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[This is an old article - circa 1992. Therefore, the reader must overlook any incorrect estate tax and other quote. Read it for it's content.]
by Errold F. Moody Jr.
Invariably in all independent studies, the great majority of individuals- single or married- have not done any type of proper estate planning. This includes a simple will. The main reason for the lack of such a plan is that it is difficult for many to accept their own mortality- better to not think about it and it therefore won't happen. Hopefully however, as one gets a more thorough understanding of the basic concepts of estate planning, they will see the importance of this issue and will immediately engage an ESTATE PLANNING attorney to guide them through the proper documentation.
There are several cautionary issues that first must addressed that are extremely important in light of current planning pitfalls. The first item requiring care by the consumer is not to use the sample will or trust documents that can be purchased from a stationary or book store and where one merely fills in the blanks. While they may be better than nothing, they rarely cover all the contingencies a consumer needs to be aware of- particularly where trusts are involved.
Living Trust Seminars
Secondly, consumers are cautioned about the innumerable "Living Trust" seminars that are being conducted nationwide. These are little more than hype. There are numerous companies throughout the U.S. that are offering "prepackaged" trusts to promoters for a very a small fee-as little as $200. The promoter (most commonly a "financial planner") signs up with the "trust" company (costs for these trusts are reduced in price the more that are sold). He/she then provides the fundamental marketing strategies to get people to seminars where this new found "expert" can elaborate on the virtues of living trusts. The marketing strategy generally involves the purchase of an ad in the local newspaper and scheduling several in-person seminars at local hotels. The ad's key phrasing is invariably how to save thousands on estate tax and how to avoid probate. The promoter concludes the seminar with an offer to come into their office for personal counseling and an offer to purchase the trusts at a price "much less than the high priced lawyers." For clients opting for these trusts, the single person may pay as low as $295 and a couple $395 (though usually higher). The "planner" almost universally asks the clients questions per a preprinted questionnaire and then sends the info to the home base of the estate planning firm- perhaps out of state. The firm prepares the estate plan plus durable powers of attorney and other documents per their published list of forms and fees and sends them back to the planner within a short time. The documents, however, must normally be reviewed by a local attorney for conformance to state statutes- or for simple legal issues that the planner might be construed to be offering legal advice. The attorney is paid a small fee for this service- perhaps $100 or so- and has agreed to perform this function in order to get new clients for any purpose. As such, the attorneys may tend to be recent graduates. There is therefore little expertise in all of the planning- certainly not by the planner who- at least in the ads seen to date- have no credentials whatsoever, nor by the attorneys who are not board certified estate planners. After all is said and done, the clients may tend to walk out with a trust that will rarely fit their fit their unique circumstances. Furthermore, they seldom comprehend the requirements of the document, what is required by them during their lives, nor how they really work when one passes away.
While these basic trusts (assumed properly funded) might be acceptable for 25% to 75% of the simplest estates, they rarely address more elaborate needs. Once life insurance policies, real estate out of state, sophisticated assets, gifted property and issues of taxation or special disposition of assets are included, the trusts, because of the preparer's lack of experience and expertise in their formation, now are only about 50% correct- or already 50% wrong.
Board Certified Attorneys
It is therefore apparent that there are innumerable questions and considerations which must be asked of the grantors or trustors (makers of the trust) in order to produce a working viable instrument. The prepackaged trusts simply do not work. It is MANDATORY that clients engage only an attorney who is knowledgeable and working in the field of estate planning- preferably a board certified specialist. While I cannot guarantee the capability of attorneys I have not worked with, I have discussed issues with some attorneys who are associated with the American College of Trust and Estate Counsel, 3415 S. Sepulveda Blvd., Ste 460, Los Angeles, CA 90034. They must have had 10 years worth of experience- and it shows. There is also a web page listing for estate/probate attorneys which seem to show some background. Just remember, do your homework since simply hiring any type of attorney for estate planning is close to being a waste of time because there is little concrete background in their initial school studies which provide any significant level of competency. While most "regular" attorneys would direct clients to a competent peer, the cut-throat competition of the industry might suggest they attempt sophisticated trusts and other estate planning devices themselves. This is unethical. For that matter, even some board certified estate planners are not doing very competent jobs. Some are not describing the many problems inherent in the trust because of the "time constraints".
Admittedly, part of that problem is due to the majority of trusts being advertised at such low rates that the amount of time necessary to properly advise the client of all the issues does not make it cost effective- though that really should not be an excuse for the attorney. Even when the attorney is providing the best of services, clients may not find it worthwhile to utilize the services of an attorney for fees of $1,000 to $3,000 when they perceive the same level of documentation available for advertised prices of $500 or so. Within that same context are a slew of similar dilemmas. Since an attorney does not, may not (or cannot) spend much time with a client- beyond that essential in completing the documents- particularly if a flat fee for the work was quoted and where "X" number of wills or trusts per day or week must be done in order to be profitable- he/she may not get a true insight into all of the individual's or couple's desires and wishes. By the same token and equally as important, clients who are billed by the hour may try to keep time to a minimum. The point is this- without a strong dialogue and comfort level with the attorney, clients feel uncomfortable in telling an attorney they have briefly met about all the skeletons in their life/lives. They do not like to air their "dirty linen in public". Perhaps there is a child on drugs, someone they wish to disinherit or any number of other problems and feel most uncomfortable presenting such facts. As a result of this trepidation, there may be areas of planning that will not be covered- such as disinheritance. Advisers can only urge clients to be as open as possible, since the instrument of the will, trust or similar document must really indicate their desires.
Attorneys and Money
As a separate caveat to the use of certain attorneys- Board Certified or otherwise- is that they MUST have complete capability with a financial calculator. I assume if you are reading this that you have already read my page on the HP12C, but to be brief: ANYONE dealing with money and the growth thereof (certainly an issues for estates) must be able to quickly and definitively adjust an estate for potential growth in the future. This is not a exercise with Quicken or the like- a couple keystrokes and the answer is there. If your estate attorney cannot do this, I frankly would be suspect about their overall ability to do estate planning. I'd suggest leaving.
