Month: August 2021

What Is Estate Planning?

Estate planning is the preparation of tasks that serve to manage an individual’s asset base in the event of their incapacitation or death. The planning includes the bequest of assets to heirs and the settlement of estate taxes.

Understanding Estate Planning

Estate planning involves determining how an individual’s assets will be preserved, managed, and distributed after death. It also takes into account the management of an individual’s properties and financial obligations in the event that they become incapacitated.

Assets that could make up an individual’s estate include houses, cars, stocks, artwork, life insurance, pensions, and debt. Individuals have various reasons for planning an estate, such as preserving family wealth, providing for a surviving spouse and children, funding children’s or grandchildren’s education, or leaving their legacy behind to a charitable cause.

The most basic step in estate planning involves writing a will. Other major estate planning tasks include the following:

• Limiting estate taxes by setting up trust accounts in the names of beneficiaries
• Establishing a guardian for living dependents
• Naming an executor of the estate to oversee the terms of the will
• Creating or updating beneficiaries on plans such as life insurance, IRAs, and 401(k)s
• Setting up funeral arrangements
• Establishing annual gifting to qualified charitable and non-profit organizations to reduce the taxable estate
• Setting up a durable power of attorney (POA) to direct other assets and investments

Writing a Will

A will is a legal document created to provide instructions on how an individual’s property and custody of minor children, if any, should be handled after death. The individual expresses their wishes through the document and names a trustee or executor that they trust to fulfill their stated intentions. The will also indicates whether a trust should be created after death. Depending on the estate owner’s intentions, a trust can go into effect during their lifetime (living trust) or after their death (testamentary trust).

The authenticity of a will is determined through a legal process known as probate. Probate is the first step taken in administering the estate of a deceased person and distributing assets to the beneficiaries. When an individual dies, the custodian of the will must take the will to the probate court or to the executor named in the will within 30 days of the death of the testator.

The probate process is a court-supervised procedure in which the authenticity of the will left behind is proved to be valid and accepted as the true last testament of the deceased. The court officially appoints the executor named in the will, which, in turn, gives the executor the legal power to act on behalf of the deceased.

Appointing the Right Executor

The legal personal representative or executor approved by the court is responsible for locating and overseeing all the assets of the deceased. The executor has to estimate the value of the estate by using either the date of death value or the alternative valuation date, as provided in the Internal Revenue Code (IRC).1

A list of assets that need to be assessed during probate includes retirement accounts, bank accounts, stocks and bonds, real estate property, jewelry, and any other items of value. Most assets that are subject to probate administration come under the supervision of the probate court in the place where the decedent lived at death.

The exception is real estate, which must be probated in the county in which it is located.

The executor also has to pay off any taxes and debt owed by the deceased from the estate. Creditors usually have a limited amount of time from the date they were notified of the testator’s death to make claims against the estate for money owed to them. Claims that are rejected by the executor can be taken to court where a probate judge will have the final say as to whether or not the claim is valid.

The executor is also responsible for filing the final personal income tax returns on behalf of the deceased. After the inventory of the estate has been taken, the value of assets calculated, and taxes and debt paid off, the executor will then seek authorization from the court to distribute whatever is left of the estate to the beneficiaries.

Planning for Estate Taxes

Federal and state taxes applied to an estate can considerably reduce its value before assets are distributed to beneficiaries. Death can result in large liabilities for the family, necessitating generational transfer strategies that can reduce, eliminate, or postpone tax payments.

During the estate-planning process, there are significant steps that individuals and married couples can take to reduce the impact of these taxes.

AB Trusts

Married couples, for example, can set up an AB trust that divides into two after the death of the first spouse.

Education Funding Strategies

A grandfather may encourage his grandchildren to seek college or advanced degrees and thus transfer assets to an entity, such as a 529 plan, for the purpose of current or future education funding.2 That may be a much more tax-efficient move than having those assets transferred after death to fund college when the beneficiaries are of college-age. The latter may trigger multiple tax events that can severely limit the amount of funding available to the kids.

Cutting the Tax Effects of Charitable Contributions

Another strategy an estate planner can take to minimize the estate’s tax liability after death is by giving to charitable organizations while alive. The gifts reduce the financial size of the estate since they are excluded from the taxable estate, thus lowering the estate tax bill.3

As a result, the individual has a lower effective cost of giving, which provides additional incentive to make those gifts. And of course, an individual may wish to make charitable contributions to a variety of causes. Estate planners can work with the donor in order to reduce taxable income as a result of those contributions, or formulate strategies that maximize the effect of those donations.3

Estate Freezing

This is another strategy that can be used to limit death taxes. It involves an individual locking in the current value, and thus tax liability, of their property, while attributing the value of future growth of that capital property to another person. Any increase that occurs in the value of the assets in the future is transferred to the benefit of another person, such as a spouse, child, or grandchild.

This method involves freezing the value of an asset at its value on the date of transfer. Accordingly, the amount of potential capital gain at death is also frozen, allowing the estate planner to estimate their potential tax liability upon death and better plan for the payment of income taxes.

Using Life Insurance in Estate Planning

Life insurance serves as a source to pay death taxes and expenses, fund business buy-sell agreements, and fund retirement plans. If sufficient insurance proceeds are available and the policies are properly structured, any income tax on the deemed dispositions of assets following the death of an individual can be paid without resorting to the sale of assets. Proceeds from life insurance that are received by the beneficiaries upon the death of the insured are generally income tax-free.4

Estate planning is an ongoing process and should be started as soon as an individual has any measurable asset base. As life progresses and goals shift, the estate plan should shift in line with new goals. Lack of adequate estate planning can cause undue financial burdens to loved ones (estate taxes can run as high as 40%), so at the very least a will should be set up—even if the taxable estate is not large.

