Estate Planning

Estate Planning Basics

When you hear the phrase “estate planning,” the first thought that comes to mind may be taxes. But estate planning is about more than just reducing taxes. It's about ensuring your assets are distributed according to your wishes. That's why, even with the estate tax reduction (and eventual repeal in 2010) under the 2001 tax act, estate planning is still critical. In addition, estate taxes still pose a threat with respect to wealth available to transfer to the next generation. Remember, the “sunset” provision means that in 2011 the estate tax will return to where it stood before the 2001 tax act, unless Congress takes further action to change the law.

In addition, the act includes other provisions that increase the complexity of estate planning, such as repeal of the generation-skipping transfer (GST) tax (in 2010, with reinstatement in 2011); reduction in the top gift tax rate but no repeal of the gift tax; increases in GST and estate tax exemptions; and repeal of the step-up in income tax basis at death.

As a result, estate planning is more important than ever without proper planning, estate taxes may still claim a large share of what you've spent a lifetime building. This section will provide an overview of basic estate planning principles, then discuss estate tax saving strategies.

FUNDAMENTAL QUESTIONS

Because estate planning is not just about reducing taxes but also about making sure your assets are distributed as you wish both now and after you're gone, you need to consider three questions before you begin your estate planning.

  1. Who should inherit your assets?

    If you are married, before you can decide who should inherit your assets, you must consider marital rights. States have different laws designed to protect surviving spouses. If you die without a will or living trust, state law will dictate how much passes to your spouse. Even with a will or living trust, if you provide less for your spouse than state law deems appropriate, the law will allow the survivor to elect to receive the greater amount.

    Once you've considered your spouse's rights, ask yourself these questions:

    Should your children share equally in your estate?
    Do you wish to include grandchildren or others as beneficiaries?
    Would you like to leave any assets to charity?

  2. Which assets should they inherit?

    You may want to consider special questions when transferring certain types of assets. For example:

    • If you own a business, should the stock pass only to your children who are active in the business? Should you compensate the others with assets of comparable value?
    • If you own rental properties, should all beneficiaries inherit them? Do they all have the ability to manage property? What are the cash needs of each beneficiary?
  3. When and how should they inherit the assets?

    To determine when and how your beneficiaries should inherit your assets, you need to focus on three factors:

    • The potential age and maturity of the beneficiaries,
    • The financial needs of you and your spouse during your lifetimes, and
    • The tax implications.

Outright bequests offer simplicity, flexibility and some tax advantages, but you have no control over what the recipient does with the assets once they are transferred. Trusts can be useful when the beneficiaries are young or immature, when your estate is large, and for tax planning reasons. They also can provide the professional asset management capabilities an individual beneficiary lacks.

WILL OR LIVING TRUST?

You have two basic choices for transferring your assets on your death: the will, which is the standard method, and the living trust, which is rapidly growing in popularity. If you die without either a will or a living trust, Florida law controls the disposition of your property and settling your estate likely will be more troublesome and more costly.

The primary difference between a will and a living trust is that assets placed in your living trust avoid probate at your death. Neither the will nor the living trust document, in and of itself, reduces estate taxes - though both can be drafted to do this. Whether a will or a living trust is better for you depends on many personal factors. Let's take a closer look at each vehicle.

Wills

If you choose just a will, your estate will have to go through probate. Probate is a court-supervised process to protect the rights of creditors and beneficiaries and to ensure the orderly and timely transfer of assets. The probate process has six steps:

  • Notification of interested parties. Most states require disclosure of the estate's approximate value as well as the names and addresses of interested parties. These include all beneficiaries named in the will, natural heirs and creditors.
  • Appointment of an executor. If you haven't named an executor, the court will appoint one to oversee the estate's liquidation and distribution.
  • Accumulation of assets. Essentially, all assets you owned or controlled at the time of your death need to be accounted for.
  • Payment of claims. The type and length of notice required to establish a deadline for creditors to file their claims vary by state. If a creditor does not file its claim on time, the claim generally is barred.
  • Filing of tax returns. This includes final income and estate taxes.
  • Distribution of residuary estate. After the estate has paid debts and taxes, the executor can distribute the remaining assets to the beneficiaries and close the estate.

A will can be advantageous because it provides standardized procedures and court supervision. Also, the creditor claims limitation period is often shorter than for a living trust.

Living Trusts

Because probate is time-consuming, potentially expensive and public, avoiding probate is a common estate planning goal. A living trust (also referred to as a revocable trust, declaration of trust or inter vivos trust) acts as a will substitute, providing instructions for the management of your assets on your death and, if funded, during your life. You will still also need to have a short will, often referred to as a “pour over” will.

How does a living trust work?

You transfer assets into a trust for your own benefit during your lifetime. You can serve as trustee or select a professional trustee. You completely avoid probate only if all of your assets are in the living trust when you die, or your assets are held in a manner that allows them to pass automatically by operation of law (for example, a joint bank account). The pour over will can specify how assets you didn't transfer to your living trust during your life will be transferred at death.

Essentially, you retain the same control you had before you established the trust. Whether or not you serve as trustee, you retain the right to revoke the trust and appoint and remove trustees. If you name a professional trustee to manage trust assets, you can require the trustee to consult with you before buying or selling assets. The trust does not need to file an income tax return until after you die. Instead, you pay the tax on any income the trust earns as if you had never created the trust.

A living trust offers additional benefits. First, unlike probate, your assets are not exposed to public record. Besides keeping your affairs private, this makes it more difficult for anyone to challenge the disposition of your estate. Second, a living trust can serve as a vehicle for managing your financial assets if you become mentally incapacitated or disabled. A properly drawn living trust avoids embarrassing guardianship proceedings and related costs, and it offers greater protection and control than a durable power of attorney because the trustee can manage trust assets for your benefit.

Because of the complexities and issues created by the 2001 tax act, Congress is likely to make further estate tax law changes that could affect the issues discussed here or your estate plan. Be sure to get professional advice before implementing any estate planning strategies.

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