Estate Planning

An updated, concise, well-drafted estate plan is one of the greatest gifts you can give to your spouse, your children, and your heirs. Have you ever thought about what would happen to your family should you die or become disabled? Dying without an estate plan can throw your heirs into a legal quagmire that can cost thousands of dollars in legal fees, taxes and other costs that could have been avoided with proper planning. In addition, for families with children, a properly drafted and current will with a guardianship appointment is critical. Without a will, your children’s future will be left to the decision of the courts.

Estate planning, however, is much more than simply drafting a will. It includes instructions about asset distribution upon death, healthcare decisions (such as withdrawals of life support and the appointment of someone to make that decision), guardianship issues, and the very difficult choice of who will care for your children if you die. Income and estate tax issues and a host of other matters are also addressed. Many of these issues must be dealt with regardless of the size of one’s estate; estate planning is definitely not limited to the rich. A well-crafted plan can give you and your family peace of mind for a lifetime.

The basic estate plan starts with a simple will plus advance directives to cover healthcare issues. If you have children, the basic plan is modified to include the guardianship provisions that will appoint someone to care for your children if you die. With a larger estate, a more complex plan can be designed to incorporate a dynasty trust for your children, which will ensure that your assets will not go unmanaged and unaccounted for to the guardian. The trust can also be designed to ensure that your children will not receive an outright distribution of assets at the age of majority when many young people may have a difficult time managing assets in a complex investment arena. Finally, for the middle income to the very wealthy, tax planning is essential to the smooth and efficient transfer of wealth between the generations.

Most people underestimate the value of their estate. Assets in your estate can add up quickly. For estate tax purposes, assets include life insurance, IRA and 401(k) accounts and other retirement assets, investments, bank accounts, personal property, business interests, and real estate (including your home). One factor many clients overlook is life insurance. A major benefit of life insurance is that it is income tax free, but it is not estate tax free.

Without any tax avoidance estate planning, the first spouse to die will pass his/her estate to the surviving spouse, and using the marital deduction, no tax will be due, no matter how large the estate. This deduction is available to all U.S. citizens. However, if no planning is done before the death of the first to die and no election is made after the death of the first to die, when the surviving spouse passes, estate taxes may be due on the total remaining estate. Currently, estate taxes are due when the value of an individual’s taxable estate is greater than $5.45 million ($5.43 million in 2015). So if the estate was worth $10.45 million, $5.45 million would be inherited tax free, but approximately $2 million in federal estate taxes would be due on the other $5 million.

For example:

  • John and Susan are married. John has $5.45 M and Susan has $5 M. They have done no estate tax planning.
  • John dies in early 2016. Susan receives John’s assets ($5.43 M) giving her a total of $10.45 M. $0 is due because of the unlimited marital deduction.
  • Susan (now having $10.45 M) dies later in 2016. $5.45 M of Susan’s assets pass tax free to the beneficiaries because of her individual estate tax exemption, but the remaining $5 M will be taxed resulting in approximately $2 M in federal estate taxes.

This result, however, can be avoided with proper planning. To preserve wealth in your estate by avoiding or limiting estate taxes, several tax-saving devices are available. For a married couple, one of the most common devices is through a Credit Shelter Trust. When the first spouse dies, the maximum estate tax exemption amount (currently $5 million) is placed in the deceased spouse’s Credit Shelter Trust (also called a bypass trust). No tax is due on the Credit Shelter Trust because of the exemption. The remaining assets are placed in a trust for the benefit of the surviving spouse or given outright to the surviving spouse. The Credit Shelter Trust can distribute income and principle to the surviving spouse if needed for health, education, maintenance, and support but the goal would be to preserve those assets so that they may be passed down tax free.

Now let’s revisit the John and Susan’s example:

  • John and Susan are married. John has $5.45 M and Susan has $5 M. They have Credit Shelter Trusts in place.
  •  John dies early 2016. Instead of Susan receiving John’s assets outright, the maximum exclusion amount (the full $5.45 M) is placed in John’s Credit Shelter to be held for the benefit of Susan.
  • Susan dies later in 2016 (with $5 M of her own and $5.45 M in John’s Credit Shelter). Susan’s $5 M passes tax free to the beneficiaries because of her individual estate tax exemption, and John’s Credit Shelter has no tax due no matter what amount is in it – even if it is more than the exemption amount – because the value of the Credit Shelter is locked in at the time of John’s death and his individual estate tax exemption was used to fund the Credit Shelter. With this simple planning, John and Sue have saved their family approximately $2 M in federal estate taxes.

For more complex estates, other tax avoidance techniques may include the following:

Tax-Free Gifts: Each year you are currently able to give $14,000 to any person free of gift taxes. (You can give $28,000 if you are married). This decreases the assets in your estate if you are above the exemption amounts.
Irrevocable Life Insurance Trusts (ILIT): You can remove the life insurance payments from your estate total by making the Irrevocable Life Insurance Trust the owner of your life insurance policies. New policies have no waiting period, and existing policies require that you live three years from the date of the transfer to the ILIT.

Qualified Personal Residence Trust (QPRT): If you survive the term of the trust, this removes your home from your estate. Additionally, the value of the gift is discounted because your children will not receive it until sometime in the future, allowing you use less of the lifetime exemption amount. You transfer the home to the QPRT, keeping the right to use it for a certain length of time. After that time, the residence transfers to your heirs. Usually the grantor reserves the right to live in the home for 10-15 years. If you die prior to the term, the home is included in the estate. If you live longer than the term, rent is usually paid to the heirs.

Grantor Retained Annuity Trust (GRAT) and Grantor Retained Unitrust (GRUT): The GRAT and GRUT are similar to the QPRT except you transfer income-producing assets to the trust for a number of years. When the trust term ends, the asset passes to the beneficiaries based on the discounted value.

Charitable Remainder Trust: The asset is given to the Charitable Remainder Trust, however, the income is paid to you for your life. The advantage of the trust is that highly appreciated assets can be sold without capital gains taxes and invested in high income producing assets. When you die, the asset is given to the charity and your estate is reduced by the value of the asset. Life insurance can be used to replace the value of the asset through use of an Irrevocable Life Insurance Trust.

Charitable Lead Trust: This is similar to the Charitable Remainder Trust, except the income is paid to the charity and the asset is transferred to your estate at your death.

Family Limited Partnerships or LLCs: The business assets are transferred to the children now to reduce the size of the estate. As the general partner, the grantor remains in full control of the assets, but again discounts the value of the business for estate tax savings.

Each year, Americans pay millions of dollars in unnecessary state and federal income and estate taxes, as well as needless probate fees. By planning your estate in advance, you can reduce if not eliminate this cost of dying as well as know that your estate will be administered the way you want it to be. At McCormick & Friman, our attorneys have extensive experience in estate planning and can help you develop a well-ordered estate plan. For a free evaluation of your estate, contact our offices to arrange a consultation.