, these trusts generally do not provide step-up benefits.
- Charitable Remainder Trusts: While providing income tax deductions and lifetime income, these trusts do not offer step-up benefits to non-charitable beneficiaries.
Why Trusts Were Once a Necessity
In the early 2000s, the estate tax threshold was low enough that many upper-middle-class households risked paying federal estate tax. In high-cost areas like the D.C. suburbs, a federal employee with a family home, Thrift Savings Plan (TSP) account, and survivor benefits could easily exceed the exemption.
The classic strategy:
- Irrevocable trusts were created to move appreciating assets out of a person’s taxable estate, avoiding future estate tax.
- Bypass or credit shelter trusts were used by married couples so each spouse could use their estate tax exemption, potentially sheltering millions from tax.
For federal employees with pensions, investment properties, and significant savings, these tools often made sense.
Today, these same trusts that once made all the sense in the world, could be robbing your loved ones of one of the most powerful tax-saving strategies – the step-up in basis.
How to Know if Your Trust May Be Outdated
Many people find that what worked in the past may no longer be the best fit today. If you’re feeling uncertain about whether your current plan still meets your needs, you’re not alone. You may need to revisit your estate plan if:
- It was created before 2010.
- Its main purpose was avoiding estate tax.
- It uses a bypass or credit shelter structure.
- You placed real estate or highly appreciated investments into an irrevocable trust.
- Your total estate is now well below the current exemption.
What to Do If You Have an Old Trust
Review with an Estate Planning Attorney or Certified Financial Planner (CFP®) Professional
- Laws have changed; your plan should reflect current tax realities.
- An attorney can determine whether modifying or dissolving the trust could restore step-up benefits.
Evaluate State Taxes
- Some states have their own estate or inheritance taxes with much lower exemptions.
- Even if you’re below the federal limit, state taxes might still be a concern.
Consider a Trust Restatement – Some irrevocable trusts can’t be changed easily, but revocable trusts can be updated without starting from scratch.
Weigh the Non-Tax Benefits – Asset protection, privacy, and control over distribution may still make certain trusts worthwhile—even if estate tax isn’t a threat.
Next Steps for Federal Employees
The significant increase in estate tax exemptions creates both opportunities and potential pitfalls for federal employee families. Estate plans designed under outdated exemption levels may no longer serve their intended purpose and could inadvertently create new tax burdens.
Federal employees should prioritize comprehensive estate plan reviews with qualified professionals who understand federal benefits and compensation structures. A Certified Financial Planner (CFP®) Professional or estate planning attorney can help evaluate whether existing trust arrangements continue to make sense under current law and identify strategies to optimize tax outcomes for beneficiaries.
It is important to ensure that your beneficiaries receive the maximum amount of your accumulated assets, while minimizing exposure to avoidable tax liabilities. If you’re a federal employee who keeps up with today’s estate planning strategies, you’ll give your family the best shot reducing estate taxes and protecting wealth for future generations.
Austin Costello is a certified financial planner with Capital Financial Planners. If you don’t feel confident in your investment strategy or your ability to keep a level head and would like feedback, register for a complimentary check up. For topics covered in even greater depth, see our recorded webinars.
*Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Ruling on CFPB Job Cuts Could Affect Challenges to Other RIFs and Reorgs
Agencies Begin Denying Union Contracts, More to Come
‘Only High Performers’ Should Receive Awards, Agencies Told
What to Know About the New Federal Application Process
OPM Limits Length of Paid Leave in Reorgs—Starting Next Year
See also
Attorney Schnitzer: How to Challenge a Federal Reduction in Force (RIF) in 2025
Alternative Federal Retirement Options; With Chart
Primer: Early out, buyout, reduction in force (RIF)
Retention Standing, ‘Bump and Retreat’ and More: Report Outlines RIF Process
