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On the Need for Estate Planning

Who Needs Estate Planning?
Just about everyone who has savings, real estate or other property needs an estate plan, however minimal the estate may seem. Although many people in their younger years do not even give thought to the issue, an estate plan should be in place for everyone, especially for any person who is married or has children, in case an unforeseen event occurs, in order to insure that what you want done with your estate after your death will in fact be done, including managing the estate, providing for guardians of minor children and minimizing estate taxes. Also, estate tax law has recently changed and some of those changes may affect your estate. If you do not have a will, or your property is not held in a trust, or jointly with other people, then the laws of the state where you live will determine who gets your property. For some people, this may be satisfactory; but for the great majority, it is not. In fact, if you die without both a will and relatives, the state will receive your property, a result no one wants. Estate planning can lessen the impact of estate taxes and help you preserve the greatest possible amount of your estate for your heirs.

Estate planning should not be restricted to deciding what will happen to your estate after your death. It should also extend to lifetime plans to insure that you will have adequate resources and proper management of them for old age and retirement.

Should I have a Will or a Trust?
Much has been written in recent years about avoiding probate. Courts charge fees to file a probate proceeding and for related court papers. Moreover, an executor is entitled to commissions based on the value of the estate, and there are other expenses such as legal fees of the attorneys who do much of the work involved in administering an estate. In many cases, however, executors’ commissions can be avoided by having a family member or a friend act as executor without accepting commissions.

The probate of a will is the process of proving in court that your will is valid (namely, that it conforms to the law of the state in which it is to be probated, that the signer of the will was of “sound mind” when signing it, and that the proper procedures were followed at the signing), and that the person named as executor should be authorized by appropriate court proceedings to administer the estate. Once appointed by the court, the executor receives the property belonging to the estate, pays the estate’s debts and taxes and then distributes the property remaining in the estate to the persons designated in the will to receive it.

A living trust (meaning a trust set up while you are alive) is a separate legal entity whereby an individual or a bank, called the “trustee”, holds property and administers it for your benefit. Typically, a living trust provides that all income earned by the trust while you are alive (and the corpus or principal of the trust if necessary or desirable), is paid to you. After your death, the remaining trust property is transferred to the persons or entities designated in the trust to receive the remainder of the trust property. The trustee has legal title to the property held in trust and has the right to invest the property to produce income. In order for a living trust to take the place of a will as a means of transferring ownership of property after death, the trust must own all of your property, meaning that all bank accounts, securities accounts and other property where ownership or title is evidenced by deed, certificate, bond or other document, must be registered in the name of the trust, not in your individual name.

Putting your property into a living trust may not completely supplant the need for a will. What would happen, for example, if you overlooked some shares of stock that you got from a distant relative years ago, put in your safe deposit box and forgot about? If it is registered in your name alone, then the only way it can be transferred after your death is through a court proceeding. If you do not have a will, the state statute governing intestate succession (that is, one who dies without having made a will) will determine who is entitled to your estate. Moreover, there are expenses associated with a trust, including setting it up, annual trustees’ commissions, the cost of bookkeeping and accountant’s services, and, in some cases, preparation of trust income tax returns every year.

Regardless of whether you put your estate into a trust while you are living, you should also have a will to insure that everything you own will be disposed of after your death according to your wishes.

There is a common misperception that having a living trust not only avoids probate but that it also avoids estate taxes. That is not the case, however, if you receive the income of the trust; in that case the trust will be included in your taxable estate.

There are occasions when a living trust is useful and should be seriously considered. For example, establishing a trust could insure that someone will be able to handle your property if you become ill or elderly and can no longer handle it by yourself. This can be accomplished, to cite one example, by setting up a trust without the immediate transfer of property with a later transfer when the need for it arises.

What Should I Do About Estate Taxes?
Estate tax is assessed on your taxable estate, meaning all of your property, including life insurance and property owned jointly with others, minus debts, funeral expenses, and expenses of administering the estate such as executor’s commissions and attorneys’ fees. There is a federal estate tax only if the taxable estate is more than $1,000,000 in 2003. This tax-free amount, formerly called the “unified credit” and now known as the “applicable exclusion amount”, will increase in stages to $3,500,000 in the year 2009 (see Schedule I at the end of this article). In 2010, the Federal estate tax is repealed, only to come back into effect in 2011, unless sometime in the future Congress makes the repeal permanent. If you are married, estate taxes can be postponed until the death of both spouses.

There are three simple ways to lessen, or at best provide the money to pay estate taxes: (1) making gifts during your life to reduce the size of your estate: (2) setting up a trust during your life or as part of your will to hold the applicable exclusion amount; and (3) having life insurance. (There are other, more sophisticated ways of lessening estate taxes but their complexity precludes discussing them in this brief article.)

