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Chapter 15

Estate Planning

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Chapter Goals

Determine what estate planning is and how to employ its key topics.

Conclude that estate planning isn’t only for the rich. Recognize the merits of having a will. Establish the steps in an overall estate plan. Develop several tax reduction strategies. Assess the advantages and disadvantages of many

estate planning tools.

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Overview

The principal purpose of estate planning is to protect and benefit others we care about after we die. Steps:

1) Understand What Estate Planning Is2) Identify Objectives3) Identify Assets4) Establish a Will5) Consider Other Estate Planning Tools to Meet Objectives6) Evaluate Obstacles and Ways to Overcome Them7) Become Familiar with All Types of Relevant Taxes8) Determine Available Financial Planning Strategies9) Incorporate Estate Risks10) Consider Separately Estate Planning for Minors11) Assess Anticipated Resources12) Finalize the Estate Plan13) Implement the Plan14) Review Periodically

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Understanding What Estate Planning Is

Estate planning is analyzing and deciding on how your assets are to be managed and apportioned to others in the event of your death or disability.

The goal is to establish an estate structure that will maximize assets left to your beneficiaries and achieve your other wishes in an efficient way.

The process, while varying in the amount of supervision needed, can be the same whether it is for a large or small estate.

Estate planning is not reserved just for the wealthy; it concerns virtually everyone.

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Identify Objectives

Questions to ask when establishing objectives:– What am I trying to accomplish? – Am I trying to set aside monies for the people with the

greatest need? – Do I want to provide for people I care most about? – Do I want to gift at least in part now or wait until my death?

When we speak of maximization of assets as an objective we have to decide on the priority that we give to others as compared with ourselves.

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Identify Assets

All household assets currently available should be identified and their owner specified.

Information should include whether assets are joint or separately owned, the original cost, and current fair market value.

The total amount, cost, and way that assets are titled are relevant to the outcome strategies that you will select.

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Establish a Will

A will is a legal instrument that specifies who is to receive a person’s assets upon death and that expresses other wishes.

– If you don’t execute a will, the state in effect provides one for you - but its standards and wishes, not yours.

The will generally includes clauses such as:– Who gets what assets. – The powers of the executor who is in charge of administering the

estate, complying with legal requirements, and liquidating its assets. A guardian, where appropriate, who is in charge of people unable to care for themselves.

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General Evaluation of a Will

A will should be evaluated for factors such as: – Does the will reflect your wishes? – Are your wishes unambiguously stated in the will? – Once written, is the will completely up to date? – Are there overlooked assets? – Can the will cause conflict? – Is the will stored in a safe place? – Does the will comply with state law? – If there are assets in other states, does the will comply

with their laws as well?

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Intestate

Many people do not have a will, for reasons such as: – Not recognizing its importance.– Believing you don’t have assets worth giving away.– Feeling when young that you have time to set one up. – Having difficulty determining whom to name as heirs or as

executors or guardians.– Finding the subject too uncomfortable to think about.

Intestate means dying without a will. The division of assets can then depend on the state you live in, the size of your assets, and how they are titled.

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Selected Reasons for Having a Will

Reasons for having a will include:– You may want your spouse to receive all your assets. – States may mandate that assets be given to elderly parents who may not

need the money.– To assign a preferred guardian.– To ensure that wishes as to who gets items of sentimental worth would

are accommodated. – To avoid conflict over distribution of assets.– Assets would otherwise pass to the children at age 18 or 21 when they

might not be mature enough.– To include important friends.– Items vary by state.– The will can provide for tax advantaged trusts.

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Consider Other Estate Planning Tools to Meet Objectives

There are a variety of other instruments that can help in overall estate planning. They include:

– Trusts.– Gifts.– Titling.– Insurance.– Powers of attorney.– Letters of instruction.

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Trusts

Trusts are separate legal entities in which a third party manages property for the benefit of another person.

The person who manages the trust assets is called the trustee.

The person to whom the property is given or for whom the property is being managed is called the beneficiary.