Funding/Implementation of Trusts
Another problem with the use of trusts- which is primarily the responsibility of the grantor/trustor- is the funding of the living trust while they are alive. Many clients do not fund the trust for a variety of reasons- procrastination, lack of understanding, no one to help them and so on. Unfortunately, assets that are not included in the trust WILL need to be probated and the client has therefore paid fees for a mostly useless document.
Some financial planners who have extensive experience in estate planning can provide substantial advantages to their clients. A financial planner who has continually counseled client(s) on many issues usually has a great insight to their wishes and desires. He/she (if having a background in estate planning) may predetermine the structure of the trust or will. Furthermore, the planner may accompany the clients to the attorneys office and dictate what should be done.
This allows many "uncomfortable" (to the clients) issues to be expressed objectively to the attorney for proper implementation. The planner may also review the draft, suggest changes and, most importantly, assure implementation of the assets into the trust. Time may be saved in drafting the document and in the review of the trust use by the attorney to the clients. The attorney may also not bill as much (seldom- but it does happen). However, that is not to say that every planner does this, nor has the expertise, nor that clients should employ someone for just this purpose. If other work- retirement planning, investments, etc.- is necessary, the fee may be more than justified. Otherwise the additional expense of a planner may be unwarranted since it will be in addition to the fee charged by the attorney.
REASONS FOR NOT DOING PLANNING
There are many reasons people have for NOT completing any type of estate planning- and none that are really justified. The first is the simple aspect that the filling out of (even the discussion of) will and trust documents makes many people aware of their own mortality. By not doing anything, they do not have to think about the inevitable. This attitude is expressed quite frequently by men. It's not an issue of WHEN they will die, but IF they will die. Women tend to be more objective. But the true issue is not about the one to die, but how the LIVING have to face their future when a loved one is gone. It is this main issue where clients must be objective. If proper planning is not done, surviving spouses and children may be left with inadequate funds on which to survive. Additionally, they may be left with a legal quagmire which must be processed through the court system. This necessitates substantial and unnecessary time which unquestionably will weigh heavily on the survivors and extends the period of grieving.
However, even if there are no direct relatives, a will or trust is still recommended since it can designate that assets are to be left to non relatives or to certain charities. This is what clients are actually planning for- the proper enrichment and survival of their close beneficiaries and/or the continuation of their good will and works past their own lifetime. Many times, people are remembered for the last acts we do and it certainly would be nice to be remembered for the issues of caring and generosity.
Another concern for not doing anything is the fact that many people feel they are being coerced into a plan only to save money for their beneficiaries (children). In some cases this may be true, but most of the time it is a sincere effort for proper planning that all must consider. Parents should not unilaterally dismiss the comments of their children or friends as pure greed, but as an opportunity to put affairs in order and keep the court system (probate) from continuing the period of grieving any longer than necessary. And in truth, planning can reduce the extra burden that estate taxes can impose on estates over $650,000. With the use of trusts, this savings of taxes can enrich the beneficiaries- but is that necessarily wrong? Better them then the government.
A third reason why people may not consider an estate plan is that they do not believe they have enough assets to warrant the use and cost of trusts or similar measures. There are two areas to address. The first is adding up current assets to see if they are already over the $650,000 exemption since estate taxes effectively start at this point. Even if the value of assets is not that high, the compounding effect of inflation over just a few years can easily increase the total value over the exemption. For example, many homeowners have had significant increases in the value of their homes the last 10 years. Add this to the amount of assets in IRA's, pension accounts, stocks, etc. and the amount may exceed the $650,000 exemption from estate tax.
Parents have also been heard to say "Well, we earned this money the hard way and the kids will have to become successful on their own" and "I don't care how much the IRS will take". Rubbish. Almost universally these same people did whatever they possibly could while earning their fortunes to have their assets escape tax whenever possible. Parents may be unwilling to do planning for their children for any number of reasons, but there is absolutely no sense, as stated above, in letting the IRS take a huge amount of those assets. Certainly everyone can find a charity to benefit- Heart, Lung, Cancer, etc. and reduce or completely eliminate the tax bite. That is certainly better then having the assets taxed as high as 55% and giving it to the government to buy hammers for $200.
One other reason for not doing planning- and one which is unfortunately understandable- is the fear of attorneys. Consumers see, sometimes justifiably, attorneys as heartless greedy people that file tons of paper that no one can understand. However, this cut throat competition and aggressiveness is tempered somewhat in estate planning because the attorneys are not in a combative situation nor subject to court room in-fighting and legalistic ploys. Estate planning is a fairly personalized and civilized process where the estate planning attorney (preferably and hopefully) engages in a one on one discussion of needs and desires. These attorneys, by their training and work, are usually much more compassionate and understanding of the emotional and financial issues involved and treat the issues and clients with respect. Unfortunately, the documentation clients receive is still very imposing and loaded with legalese. The attorney needs to explain, in simple English, what the document really means and how everything works. Some may provide separate letters explaining the material. (Unfortunately the issue of cost becomes a major factor once again. If an attorney is charging minimal fees, there usually are no separate letters of explanation- nor little commentary either. (If someone other than an attorney is doing the documentation, there probably is little understanding of the legal issues to begin with.) It is incumbent on clients to make sure, by whatever means, that they understand what they are signing and how it works.
REASONS FOR DOING PLANNING
The "supposed" reasons for not doing planning were put first in order to get the emotional rationalizations out of the way. Consumer's needs to do estate planning are several fold. First, it is necessary to determine who will receive assets when someone dies- and as expeditiously and economically as possible. Additionally, some clients may wish to put assets under current management either through powers of attorney or living trusts. They may wish these managers/trustors/attorneys to become intimately familiar with the assets and to potentially manage the assets after their demise as a going business- or at least to distribute them in an orderly manner to the beneficiaries. In order to effectuate this proper transfer, they need to establish at least a will, durable powers of attorney and perhaps testamentary or living trusts.