1. Gifts. Gifts of up to $11,000 can be made in 2003 to as many different people as you choose, all of them being free of gift tax. (The annual gift tax-free amount became indexed for inflation beginning in 1999 so that the annual exclusion may increase in 2004 and later years.) Over a number of years, the annual gifts can add up to a very substantial amount. Once the property or money has been given away, however, you no longer own it and are not entitled to the income earned by it. So, giving everything away may not be a practical solution. Giving away part of your estate (if you are financially able to do so) will reduce the size of your estate, and consequently the amount of estate taxes. Gifts to children can be put into trusts until the age of majority or even later.

Charitable gifts are not limited to $11,000 per year, but there are other limitations. Such gifts achieve immediate income tax benefits because they are deductible on your income tax return in the year the gifts are made, and they reduce the size of your estate. Charitable gifts made in your will reduce the size of the taxable estate, dollar for dollar.

Charitable gifts in trust can be used to reduce the size of your estate now, achieve a present charitable deduction against your income tax and still permit you to keep the income earned by the trust during your life.

2. Applicable Exclusion Amount Trust. Estate taxes can be substantially reduced by the use of a trust established while you are living or by your will that would be funded by the amount that is free of Federal estate tax (see Schedule I). This kind of trust, known as an “applicable exclusion amount trust”, can hold the amount of your estate that is not subject to federal estate tax in trust for your spouse’s life. When your spouse dies, whatever is left in that trust, plus your spouse’s own applicable exclusion amount, can be transferred to your heirs free of federal estate tax. The applicable exclusion amount is increasing, as indicated in Schedule I, so that, for example, if the first spouse dies in 2004, creating the applicable exclusion amount trust in his or her estate means that, assuming the second spouse also dies in 2004, up to $3,000,000 ($1,500,000 for each spouse) of family property can pass to your heirs free of federal estate tax. The trust benefits the surviving spouse who may need the income and principal from that property to live on; after the surviving spouse’s death, the amount remaining in the trust will pass to your heirs (or anyone else you designate) free of federal estate tax. Alternatively, the applicable exclusion amount could be given to your heirs outright at the time of your death, if your spouse has no need for it.

3. Life Insurance. Life insurance does not avoid estate taxes but instead provides the money to pay them. Many people mistakenly believe that life insurance is free of estate tax. That is not the case, however, if you own the insurance policy or it is payable to your estate. For example, an insurance policy on your life, payable to your child, is subject to estate tax if you have the right to change the beneficiary. (There is no separate estate tax on insurance; instead, the insurance proceeds are included with and added to the other taxable property you own; if the total is less than the tax-free amount, there is no Federal estate tax.) On the other hand, if someone else, or a trust, owns the policy, then the proceeds are not included in your taxable estate. In that event, however, you lose the right to change beneficiaries during your lifetime, which may be a problem if circumstances change.

Properly structured, life insurance can provide the money needed to pay estate taxes and avoid having that money counted as part of your taxable estate. One type of life insurance policy, known as a “second to die” or “survivorship” policy because it insures two lives (usually yours and that of your spouse) is less expensive than single life policies because the premiums are based on two lives instead of one. Even if you are not married, insurance can still provide the money to pay the estate taxes. In either case (an individual or a survivorship policy), the insurance must be owned by a trust or persons other than you in order to avoid having the policy’s proceeds included in your taxable estate.

Do You Know What You Own and How You Own It?
Estate planning involves a great deal more than merely making a will. A will does not affect property owned jointly or held in trust. Thus, when a house is purchased, the decision on the manner of ownership (for example, husband and wife as tenants by the entirety or joint tenants with right of survivorship) is in reality a form of estate planning because in both cases, the house will pass to the surviving spouse or other person regardless of what a will may provide. This is also the case with bank accounts, securities and other registered property. An estate plan must be prepared carefully to insure that it is consistent with the manner in which real estate, securities, accounts and like assets are held.

In planning a will, the first step is to prepare an inventory of what you own and the type of ownership. Then an attorney can advise you how the will or trust will affect your property. Cases are known where complex wills are prepared and are useless because all the property is held jointly with others. Only after the inventory is prepared can proper estate planning be done by your advisors.

CONCLUSION

For most people, it is prudent to have a will and to consult with an attorney to formulate the best possible estate plan for your circumstances. If you die without a will, your property may be distributed in ways you never intended. It is also recommended that your will and estate plan be reviewed every five years.

© 2003 by Richard A. Whitney

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