The 2026 Estate Tax Exemption Drop: What It Means for Your Retirement Plan

What the Estate Tax Exemption Sunset Means

The Tax Cuts and Jobs Act of 2017 roughly doubled the federal estate and gift tax exemption. For 2024, that exemption was $13,610,000 per person, or $27,220,000 per married couple using portability. This meant that the vast majority of American estates - including many that feel quite wealthy - passed to heirs entirely free of federal estate tax. The TCJA provisions were not permanent. They were scheduled to sunset after 2025, reverting to pre-TCJA levels adjusted for inflation. That reversion brings the exemption down to approximately $7,000,000 per person - meaning the per-couple exemption drops from over $27,000,000 to approximately $14,000,000. For estates between $7,000,000 and $13,610,000 per person, this change is the difference between paying zero federal estate tax and suddenly owing up to 40% on the amount above the new lower threshold. A single individual with a $10,000,000 estate currently owes no federal estate tax. Under a reduced exemption of $7,000,000, they would owe 40% on $3,000,000 - a tax bill of $1,200,000. For married couples with estates in the $14,000,000 to $27,000,000 range, the exposure is similarly stark. A couple with a $20,000,000 estate currently owes $0 in federal estate tax. Under reduced exemptions, they could owe 40% on $6,000,000 - a $2,400,000 federal tax obligation. The IRS has confirmed through formal guidance that gifts made under the higher exemption will not be subject to a clawback if the exemption later decreases. This is a critical planning point: gifts made today at the higher exemption amount are protected permanently.

State Estate Taxes: A Second Layer Many People Miss

Even for estates that fall below the federal exemption, state estate taxes can create a significant tax burden. Twelve states and the District of Columbia impose their own estate taxes, often with much lower exemptions than the federal threshold. State exemptions vary widely. Massachusetts and Oregon have exemptions starting at $1,000,000 - meaning estates above $1,000,000 face state estate tax even if they are far below the federal threshold. Washington state's exemption is $2,193,000. Illinois begins at $4,000,000. Connecticut's exemption is $13,610,000, matching the federal level. For residents of high-estate-tax states, the planning calculus is different. A Massachusetts resident with a $3,000,000 estate may owe no federal estate tax under either the current or reduced exemption - but they owe Massachusetts estate tax on the amount above $1,000,000. State estate tax rates typically range from 10% to 20%. Six states also impose an inheritance tax - a tax paid by the beneficiaries who receive the assets rather than by the estate itself. States with inheritance taxes include Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Rates and exemptions vary by state and by the relationship between the beneficiary and the deceased. Spouses are typically exempt; more distant relatives or non-relatives pay higher rates. For estates with significant assets in multiple states - including real property - multi-state estate tax planning requires careful attention to which state's rules apply to which assets.

Gifting Strategies While the Higher Exemption Lasts

The single most important action available to estates that could be affected by a reduced exemption is making large gifts now, while the higher exemption is available. The IRS has confirmed that gifts made under the higher exemption will not be subject to clawback - meaning even if the exemption drops later, gifts made today are protected. The annual gift tax exclusion - separate from the lifetime exemption - allows any individual to give up to $18,000 per recipient per year without using any of the lifetime exemption. A married couple can give $36,000 per year to each child, grandchild, or other recipient. For a family with five children and ten grandchildren, that is $540,000 per year in tax-free gifting that does not touch the lifetime exemption at all. For larger wealth transfers, the lifetime exemption allows gifts far above the annual exclusion, but those larger gifts reduce the exemption available at death. If you give $5,000,000 during your lifetime and your exemption is $13,610,000, your remaining estate exemption is $8,610,000. Strategies used under the higher exemption before it potentially resets include spousal lifetime access trusts (SLATs), grantor retained annuity trusts (GRATs), and outright gifts to irrevocable trusts. Each has different trade-offs for control, access, and asset protection. The common thread is using the higher exemption now to permanently remove assets from the taxable estate, with the IRS confirmation that the benefit will not be clawed back later.

The Life Insurance Role in Estate Tax Planning

For estates that face genuine estate tax exposure - either now under the higher exemption or more broadly under a reduced exemption - life insurance is one of the few tools that can generate tax-free liquidity precisely when estate taxes are due. Federal estate taxes are due nine months after death, typically in cash. An estate that is rich in illiquid assets - real estate, business interests, farmland - may be forced to sell those assets at unfavorable prices to pay the tax bill. Life insurance provides an immediate, income-tax-free death benefit that can fund the estate tax without forcing a fire sale. For maximum estate tax efficiency, life insurance should be owned by an irrevocable life insurance trust (ILIT) rather than by the insured directly. If you own your own life insurance at death, the death benefit is included in your taxable estate. An ILIT-owned policy keeps the death benefit outside the taxable estate entirely, providing tax-free liquidity to the estate or heirs. The premium cost of an ILIT-owned policy is funded using annual gift tax exclusion amounts paid to the trust - a technique that effectively converts annual gifting capacity into an income-tax-free and estate-tax-free death benefit. This is one of the few estate planning strategies that is fully settled in tax law and has no sunset risk.