Of particular concern, and which most texts and writings seem to have overlooked, is the need for basic planning to keep the time of grieving to a minimum. That usually is in regards to "unnecessary" probate. For small estates and under certain conditions, probate may not be a problem and the cost may be incidental. (In California, if assets are $100,000 or under, formal probate is not necessary.) In other situations, probate may actually be beneficial since the court will oversee all aspects of the distribution of the assets (but it also makes the assumption that court officers, attorney and judges are well versed in investments, valuations, etc.- something the author is not willing to grant). It also can keep creditors from attaching assets after a statutory period of time. However if there is one area where things can go wrong and thereby cause continued emotional drain, probate is it. The cost of probate may not be the issue- it's the time element stretching into years that is the concern. These are the comments repeatedly expressed by people who have had to act as executor and executrix on estates. As an example were three sisters, living in different states, who had hoped to close their father's "simple" estate rather quickly. They have waited over three years without resolution of the problems. The probate process has caused them to continually be reminded of his death. To remember is one thing, but to be forced into it is altogether unnecessary- particularly where proper planning by their father could have avoided all the difficulties. Another consideration for proper planning is the infighting of the heirs. Some heirs may feel that other beneficiaries took advantage of them, that the executor of the estate should not have taken fees, etc., etc. This can go on for decades. A trust can mitigate some of these problems. While it is not a guarantee of family bliss, at least one can at least try to keep unhealthy issues to a minimum.
Additionally, if no planning is done, the court system will probate the assets anyway and distribute them according to state statute. It's called dying intestate- without a will. Perhaps one third or half of the assets will go to the spouse and the rest to the children. The deceased may not have wanted that, but since there are no directions to the contrary, the state will determine the disposition. Dying without a will unquestionably costs additional time and expense. A will is the ABSOLUTE MINIMUM a client must do to protect assets and allow a distribution as desired.
Another very valuable reason for planning is continued management of assets. This may include not only various investments but, in particular, a family business. Time and time again, a life's work has been lost because there was no plan to continue the business after the death of the business owner. Creditors demand their money. Purchasers of the businesses products or services lose confidence in the ability of new or non-existent management to continue the manufacture and quality of products. The list of problems is endless, but the end result is essentially the same- purchasers go elsewhere and business orders decline. And when the business suffers, its value drops dramatically. Perhaps the only value is the inventory that is left- and this might have to be disposed of at a fire sale providing only 15 cents of the dollar. A proper business plan covering key men/women with adequate funding from insurance (many people despise insurance, but it does solve MANY problems at a low cost) can provide continuity of the business and a greatly enhanced value to the beneficiaries.
Some people still believe that there isn't much time to worry about estate issues since they are not going to live long enough to have much anyway. Life expectancy statistics in 1993 indicated the following: Life expectancy at birth has now been raised to 75.5 years. The death rate is 8,603 per 1 million people in 1992, down from 8,638 in 1990. Women are expected to outlive men by 6.9 years and whites will outlive blacks by about 7 years.
To summarize, proper planning can reduce costs, save time, save taxes, provide continuing management- literally all the things one tries to do while alive.
TITLE- JOINT TENANCY
On illustration one, there is a chart addressing the differences between joint tenancy and community property. Since community property is only available in a few states, let's fist review joint tenancy and its uses and MISUSES. We shall first consider a man and wife. As holders of any property (home, stocks, bonds, etc.), when one dies, the property immediately passes to the survivor. There is NO probate. However, the percentage ownership passing FROM the deceased IS included in the deceased's estate for estate tax purposes. (A $100,000 property would normally have 50% ownership- therefore $50,000 of value would included in the deceased's estate. These figures can vary depending on circumstances and one should check with a CPA or tax attorney for specific variations to an individuals situation.) However, with a husband and wife as owners, there does not have to be any estate tax at all if the deceased uses the unlimited marital transfer- explained elsewhere. Simply stated however, all property can go from one spouse to another with no tax implication at that time- though there may be other tax implications at a later date when the survivor subsequently dies.
Joint tenancy may also be used with anyone else as well. But putting property into joint tenancy may involve gifts. For example, assume an individual has property worth $100,000 and wishes to avoid probate (joint tenancy, as stated, does this automatically). Perhaps a son or brother or friend (does not have to be a relative but in this case we are specifically excluding a spouse) is put on title as joint tenant. Irrespective of anything else, the individual has just given a gift of $50,000 to the one designated. A gift tax form will need to be filed for everything over the $10,000 per person per year annual exclusion. Part of the $650,000 annual exemption ($40,000) will need to be used up leaving $610,000 as an exemption at death. But should that have already been used up from prior gifts, then gift tax will apply. The issue then is who is to pay the gift tax- donor or donee?
There may be the situation where the joint tenant is merely put on for convenience- to simply pass the assets upon death with no current gift intended. If so, the total amount of the property will be included in clients estate for tax purposes and no gift tax form need to filed. The fallacy in joint tenancy is that many consumers assumed that they could transfer the assets to avoid probate AND current and later taxation. That is not the case. Probate can be avoided but the tax implications do not go away simply by using joint tenancy. There are also other problems with joint tenancy. What about the fact that a joint tenant may PRE-decease? In such cases, the property reverts back to the grantor and then one must start all over again with another beneficiary. Some grantors simply forget to do this and the property ends up going through probate as though the person died intestate. An even greater problem is if the joint tenant selected comes under financial or legal problems- or even a divorce. Can the creditors or ex-spouse attach the property? What happens if a son or daughter was selected as a joint tenant and they later get hooked on drugs? Could they sell their half of the property to others? Is it possible to get the property back? These predicaments have happened and it is therefore necessary to review all other types of planning options before blindly using joint tenancy as a panacea. But obviously there are the good points with joint tenancy. Probate can be avoided, a quick transfer to your desired beneficiaries is initiated and the cost is relatively inexpensive. This is particularly true on small estates where few people may be involved and where the cost or use of a trust is prohibitive or unnecessary. But it is not a cure-all for every circumstance.
TITLE- COMMUNITY PROPERTY
This form of titling is available nine states. It is worth considering however not only for those states, but also for the times when a couple may LEAVE a community property state or MOVE into one. It may be possible to retain or convert assets to community property status (see a good attorney to determine if warranted) which could give significant tax advantages. As shown on the diagram, community property grants a full step up in basis upon death versus only one half basis with joint tenancy. On a $600,000 property used in the example with an initial basis for both at $50,000, tax on a subsequent sale under joint tenancy could be $50,000. With community property it is $0. (Discussion on the new laws providing a $500,000 exemption for married filing joint and $250,000 single on the sale of a residence is not addressed for this example- further other property can use the community property titling), almost all attorneys have universally suggested a change to community property because of this advantage. No other tax repercussions should occur due to the change in re-deeding (such as property reassessment). Some attorneys indicate that a re-deeding is unnecessary- a change in the will or trust documents is sufficient. Others say that the IRS will even allow a surviving spouse to treat joint tenancy property as community property even after the death of the other. But in order to be sure of all potential complications, an attorney should be contacted.
