5 minute read

How Inflation Affects Estate Planning & What To Do About It

In this guide, we define inflation, how it can affect estate planning, and tools you can implement to adapt. Keep reading to learn more!

Patrick Hicks

Patrick Hicks, @PatrickHicks

Head of Legal, Trust & Will

The New York Times article “Inflation Has Arrived” penned earlier this year perfectly captures the worry of many Americans. Inflation is synonymous with higher prices and higher interest rates. This of course affects our day-to-day purchasing power, but it also affects our long-term financial planning. How will it impact our ability to save? How will it impact the value of our assets and investments? Another question that everyone should be asking is — how will it affect my Estate Plan? This guide will help define inflation, how it can affect estate planning, and tools you can implement to adapt.

What is Inflation?

Inflation is an economic term that describes the way that goods and services increase in price over time. What does that mean for you? Inflation measures the purchasing power you lose over time, or how far your dollar will stretch today versus tomorrow.

A real example can help describe inflation beautifully. The median price of a home in the 1950’s was $7,400. Today, it’s $374,900. That is a mind-numbing increase of 4,966 percent! Of course, our median wages have increased to keep up with inflation. However, the increase in wages is much lower than the increase in prices. For instance, the U.S. median household income in 1950 was $2,990. Today, it is $67,521. Our wages have only increased by a little over 2,000 percent. 

This example helps illustrate one of the key reasons why Americans struggle financially so often. We are forced to buy goods, services, and assets that cost so much more, with relatively fewer wages. 

What Causes Inflation?

According to the New York Times article, high inflation can be caused by a “hot economy.” In other words, this is when consumers have relatively high disposable incomes to spend, which causes other consumers to access more credit so that they can “keep up with the Joneses.” Businesses often raise their prices to keep up with supply (or they realize they can charge more without losing customers).

Today, we are experiencing a different cause of inflation. Gas prices are at a historical high, peaking at an average of $5.44 per gallon in California. This is one example of “inflationary bursts” caused by supply shortages and increased demand following the aftermath of a global pandemic. Consumers often look to experts and officials to gauge whether  price spikes are short-term or here to stay.

A tell-tale sign is a hike in interest rates.

How Does Inflation Tie Into Interest Rates?

An interest rate is the percentage of money charged by a lender for the use of their borrowed money. This percentage is based on the total sum that was lent or borrowed. Consumers can play into both the borrowing and lending roles. For instance, they might pay interest to a lender when buying a house, an automobile, or when using a credit card. In other instances, they might earn interest when putting money into a high-yield savings account or investing in company stocks.

Interest rates vary by product and financial institution, but they can collectively increase or decrease based on inflation. According to Investopedia, interest rates tend to increase and decrease in correlation with inflation rates. 

The U.S. Federal Reserve (the Fed) also has a say over how interest rates are affected by inflation. This government agency establishes monetary policies that also announce what will happen to interest rates. The federal rate affects interest rates set by banks and other financial institutions, thus influencing the economy as a whole.

Here are some areas of the economy that are affected by interest rates.

  • Stock and bond interest rates

  • Consumer and business spending

  • Inflation

  • Recessions

When interest rates fall, borrowing money becomes easier. This means that more Americans will open credit cards, buy homes, and pump cash into the economy. When interest rates rise, the cost of borrowing becomes more expensive. Although there is generally a one-year lag, the Fed can manipulate the currents in the economy by leveraging the interest rate.

With the latest hike in prices, the U.S. government may or may not increase interest rates. Some officials say that the current spike in prices is temporary and is due to supply chain shortages caused by the pandemic. However, it’s always smart to plan ahead and think about how an increase in interest rates could affect your personal financial planning and goals.

How Does Inflation Affect Estate Planning?

Inflation directly impacts prices. Although prices have steadily increased throughout our economic history, economic and geo-political events cause  unpredictable spikes and valleys.

This can make estate planning tricky. Although we know the value of our assets today, we don’t necessarily know the value of our assets tomorrow. In most scenarios, we simply want for the value of our assets to increase over time. This means that our wealth is growing and we have more to leave to our loved ones.

However, unpredictable price increases can be troublesome in the context of taxes. For instance, let’s say that you have a home valued at $1 million, but inflation increases the value to $1.5 million. This means that you will need to assess the value of your home in relation to potential tax thresholds. The total value of your estate is used to assess possible estate taxes and inheritance taxes at the state and federal level, so it’s important to keep a watchful eye. 

A worst-case scenario would be passing away during a period when assets are held at unusually high values such that your estate is forced to pay taxes. Even worse, if those same asset values fall soon after, your inheritance will hold much less value than you had planned.

How to Hedge Against Inflation for your Estate Plan

To clarify, inflation is not necessarily a bad thing. Thanks to inflation, some of your assets will increase in value. For instance, nearly every homeowner buys a home as an investment with the expectation that the price and thus value of their home will increase over time. Selling the home later down the line may give them greater purchasing power relative to their wages. Alternatively, they may plan to hold on to the home and pass it down to their children. Inflation can help increase the value of your estate as a whole. 

However, inflation can cause unexpected and unwanted outcomes for your Estate Plan without proper planning. Here are some tips to help hedge your Estate Plan against unwanted inflation.

1. Keep An Eye on Tax Thresholds

The first thing to do is to keep an eye on your tax thresholds. Knowledge is power, and you may be relieved if you find out that you are nowhere near any state of federal tax thresholds. In 2022, the federal estate tax exemption is $12.06 million until 2025. This threshold may be changed after 2025 to adjust for inflation.  State tax thresholds are much lower, with some of them as low as $1 million. 

2. Take Action As Needed

If you become concerned about your total estate value and its proximity to federal or state tax thresholds, it’s time to take action. First, make sure you’ve named beneficiary designations wherever possible. These are assets that pass directly to your beneficiaries upon your passing, meaning they are not included in your estate. This simple act can reduce the size of your estate by just enough. Common examples of assets with beneficiary designations include life insurance policies and retirement savings and investments.

Another tool to exercise is the gift tax exclusion. The Internal Revenue Service announces the annual exclusion for gift tax each year, which is currently at $16,000 and is adjusted for inflation. These exclusions add up to your lifetime exemption limit of $12.06 million for estates. By giving gifts throughout your lifetime, such as to charities and loved ones, you could methodically reduce the size of your estate. 

3. Assess Your Estate Plan as Inflation Changes

Assessing your Estate Plan should be an ongoing process. Even if you are far beneath the tax thresholds today, inflation could cause a sneaky rise toward it. Further, the government can adjust thresholds, exemptions, and inflation rates at any time. This is why you should always keep a watchful eye on inflation, the value of your assets, and the tax thresholds. We recommend assessing and evaluating your Estate Plan on an annual basis at minimum. 

Trust & Will is an Affordable Tool to Keep your Estate Plan in Place

Last but not least, one of the key reasons why many Americans don’t set up an Estate Plan is because they think it’s too expensive. There is some truth to this. Yes, if you work directly with an estate planning attorney, setting up and maintaining your Estate Plan can be costly. Of course, this can be warranted and necessary if you have a large or complicated estate.

However, for most Americans, there is an easier, more affordable way. Trust & Will is an estate planning platform and service that provides online estate planning products that are easy and affordable. For the price of a romantic date, you could easily have the basic foundation of your Estate Plan set up! Not only can you set up your Estate Plan without breaking your wallet, you can do it all from the comfort of your home. Last but not least, Trust & Will is an affordable tool that will help your Estate Plan in place once it’s set up so you can review it and update it on a routine basis without worrying about your finances. There’s no reason to wait - get started today!


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