You've worked hard to build your assets—your
investments, your home, your treasured possessions—and
to provide a level of financial security for your loved
ones. Doesn't it make sense to work just as hard to
protect those assets for your heirs?
That's the primary goal of estate planning—to protect,
preserve and manage your estate if you die or become
disabled. Some people see no need for estate planning
until they reach a certain age. Others believe that it's
only for the wealthy. But in truth, it's wise for
everyone to
start the estate planning process as early as possible.
Without an estate plan, the fates of your assets and your
loved ones may be decided by attorneys or the government.
The state could decide who will care for your minor
children. Taxes and legal fees could eat away at your
estate, and distribution of your assets could be delayed
at a time when your heirs need them most.
So why doesn't everyone have an estate plan? Aside from a
natural reluctance to face our own mortality, some people
are put off by the belief that estate planning will be
complicated, time-consuming and costly. But setting up an
estate plan doesn't have to be complex.
Estate planning can begin with something as simple as
updating the beneficiaries of your insurance policies and
retirement accounts. It may involve adding one or more
heirs as co-owners of your home, bank and brokerage
accounts, or other assets. To make sure all of your wishes
are carried out, you'll need to draft a will and perhaps
establish one or more trusts, but even these activities
can be handled in a few brief meetings with an estate
attorney.
Why you need an estate plan
It lets you accomplish these crucial objectives:
Ensure that your assets
go to the people you choose, not those the state
chooses.
Specify who will care
for your minor children.
Defuse potential
family conflicts over your assets.
Minimize estate taxes and other
transfer taxes.
Avoid the costs, publicity
and delays of probate.
Help ensure that you and
your affairs will be taken care of as you wish if
you
become
incapacitated.
Even if your estate is modest, take care of
the basics:
Tell loved ones where
to find your documents and a list of your
accounts, assets
and
insurance policies.
Draft a will and final
letter of instructions.
Establish durable powers of
attorney and health care in case you're
incapacitated.
Update your account
titling and beneficiaries.
Consider funding a revocable
living trust with your titled assets along with a
"pour-over" will to
ensure other assets avoid a
costly probate process.
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Get started!
Most people can meet their estate planning goals with the
simple, four-step process outlined below.
Take inventory of your assets and liabilities. List
the value of your home and other real estate, cars,
jewelry, artwork and other physical assets. Gather recent
statements from your bank and brokerage accounts. Make a
list of all insurance policies, their cash values and
death benefits. Finally, list all liabilities, including
mortgages, lines of credit and other debt.
Define your estate planning goals. To whom do you
want your assets distributed, and in what proportions? If
these heirs aren't living at the time of your death, whom
do you wish to name as successor beneficiaries? Whom do
you want caring for your minor children? What do you want
to put aside for your children's ongoing care and
education? Who should manage your affairs if you become
disabled, and distribute your assets upon your death? Who
will make health care decisions on your behalf if you
become incapacitated? Answering these questions before you
meet with an
estate planner can save you both time and money.
Have an estate planning attorney draft your documents.
Laws regulating estate settlement vary from state to
state, so we strongly recommend that you meet with an
experienced attorney to prepare your estate plan. A
qualified attorney will review your objectives and explain
the tools—wills, trusts, powers of attorney and
more—you can use to help accomplish your goals. Many of
these documents are fairly standard in format, which can
substantially reduce the cost of developing your plan.
Follow through on your plan. If you set up a trust,
fund it promptly. If you fail to do so, the agreement
won't take effect, and your assets may not pass to your
beneficiaries as you'd intended.
Consider these smart strategies
Start by transferring
wealth in your lifetime
Lifetime
gifts are generally better than testamentary
gifts when transferring wealth. Think of it this way:
Picture four quarters on the table in front of you. If you
die with all four quarters, your heirs are left with two
quarters and the federal government gets the other two.
Instead, move two quarters aside, representing a lifetime
gift to your loved ones. Now, take 50% of your remaining
two quarters, or one quarter, and move it to the other
side of the table as the gift tax you would owe.
Look—you've still got a quarter left!
Currently, you can give up to $13,000 each to any number
of persons in a single year without incurring a taxable
gift ($26,000 for spouses "splitting" gifts).
You can give away a total of $1 million during your
lifetime before any out-of-pocket gift tax is due.
Tip: Make unlimited payments directly to medical
and educational providers on behalf of your loved ones,
and preserve your $1 million lifetime exemption.