Even though a will has been properly designed and indicates who will get your property, the courts, in almost all jurisdictions and under most conditions, will require a review of the document and the ultimate distributions. It can be, though not necessarily is- both time consuming and expensive. (Most of the comments below are applicable for many states, but be sure to check state statues for dissimilarities. Even minor differences can have significant repercussions.) The courts have established statutory rates for a probate attorney. Those are the minimum fees regardless of the amount of time or effort involved UNLESS the attorney feels that extra time or effort is warranted. In such cases, the attorney can petition the court to charge MORE than the statutory rates. Note that the fees should be doubled since they represent costs for the attorney and costs for the personal administrator (previously called executor or executrix). Many people may have close relatives administering the estate and feel that these individuals will not charge any fees against the estate. In other times, the grantor may not even give the fees a thought- but it is the other heirs and beneficiaries that WILL. And they don't want fees charged since it will diminish their distribution. But beneficiaries and grantors should be aware of all the work, frustration and added emotion administrators must bear. Also, grantors should be aware that they may be unfairly burdening one child out of, say five, and that the individual should be paid for this work. The difficulty the administrator has is that if they accept or charge a fee, they may suffer the alienation of the rest of the beneficiaries. While this may be totally uncalled for, it is indicative of many situations where the beneficiaries get greedy. In order to eliminate or at least reduce such animosity, all heirs and beneficiaries- particularly in the family- should be advised of the contents of the will or trust and have a complete understanding of what will transpire at death. In this review, it should be made aware that "so and so" will be acting as the administrator and will charge a fee and that is what the grantor wants. Admittedly this conversation happens next to never, but it is worthy of mention. Absent such a discussion, the details might be spelled out in the trust or will. It may help to stop some of the sibling rivalry and in-fighting.
The comments so far have been fairly negative regarding probate. For "regular" sized estates, probate may, but as stated, does not have to, take a long time to straighten out the affairs. If there a few properties and assets and all are located in one jurisdiction, probate should not be onerous. And for small estates- $100,000 and under in California- there are no fees and probate would probably be completed in very short order. Additionally there are times when probate may actually be valuable. In some states, probating even a small portion of an estate may stop creditors from attaching any other assets after a period of time has gone by (four months in California). So probate is not all bad, nor should excessive measures and costs be instituted where little problems are anticipated. But in order to KNOW whether or not a problem may arise, proper counsel should be sought to discuss the matter in detail.
A will is the formal document that is the minimum requirement to pass assets to the heirs and beneficiaries desired. A person can pass assets to close relatives even though dying intestate (without a will) since the state, by statute, allocates a certain amount to a surviving widow and children. However, the percentages are pre-selected and cannot be changed by the deceased or the family. The distribution probably does not conform to any of the deceased's true wishes. But for those who have few assets or money and are not concerned about the ultimate distribution of property, a will is not mandatory- but to not set one up is still foolish. In regards to the distribution of intestate property, the property will all go to the surviving spouse, absent any children. Nothing to friends, a brother, a charity. If there is/are children, the courts may stipulate that one half will go to the wife, the other one half to the child. If there is more than one child, the split may be the same in some states (50/50) or perhaps one third will go to the wife and two thirds to the children. The concern might be if any of the children are more in need of funds than others (such as a handicapped child), or should not get anything (on drugs) or any number of other reasons. None of these issues will be carried out without the proper documentation through at least a will.
SEE STATE REGULATIONS
The will is also the instrument to indicate who will take care (guardian) of minor children- it cannot be done in a trust. The document will also indicate if these same guardians will have control of investing the assets from the disposition of assets from the estate. Caution is advised here- being able to take care of and raise a child is no indication of financial acumen. This fact seems to have been overlooked by many estate planning attorneys who have simply made the guardian and financial manager one and the same without reviewing any investment experience whatsoever.
Additionally, anyone of these individuals may be delegated as the personal administrator of the estate. As stated, they don't have to be the same person- and probably shouldn't be. Each has an expertise in their own area and only the best person for each category should be chosen. And regardless of who is selected, two individuals should/must be selected for each position since one may be unable or unwilling to serve. Best to be prepared. The will can also take care of eventualities such as a beneficiaries PREdeceasing the maker. A properly designed will can indicate where that property will ultimately be distributed regardless of the situations that might arise. Admittedly, one does not like to think about some of these morbid considerations, but better to do it here and now then let the courts potentially drag it out for years.
Also be aware that a will cannot dictate policy that is against the law. For example, assume, for whatever reason, that a husband wished to disinherit his wife or only give her a very small portion of the assets. This probably won't work because of the "widow's election". The states have statutes limitations that require that a widow get at least a minimum amount of the estate. So unless the wife has signed off against this widow's election via a written document, she will probably still be able to assert her rights and get a minimum amount of the estate regardless of the maker's wishes or intentions. A will is also necessary even though living trusts have been established. It is needed to transfer any miscellaneous properties into the trust that have remained, for whatever reason, outside of the trust. It is usually called a pourover will. The will also can waive bond and empower the administrator to sell or retain property.