The person setting up the trust to comply with their own specifications is called the grantor or trustor.

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Trusts, cont.

Advantages of a trust:– To obtain professional management.– For tax purposes.– For control purposes.– To bypass probate.– For strengthening protection from creditors and

dissatisfied relatives.– To consolidate management.– Can provide for different people over time.

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Trusts, cont.

Disadvantages of a trust:– Cost.– Potential trustee deviation from wishes.– Effort required to set up.– Possible resentment by beneficiaries.

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Types of Trusts

A living trust is one set up during a grantor’s life. A testamentary trust comes about after death. A revocable trust is one that can be revoked or

changed by the grantor whenever desired. An irrevocable trust is one that cannot be altered.

– Its main advantage over other trusts is the ability to qualify for favorable estate tax treatment.

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Gifts

Gifts are irrevocable transfers of property to others. – They are called intervivos transfers because they happen

while the giftor is alive.– Gifts can provide funds when needed, thereby raising the

satisfaction of the recipient and donor.

In order for an item to be considered a gift it must: – Be given without any characteristics of control left with the

giftor. – Cannot be exchanged for an agreement to provide a contra

gift or service.

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Gifts, cont.

Gifts are combined with estate assets to establish the exemption from estate taxes.

The first $1 million of lifetime gifts depending on year will not be subject to federal taxes.

In smaller estates no federal estate or gift tax will be due at all.

By a gift of property, the recipient there takes the cost basis of the person providing the gift. When the property is sold, the recipient will pay an income tax at capital gains rates on the difference between the proceeds received and the cost basis.

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Gifts, cont.

Gifts that don’t count as a deduction from the lifetime exemption, an additional benefit include:

– Gifts between married people.– Gifts of under $11,000 per year.

Each person is allowed to make a gift of $11,000 per year per person without it affecting the estate tax exemption.

Spouses can combine their deduction to gift $22,000 per year to each person.

If they wished to, for their child’s family of four they could gift $88,000 per year by gifting $22,000 to each member.

– Charitable gifts. An unlimited amount of money may be donated to charitable

institutions for estate tax purposes. A charitable contribution is income-tax deductible based on

its fair market value at the time of the gift.

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Gifts, cont.

Two principal types of charitable trusts for gifting purposes are:

– Charitable remainder trust: The donor receives a stream of annual income for a fixed period or for life, and the remainder is given to the charity. The NPV of the remainder portion is deductible for income tax purposes.

– Charitable lead trust: The charity receives the stream of income for a designated term, and the balance thereafter goes to an heir. The income tax deduction in this case comes from the NPV of the charity’s income received.

The government will not allow tax benefits for any charitable transaction that lacks charitable intent.

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Titling and Transferring of Assets

It is very important to determine the way an asset is titled for both inheritance and tax purposes.

Property owned jointly with someone else can be titled in one of three ways:

– Joint Tenancy with Right of Survivorship: Allows a person to automatically inherit the property upon the death of the other owner. The surviving co-owner’s right to the property takes precedence over the provisions stated in a will and, as mentioned, bypasses probate.

– Tenancy by the Entirety: In the event of death the surviving co-owner receives full ownership. However, it is only available to married persons and can only be undone by consent of both parties. Only some states allow.

– Tenancy in Common: Each co-owner owns a specified percentage of a property.

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Titling and Transferring of Assets, cont.

Property owned by a trust is treated the same way as property owned by any other entity.

Marital property refers to rights in property gained through marriage. Separate property is an asset owned entirely by a person.

Generally, assets owned before marriage and gifts and inheritances made specifically to a person are considered separate property if they are kept in separate accounts.

Whether the property is marital or separate property can determine who is entitled to receive the assets at death or divorce.

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Life Insurance

Potential roles of life insurance in estate planning: – Liquidity: Life insurance can provide a ready source of

cash flow, which can fund estate taxes and enable postponement of the sale of property and other business decisions to an optimal time.

– Relative assurance of payment: The insurance policy can provide the structure that enables a stated sum to be left to beneficiaries at death.