The lucky recipient of the gift owes no gift tax or income
tax. Your treat is seeing the enjoyment of your gift, plus
transferring future appreciation on the gift to the
beneficiary, outside your estate.
Here are a couple of things to remember
about lifetime gifting:
Leave yourself enough to live on. The gift has to
be irrevocable, so don't give until it hurts. Plan
carefully with a tax professional.
Stay up on the law. If the estate tax is
repealed in the future, you may regret having paid gift
tax now in an effort to minimize your estate tax. Do the
best you can based on what you know now.
Keep these basics in mind
Don't be seduced by what someone else did.
It's your estate, so begin and end with your
personal goals.
Use a qualified estate planner who's
up-to-date on the latest statutory, regulatory and
judicial developments. Or consider combining a CPA
(for tax-efficient strategies) with an estate
planning attorney (to draft the legal documents).
Be wary of strategies that seem too good to
be true, such as big valuation discounts or
"tax-free" offshore deals.
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To take care of your
surviving spouse
Typically, spouses will use a credit shelter (bypass)
trust to preserve the first-to-die's estate tax exemption.
Assets beyond that estate tax credit can pass to the
surviving spouse outright, or via a marital trust, without
any current estate taxation (for U.S. citizens).
Simple
Strategies to Consider
If the strategies in this article seem too complex
or aren't a good fit for your needs, here are some
everyday financial planning ideas with attractive
estate planning kickers.
Convert to a Roth to reduce (or create) your
estate
Beginning in 2010, investors can convert a
traditional IRA to a Roth IRA regardless of
income. Converting all or part of a traditional
IRA into a Roth
IRA could be a useful estate planning
technique—if you think you won't need your
traditional IRA for your own expenses.
Although your Roth will still be included in your
gross estate, there are no required minimum
distributions, allowing the account to grow larger
than it otherwise might under the traditional IRA
rules. Also, your heirs will be able to take
withdrawals free of income tax.
What's more, the income tax you pay on conversion
(preferably from assets other than the IRA) will
reduce your gross estate. In effect, you're making
a gift by prepaying the income tax on behalf of
the beneficiaries without it really counting as a
taxable gift.
Tip: A Roth conversion is great for
situations where there's no taxable estate,
because those heirs would have no future income
tax deduction available for previously paid estate
taxes anyway.
Even when a future deduction for estate taxes
attributable to the inherited IRA would be
available, there might still be some advantage to
a Roth, primarily because the converted Roth would
not be subject to minimum distributions during the
original account holder's lifetime—and therefore
the balance could potentially grow much larger.
Obviously, this strategy requires some serious
number crunching.
Reduce your overall
estate with charitable gifting
A charitable remainder
trust (CRT) is primarily a diversification and
income tax strategy, although the charitable gift
component will have an impact on reducing your
gross estate.
A testamentary charitable lead trust (CLT), on the
other hand, is typically more appropriate for
estate planning purposes, rather than as a
lifetime income strategy. At death, a portion of
your estate is placed into the testamentary CLT,
reducing your gross estate. The charity you choose
receives an annuity for a period of years. At the
end of the term, your heirs receive the remainder
interest.
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To take care of your spouse
and children from a prior marriage
With a qualified terminable interest property (QTIP)
trust—the most flexible marital trust—the executor
decides how much of the estate qualifies for the unlimited
marital deduction. The surviving spouse's needs and
expenses are still taken care of during his or her
lifetime, but the eventual distribution of trust assets to
the first spouse's children is protected. This trust is
especially attractive for people with children from a
prior marriage, or if there's concern over what might
happen if a surviving spouse remarries.
To capitalize on a valuable
home while you're still living there
A qualified personal residence trust (QPRT) allows you to
transfer a residence into a trust for gift purposes, while
retaining the right to live there for a period of years.
At the end of the term, the residence is transferred to
the beneficiary.
Tip: Use the QPRT strategy when interest rates
are high, because a higher discount rate (determined by
the IRS) means that the present value of the home subject
to gift tax is lower.
Here's what makes this strategy effective: For gift tax
purposes, the transfer is calculated as the present value
of the remainder interest. The right to stay in the house
has value, which is deducted from the gift. What's more,
any future appreciation after the transfer to trust is not
included in the grantor's estate. The grantor may arrange
to stay in the house at the end of the term at fair market
rent. One caveat: The longer the term of the QPRT, the
smaller the gift will be for tax purposes. But the grantor
must outlive the trust's term or the home value will
revert to the estate, so plan for that trade-off.
