The Little Blue Book of Estate Planning

The Little Blue Book of Estate Planning

Kevin M. Flatley, Esquire

Chapter 1. An Estate Plan

Chapter 2. Trusts, Estate Taxes,and The First Variable in a Trust: Trust Distributions

Chapter 3. Generation-Skipping

Chapter 4: The Second Variable in a Trust: Trust Management

Chapter 5. Avoiding Probate

Chapter 6. Who Should Own the Family Assets

Chapter 7. Six Rules of Thumb for a Married Couple Without Children

Chapter 8. Estate Taxes and the Unmarried

Chapter 9. Saving Estate Taxes With Real Estate a Major Asset

Chapter 10. Choosing a Trustee

Chapter 11. Gifts

Chapter 12. A Defective Trust

Chapter 13. A Qualified Personal Residence Trust, or “QPRT”

Chapter 14. The Family Limited Partnership

Chapter 15. A Grantor Retained Annuity Trust (a GRAT)

Chapter 16. Irrevocable Insurance Trusts: The Last Great Tax Shelter

Chapter 17. Gifts to Charity

Chapter 18. Planning With A Spouse In Ill Health

Chapter 19. Estate Tax Treatment When a Spouse is Not a U.S. Citizen

Chapter 20. The Three Q’s of Estate Planning

Chapter 21.Gifts to Minors

Chapter 22. The Sale of a Business

Chapter 23. Medicaid Trusts

Chapter 24. So, You’ve Been Named an Executor

Chapter 25. Estate Tax Repeal

Chapter 26. State Estate Taxes

Chapter 1. An Estate Plan

Whether we know it or not, we all have an estate plan.

If I do nothing, and I have assets in my name, my state legislature will provide an estate plan free of charge. In most states, this estate plan will divide my assets equally between my spouse and my children; if I am single and I have no children, the state provides for distribution among parents, then siblings, then on to cousins, aunts, uncles, nephews and nieces and other assorted hangers-on. Look in the paper any day to see what your legislators are doing, and decide for yourself whether you trust them to draft a proper estate plan for you. When you read your paper, you will want to talk to your lawyer about a will, and soon.

Many individuals worry that the state will get their assets if they do not have a will. This almost never happens, since there is usually some distant relative somewhere who will appear when there is an inheritance at stake.

Joint Tenancy

Most of us have at least a simple estate plan. Owning assets in joint names is a simple estate plan. With joint ownership, my joint tenant will receive my bank account or my home immediately upon my death. There is generally no delay, no interference by the probate court, and the process is plain and simple.

The simplicity of a joint tenancy may result in a costly estate plan in the end, though. We will see later that I can leave my assets in joint names, and have them pass to my spouse with no "probate" and with no estate tax; but when my spouse then owns this property, it may ultimately face both probate and tax on my spouse’s death. It will be subjected to probate when my spouse dies if it is worth more than $15,000 to $25,000 in most states; and it will pay an estate tax at my spouse’s death at rates that can easily reach 45% or more if our assets, mine and my spouse’s own assets, exceed $1,000,000.

One witty lawyer refers to owning a home in joint names creating an "expensive joint", again because joint assets over $1,000,000 will pay estate taxes on the death of the second joint tenant. The home my wife and I own as joint tenants will pass to my wife easily and without tax because we hold it in joint names; but the expense occurs at her death, when the home, the expensive joint, is subjected to costly probate and tax procedures.

A Will

Even if most of your assets are in joint names you will still want to have a will. A simple will is not expensive, and you will always have something in your sole name: the clothes on your back, the money in your wallet, the Series E bond you bought in 1980, payable to your estate, and your home furnishings. It would be a shame to have to divide the antique buffet in your dining room into 3 shares just because you did not leave it specifically to your child living with you at your death; and believe me, it is just this type of asset that your kids will split into shares to assure that one child does not get an advantage over the others.

A will also lets you name an individual or an organization to take care of your estate, after you are gone. In some states this individual or organization is called a personal representative, but since most states refer to this individual or organization as an executor, we will use the designation "executor" for this role, but the terms personal representative and executor are interchangeable.

The executor’s role is to assemble your assets, pay your estate taxes, pay your income taxes and the estate’s income taxes, and distribute the assets the way you direct the assets in your will. Some of the executor’s most difficult tasks are determining where the taxes will be paid, distributing the assets to the right parties and places, and holding assets in “pockets” which will minimize income taxes. If your estate is simple, a home, a brokerage account and an IRA, a family member working with a good lawyer can serve as your executor. If your estate is more complex involving a diversified portfolio of securities, or a family business, an IRA or another pension plan, or many parcels of real estate, you should consider a professional executor: a bank, trust company, or other professional involved in settling estates. A professional executor will often assign a senior officer to handle complex issues, but a lower paid staff to perform ministerial duties, which should lower the cost of estate settlement. We go into this role of an executor in more detail in Chapter 7.