Even though a properly drawn will or trust contains valuable information, it may not contain certain immediate information necessary to your surviving spouse or other beneficiaries. For example, family members need to know where certain are- bank and retirement accounts, insurance policies and so on. Emergency instructions might include where the spare keys to the house and car are, who will take care of the kids or aged parent short term, who feeds the pets, etc. You should prepare a statement of where everything is so your beneficiaries are not searching in vain for documents. Copies of everything should be given to the administrator. This is particularly true of your will if it has been placed in a safety deposit box. Once you die, the box may be "sealed" by the state and it could be several weeks before anyone would be allowed to open it. Too many things can go wrong in the interim. Make sure these same individuals also have burial instructions- how elaborate or simple; religious or secular. Instructions should include the names of people at work that should be called regarding the last check, insurance proceeds, etc. These monies may not be received in time to keep the family going so, adequate cash should be maintained to fund for several months of expenses. Equally important are the documents on living wills, powers of attorney, and long term health care. Should you become incapacitated, the instructions allow others to immediately continue "business as usual" without undue (or at least excessive) delay or expense. The individuals selected can carry on a business, monitor investments and carry out other instructions per your desires. And should you end up in a coma, the living will states your desires for prolonged life sustaining measures- or none at all. In fact commencing in December 1992, medical institutions and nursing homes must, under the Patient and Self Determination Act, tell patients that they have the right to refuse treatment or to have life support turned off if they do not want it. They will ask if a document as already been written on these issues (Durable power of Attorney for Health Care). It is far preferable to have your attorney-in-fact already chosen and all your thoughts properly illuminated beforehand- not during the irrational period of a hospital stay. However, although over 95% approve of having a written document, only 10% have done so.
UNLIMITED MARITAL TRANSFER
A husband and wife can transfer any amount of assets to the other spouse either while alive or at death through a will or other instrument and no gift tax or other current tax ramifications would apply (other issues will undoubtedly pertain however). For example, a husband with a personal estate of $1,000,000,000 can transfer all of these assets to his spouse with no income or gift tax implications. This may be poor tax planning however since the full amount of the estate will be taxed upon the surviving spouse's death (though there are ways around this as well). This is more clearly defined in the Lifetime Exemptions sections. Knowing when and how to use the marital transfer can produce greater benefits than simply gifting everything at once to the survivor.
Most married couples share their assets 50/50 and the courts generally look in this direction absent any other agreement. But obviously an agreement can be made between the parties either pre- or post- nuptial where certain property or inheritances owned by one party are to be retained as sole ownership- and with sole control- even during marriage. This means that the owner may do anything he/she wishes with the assets during marriage- even if the other party objects- and can distribute such assets at death to any beneficiaries desired. Separate checking and other money accounts for this property should be maintained in order to show no commingling of funds with married monies. An attorney should prepare these documents and will be able to indicate all the filings necessary to keep the property under a single ownership.
Congress allows each person to exempt $650,000 from estate taxes. The "lifetime exemption", as it is called, is most often used at death. However, unknown to many, the exemption may be used while alive. For example, gift taxes normally would be applied to transfers of assets to others (excluding spouses) over $10,000 per person per year. A friend gifting $150,000 of assets (house, boats, whatever) to another would have to file gift tax form on $140,000 ($150,000 minus the $10,000 free annual transfer) and potentially pay a gift tax on that amount. However, the donor normally would not pay any current gift taxes since he/she would use $140,000 of the lifetime $650,000 exclusion. This would leave the grantor with $510,000 to continue to use during his lifetime or to be used at death. If the entire amount is used while the grantor is alive, then the grantor would then be liable for current gift taxes for amounts granted beyond the total $650,000. Caution is advised however in the transfer of assets for married couples when one spouse dies. The deceased spouses estate must have specifically designated the use of the $650,000 lifetime estate tax exemption upon death- otherwise it may be lost. While this does not create an immediate tax problem since all assets may be transferred to the surviving spouse without taxation under the unlimited marital transfer, subsequent transfers upon death of the surviving spouse can have severe tax implications. If a couple had a $1,300,000 estate and the exemptions WERE used by both parties through proper estate planning then NO estate taxes have to be paid (probate fees may still be applicable in many states however). But if the first to die did NOT use their exemption and simply gave everything he or she owned to the surviving spouse under the unlimited marital transfer, then when the survivor dies, ALL the assets were in their estate. Assuming no appreciation, this would be the full $1,300,000. Since only one $650,000 exemption was available (the first to die didn't use theirs- and if you don't use it, you lose it), then estate taxes would need to be paid on the other $650,000. That's $227,500 in taxes versus $0 by using both exemptions under proper planning.
(PFS, 1993) Twenty nine states levy taxes that can reduce the net amount to your heirs even though the estate was not subject to federal estate tax. However, in the following states there is no problem since they impose a pickup tax only when the estate is subject to federal tax: AL, HA, UT, AL, IL, VT, MI, VI, CA, NV, WA, TX, CO, NM, WV, FL, ND, WY, AZ, and GO. These states get part of what the federal government collects. But the others use an estate tax- a tax levied on the value of the estate- or an inheritance tax- a tax based on each heir's share of the assets. Nine states collect their own death taxes. Certain states- DE, LA, NY, NC, OR, RI, SC, TN and WI restrict the making of gifts to even less than what federal law allows. Only the states of MA, MN, NY, NC, TN and WI follow the federal rule of counting life insurance as part of your estate.
Each person can give away $10,000 per person per year without any gift tax ramifications. If a grantor had five children therefore (does not have to be a relative- can be anybody), each could be given $10,000 each year and no gift tax need be paid- nor would any gift form even need to be filed. If the grantor's spouse elected, he/she could gift along with the grantor. The gifts would now amount to $20,000 per person annually for a total of $100,000 of assets passed that year with no gift tax liability. Why would anyone consider this avenue? Perhaps an individual has a large estate. If all was passed at death, the estate taxes could reach 55%- severely reducing the amount distributed. The annual gifting therefore has the effect of reducing the amount of the ultimate estate subject to estate tax at death. If enough property is given away during life, there may be no estate taxes to be paid at all. Another reason for current gifting involves a rapidly appreciating asset. By gifting the property now, the grantor is able to exclude any appreciation in subsequent years. For example, assume a $100,000 property is appreciating at 9% per year. If the grantor were to die in 18 years, the property would then be worth $471,712. By gifting the property now when valued at $100.000, $371,712 would be excluded from the grantor's potential estate tax later on.
This appreciation has effectively been "given" to others. And as stated previously, gifts made over $10,000 per person per year are required to be offset against the lifetime 650,000 exclusion. Once you gift over that amount, gift tax would need to be paid. But it is not mandatory that the grantor pay the taxes. In some situations, the grantor may have assets to gift but no money to pay any gift tax. In such cases, the grantor/donor could make a "net gift". This requires that the receiver of the property pays any gift tax due. While seldom utilized, it may fit unique circumstances.
