Randall A. Denha, J.D., LL.M. is the founding member of Denha & Associates, PLLC. Mr. Denha, a former partner at one of the most prestigious estate planning firms in the country, specializes in the areas of estate and personal tax planning, business and succession planning, family wealth planning, asset protection planning and integrating all of the foregoing into a truly comprehensive plan. www.denhalaw.com [1]
No two estates are the same. Yet while every estate is unique in its own ways, some estates can be put in a category with similar estates. Those similar estates are likely to have plans that share a number of common features. My goal is to present the classic categories and key elements of plans that fall into the following general categories:
All estate plans
Every properly drafted estate plan should have a pour-over will, revocable living trust, financial power of attorney and durable power of attorney for health care. You also need to keep your beneficiary designations up to date on your IRAs, 401(k)’s and other retirement plans, annuities, and life insurance. Prepare a notebook or final letter of instruction (see July 2011 Denha & Associates, PLLC Law Blog) for your executor that lists details about your assets and debts, has copies of key financial documents, and provides any other information that would be helpful.
Traditional-middle wealth couples
In this classic situation, under current law neither spouse’s estate will owe federal estate taxes. But there might be a state tax (each state has its own laws in this regard), and we don’t know what the federal estate tax will be when the current tax expires after 2012.
Some people advocate doing away with the traditional bypass trust in this situation, but the bypass trust still is important. A typical estate plan will have each spouse leave a portion of the estate directly to the other spouse and the rest of the estate to the bypass trust. The bypass trust then helps support the surviving spouse and/or children for the rest of his or her life, and then the children of the marriage (or other loved ones) receive the trust assets. The trick with the shifting tax law is setting a formula that determines how much of the estate goes into the bypass trust. The wrong formula could place all or most of the estate in the bypass trust and leave the spouse with few independently-owned assets.
In these situations there often is life insurance that was purchased years ago. It’s probably not worth transferring it to an irrevocable trust to keep it out of the estate. A better option, with estates of this size, is to transfer ownership of the policy to the other spouse. It’s also a good idea to name the spouse as the initial beneficiary and the bypass trust as the contingent beneficiary. That way, the surviving spouse can either receive the benefits or disclaim them and have them go in the trust for the kids.
Traditional wealthy couples
These couples, either now or through future appreciation, own more than $5 million per spouse or $10 million for the couple. Estate tax reduction is more of a focus for these estate owners, and they should review all available strategies with their planners. As mentioned above, I don’t believe it’s a good idea to rely on the new portability provision and not use a bypass trust or QTIP trust.
Wealthy couples also need to consider making lifetime gifts, either outright or through trusts. This will remove not only the assets’ current value but also their future appreciation from their estates.
Each spouse can give each person up to $13,000 free of gift taxes each year under the annual exclusion. Or the couple jointly can give each person up to $26,000 tax free. Unlimited tax-free gifts can be made for medical or education purposes. The payments must be made directly to the provider of the services and other conditions must be met. Gifts above these amounts can be tax free but will reduce the lifetime estate and gift tax exempt amount, currently $5 million per person.
To make large gifts effectively and at discounted market values, wealthy couples should consider using family limited liability companies, grantor retained annuity trusts, sales to defective trusts and other strategies. Some people will want to make taxable gifts now to remove appreciating assets from their estates.
Charitable giving also is often a goal. Consider how much to give during your lifetime and how much through your estate. The gifts can be leveraged with other goals through charitable remainder trusts, charitable lead trusts, gift annuities, gifts of remainder interests in property, and other strategies. Finally, these couples might consider purchasing large life insurance policies to pay the estate taxes, provide a suitable legacy for loved ones or charity, or to provide cash to an estate that is mostly illiquid assets.
Blended families
A second or subsequent marriage, stepchildren, or other characteristics outside the stereotypical traditional family, bring additional concerns come into play. The goals usually are to ensure that, after the current spouse is provided for, the remainder of the estate passes to the owner’s children. This is effectively and efficiently done by leaving the assets to a trust that support the surviving spouse for life and then passes the remainder to the designated children. Care also needs to be taken in selecting beneficiaries for IRAs, retirement plans, annuities, and life insurance. A key element of blended family plans is communication between the estate owner and loved ones. Otherwise, blended families are most likely to have bad feelings, broken relationships, or lawsuits after the estate is revealed. Children need to know in advance the general outline of the plan and how they are protected.
People without children
The issue for these estate owners is not so much what to do with their assets but who to rely on for other aspects of the estate plan. As we discussed earlier, every estate plan should include a financial power of attorney, medical power of attorney, and other documents. Most people rely on one or more of their children to fill these roles. Someone without children, even if there is a spouse, should have younger people in these roles and select the people carefully. Too often older people without children living nearby are befriended by people who seem to be friends but really are looking to seek control of their assets.
In these situations, the best solution is to select professionals who will assume these roles for compensation. The compensation will be like insurance premiums. You’re more likely to receive the kind of medical care you want and have your finances handled properly than if you place the burdens on friends or distant relatives. Putting professionals in these roles also reduces the odds that your distant relatives sully your memory by accusing each other of undue influence or pilfering your estate.
Unmarried couples
Whether same sex or opposite sex, couples who live as spouses but aren’t married have the same issues. They don’t have advantage of the marital deduction for either gifts or bequests and they don’t have portability of their estate tax exemptions between each other. In drafting estate documents, the lack of the marital deduction matters only when one of the estates is worth $5 million or more. Then, life insurance or other tools should be considered to pay or reduce estate taxes. Otherwise, these couples still are likely to use bypass trusts as the foundation of their wills.
These couples do need to be careful about lifetime transfers between each other. They don’t have access to the unlimited marital deduction for gifts between spouses. Making a gift to the other spouse of more than $13,000 in a year reduces the lifetime exemption amount and requires filing a gift tax return. Even the simple act of creating joint title to real estate or a financial account can be a taxable event.
Special needs children
There are three special issues for families with special needs children. The first issue is management and distribution of assets. Lifetime gifts and estate bequests shouldn’t be given directly to the child. They need to be put in a trust. Ideally, a sibling or other person who cares about the special needs child oversees distributions from the trust and someone who knows how to manage money handles the investments.
The second issue is providing sufficiently for the child. In most cases this means purchasing enough insurance on the lives of one or both parents early when it is known the child will need lifetime assistance. This type of insurance should be payable to the trust after the parents pass away. The third issue for at least some families is drafting the trust to maximize the child’s qualification for government assistance programs. An experienced estate planner should know the right language for the trust.
Businesses and special assets
These assets tend to be illiquid, valuable, and require special management skills. You need to decide who will financially benefit from the asset, who will manage the asset, and how to ensure estate taxes won’t require a forced sale of or borrowing against the asset. It is not unusual, for example, to decide that all your children will own equity in a family business or real estate and receive income distributions from it. But only one child will have the authority to manage it and will be paid for those tasks. Alternatively, you could decide this split between ownership and management will be too messy. Then, you leave full ownership of the business or other asset to the child who is qualified to manage it. If you don’t have enough other assets to equalize the inheritances of the children, you rely on life insurance to provide their bequests.
There are a number of ways to reduce estate and gift taxes on these assets, some of which we already mentioned. You need to meet with an estate planner and run through the advantages and disadvantages of the strategies to find the best approach for you. One key: The earlier you start planning the more options you have!
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