- Estate Planning Basics
- Estate Tax Saving Strategies
- Implementing and Updating Your Plan
When you hear the phrase “estate planning,” the first thought that comes to mind may be taxes. But estate planning is about more than just reducing taxes. It’s about ensuring your assets are distributed according to your wishes. That’s why, even with the estate tax reductions over the past several years (and scheduled repeal in 2010), estate planning is still critical. In addition, estate taxes still pose a threat with respect to wealth available to transfer to the next generation. Remember, in 2011 the estate tax will revert to higher rates and lower exemptions, unless Congress takes further action to change the law.
In addition, other changes over the decade have increased the complexity of estate planning, such as the scheduled repeal of the generation-skipping transfer (GST) tax (in 2010, with reinstatement in 2011); reduction in the top gift tax rate but no repeal scheduled for the gift tax; increases in GST and estate tax exemptions; and adjustments to the rules for step-up in income tax basis at death (for 2010).
As a result, estate planning is more important than ever — without proper planning, estate taxes may still claim a large share of what you’ve spent a lifetime building.
Planning tip 1
Keep In Mind Community Property
|Some of the strategies in this booklet depend on the ownership of assets. Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin have community property systems. (Alaska’s is elective.) Under such a system, each spouse usually has a one-half interest in property acquired during marriage. If you live in a community property state, keep this in mind as you relate our ideas to your situation.|
This booklet will help you start preparing a plan to reduce your estate taxes. And if you already have a plan in place, it will show you how to make the adjustments necessary to take advantage of these changes and suggest strategies you currently may not be employing. We begin in this first section by offering you an overview of basic estate planning principles. Then we start discussing estate tax saving strategies.
Certainly this booklet is no replacement for
professional financial, tax and legal advice.
Congress is likely to make further estate
tax law changes that could affect the issues discussed here — or your estate plan. In addition, many states have now "decoupled”
their death taxes from the federal estate tax, so that state taxes may be due upon your death even if no federal estate tax is due.
Be sure to get professional advice before implementing any estate planning strategies.
Because estate planning is not just about reducing taxes but also about making sure your assets are distributed as you wish both now and after you’re gone, you need to consider three questions before you begin your estate planning.
1. Who should inherit your assets?
If you are married, before you can decide who should inherit your assets, you must consider marital rights. States have different laws designed to protect surviving spouses. If you die without a will or living trust, state law will dictate how much passes to your spouse. Even with a will or living trust, if you provide less for your spouse than state law deems appropriate, the law will allow the survivor to elect to receive the greater amount.
Once you’ve considered your spouse’s rights, ask yourself these questions:
- Should your children share equally in your estate?
- Do you wish to include grandchildren or others as beneficiaries?
- Would you like to leave any assets to charity?
2. Which assets should they inherit?
You may want to consider special questions when transferring certain types of assets. For example:
- If you own a business, should the stock pass only to your children who are active in the business? Should you compensate the others with assets of comparable value?
- If you own rental properties, should all beneficiaries inherit them? Do they all have the ability to manage property? What are the cash needs of each beneficiary?
3. When and how should they inherit the assets?
To determine when and how your beneficiaries should inherit your assets, you need to focus on three factors:
- The potential age and maturity of the beneficiaries,
- The financial needs of you and your spouse during your lifetimes, and
- The tax implications.
Outright bequests offer simplicity, flexibility and some tax advantages, but you have no control over what the recipient does with the assets once they are transferred. Trusts can be useful when the beneficiaries are young or immature, when your estate is large, and for tax planning reasons. They also can provide the professional asset management capabilities an individual beneficiary lacks.
You have three basic choices for transferring your assets on your death: the will, which is the standard method, the living trust, which is rapidly growing in popularity, and beneficiary designations, for assets such as life insurance and IRAs. If you die without either a will or a living trust, state intestate succession law controls the disposition of your property that doesn’t otherwise pass via “operation of law,” such as by beneficiary designation. And settling your estate likely will be more troublesome — and more costly.
The primary difference between a will and a living trust is that assets placed in your living trust, except in rare circumstances, avoid probate at your death. Neither the will nor the living trust document, in and of itself, reduces estate taxes — though both can be drafted to do this. Whether a will or a living trust is better for you depends on many personal factors. Let’s take a closer look at each vehicle.
Planning tip 2
Title Assets Correctly
|Only assets titled in your living trust’s name avoid probate. When you create the trust, make sure you direct your legal advisor to change the title of all assets you want managed by your trust’s provisions.|
If you choose just a will, your estate will have to go through probate. Probate is a court-supervised process to protect the rights of creditors and beneficiaries and to ensure the orderly and timely transfer of assets. The probate process has six steps:
- Notification of interested parties. Most states require disclosure of the estate’s approximate value as well as the names and addresses of interested parties. These include all beneficiaries named in the will, natural heirs and creditors.
