What is “estate planning?”
Some people think that estate planning is only about deciding what will happen to their property after death. However, a comprehensive estate plan addresses many other issues such as planning for management and control of assets during any period of incapacity; minimizing taxes, expenses, delay and inconvenience in settlement of the estate; implementing complex dispository schemes; and taking measures to protect the estate from creditors and predators.
Creating a comprehensive estate plan requires careful analysis of each individual’s estate, his or her estate planning goals and the applicable state and federal laws. Once the estate plan is formulated, the next step is to implement the estate plan which is done through executing legal documents, but can also involve additional steps such as transferring assets, changing beneficiary designations or even forming entities.
Formulating and implementing an estate plan can be very complex. Each person’s estate plan is unique and should be tailored to meet that person’s specific wishes and goals. There is no “one size fits all” estate plan. Consequently’ the specific documents or steps that may be used in an estate plan can vary significantly from person to person.
Why be concerned about estate planning?
Everyone has some idea what they would want to happen to their property or how to provide for their families in the event of death or incapacity. However, unless you are proactive and take steps to document your wishes in a formalized estate plan, it is likely that you will not realize your estate planning goals. This is because in the absence of your own formal estate plan there are numerous default rules provided by state law that will control the management and disposition of your assets and affairs in the event of incapacity or death.
Application of these default rules for estate planning has significant drawbacks.
If you don’t have a plan
The default rules require court proceedings, such as an intestate probate proceeding or a conservatorship action. Court proceedings take time and the delay could cause loss or depletion of one’s estate or delay in implementing medical or financial plans or procedures.
Court proceedings are also public in nature and all records submitted to the court become part of the public record. For example as part of an intestate probate proceeding it is necessary to identify in the court documents the assets in the decedent’s estate, the assets’ values, the decedent’s heirs and each heir’s anticipated share of the estate. The court proceedings also require all interested parties receive notice and be provided an opportunity to join in the proceeding. This could result in considerable additional cost and delay before final settlement.
This could also result in persons who you would not want involved with your affairs being involved in the disposition of your estate or possibly even being appointed to fiduciary roles.
Being proactive and actively formulating and implementing your estate plan will give you control over the management of your affairs and the peace of mind knowing that you have provided for your family. The alternative is to rely on the default rules, essentially giving up control over the outcome of how your affairs are managed, how and when your estate is settled and the ultimate financial and emotional cost to your family.
Basic Estate Planning Tools
The following is a brief description of some of the more commonly used estate planning tools:
- Will. A Will is a legal document that states the maker’s directions regarding the disposition of his or her estate after death. The Will is essentially a roadmap through the probate process (see below), and it provides for naming who is responsible for overseeing the settlement of the decedent’s estate (the executor or personal representative). Once the probate proceeding is commended and the Executor appointed, the Executor is then responsible for overseeing the identification and marshalling of decedent’s assets, paying the decedent’s debts and expenses, and finally, distributing the decedent’s estate in accordance with the Will. A Will can include provisions to implement steps to minimize estate taxes, or to hold and protect property for the benefit of minors or incapacitated persons, but with only a Will, in most cases a probate proceeding will be required to settle the estate.
- Trust. A Trust is a fiduciary relationship where a person (the trust creator or Trustor) transfers property to a fiduciary (the Trustee) to hold for the benefit of a beneficiary or beneficiaries. The Trustee is bound to hold the property and use it for the benefit of the beneficiary and not for the Trustee’s personal benefit or use. A trust can be established during the Trustor’s lifetime (inter vivos) or through the provisions of a will after death (testamentary). Trusts can serve a variety of purposes in estate planning such as estate tax planning, probate avoidance, asset protection or for benefit qualification.
- Revocable Living Trust. A Revocable Living Trust is a trust established by the creator of the trust (called the Trustor, Settlor or Grantor) during the Trustor’s lifetime and under the terms of the trust agreement, the Trustor retains the power to revoke and amend the trust. Typically the Trustor is also the Trustee and the primary beneficiary, and thereby retains complete control and use of the assets in the trust. Due to the Trustor’s power to amend or revoke the trust and being the primary beneficiary, a revocable living trust does not provide asset protection for the Trustor. For purposes of taxes, creditors or other liabilities, the trust is ignored and the assets deemed still retained by the Trustor. However, the key feature of the trust is that it allows for management and transfer of assets upon the death or disability of the Trustor without court proceedings. Upon death or disability of the Trustor, a successor trustee named by the Trustor in the trust agreement has immediate authority to control and management the trust asset in accordance with the direction of the Trustor as proscribed in the trust agreement.