To minimize gift tax value
With a grantor retained annuity trust (GRAT), the grantor
transfers assets to a trust for a relatively short period
of years. During the term, the grantor receives an annuity
from the trust. At the end of the term, the remaining
assets pass to the beneficiary.
The annuity payments reduce the gift's value for gift tax
purposes; the value is determined at the time of transfer
into the trust. As long as the assets in the trust
outperform the discount rate (or hurdle rate), this can be
an extremely effective transfer strategy.
Tip: Use a GRAT in a low-interest-rate environment
because the assets have a better chance of beating the
hurdle rate. GRATs also work especially well with assets
currently depressed in value but with the potential for
significant appreciation.
To have greater control
over the time period of your gift
In order for a gift to qualify for the annual $13,000
exclusion, it must be a "present interest," not
a "future interest." In other words, the
recipient must be able to use or spend the gift
immediately, with some exceptions for gifts to children.
The Crummey power trust (named for the taxpayer who first
used the strategy) allows transfers to the trust to
qualify as a present interest. Also, you can write in your
own rules about when and how the beneficiary ultimately
receives control of the assets.
The beneficiary of a Crummey power trust gets a limited
period of time during which he or she can withdraw the
annual gift from the trust, after which the gift becomes
subject to the provisions and terms of the trust. As long
as this "Crummey power" is available, whether or
not it's exercised, the gift creates a present interest
and qualifies for the grantor's annual gift tax exclusion.
Of course, if the beneficiary wants the grantor to
continue funding the trust, he or she typically does not
exercise the power. (If the grantor wanted the beneficiary
to spend the money now, why create a trust?) Crummey
powers are often used with irrevocable life insurance
trusts (below).
To transfer wealth from an
illiquid business or real estate
Life insurance is often used in estate planning to provide
liquidity in the case of closely held or hard-to-sell
assets (a family business, family farm, significant real
estate holdings, etc.) or as a wealth replacement vehicle
to provide for family members in the face of estate tax
liabilities or charitable bequests.
However, though life insurance proceeds are generally
income tax free to the beneficiary, they're included in
the decedent's gross estate as long as the decedent owns
the policy. The most effective way to avoid this problem
is with an irrevocable life insurance trust. As long as
the trust owns the policy, the proceeds are outside the
estate and will pass free of both income and estate taxes.
Tip: Have your irrevocable life insurance trust
purchase your life insurance policy, because the transfer
of an existing policy within three years of death will
bring the proceeds back into the estate.
To maintain family assets
and relationships
A family limited partnership (FLP) can be an effective way
to manage and control family assets while providing for
the tax-effective transfer of wealth to others. In the
typical arrangement, mom and dad gift the majority of the
partnership to family members in the form of limited
partnership interests. Because limited partners have no
say in running the partnership and usually can't sell or
borrow against their interests, valuation discounts
arising from lack of liquidity and marketability will
apply for gift tax purposes. Additional valuation
discounts may apply to the assets themselves (for illiquid
small business or undivided interests in real estate, for
example).
Structured correctly, FLPs can be a valuable planning
tool. However, overly aggressive structures that seek
unreasonable valuation discounts or run afoul of the rules
in some other respect may invite unwanted scrutiny from
tax authorities. For this reason, it's very important to
work with a reputable expert when considering a family
limited partnership.
Finally, don't get
paralyzed waiting for estate tax repeal
Although the
estate
tax is set to expire in 2010, under current law it
comes back in 2011 in all its pre-2001 glory (see table
below). Many of your estate planning decisions will depend
on what you think Congress might do down the road.
That's anyone's guess, of course. We could revert back to
the old law, or we could end up with higher limits for
taxable estates. One possibility is that the 2009 estate
tax exemption amount of $3.5 million and top rate of 45%
could be extended. As frustrating as the uncertainty might
be, the best you can do is plan based on what you know
now. Remember, any guess about the future is still just a
guess, and the law as it stands is still the law.
| 2010 |
0% |
Repeal |
35% |
$1,000,000 |
| 2011 |
55% |
$1,000,000 |
55% |
$1,000,000 |
Note: Unless Congress acts to
change the current law, in 2010 larger estates may no
longer receive an automatic step-up in basis equal to the
date-of-death valuation. For 2010 only, inherited assets
over $1.3 million (over $4.3 million for spouses) will
retain their original cost basis.
Again, we've highlighted just a few of the many estate
planning ideas available. As you consider these and other
transfer strategies, be sure to work with trusted
professionals who can help you put together an estate plan
based on your particular needs and goals.
