Loading ...The purpose of this overview is to present the key issues you must consider in order to first determine what estate plan will be best for you, get that executed and then complete the follow up work of beneficiary designations, etc. (Note: the two biggest issues we see are (1) that no plan has been done or (2) that wills and trusts are in place but the asset ownership frustrates the plan by having assets pass to the spouse and not the trust.)
(There is a great deal of information here, so let us know if it does not answer any of your questions – contact us at Contact Us.)
Before beginning, here are some basic definitions:
Will – this formal document designates your executor and alternates, a guardian and alternates if you have children under age 18, instructs your executor to pay off your debts then distribute your estate per your wishes.
Trust – is an entity that you create and can be used for many purposes, as the trustee acts like the owner but the beneficiaries get all the benefits from what the trust contains. For estate planning, a trust can be used to save on estate taxes in various ways.
Fiduciary – the person acting on your behalf, as in a guardian, executor, trustee, health care proxy or attorney-in-fact (as explained in more detail below).
The next section is a general description of the goals, which an estate plan should address:
1) Providing for Survivors: Estate planning and the analysis of life insurance connect in the following way: you want to use your resources to make sure that those who survive you have what they need to maintain the same standard of living, during their life expectancy, that you all had during your life, and you need the documents to make this happen. If the investable assets are not sufficient, even after making liquid certain kinds of personal property (e.g., a second home), then there is a need for life insurance.
In most cases, the type of insurance to be acquired is term insurance. This is merely a death benefit used to fund the shortfall between assets required to maintain the lifestyle of the survivors and actual assets available. Whole life or other types of insurance should only be used when permanent insurance is required, as in the case of maintaining estate liquidity throughout your lifetime.
2) Flow of Assets: After you determine the assets required to support the lifestyle of the survivor, you determine to whom the assets flow. For example, you could leave everything directly to the survivor, you could separate some portion of the assets by gift now or at death to go directly to children or you could have a trust control the division of assets as needed over time. Separating assets by gift now would be important if you wanted to ensure some minimum funding for children, such as guaranteeing coverage for their college expenses. (Note: you can use 529 plans or trusts for gifting, as well as more complex ideas.)
The typical procedure is to execute a will that pours your assets over to a trust that creates the appropriate sub-trusts to use all relevant tax credits. Although this is done largely because of estate tax planning, it also addresses the question of having assets remain available for children after the surviving spouse dies.
When all assets flow entirely to the surviving spouse, under that person’s complete control, you grant the greatest flexibility to the survivor. However, as discussed below, there are estate tax consequences as well as loss of control by you over the ultimate disposition of trust assets.
3) Control Over Assets: As indicated above, the surviving spouse could be allowed to have complete control over the assets. In the alternative, trust vehicles can be used. What you gain by use of the trust is the estate tax savings discussed below. However, you also gain a heightened level of attention on the assets. That is, you have engaged a trustee to focus on providing for the surviving spouse, maintaining his or her lifestyle, while still attending to the interests of other beneficiaries, such as children. In this way, the trustee will try to preserve the trust assets in the best way possible for the longest duration. Finally, the trustee must distribute the assets per your instructions; if assets went to a survivor, they are not bound in any way to follow your wishes, so you may not achieve your estate planning goals.
4) Estate Tax Considerations: When the potential combined estate of a husband and wife exceeds $1,000,000, and they have other beneficiaries for whom they want to maximize the estate after taxes, then trusts are typically used. The estate tax plan is based first on federal law, which allows an unlimited marital deduction, i.e., all assets can pass to the surviving spouse without any estate taxes. Only when the second death occurs are the estate taxes then due to the federal and state governments.
Late in 2010, Congress raised the credit to $5 million and lowered the tax rate to 35%. The unused exemption of a deceased spouse is “portable”, getting passed to the surviving spouse (see new estate planning pitfalls: need for careful planning and follow through )
Also, the date-of-death value again serves as the basis for estate assets. Finally, the exemption will be indexed for inflation. In 2013, the exemption again falls back to $1 million and the rate goes back up to 55%, unless Congress again takes action.
With the trust structure, sub-trusts can be created so that both the credit and the marital deduction are used. This structure takes advantage of the credit at the first and second deaths. In contrast, wills that pass all assets outright to the surviving spouse would only take advantage of the credit at the second death. The total tax savings for an estate of $10 million or more is excess of $1,750,000 for the combined estates.
Trust vehicles can also describe ways in which assets are paid out to beneficiaries. For example, the grantor of a trust could insist that assets not go to children until they are age thirty-five. The trust vehicle could also provide where assets flow if all family members die without issue. For example, assets could flow to a charity or educational institution.
The change in the tax law from the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 gives us a two year window for significant estate tax planning, ending December 31, 2012. Instead of a $1 million lifetime cap, you can now gift up to $5 million. When your spouse joins in, a major amount of wealth can be transferred. This makes it important to act now, because the law could change in for 2013.
What about the Future? Most observers expect the $5 million exemption to stay, along with the 35% estate tax rate. The exemption could be lower, or the rate increased. All of this is reason to review the ideas below and then update your estate plan.