– Escapes probate and spousal election: Escapes probate because it is not payable to the deceased or the estate.

(Continues next slide)

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Life Insurance, cont.

– Tax savings: The proceeds from insurance arising from the death of a person are not subject to income taxation but are subject to estate taxation.

– There are generally a maximum of three parties to an insurance policy: the owner of the policy, the insured, and the beneficiary.

– When the owner is also the insured, the amount will be taxable for estate purposes.

– However, where the proceeds are payable to another beneficiary and all incidents of ownership are eliminated by the insured, no estate taxes will be assessed on the estate of the insured.

– Life Insurance Trust: The life insurance trust must be irrevocable to qualify for estate tax savings.

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Power of Attorney and Letters of Instruction

A power of attorney is a legal document that lets someone act on your behalf.

The letter of instruction is a supplement to a will that helps people understand your thinking and provide direction for matters to be accomplished.

– It can indicate where the will and other important papers are located as well as the telephone numbers of advisors and perhaps an evaluation of them.

– It can discuss sensitive family matters that an executor may find helpful such as conflicts, untrustworthy individuals, and so on.

– It can include burial wishes and provide a justification for certain life actions including those provided in the will.

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Evaluate Obstacles and Ways to Overcome Them

Obstacles are impediments to the estate planning process.

– Probate is sometimes viewed as a ponderous process, because the procedures that must be followed result in expenditures and delay in distributing estate assets. Probate also opens up your private affairs to public scrutiny.

– Conflict may occur in relation to: The division of assets. Executors and guardians. The Age of inheritance.

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Become Familiar with All Types of Relevant Taxes

Three types of assessments in connection with planning in this area are:

– Estate tax. Taxes that are due after the death of the owner are based on assets owned at death. Estate tax law provides an exemption from taxation for initial asset

accumulation. The exemption is in the form of a credit against taxes called a unified credit.

– Gift tax. Lifetime transfers are now combined with estate assets to compile $1 to $3.5 million total exemption

– Income tax. assessments based on job-related and investment earnings. Income taxes on gains on sale of assets are based on selling price

minus original cost. Congress passed into law a bill providing that assets at death be

given a fair market value basis for income tax purposes instead of the original cost.

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Become Familiar with All Types of Relevant Taxes, cont.

Estate tax law as of the raising of the unified credit in 2000 is as follows:

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Determine Available Financial Planning Strategies

Some basic strategies include: Consider a Bypass Trust.

– A bypass trust is a document that is set up while the grantor is alive or it is provided for in the will. The principal benefit of the bypass trust is the ability to use both husband and wife’s unified credit to advantage while providing funds for the surviving spouse to live on.

Gifting versus Bequests. – Gifting provide resources when needed and allows you to

observe the benefits of your gift. – Bequests can be safer, allowing the grantor to maintain all assets

for household use. They can also postpone providing assets to younger people when there is concern about negative influences of money.

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Determine Available Financial Planning Strategies, cont.

Investing for Estate Planning.– Where money has been set out exclusively for beneficiaries,

the investment policy can take on the risk tolerance of the beneficiaries instead of the grantor.

– Where liquidity or estate tax is an issue, life insurance can be considered as an investment asset in the asset allocation.

Consider Placing Monies in Joint Name in Smaller Estates.

– If taxes may are not an issue, placing money in joint accounts can ensure that the intended person receives the money quickly and free of probate expenditures.

– On the other hand, be aware that you are providing another person with ownership rights in your estate while you’re alive.

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Determine Available Financial Planning Strategies, cont.

Integrate Estate and Income Tax Considerations in Planning.

– There are many occasions when possible actions involve a choice between an income tax and an estate tax.

– Your goal should be to consider both by using a time value of money technique such as obtaining the NPV of both alternatives and selecting the one with the greatest sum made available net of taxes.

Gift Fast-Growing Assets.– Assets that are expected to increase rapidly in value are

often preferred gifting vehicles. They eliminate assets that can increase the estate’s valuation and therefore estate taxes.