- Power of Attorney. A Power of Attorney is a grant of authority by one person (the “Principal”) to another person (the “Attorney-in-fact”) to act on the Principal’s behalf. The grant of a power of attorney is very useful as it allows one to provide for the management of his or her affairs in the event of incapacity or unavailability. Whereas the successor Trustee of a revocable trust has the authority to manage the trust assets upon the incapacity of the Trustor, the Trustee has no authority over assets not in the trust nor any authority to act on behalf of the Trustor personally. Consequently without a power of attorney in place prior to incapacity, there is no one with the immediate legal authority to manage one’s personal matters such as paying bills, depositing checks in the Trustor’s name, filing the Trustor’s tax returns, making arrangements for in-home health care, or making medical decisions. Rather, it would be necessary to commence a court proceeding such as a guardianship or conservatorship action to have some one appointed by the court to manage the incapacitated Trustor’s affairs.
- Advance Directive. An Advance Directive is a document where you can give specific instructions about any aspect of your health care. Using an Advance Directive allows you to have some control over your medical care by providing instruction as to your wishes in the event you are unable to express them yourself. For example, you can express your wishes regarding the provision, withholding, or withdrawal of treatment to keep you alive, administering pain relief, an intention to donate your bodily organs and tissues following your death or the designation of a physician to have primary responsibility for your health care.
What is “Probate?”
Probate is a legal process for administering the assets and affairs of a Decedent. Under the direction of the court, a person is appointed to oversee the administration of the Decedent‘s estate (called the Executor, Personal Representative or Administrator), all the Decedent’s assets are identified and collected, all debts and expenses are paid and then finally, the remaining assets are distributed to the Decedent’s heirs.
The biggest negative aspect of probate is that it is a court proceeding. All the documents and information submitted as part of the probate proceeding become part of the public record. Consequently, the Will including all of the dispositive directions of the decedent and a detailed inventory of the decedent’s property become recorded and viewable by anyone.
Court proceedings can also cause delay in final settlement of an estate due to the notice requirements (having to provide advance notice to various parties prior to taking certain actions), or simply due to congestion on the court calendar.
Finally, in some states like California, attorney and executor fees for probating an estate are statutory and based on a percentage of the value of an estate. As a result, the cost of probating the estate can be substantial due to the value of the estate and not necessarily the amount of work that must be done to settle the estate. For example, under current California law, the statutory attorney’s fees on an estate valued at $500,000.00 would be $7,500.00. And that does not include the additional costs of court filing fees, mailing costs, publishing costs, or the costs of additional attorney’s for other interested parties.
Even aside from the delay, lack of privacy and potential for disputes in the court proceedings, from an economic standpoint, a few thousand dollars for a properly drafted probate-avoiding trust is significantly less than the costs that will be incurred through a probate proceeding.
Sophisticated Estate Planning
In addition to the basic estate planning tools, often the personalized estate plan will require other tools and techniques to fully realize your estate planning goals. The following is a brief description of some of the additional tools that an experienced estate planning professional may recommend after careful analysis to help you achieve your goals:
- Irrevocable Trusts. An irrevocable trust is a trust that once established cannot be terminated or “undone” by the Settlor. Typically the only way an irrevocable trust will terminate will be under the terms of trust itself, by full distribution of all the trust assets, or through a court proceeding resulting in an order to terminate the trust.
Irrevocable trusts are typically designed to reduce the size of the estate of the Settlor and thereby reduce potential estate taxes, though they can also serve to provide asset protection, for public benefit planning or to provide liquidity for an estate. Irrevocable trusts are designed and drafted to address specific assets and/or issues for the Settlor and the Settlor’s estate. As irrevocable trusts are “irrevocable” their use and function within an estate plan must be carefully considered and should not be undertaken without consultation with an experienced estate-planning attorney.
(i) Irrevocable Life Insurance Trust. An Irrevocable Life Insurance Trust (“ILIT”) is a type of irrevocable trust that is specifically set up to own life insurance on the life of the Settlor. Although the proceeds of a life insurance policy pass tax free to the beneficiary at death, as long as the Settlor has any “incidents of ownership” in the policy the amount of the death benefit is includible in the Settlor’s estate for estate tax purposes. Therefore, instead of the Settlor holding an insurance policy and thereby increasing the total value of his estate, the policy can be held in an ILIT to which the Settlor contributes the funds to pay the policy premiums. At the Settlor’s death, the policy proceeds can be used to provide liquidity to the Settlor’s estate (i.e. by purchasing assets from the estate, or making a loan to the estate to pay estate taxes), or just to provide additional benefits to the Settlor’s heirs.