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How to avoid Deadly Estate Planning Mistakes

Most estate planning mistakes tend to fall into one of several categories. Every estate plan has unique features, but the same problems and mistakes recur. Many mistakes don’t vary with the value of an estate and other factors. Each of the classic mistakes is avoidable. All that’s needed is knowledge of what to beware of and a little time working with your planner.

Not understanding the plan. Many people, even the sophisticated and wealthy, become passive in the presence of an estate planner. They rely on the planner to make sure everything in the plan is what they need and is done properly. It’s not unusual for a person to sign the documents and say to the attorney, “I don’t really know what I just signed.” A few years back a survey of estate planning attorneys reported that the attorneys said they believed a high percentage of the plans they prepared weren’t fully implemented, and that the major reason for failure to implement is the clients didn’t understand the plans or what they needed to do after leaving the office.

Part of the estate planner’s job is to be sure you understand the basics of how the plan works, what you need to do to implement or maintain the plan, and how it works for you and your beneficiaries. It’s also part of your job to understand those things. You don’t need to know all the legal angles and why certain language is used, but you do need to understand the fundamentals.

Sometimes that means insisting the planner spend time walking you through the plan and the documents. Another good step is to take notes at each stage of the planning process. Often people make decisions after a discussion with the estate planner. At the time, they fully understand the decisions and the reasons for them, because they’ve been hashing them out with the planner. But days, weeks, or months later, the details are hazy. Take notes about the key decisions and why you made them, so you can refer to them in the future.

Outdated beneficiary designations. There are numerous cases and rulings involving this one, and it seems every estate planner has at least one horror story. Remember what your will says doesn’t affect who inherits certain assets. These assets have separate beneficiary designation forms, and that determines who inherits. These assets include retirement accounts, annuities, and life insurance.

Failure to update beneficiary designations means an asset might go to your parents or siblings, because that’s what you put on the form years ago when you first opened the account. Sometimes the asset goes to an ex-spouse, the estate of a deceased person, or other unintended beneficiaries. Other times someone is inadvertently excluded, because they were born or married into the family after you completed the form.

Review your beneficiary designations every couple of years and after every major life change in your family.

Not updating asset ownership. You might own some assets in your own name and others in joint title with your spouse, an adult child, or someone else. Some assets might be in trusts, limited partnerships, or other vehicles.

Like the beneficiary designations, these need to be reviewed. Does the arrangement still meet your needs? Has something changed in your situation, the law, or something else that makes different ownership better? The Tax Cuts and Jobs Act made significant changes in income and estate taxes. Many people should review their plans to see if their current plans are obsolete or add unnecessary costs and complexity.

Every estate plan has unique features, but the same problems and mistakes recur. Each classic mistake is avoidable. It’s not unusual for a person to sign the documents and say to the attorney, “I don’t really know what I signed.”  It’s not unusual for a person to sign the documents and say to the attorney, “I don’t really know what I signed.”

Failure to fund revocable trusts. Many estates include a revocable trust, also known as a living trust. Assets owned by the trusts avoid probate and help with disability planning and some other issues. They generally aren’t created to save taxes.

The problem in many estates is the owners skip a step. The trust is created after the attorney prepares the trust agreement and all the interested parties sign it. After that, the trust has to be funded. That means legal title to assets has to be transferred to the trust.

For some assets that’s easy. Household and personal effects are transferred to the trust with simple language in the trust or a schedule of assets attached to the trust agreement. But other assets require more. For real estate, the deed has to be changed to reflect that the trust now is the owner. Automobile registrations have to be changed. For financial accounts, you have to change the name of record with the custodian. That might mean applying to open a new account and transferring the old account assets to the new account.

None of these steps is difficult or expensive, but many people neglect to do them. The result is they wasted money paying for the trust documents. Their assets won’t avoid probate, and they won’t reap the other expected benefits of the trusts. Be sure you are clear with your planner about any actions you need to take to ensure the plan is fully implemented and maintained.

Not coordinating trusts and retirement plans. Many people routinely designate their living trusts or other trusts as beneficiaries of their retirement plans. There can be good reasons to name a trust as an IRA or other retirement plan beneficiary. But there also are potential problems. Because of IRS regulations, naming the wrong type of trust as an IRA beneficiary can accelerate taxes.

To retain the tax deferral of a retirement account, a trust that is the beneficiary of the account needs to have certain language that qualifies it as a see-through trust. Be sure any trusts you named as beneficiaries qualify and meet your goals. Otherwise, name individuals as beneficiaries instead of a trust.

Not updating powers of attorney. Every estate plan should include powers of attorney. You need at least two, one for financial matters and one for medical care (often called an advance medical directive). You’re more likely to become disabled and need these documents before you need a will and the rest of your estate plan.

Unfortunately, many people don’t have either of these documents, and others haven’t kept them up to date or given the details much thought. Be sure you have these documents and that they have been reviewed recently.

Not updating the plan. I’ve highlighted some parts of the plan that routinely become obsolete for many people. But there are other parts of the plan that might need to be changed from time to time. You should be in touch with your estate planner any time there’s a major life change in your family, such as a birth, death, divorce, or marriage. Changes in your net worth, the composition of your estate, job status, residence, and many other factors also should trigger a review of your plan. Of course, a change in your goals or in the law also means a meeting with your planner is in order.

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