TAXATION OF ESTATE
As stated, each individual is able to exempt $650,000 from estate taxes. That exemption equals $211,300 of tax. If a deceased has an estate above that amount, the IRS starts taxing at 37%. It is a progressive tax increasing to 55%. It is possible, if one is married, to use various trusts (testamentary and funded revocable) to remove up to $1,300,000 from taxation- thereby saving $227,500 in tax. Other strategies involve gifting to individuals, as previously mentioned, and obviously to gift property to charities at any time. The amount given to charity is not considered part of your taxable estate.
POWER OF ATTORNEY
A power of attorney allows another individual, selected by a grantor, to do certain acts for the grantor which have legal authority. The grantor normally gives specific powers that last for a specified period of time. The grantor may give this power since he/she is unavailable to transact some business- vacation, etc. This designation of authority should be in written form- it would be an unusual exception for a court to uphold a real estate exchange or other business transaction based solely on a verbal granting of authority. And while the grantor can write the document personally or use a form available at a stationary store, an attorney should perform this function. The cost for drawing up the document should be minimal for most situations- unless they are unduly complicated. The individual chosen- called an attorney-in-fact- should be someone very knowledgeable about the business to be transacted. A trusted friend is not the best choice unless competency, expertise and experience are found as well. Some banks, title companies and other institutions have an aversion to accepting powers of attorney. They may be unfamiliar with the instrument in many cases and probably fear any liability that may accrue. One way to get limit this problem is to be sure that the power of attorney is VERY explicit in defining who, what, when, where and why. A tightly written document defining all the parameters may make the institution much more comfortable. A loosely written document provides too much exposure for something to go wrong. Unfortunately there is a major drawback in the use of the "regular" power of attorney. While it is most adequate in performing its intended use- completion of a function while the grantor is unavailable- it is totally useless when incompetency happens. Under such potential problems of disability or mental impairment where the grantor is no longer capable of carrying on his/her affairs in an orderly knowledgeable manner, the regular power of attorney CEASES. Since no one may be empowered to act, the business may suffer- even fail- and investments may lose value because they are not being monitored. The power of attorney is ineffective since it ceases in authority- by state statues- once the grantor is declared incompetent. In order to overcome this obstacle, the grantor should utilize a DURABLE POWER OF ATTORNEY.
This allows the Attorney-in-Fact to continue to act even though the grantor has been declared incompetent or becomes incapacitated. This document would eliminate, in most instances, the need to go through the lengthy and costly court proceedings of a declaration of incompetency and the selection of a guardian or conservator. Some grantors find a difficulty in the use of a Durable Power of Attorney in that the attorney-in-fact is able to carry out the measures indicated in the document even when the grantor is alert, healthy and able to do all transactions personally. The grantor feels uncomfortable about this exposure and wants to limit the exercise of authority to situations only when and if incompetency should exist. The grantor can therefore utilize a SPRINGING Durable Power of Attorney. It is only activated when the grantor is declared incompetent. Until such time it is dormant and the attorney-in-fact has no authority to act in any of the affairs. Unfortunately this exposes a problem. The grantor still has to be declared incompetent by the court system before a springing power of attorney takes effect. Too much time may elapse going through these proceedings. It is probably preferable that a regular Durable Power of Attorney be completed while the grantor is competent and that it be given to a spouse or legal attorney who will only give it to the attorney in fact when and if incompetency occurs. The durable power of attorney may be used instead of a trust for small estates- under $650,000 or so. It provides similar management of assets but is less costly to initiate and no property titling need be changed. But, as stated, not all jurisdictions will accept the attorney in fact and its use does not help in the reduction of estate taxes by separating the assets upon death.
These trusts are established while the grantor is alive but, unlike the revocable living trusts, no properties are put into the trust until death. They are therefore UNFUNDED during lifetime. (A "pourover or trust" will provides the documentation and power to transfer property to the trust.) They are used to manage assets immediately after death and also help reduce estate taxes since a married couple can structure the trust to offset up to a $1,300,000 estate from taxes. These can also be used to manage assets for an underaged child. Be aware however that probate may still a factor. Since all properties were owned individually at death, they will need to be probated in full even though they immediately go into trust for management. The trust documents establish who would act as the trustee(s), what powers and duties are granted to them- basically whatever desires and wishes the grantor had. The trustee can be the surviving spouse, a friend, corporate trustee or combination thereof. If friends are used, be sure to ask them if they will serve. They should not be surprised by this request after a death has occurred. Successor or alternative trustees must also be selected in case the first trustees are unwilling or unable to serve.
As stated, the
testamentary trust can also be used in conjunction with a will to manage assets
for underaged children or even elderly parents. For example, if a grantor died
with an estate of $250,000, there is no one who would want it to go directly to
a 14 year old child- or possibly an invalid brother. A testamentary trust is
therefore designed to receive the assets and the trustees and guardians will
then take over. This trust can also be used for active beneficiaries as well. If
a surviving spouse has little or no experience in dealing with financial
affairs, much of the value of an estate could be lost as they try to learn-
assuming they could. With the assets passing directly to the trust, the trustees
could continue professional management without any losses (hopefully). Obviously
this should be discussed with a spouse before trying to institute.
FUNDED REVOCABLE TRUST (LIVING TRUST)
This is similar in format to the testamentary trusts with the one exception- properties are put into the trust while the grantor(s) are ALIVE. The impact of this decision is that it can avoid most of the potential problems with probate. As stated previously, probate should not be avoided in all cases- and in some cases may be exceedingly beneficial. However, many people do feel that probate is a complicated, costly, public and a bureaucratic process that they wish to avoid. And, as with the testamentary trust, a man and wife with a $1,300,000 estate will be able to reduce their estate tax exposure from $227,500 to $0 through the use of A/B trusts. They can also reduce their probate fees from around $40,000 at each death down to $0. (In actual practice, the trustees will need to engage an attorney for the processing of properties in the trust. These costs can also be substantial- sometimes matching or exceeding probate costs. Proper pre-planning, however, can keep the fees to a reasonable level.) Additionally, there probably will be some properties that have remained outside of the trust and that will need to be transferred to the trust. This will be done by a pourover will. The property should be minor in value and probate fees and time should be minimal. Even if all properties were funded, experts suggest that some minor property be probated- even a small life insurance policy- so that creditors are put on notice and all claims are nullified in the normal four month period.