(ii) Qualified Personal Residence Trust. A Qualified Personal Residence Trust (“QPRT”) is an irrevocable trust specifically designed to hold the residence of the Settlor. Again, the goal is to reduce the value of the Settlor’s estate, in this case by removing the value of the Settlor’s residence from the estate. Under a QPRT, the Settlor contributes his residence to the trust in exchange for the right to reside in the residence for a term of years. If the Settlor dies during the term, the value of the house is includible in the Settlor’s estate, but if the Settlor survives beyond the term, the value is excluded. Once the term expires the Settlor has no right to occupy or use the residence and must rent the residence under reasonable terms to continue occupancy.
- Dynasty Trust. A Dynasty trust is a trust that may be revocable or irrevocable, though it will become irrevocable at the death of the Settlor. The purpose of the Dynasty trust is to retain the assets in trust over the course of numerous generations of the Settlor’s family. Under the laws of many states, trusts can only exist for a specified period of time after which they must terminate (i.e., 99 years or 21 years after the death of the Settlor’s youngest child).
These “rules against perpetuities” arose based on the public policy that the economy is hurt when assets are held idle and concentrated within a family for generation after generation. However, some states have amended their laws to allow trusts to continue for extended periods (Wyoming, 1,000 years) or indefinitely (Alaska). The aspect of the Dynasty trust sought by the Settlor is the extended asset protection for the Settlor’s heirs and a consistent management, control and usage of the asset within the trust
- Grantor Trusts. Grantor trust refers more to an income tax classification of a trust. If a Settlor retains a right or interest, the trust can be deemed a Grantor trust in which case for income tax purposes the trust is disregarded and any income or loss from the trust is attributed to the Settlor. If a trust is irrevocable and the grantor retains no power, authority, control or benefit from the trust, the trust itself becomes a taxable entity and no tax attributes are attributable to the Settlor nor is any of the property deemed to be held or controlled by the Settlor.
However, in some circumstances there may be significant benefits to the Settlor being deemed to have some interest or control in the trust (i.e., having trust income taxed at lower rates to the Settlor, or be the deemed owner of the residential property in the trust for property tax purposes or for income tax purposes for the exemption on sale of a personal residence). As such sometimes, though a trust is irrevocable, the Grantor may purposely retain a right or interest to make it a grantor trust for specific tax benefits. Such a trust is also referred to as an “Intentionally Defective Grantor Trust.”
- Charitable Trusts. As an encouragement for philanthropy, gifts to charities from an estate are also deductible from estate taxes. To maximize the benefit of charitable giving, trusts have developed by which a Settlor can receive both a current charitable deduction from income taxes, and an additional deduction from estate taxes at death. To achieve both these benefits the Settlor must establish an irrevocable trust with a charitable beneficiary. However, the Settlor and/or other non-charitable beneficiaries can also be named as beneficiaries and receive either current benefits from the trust (trust income) or the remainder of the trust upon the death of the Settlor
Create a Comprehensive Estate Plan That Works for You
Creating a comprehensive estate plan requires careful analysis of each individual’s estate and his or her estate planning goals. There are many tools and techniques available, and each has pros and cons that must be carefully considered. As a result, formulating and implementing an estate plan can be very complex.
Each person’s estate plan is unique and should be tailored to meet that person’s specific wishes and goals. As mentioned earlier, there is no “one size fits all” estate plan. Attempting to save a few dollars by doing-it yourself or shopping for the cheapest advice you can find can have dire consequences for you and your family. The few dollars you save now may cost your family tens of thousands of dollars later, not to mention the disputes and emotional costs of an incorrect, incomplete or insufficient estate plan.
Time and time again we have seen tragic examples of the “bargain” estate plan tainting an individual’s lasting legacy with resentment, disputes, family discord and significant additional costs. Unfortunately, in most cases working with experienced estate-planning professionals could have avoided these unintended consequences at a cost significantly less than the final financial and emotional costs paid by the families left behind.
As part of our asset protection planning the Sutton Law Center works with estate planning firms around the country. Know that your asset protection plan and estate plan will be handled with the highest professionalism and care from our Reno estate planning attorney.