- Appointment of an executor. If you haven’t named an executor, the court will appoint one to oversee the estate’s liquidation and distribution.
- Inventory of assets. Essentially, all assets you owned or controlled at the time of your death need to be accounted for.
- Payment of claims. The type and length of notice required to establish a deadline for creditors to file their claims vary by state. If a creditor does not file its claim on time, the claim generally is barred.
- Filing of tax returns. This includes final income and estate taxes.
- Distribution of residuary estate. After the estate has paid debts and taxes, the executor can distribute the remaining assets to the beneficiaries and close the estate.
Probate can be advantageous because it provides standardized procedures and court supervision. Also, the creditor claims limitation period is often shorter than for a living trust.
Because probate is time-consuming, potentially expensive and public, avoiding probate is a common estate planning goal. A living trust (also referred to as a revocable trust, declaration of trust or inter vivos trust) acts as a will substitute, providing instructions for the management of your assets on your death and, if funded, during your life. You will still also need to have a short will, often referred to as a “pour over” will.
How does a living trust work? You transfer assets into a trust for your own benefit during your lifetime. You can serve as trustee or select a professional trustee. You completely avoid probate only if all of your assets are in the living trust when you die, or your assets are held in a manner that allows them to pass automatically by operation of law (for example, a joint bank account). The pour over will can specify how assets you didn’t transfer to your living trust during your life will be transferred at death.
Essentially, you retain the same control you had before you established the trust. Whether or not you serve as trustee, you retain the right to revoke the trust and appoint and remove trustees. If you name a professional trustee to manage trust assets, you can require the trustee to consult with you before buying or selling assets. The trust does not need to file an income tax return until after you die. Instead, you pay the tax on any income the trust earns as if you had never created the trust.
A living trust offers additional benefits. First, unlike probate, your assets are not exposed to public record. Besides keeping your affairs private, this makes it more difficult for anyone to challenge the disposition of your estate. Second, a living trust can serve as a vehicle for managing your financial assets if you become mentally incapacitated or disabled. A properly drawn living trust avoids embarrassing guardianship proceedings and related costs, and it offers greater protection and control than a durable power of attorney because the trustee can manage trust assets for your benefit.
Who should draw up your will or living trust?
Planning tip 3
Professional vs. Individual Executor or Trustee
|Advantages of a professional executor or trustee:
Advantages of an individual executor or trustee:
A lawyer! Don’t try to do it yourself. Estate law is much too complicated. You should seek competent legal advice before finalizing your estate plan. While you may want to use your financial advisor to formulate your estate plan, wills and trusts are legal documents. Only an attorney who specializes in estate matters should draft them.
Selecting an executor or trustee
Whether you choose a will or a living trust, you also need to select someone to administer the disposition of your estate — an executor or personal representative and, if you have a living trust, a trustee. An individual, such as a family member, a friend or a professional advisor, or an institution, such as a bank or trust company, can serve in these capacities. (See Planning Tip 3.) Many people name both an individual and an institution to leverage their collective expertise.
What does the executor or personal representative do? He or she serves after your death and has several major responsibilities, including:
- Administering your estate and distributing the assets to your beneficiaries,
- Making certain tax decisions,
- Paying any estate debts or expenses,
- Ensuring all life insurance and retirement plan benefits are received, and
- Filing the necessary tax returns and paying the appropriate federal and state taxes.
Whatever your choice, make sure the executor, personal representative or trustee is willing to serve. Also consider paying a reasonable fee for the services. The job isn’t easy, and not everyone will want or accept the responsibility. Provide for an alternate in case your first choice is unable or unwilling to perform. Naming a spouse, child or other relative to act as executor is common, and he or she certainly can hire any professional assistance needed.
Finally, make sure the executor, personal representative or trustee doesn’t have a conflict of interest. For example, think twice about choosing a second spouse children from a prior marriage, or an individual who owns part of your business. A co-owner’s personal goals regarding the business may differ from those of your family, and the desires of a stepparent and stepchildren may conflict.
Selecting a guardian for your children
If you have minor children, perhaps the most important element of your estate plan doesn’t involve your assets. Rather, it involves who will be your children’s guardian. Of course, the well-being of your children is your priority, but there are some financial issues to consider:
- Will the guardian be capable of managing your children’s assets?
- Will the guardian be financially strong? If not, consider compensation.
- Will the guardian’s home accommodate your children?
- How will the guardian determine your children’s living costs?