States Estate Taxes: The federal estate tax law phased out the federal credit for state estate taxes. Many states lost revenues because they had soaked up the credit as a “sponge tax”. In response, Massachusetts and other states “decoupled” the state estate tax from federal law. Massachusetts froze its threshold above which an estate is taxable at $1 million in 2006. Other states have similar amounts. Therefore, additional planning is required for it and most other states.
Life Insurance Trust: You can also make an irrevocable trust the owner of any insurance on your life. This can exclude all death benefit proceeds from both estates, avoiding estate taxes. However, this requires an irrevocable transfer to the trust; you cannot get the insurance back out. You can use this trust to receive insurance proceeds that can pay for estate taxes, thereby preserving more of your estate after taxes without increasing the taxable estate.
5) Fiduciaries: In describing the estate plan, many choices revolve around the fiduciary that you select for a particular role. For example, people who typically would have chosen to have all assets flow to the surviving spouse become willing to use trusts when they realize that the person whom they expect to select as trustee will make decisions that they would have made had they survived. The fiduciaries that must be put in place include the following:
a) Executor: This is the person who “marshals” all assets of the estate together, pays death expenses and transfers ownership of property to the surviving spouse or trust. This is approximately a nine-month task.
b) Guardian: This is the person whom you select to love and care for your children in your absence. The spouse selects the surviving spouse and then a second or third choice beyond that. This job lasts until each child has reached majority (age eighteen).
c) Trustee: This person has potentially the longest term job because he or she must manage the trust assets and make distributions of income and sometimes principal to the surviving spouse, children and even grandchildren. Depending on the terms of the trust, this job could last until the children are young adults.
6) Ancillary Documents: There are additional documents that you should consider having within an estate plan. These include the following:
a) Durable Power of Attorney: This is the grant by you of a power of attorney to the other spouse to manage your financial affairs if you become incapacitated.
b) Health Care Proxy: This document allows you to appoint people to make decisions about your health care and treatment when you are not capable of doing so. You typically select the surviving spouse and then have a first and second alternate if you wish. Some states call such documents “medical directives” or “medical powers of attorney.”
c) Living Will: This makes your wishes clear as to whether or not you want to have heroic means used to prolong your life.
d) Anatomical Gift Instrument: This allows you to have a hospital use organs and other body parts for others in need of a transplant.
The foregoing is a summary of the estate planning considerations that you will want to review together. From that discussion, documents can be drafted for your review, which we can then revise for final execution copies.
What about Advanced Planning Techniques for Large Etates? – see our separate post to our Newletter. The new higher credit allows for great gifting strategies, but each has it reasons for caution, and has to be coordinated with state estate tax rules.
ESTATE PLANNING “TO DO” LIST
As noted above, estate planning and the analysis of life insurance connect and you need to do the analysis with your financial advisor in order to make sure that the survivors have sufficient resources to maintain the same lifestyle during their life expectancy. Then you pick your fiduciaries and have the documents drafted and executed, and the life insurance.
What you have to do after you have the proper documents executed Once the documents and insurance are in place, make sure to review and complete the following:
OWNERSHIP AND BENEFICIARY DESIGNATIONS
Qualified Plans (IRA’s, 401k plans, etc.):
Primary Beneficiary – to the surviving spouse (so he or she can roll over the proceeds to an IRA and thereby defer income taxes); and
Secondary Beneficiary – to your children (or your own revocable, depending on whether you want the assets controlled or available to children).
Life Insurance and Annuities:
Primary Beneficiary – when not owned by an irrevocable trust, such as group term, to your own revocable trust (for estate tax benefits, e.g., using credit at first death); and
Secondary Beneficiary – to the surviving spouse (in case of trust has been terminated for some reason).
Other Assets:
Consider changing ownership of any jointly held assets to ownership by one of you. Any assets held as joint tenants with rights of survivorship will go to the survivor by operation of law and never get to your revocable trust. (You want to be sure that you have sufficient assets going to the trust to realize the full tax reduction effect.)
You may even want to fund your trusts, moving investment accounts over to your own revocable trust. This has no impact on your income taxes.
You can also choose to fund your revocable trust now. This will save a significant amount of time for the executor, and the attorney he or she hires, as this will need to be done after your death otherwise.
MEMORANDUM TO SURVIVORS
You should also consider compiling a reference book or adding to your financial plan book photocopies of important papers, identifying where the originals are, then adding a list of important contacts, instructions to your executor and trustee and other important notes for family and friends. You would update this at least annually with new asset statements (consider this as you gather information for preparing your taxes). To be more specific, the list (and copies) should include:
• 1. Location of original will, trust, etc.
• 2. Location of health care proxy and durable power of attorney
• 3. List of professionals with contact information: doctor, attorney, CPA, etc.
• 4. List of fiduciaries with contact information: health care proxy, guardians, executors and trustees, attorney-in-fact for durable power of attorney, etc.
• 5. Location of insurance policies and valuables such as original titles, etc.
• 6. Location of safe deposit box for valuables and items in #5 or 7
• 7. List of all bank and investment accounts and location of any stock certificates or other documentation for investments
• 8. List of all mortgages, loans and credit card accounts
• 9. Any appraisals or other listing of items by value
• 10. All automatic debits that need to be addressed (stopped, changed)
• 11. List of all password protected accounts (e-mail, on line banking and credit cards, etc.) and where to locate the passwords… and the password to access the password
After you review this overview, let us know how we can help you get your estate plan in order.