These living trusts also provide numerous other benefits. One major feature is the use of professional management where the grantors are no longer willing or able to do continued management of business, investment or other affairs. It also allows continued management because of incapacity or incompetency. Under such conditions, the trustees selected can take care of affairs as had been previously indicated in the trust documents. The practice is similar to the durable power of attorney addressed previously. The selection of the trustees is crucial. Perhaps the surviving spouse has adequate expertise to handle the affairs, but if not, other trustees may be selected to work with them. The trustees MUST be trusted but, even more importantly, be KNOWLEDGEABLE- a fact that is many times missing in the review. They may be friends, relatives, other individuals as well as corporate trustees. Individual or corporate trustees might be the ONLY entities selected. This might reduce the emotional strain on the surviving spouse since these trustees may be able to provide concise knowledge and expertise without engaging the spouse in any of the activities which they may be unprepared and unqualified to handle.
But be aware that the selection of a separate trustee- even corporate trustees- is not a simple task in itself. These individuals must be compatible to the grantor's risk scenario, location, personal style, attitudes, etc., They must have an supportable track record. A local bank may NOT have extensive- or even adequate- skills to handle management of an estate. They should not be picked- though quite often are- because the tellers have been nice or the bank is just around the corner. Nice and competency do not necessarily relate. Furthermore, a non-spouse trustee in no guarantee for success in running the affairs for surviving spouse/beneficiaries. They must be monitored on an ongoing basis to insure their competency. Additionally, when the use of a separate individual or corporate trustee ONLY is contemplated, the surviving spouse may end up being even further removed from the activities of the assets. Maybe, at this point, the survivor may need to be ACTIVELY involved so that he/she can take over the management at a later time. Numerous factors must be considered. But it is much better to make those decisions while alive through a trust document that have them forced on a survivor at an untimely death.
In regards to improper or unknowledgeable trustees- and as mentioned in other areas of this site- a "trust protector" statement should be utilized within most trust. This gives beneficiaries the ability to hire a separate and independent agent to review the activities of the trust at least annually. If such person finds that the trustees are not performing adequately, he/she has the right to request a transfer to other trustees that can perform the required activities. Since the ability is already stated in trust, it can avoid lengthy and costly transfer that take court approval. Due to past experience with trusts, I clearly suggest that all trusts carefully consider the inclusion of proper language.
The are other considerations to a living trust as follows:
1. The actions of the trust are PRIVATE. Probate becomes public knowledge but nothing happening within a trust is anyone else's business.
2. It permits administrative ease since trustee has immediate access to the property without the "red tape" of court supervision.
3. It may eliminate probate in another state (ancillary probate) where other property is located. A trust may have to be set up in the other state, but it may be economically worthwhile.
4. It can avoid the time and expense of establishing a conservatorship if the Trustor becomes incompetent to manage affairs. This was mentioned previously but bears repeating- particularly for the elderly.
There are disadvantages:
1. A trust costs more to establish.
2. Putting the property in trust can be a hassle. This can be particularly true with individual stocks and bonds. Preferable to open up a street account with a broker-dealer firm and let them do transfer.
This is MUCH faster and cheaper. Securities are guaranteed against loss up to at least $500,000. Dividends are paid as before and monthly or quarterly statements are sent. (A fee might be charged by the brokerage company however if it is not active.)
3. Some property should not be put in a trust- race horses for example.
4. Some real estate agents, escrow companies, title companies and other institutions may be unfamiliar with ownership of property in trust and may not want to insure. Usually means that it is necessary to seek out competent knowledgeable people before any transaction takes place- but that should be a normal course of events anyway.
5. Trusts could lose ability to utilize annual $10,000 gift exclusion since, as late as 1993, the IRS had determined the funds MUST be taken out of the trust beforehand. The new tax laws (1998) indicate that a trust will be allowed to do the annual gifting directly- though checking with an estate attorney would be prudent the first time.
6. Depending on state laws, creditors may still make claims for longer period than that if assets had been probated.
7. There is the cost of preparing income tax returns on the irrevocable trusts.
8. In addition to the
costs of a trust, there are many other costs and problems that the promoter of
living trust are not addressing . Per Senior Spectrum, July 1991, Jeanne Levin,
Santa Rosa attorney, "people are being told (and sold) the idea that a living
trust is a way of avoiding lawyers and all administration. When you die.....
assets must be collected, invested, managed and distributed to the
beneficiaries. The successor trustee probably does not know how to proceed and
must seek professional assistance." When a spouse dies, "it is a title company
policy that a special form be recorded at the county recorder's office to remove
the deceased's trustees name from the records. The survivor must execute a new
durable power of attorney. And if assets are greater than $650,000, much more
administration occurs. The successor trustee must find and collect all your
assets, file for and receive a federal tax I.D. number for the trust, arrange to
have tax returns prepared and make distributions to the beneficiaries. Decisions
must be made whether to sell property and distribute the proceeds or to transfer
the title directly. Investment decisions are held to the prudent man standard
and the trustee must be careful to do nothing to subject them to liability. As a
result, successor trustees usually employ professional advisers (accountants and
attorneys) though fees are usually far lower than probate" (though not
necessarily in large estates).
OWNERSHIP, TAXATION, and IRREVOCABLE LIFE INSURANCE TRUSTS
This section includes policies that are individually owned, and group policies as well. Clients may question the inclusion of group term for estate taxes since they did not actually buy it. But the problem is not simply the ownership, but whether or not there was any incidences of ownership in the policy. These include any of the following where one can:
1. Change the beneficiaries
2. Surrender or cancel the policy and receive the cash value, if any
3. Assign the policy
4. Pledge the policy as collateral for a loan
If an individual has any control of the policy through the items listed, then the proceeds will be included in the deceased's estate- though the monies can go directly to the beneficiaries. If the amount of the deceased's estate is over $650,000 and life insurance is added to that. Estate taxes start at 37% and go as high as 55%. The life insurance can be excluded from an individual's estate. The simplest method is to gift current policies to beneficiaries and release all ownership to them. If there is cash value in the policy, gift taxes may be involved. (There are very technical areas of present value, Crummey powers, etc. which need to be reviewed with a competent life insurance agent AND an attorney. They are too complicated for this presentation.)
