Resources : Estate Planning

Getting Comfortable with Estate Planning

Who needs an estate plan, anyway? In truth most of us do, if we have any assets and care about what happens to them after we are gone. The goals of estate planning include reducing transfer taxes, ensuring that property passes efficiently to beneficiaries, maintaining privacy, and establishing health care directives to manage end-of-life decisions. These topics can be challenging to discuss. Add to that the complexity and expense of the planning process, and it’s easy to see why many of us put off this important project.

A good estate plan is foundational to your financial health. The purpose of this article is to introduce some of the issues and terminology, and perhaps to spark a discussion between you and your spouse about whether it’s time to create an estate plan. If you’re asking that question, then it is probably time to find a good estate attorney. This process is much too complex and too important to attempt to do it yourself from an online template, or to knock it off in an estate planning seminar weekend at a bargain price. Interview at least two or three attorneys, and find someone who makes you feel both confident and comfortable.

Federal estate tax rules have changed in the last several years. The exclusion amount has increased to over $11 million per person currently, and the exclusion has been made portable between spouses, with the result that fewer people owe estate tax under the current rules. This means that an individual with an estate of $11 million or less, (or a couple with $22 million) would not owe any estate tax if they have made no taxable gifts (more than $15k per person per year) during their lifetime. However, that exclusion is scheduled to reset in 2025 to about half the current level. Given that current law may change, and none of us knows when we will die, it can be difficult to predict whether a given individual will be leaving assets in excess of the exclusion.

The tools of estate planning include wills, powers of attorney and trusts with interesting names like GRAT, GRUT and QTIP. The array of legal instruments can be bewildering, but we can simplify it by considering that each of these instruments are intended to accomplish an orderly transfer of property at the death of an individual, and/or to reduce the transfer tax, which includes Estate, Gift and Generation-Skipping taxes. To understand the tools we need, it’s helpful to look at the ways in which property may be transferred on death:

• Probate: judicial supervision of estate distribution according to the decedent’s will, or according to the state’s laws of intestacy in cases where there is no will.
• Operation of law: property held in joint tenancy with right of survivorship.
• Contract: IRA, 401(k) plan, pension, annuity, life insurance
• Trust: revocable and irrevocable trusts established during your lifetime are legal entities which manage and distribute property after your death according to the trust agreement, thus avoiding probate.

Your will directs distribution of property, names guardians for your children and an executor for your estate, and it can also create trusts. During probate, the will is filed and validated by a court in a public process. You can limit how much of your property passes through probate by using other means to transfer your property, such as trusts, contracts and legal title.

Property passes by operation of law when it is titled in such a way that the decedent’s interest passes directly to the survivors, as in a Joint Tenancy with Right of Survivorship (JTWROS) or Joint Tenancy with Right of Survivorship (CPWROS). Many couples own property titled this way. It’s a simple way to ensure the surviving spouse has immediate control of assets.

Property that passes by contract includes IRA’s, employer-sponsored retirement plans such as 401(k)’s and 403(b)’s, annuities and life insurance. These types of property are not included in your will, but they are all included in your estate for tax purposes. They will pass to your named beneficiaries, which are established when you set up the account. It’s wise to review beneficiaries periodically to ensure that they are still appropriate. For tax reasons, it’s often preferable to name beneficiaries on your qualified accounts rather than listing your trust as beneficiary. If you own life insurance, naming your estate as beneficiary, or yourself as owner, will cause the proceeds to be included in your taxable estate. To avoid this, you can have your policy purchased by a trust (such as an Irrevocable Life Insurance Trust or ILIT), which can provide liquidity to your estate without creating an unnecessary estate tax burden.

Trusts can be established during your lifetime (living trust) or at death (testamentary trust), and can be either revocable or irrevocable. Trusts are "funded" when assets are re-titled in the name of the trust. Here are some common types of trusts:

Revocable Living Trust
This type of trust provides flexibility to change beneficiaries and trustees at any time prior to your death. It becomes irrevocable on your death. This type of trust does nothing to reduce estate tax, but it avoids probate and creates a private arrangement directing the management of your property in the event of your incapacity or death. Trust income is taxed on your personal tax return, and you as grantor retain full authority and control, and can serve as trustee if you wish.

Bypass Trust, AB Trust or Credit Shelter Trust
This type of trust was commonly used to preserve the exclusion amount for the first spouse who dies, which creates estate tax savings at the second death. Since the exclusion amount was made portable between spouses, this type of trust is not needed as often as it was before 2011. If your estate plan calls for creation of a bypass trust, ask your attorney if this is still appropriate. If it’s not needed to save on taxes, a bypass trust can create unnecessary expense, limit the survivor’s access to assets, and eliminate a potential step-up in basis at the second death. Your attorney may be able to provide for the survivor to choose, by disclaiming assets to go into a bypass trust, if that is appropriate at the time of the first death.

Charitable Remainder Trust, or CRT
This is an irrevocable trust that removes property from your taxable estate, reducing estate tax due. It can be useful as a method of charitable gifting combined with an income source for the donor. This type of trust can be a good vehicle for appreciated assets such as stock. You gift the assets to the trust, which sells them and holds proceeds for the remainder beneficiary, a qualified charity. The trust pays you an annuity. At the end of the annuity period, the remainder goes to the charity. You get a current charitable income tax deduction in the year you gift the assets, avoid paying capital gains tax on the appreciation and receive an income stream for a period of time.

Charitable Lead Trust, or CLT
This type of irrevocable trust is like the inverse of a CRT: The charity gets an income stream for a term of years, and the grantor gets a tax deduction based on the expected income to the charity. At the end of the term, the assets either go back to the grantor, or to designated beneficiaries.

There are many other types of trusts that can be set up to reduce estate and income taxes, create a gift for a favorite charity, provide for a child with special needs or children from a prior marriage, or any number of purposes. Consult an estate planning attorney to see which ones may be appropriate to your circumstances.

This information is not intended to be a substitute for specific individualized advice. We suggest that you discuss your particular situation with a qualified estate planning attorney.