A will also lets you decide where your assets will go if assets are in your name or if your joint tenant dies before you. Individuals worry less about the prospect of a joint tenant dying before them, although they are eerily concerned about “dying together” with a spouse. In all of my years in the estate planning business, I can only remember one instance of clients dying together: a husband and wife both killed crossing a busy street. It is much more likely that there will be an orderly progression of assets from one spouse to the other, and it is important to spell out in a will who is to receive the assets at the death of the second spouse. In a will, you can specify which of the children receive specific assets, and if you wish, you can assure that the in-laws do not share in your wealth.

In the estate planning business, we begin to wonder whether there are any decent sons-in-law or daughters-in-law. Most every client with whom I have ever discussed a will or trust wants to be sure these “children-in-law” don’t get a piece of the family inheritance, and usually, it is couched in whispered terms like “he’s a wonderful husband and father but...”; or, “she’s nice, but she has no idea of the value of a dollar...”, coupled with the other spouse’s wink of the eye and “...my glory, can the girl spend money....” There are almost no parents who want these in-laws to see any of their money, and they often want them to be specifically excluded, until they are assured that state law almost always allows assets to follow the family’s blood lines if assets are left “… to my children; but if they are not around, to their children, etc….”

With a will you can also do most anything you choose with your assets. I remember an individual early in my career whose idea of equality was to leave one child his business and to divide the rest of his estate equally between this child and his sister. To me this is grossly unfair, but then, I did not build this estate, and he did. The law will generally let him do anything he wants, with well-defined exceptions: if I completely neglect a child and I do not even refer to the child in the will, this child can demand a share; there is an assumption that he was forgotten, as if we would ever forget the little darling. I can correct this situation in most states by just mentioning this black sheep, without leaving him or her anything.

Most states provide relief to a widow or widower left little or nothing under a will, unless there was a prenuptial agreement. Usually, it is not sufficient to say in a will that you remember your spouse but you are disinheriting your spouse anyway. You may die happy with this term in your will, but the courts will generally leave a portion of your estate to or for your spouse, even if you never liked each other much during your lifetime.

A will can be challenged on the basis of incompetence, undue influence, or carelessness about observing the formalities of executing a will. All you need in many states to invalidate a will is for one witness to leave the room while another witness is signing a will, and bingo!, you have no will!

It is important to have a will drawn by a good lawyer, and executed in the presence of a good lawyer, and even then, you need to be diligent. I once interrupted a will signing when I saw that the husband had just signed his wife’s will, and there have been countless times when I have read wills with missing dates or other important “blank spaces” left empty unintentionally.

A Trust

If a will is all that is required to leave assets to responsible adults who know their way around the financial markets, so is the converse true also. If we are leaving assets to the vulnerable, or to individuals uneducated or disinterested in the financial markets, or to the very young or the extremely old, then more than a will is required, and a trust is the logical extension of a will.

A trust can be as simple as a bank account registered to me as trustee for my son. Ordinarily, this bank account will be at my disposal during my lifetime, and it will pass to my son when I die. This simple trust will be included in my estate for estate tax purposes, if my estate exceeds the estate tax exemption.

A trust can also be created by a simple document of one sentence appointing my daughter, my son, or anyone else I choose, trustee. This trust document too will take care of me during my lifetime, and it will pass the “trust assets” on to my beneficiaries when I die. If the trust specifies that it is to pass to my 3 children when I die, most states will leave the trust assets to my 3 children equally. If one of my 3 children dies before me, leaving 2 children of his own, in most states these grandchildren will receive their parent’s 1/3 share. This is a “per stirpes” distribution favored by the common law and most states, unlike a “per capita” distribution, which would leave 1/4 to each of my 2 surviving children, and 1/4 to each of the two grandchildren in my example.

A trust can also be a more complicated agreement spelling out in great detail what I am to get from the trust during my lifetime, and what my family is to receive at my death. Lawyers are sometimes accused of getting paid “by the page”, since often a fairly uncomplicated trust will run 20 to 40 pages in length. You should not be frightened by the length of a trust, since generally every one of the numerous paragraphs in a trust will keep you out of court, or out of trouble.

A trust can give you and later your beneficiaries the right to take the assets in the trust on demand, but often a trust will put limits on the beneficiaries’ access to trust assets. Our next several chapters are devoted to the reasons individuals put restrictions on beneficiaries' right to take money out of a trust. Restrictions are generally designed to keep assets from those three dreaded enemies of the people: the tax man, the probate judge, and, most dreaded of all, the in-laws, both sons-in-law and daughters-in-law.