If a new policy was contemplated, it might be preferable if the beneficiaries bought and owned the policies themselves. If they don't have the money, the monies could be gifted (remember an individual can gift up to $10,000 per person year with no gift tax assessment) by the insured- though anyone else may also. But if the beneficiaries (children?) are either too immature or too young, then the policies should not be owned by them but through a separate entity of an irrevocable trust. Irrevocable means that it cannot be changed once it has been established (some minor allowances exist).
IRREVOCABLE LIFE INSURANCE TRUSTS
If an insured currently owns a policy but does not wish it to be included in his/her estate upon death, the policy may be transferred out of the estate through two methods. In the first case, the policy may be transferred (gift taxes may apply if cash value is above $10,000) to a IRREVOCABLE life insurance trust. This must be set up by an attorney. The insured/grantor gives up ALL incidences of ownership- no changes of beneficiaries is allowed, no loans can be made, etc. Upon death, the proceeds of the insurance are immediately distributed to the trust (no probate required). The assets are then controlled by the trustee and distributed or invested per the terms of the trust. Employer group policies may also be transferred as long as it is allowed by state law and the life insurance company. While the insured is alive, he/she CANNOT be the trustee of this irrevocable trust. In such a case, the insured/trustee will be considered to have maintained control of the policy and the insurance proceeds will be included in the estate. Premiums necessary to be paid on the policy may be gifted to the trust each year- BUT they should not be earmarked for payments of the premiums NOR should the check be made for the exact amount of insurance NOR should the check be sent to the trust on the day the premium is due. Admittedly everyone, including the IRS, knows what the money is essentially being used for, but the letter of the tax law must be followed in order to avoid taxation.
An insured must be properly counseled before putting a policy in an irrevocable trust since, as stated, no changes can theoretically be made. The greatest problem is if a spouse is shown as the beneficiary on the policy AND a subsequent divorce takes place. It could be impossible to get him/her off as beneficiary- though new policies are designed to allow a split of the policy should a divorce be initiated. Careful, very careful ,structure of the trust document is necessary to cover all contingencies. But irrevocable trusts are viable instruments to eliminate polices from estate tax.
SPECIAL NOTE: Whenever an existing policy is transferred to a trust, the insured MUST stay alive for at least another THREE years. If death occurs within that time, the life proceeds WILL be included in estate. This is simply known as the three year rule in contemplation of death.
The situation is
different if a NEW policy is being purchased. In this case, the irrevocable
trust (via the separate trustee) should buy the policy, not the insured. In this
way, the insured NEVER was the owner of the policy and the three year would not
apply. Gift payments by the insured would continue as indicated above.
SECOND TO DIE LIFE INSURANCE
When life insurance is purchased to pay off estate taxes for a married couple (though the concept is valid for some business purposes), almost universally the best insurance to purchase (within a irrevocable trust hopefully) is the policy that only pays when the LAST survivor dies.
This Second to Die insurance is NOT planned for any other purpose- just for the payment of estate taxes and to keep as much of the principal as possible paid to the beneficiaries.
Term, whole, universal and variable insurance can be purchased on both individuals and used to pay estate tax, but it is far too expensive to buy single policies on both lives. Some insured comment on the use of supposedly cheaper term insurance. However, term policies are fairly expensive at ages 65 and above. Furthermore, term insurance is for a relatively short period of time and insurance for estate purposes may be needed for thirty years or more.
Second to die insurance however is CONSIDERABLY cheaper since the price is based on the actuarial lifetimes of two people, not just one, and the risks to the company are much lower. But, as is noted previously, insurance will be included in a deceased's estate and subject to taxes. Since this policy is almost universally used to pay estate taxes, there is no sense in adding to the problem and the policy should be initially established in a irrevocable life insurance trust.
FIRST TO DIE INSURANCE
This is an offshoot of the second to die policies and a progression of the effort to reduce overall estate tax. Second to die policies essentially allow the surviving spouse to receive all assets over the $650,000 exemption of the first to die. However if one has rapidly appreciating assets in this "kitty", they will be worth far more upon the survivor's death- and obviously incur far more estate tax- and a higher amount of insurance. If a trust is established where some, or even most, of these assets are taxed upon the FIRST death, they then can escape the tax on the appreciation at the second to die. Admittedly the assets are placed beyond the total control of the survivor since they must be placed in an irrevocable trust of the first to die. But recognize that the power of withdrawal of 5 %, etc. still can leave the survivor considerable sums. And while first to die insurance costs more than second to die, recognize that there may be far less insurance to buy anyway since the value of the assets would be that much lower.
Testamentary Trust: $600 to $1000
Living Trust: $700 to $2,000
Irrevocable Life Insurance Trust: $1,000 to $2,000+.
These rates were from a
sampling of estate planning attorneys in sole ownership to medium sized firms
around the San Francisco area. The ranges in fees usually relate to complexity.
However, very large estates may cost considerably more and irrevocable trusts
are, by their nature, very complex. Quotes at the lower end of the scale may
mean a "boiler plate" type of operation where the attorney is more concerned
about completing the document than about a total review of family history and
current situation. Many of these rates are in the leading newspapers and
represent the "trust mills" mentioned previously. Also be aware that if an
attorney is located in a downtown major city, someone is paying the rent on the
luxurious offices, validated parking, the extra secretaries, etc. It is
suggested that all fees should be discussed prior to making a formal appointment
(basic trusts only- one cannot get a firm figure for complicated situations over
the phone) and preferably getting it in writing.
Clients should also inquire about prior experience the attorney has had in estate planning and whether they are board certified. Clients should feel fairly comfortable with the attorney before proceeding.
In summary, if you are confused about the above and unsure what to do, I can at least tell you this. GO OUT NOW, BUY ANY FORM, BOOK, COMPUTER PROGRAM, ANYTHING, TO WRITE A WILL. DO NOT DIE WITHOUT AT LEAST A WILL. Then, decide on what other avenues of estate planning will be necessary and get that done expeditiously.
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C. Francis Baldwin
Updated Sunday, August 28, 2016