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Determine Available Financial Planning Strategies, cont.

Pay Compensation to Executor on Large Estates.– Paying an executor who is a beneficiary for their services can be

advantageous. Think about Designating Younger People as Heirs.

– Estate taxation repeats at each death of the owner. Therefore, the NPV of estate taxes is likely to be lower for each generation below yours that you provide for.

Give Consideration to the Step-up in Basis.– The elimination of income taxes on assets with a low cost basis by

retaining instead of selling should be considered by people who are elderly or seriously ill.

Consider IRAs and Other Qualified Plans.– Nonmarital beneficiaries of an IRA can defer taxation upon death

and take mandatory withdrawals based on their life expectancy.

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Incorporate Estate Risks

Two principal risks include longevity and incapacity.

Longevity: – Ironically, dying in the period close to the retirement date can

place greater resources in the hands of beneficiaries, as the retiree often has accumulated substantial sums for retirement.

– Unusually long lives can place retirement and therefore estate sums in jeopardy.

– One approach is to plan conservatively for retirement needs, assuming death at age 90.

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Incorporate Estate Risks, cont.

Incapacity:– Can disrupt the normal functioning of the household. Legal

documents that can help include:– Health-Related Trusts: A revocable living trust can provide the

funding to administer a person’s care under the supervision of a trustee when the person can no longer handle his or her own affairs.

– Durable Power of Attorney: Remains in effect over time with the amount of power and the circumstances under which it can be used stated in the document.

– Springing Power of Attorney: Does not take effect until a specific event stated in the document occurs.

– Medical Power of Attorney: Allows someone else to make medical decisions when you are not capable of doing so yourself. It is used because a general durable power of attorney is not recognized in medical matters.

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Consider Separately Estate Planning for Minors

For children under 14:– The first $800 of income on investments is not taxable.– The next $800 is taxed at the child’s low tax rate. – The rest is taxed at the parent’s marginal rate.

Under the Uniform Gifts to Minors Act a donor can make a gift to a minor and have a guardian supervise that gift in a way similar to that of a guardian acting as a trustee.

A 2503C trust for minors can be set up.– Provides more flexibility as many kinds of assets including

property can be placed into it. – Any outlays of income from the trust must be spent on behalf of

the child and the money distributed when the child becomes 21.

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Assess Anticipated Resources and Finalize the Estate Plan

Since the date of death is not known, the anticipated resources will be an estimate.

Where amounts are specifically set aside for estate planning and not used for retirement planning purposes as well, the figure will be easier to ascertain.

The total amount projected as available will help determine the tools and strategies used.

To finalize the estate plan, we integrate the original objectives, which are typically both financial and personal.

The strategies and tools will attempt to maximize assets selecting those that achieve the purpose depend on circumstance.

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Summary of estate planning tools

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Implement the Plan and Review Periodically

Implementation involves drawing up the legal documents by the estate attorney and the actions that the grantor must take.

Estate planning is one of those financial areas that should be reviewed fairly frequently.

– Economic circumstances change and people’s opinions on what they want to do with their monies and their other wishes can shift over time.

– Tax and other estate planning laws are altered by the government and new tax strategies arise.

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Chapter Summary

Estate planning is analyzing and deciding how your assets are to be managed and apportioned to others in the event of your death or disability.

The financial planning objectives are to minimize taxes and to provide assets to the ones we care for with as little conflict as possible.

A will, which virtually everyone should have, is often the most important document in estate planning.

Trusts are separate legal entities in which a third party usually manages property for the benefit of another person.

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Chapter Summary, cont.

Gifts are irrevocable transfers of property to others, and if the giftor maintains some ownership rights they are not gifts.

Life insurance roles in estate planning include providing liquidity, relative assurance of payment, and tax saving.

Probate is the procedure after death during which the court validates the will and/or administers certain estate assets.

The principal estate risks are longevity and incapacity. A power of attorney is a legal document that allows

someone to act on your behalf.