Chapter 2. Trusts, Estate Taxes,

and The First Variable in a Trust: Trust Distributions

Before approaching an attorney about an estate plan, it is useful to have in mind a broad outline of how a trust should be structured.

In structuring a trust, there are two major variables you control. In this chapter, we discuss the first variable, the distribution of trust assets; and in Chapter 3, we will look at the second variable: the management of assets in trust. The terms for distribution of trust assets are often dictated by tax considerations, and we will discuss this issue in this chapter first, so this chapter will have a heavy emphasis on taxes; in Chapter 3 we will discuss the investment instructions most often given in a trust document, and we will discuss there and in Chapter 7 how you should go about the process of choosing a trustee.

Trust Distributions

The first major responsibility of a trustee is the payment of funds from the trust. These payments can be a matter of following a clear direction in the trust instrument, or they can involve tremendous latitude given the trustee.

Recall from Chapter 1 that you can create a trust instructing the trustee to pay the trust assets back to you upon request. Further, a trust can be just as open for other beneficiaries, requiring the trustee to pay funds to a surviving spouse, or children, or other beneficiaries on request. Trusts more often leave a trustee with discretion over payments to a spouse or children for tax purposes; or for personal reasons such as a worry about ability to manage money, a concern about the reach of another husband or wife, or the need for control where a divorce is likely on the horizon.

Often, though, a trust is created with a primary focus on estate taxes. The Federal government is quite generous in allowing assets to pass from one spouse to the other: any asset of unlimited value, is allowed to pass to a surviving spouse with no Federal estate tax. Most states now follow the Federal rules, although there is a discussion of state estate taxes in the back pages of this book, in Appendix A.

There is a trap for the unwary in the tax law's apparent generosity to a married couple. The trap lies in the tax assessed against a single person's estate, often a surviving spouse. A single person's estate pays a tax in the 45% to 50% range on all assets in excess of the following sum:

Tax Free Sum

2002 / $1,000,000 / 2006 / $2,000,000
2003 / 1,000,000 / 2007 / 2,000,000
2004 / 1,500,000 / 2008 / 2,000,000
2005 / 1,500,000 / 2009 / 3,500,000

Although estate tax repeal is slated for the year 2010, this repeal must pass the Congress again to take full effect. It is our sentiment that you should plan your affairs assuming this repeal will not occur.

The Estate Tax

The following shows these rules in practice. Note that you can leave your spouse your entire estate with no federal tax at all. At the surviving spouse's death, though, this second estate is taxed as the estate of a single person often resulting in a substantial tax before the estate passes to heirs!

Assets in Trust Save Estate Taxes

The following exhibit provides a contrast to an arrangement leaving all assets from one spouse to the other. This Trust B in a trust agreement might be labeled a Bypass Trust, or a Family Trust, or a “Credit-Shelter” Trust; but for our purposes, we will refer to Trust B as a Bypass Trust.

The facing page shows the impact if the first spouse dies after the year 2006.

THE YEARS 2002 and 2003

$1,000,000 Exemption

An Additional Example

THE YEAR 2006 to 2008

($2,000,000 exempt)

Once the second estate reaches the estate tax exemption, every $1,000,000 added to the second estate increases the estate tax on the second estate by $450,000 to $500,000. Notice, though, that assets up to the estate tax exemption left in a Bypass Trust are tax free in the first estate of a married couple, but the essence of a Bypass Trust is that assets left to the Bypass Trust are tax free again in the estate of the surviving spouse. In the following pages we describe your options in structuring a Marital Trust and a Bypass Trust.

A BYPASS TRUST

A properly drawn Bypass Trust left by one spouse for the other will avoid all tax on the assets in the Bypass Trust at the second death. There is a limit to the amount an individual will want to leave to a Bypass Trust, and this limit is generally the amount of the estate tax exemption ($1,000,000 in 2002 and 2003, more later). While more can be left to a Bypass Trust, the excess over this exemption will pay estate taxes, so typically no more than the exemption will be left to a Bypass Trust. As the exemption increases, this increasing limit is the amount to leave to a Bypass Trust.

The Terms of a Bypass Trust

A Bypass Trust can be so generous in its terms that it almost amounts to an outright gift; or it can be restrictive enough to assure that payments will only be made in specified circumstances.

A Generous Bypass Trust

A Bypass Trust can direct a trustee to be very generous with the trust's assets. A Bypass Trust can provide a spouse with all of the following benefits, and still avoid a tax at the spouse's death:

all income to the spouse

the right of the spouse to take 5% of the capital each year
the ability of the trustee to pay additional sums for all the comforts and luxuries of life
the right to change the trustees within limits
the ability to change the ultimate beneficiaries of the trust

These terms are about as generous as an individual can be with a spouse and still avoid tax at the spouse's death.