If you prefer, you can name separate guardians for your child and his or her assets. Taking the time to name a guardian or guardians now ensures your children will be cared for as you wish if you die while they are still minors.
You also should be aware of the other procedures involved in estate settlement. Here is a quick review of some of them. Your attorney, as well as the organizations mentioned, can provide more details.
When thinking about transferring your property, what probably first comes to mind are large assets, such as stock, real estate and business interests. But you also need to consider more basic assets:
Safe deposit box contents. In most states, the bank seals the box as soon as it learns of the death and opens it only in the presence of the estate’s personal representative.
Savings bonds. The surviving spouse can immediately cash in jointly owned E bonds. To cash in H and E bonds registered in the deceased’s name but payable on death to the surviving spouse, they must be sent to the Federal Reserve.
The surviving spouse or other beneficiaries may be eligible for any of the following:
Social Security benefits. For the surviving spouse to qualify, the deceased must have been age 60 or older or their children must be under age 16. Disabled spouses can usually collect at an earlier age. Surviving children can also get benefits.
Employee benefits. The deceased may have insurance, back pay, unused vacation pay, and pension funds the surviving spouse or beneficiaries are entitled to. The employer will have the specifics.
Insurance they may not know about. Many organizations provide life insurance as part of their membership fee. They should be able to provide information.
The next step is to get an idea of what your estate is worth and whether you need to worry about estate taxes, both under today’s rates and as exemptions increase over the next several years.
How much is your estate worth? Begin by listing all of your assets and their
value, including cash, stocks and bonds,
notes and mortgages, annuities, retirement
benefits, your personal residence, other
real estate, partnership interests, life
insurance, automobiles, artwork, jewelry,
and collectibles. If you’re married, prepare
a similar list for your spouse’s assets. And be
careful to review how you title the assets, to include them correctly in each spouse’s list.
If you own an insurance policy at the time of your death, the proceeds on that policy usually will be includible in your estate. Remember: That’s proceeds. Your $1 million term insurance policy that isn’t worth much while you’re alive is suddenly worth $1 million on your death. If your estate is large enough, a significant share of those proceeds may go to the government as taxes, not to your chosen beneficiaries.
Transfer tax exemptions, highest rates and potential liability
How the estate tax system works
Planning tip 4
Consider the Impact of State Death Taxes
|Many states, prompted by changes to the federal estate tax (such as increases in the federal exemption amount and elimination of the credit for state death tax), now impose estate tax at a lower threshold than the federal government does. Previously, most states used a pick-up death tax system, by imposing a tax equal to the allowable federal credit for state death taxes paid. The state and federal estate tax systems were coupled, with the state, in effect, collecting a portion of the tax that would have otherwise been paid to the federal government.|
|Changes to the federal estate tax, however, have undermined the federal-state estate tax relationship. Although states have reacted differently to these changes, many have “decoupled.” In other words, the states have rewritten their death tax laws so they no longer reference or tie into the current federal rules.|
|Some states have decoupled by imposing a tax equal to the amount of the former federal credit for state death taxes, while still recognizing the scheduled increases in the federal exemption amount. Others have established their own (lower) exemption amounts, or they’ve referenced the federal exemption amounts that were scheduled to be in effect before the recent changes. So, even if you aren’t subject to federal estate tax, you may be hit with a state death tax.|
|Many state tax systems are currently in a state of flux, and the federal rules are likely to change. To be safe, design your estate plan with some flexibility so that certain taxrelated decisions can be made as events unfold.|
Here’s a simplified way to compute your estate tax exposure. Take the value of your estate, net of any debts. Also subtract any assets that will pass to charity on your death — such transfers are deductions for your estate. Then if you are married and your spouse is a U.S. citizen, subtract any assets you will pass to him or her. Those assets qualify for the marital deduction and avoid estate taxes until the surviving spouse dies. (If you are single or your spouse isn't a U.S. citizen, see “Special Strategies for Special Situations” for more information.) The net number represents your taxable estate.
You can transfer up to the exemption amount
at death free of estate taxes. This amount is
scheduled to increase for 2009, be eliminated
for 2010 along with the estate tax and revert
to $1 million in 2011. (See Chart 1.) But note
that the gift tax
exemption, and therefore the amount you can give during life without tax, isn’t scheduled to increase beyond $1 million. Also, even in 2010 the gift tax isn’t scheduled to be repealed — so lifetime gifts of more than $1 million will still be subject to
If your taxable estate is equal to or less than the exemption and you haven’t already used any of the exemption on lifetime gifts, no federal estate tax will be due when you die. But if your estate exceeds this amount, it will be subject to estate tax.