Estate Planning Overview

AN OVERVIEW OF ESTATE PLANNING

By Rory Clark, Esq.

• COMPONENTS OF YOUR ESTATE PLAN
• PREPARING THE PLAN
• ESTATE AND GIFT TAXES
• UNIFIED CREDIT
• MARITAL DEDUCTION
• GENERATION-SKIPPING TRANSFERS
• TRUSTS
• CONSIDERATIONS IN ESTATE PLANNING
• OTHER GENERAL INFORMATION
• GLOSSARY

Estate planning means planning for the disposition or distribution of your assets during your lifetime and upon your death. A good estate plan has three goals:

• To make sure your wealth reaches the individuals or organizations you select in the manner you choose.
  
  
• To minimize the effect of federal or state taxes on your estate.
  
  
• To allow you to select who will act in various fiduciary roles on your behalf.

Most people work an entire lifetime to accumulate assets: a home, cars, savings, etc. The small amount of time and money required to create an estate plan will ensure that your assets are passed on to the people you want in the way you want at the lowest cost.

The more you understand estate planning and the probate process, the better the chance that your estate plan will achieve your goals.

COMPONENTS OF YOUR ESTATE PLAN

An estate plan is composed of at least some of the following documents:

• Will
  
  
• One or More Powers of Attorney
  
  
• Advance Medical Directive (sometimes called a Living Will) and Durable Health Care Power of Attorney
  
  
• Trusts
  
  
• Beneficiary Designations to your Life Insurance and Retirement Plans

The following is a brief explanation of what each of these documents is intended to do.

1. WILLS. Virtually every adult needs a Will, regardless of age, marital status, or health. A Will is a written document that:
   • Outlines how you wish to distribute your tangible personal property, real property, and other wealth.
     
     
   • Designates an executor who is responsible for amassing and preserving your assets, paying creditors and taxes, and distributing the remaining property among your beneficiaries.
     
     
   • Appoints guardians for minor children.
   
   Often a Will creates trusts for the benefit of a surviving spouse or children to support them during their lifetime or, in the case of minors, until they are of age.
   
   If you die without a Will (or "intestate"), the courts will take control of your estate and distribute your assets according to the state's intestacy laws. This method of distribution is designed in a general fashion and may not achieve your objectives. For instance, your assets may not go to the individuals or charities you would have selected, and you will not be able to select a guardian for any minor children or the administrator of your estate. Also, your estate will not have the benefit of tax planning to minimize the effect of federal and state death taxes. If you lose your mental capacity, you cannot make a Will.
   
   
2. POWER OF ATTORNEY. A Power of Attorney will enable you to appoint someone you trust to act on your behalf in limited commercial or personal matters (depositing checks, paying bills, signing your tax returns, making gifts, etc.) or, if you choose, in almost all matters, should you become incompetent or unable to manage your affairs. These sorts of powers of attorney fall into two categories: "durable" (they become effective on signing) and "springing" (they become effective upon incompetence). Because of practical considerations associated with springing powers of attorney, durable powers of attorney are more common.
   
   
3. ADVANCE MEDICAL DIRECTIVE AND DURABLE HEALTH CARE POWER OF ATTORNEY. An advance medical directive and durable power of attorney allows you to both instruct those providing your health care of the manner in which you wish to be cared for should your death be imminent or should you become permanently unconscious and appoint an agent to make medical decisions on your behalf consistent with any wishes you may have expressed.
   
   
4. TRUSTS. As noted earlier, trusts are frequently created by a Will. However, they can also be created during one's lifetime. They are commonly created for the benefit of children and grandchildren, or aging parents, and are frequently used as a device by which estate taxes can be avoided, such as life insurance trusts.
   
   
5. BENEFICIARY DESIGNATIONS. Life Insurance and retirement benefits are payable to a designated beneficiary. Your Will will not govern these benefits unless they are paid to your estate. Retirement benefits require special care as the rules governing these benefits are quite complex.

PREPARING THE PLAN

The first step in estate planning is to take an inventory of your assets, including your home, interests in a business, jewelry, stocks and bonds, bank accounts, insurance, retirement plans, and other property, and to not how they are owned. An inventory of your debts should also be made.

The second step is to determine what your goals are with respect to your estate. For example, do you want any assets to pass to your spouse or children, be set aside for your children's education or the education of your grandchildren, or to pass to a charity? Who would be a good candidate to serve as your executor or as your children's guardian? If something wereto happen to your entire immediate family, what should happen to your property?

The third step is to consider the tax ramifications of your plans.

Most estates include "probate" assets and "non-probate" assets. Probate assets are those that are disposed of pursuant to the terms of your Will. Non-probate assets are those that transfer automatically to another person on your death. Examples of non-probate assets include:

• Proceeds of insurance policies where beneficiaries are named.
  
  
• Balances of retirement plans, individual retirement accounts (IRAs), or Keogh accounts that are payable to designated beneficiaries.
  
  
• Property owned jointly with "rights of survivorship" that passes directly to the co-owner (such as a house in joint tenancy or joint bank account).
  
  
• Assets held in trust.

ESTATE AND GIFT TAXES

Your entire estate (both probate and non-probate assets) is subject to federal and state death taxes. If you fail to plan for estate taxes, your estate may be subject to unnecessary taxes.

A federal tax, called the unified estate and gift tax, potentially imposes a tax each time you transfer any property to someone else, either while you are alive or upon your death. The tax rate is progressive. Each person has a unified credit against the unified estate and gift tax. The effect of the credit is to create an "exemption equivalent amount" which offsets the tax up to a specific limited value of the property in your taxable estate. Under the Economic Growth and Tax Relief Reconciliation Act of 2001, the exemption equivalent will increase in increments applicable to deaths occurring in the following years:

As the tax law is currently in force, the estate tax will be eliminated in the year 2010, but will be reinstated in the year 2011as it existed in the year 2002, with an applicable exclusion amount of $1,000,000.

Currently, an individual may transfer $1,500,000 as lifetime gifts or on death without payments of federal estate or gift tax. The current estate and gift tax ranges from 40% to 49% where amounts transferred during life or at death exceed the applicable exclusion amount. There is also a deduction allowed from a person's estate for the property that passes to a surviving spouse. This is referred to as the marital deduction or unlimited marital deduction.

Gifts of "present interests" during your lifetime that do not exceed $11,000 (adjusted for inflation after 1997) per recipient per year (or $22,000 if your spouse agrees to "split" the gift) are excluded from that tax. This means you can give away $11,000 per year to as many people as you wish (or $22,000, if your spouse joins with you) without those gifts being taxed. A "present interest" is one that gives the donee the immediate right to use the gift.

UNIFIED CREDIT

Even if you give away more than $11,000 (adjusted for inflation) to someone in a given year, you might not actually pay a tax on that gift in that year. The law allows every individual to make taxable gifts in his lifetime or upon his death of up to the applicable exclusion amount ($1,500,000, as increased as recited above) free of federal gift or estate taxes.

MARITAL DEDUCTION

Any property you give to a spouse either by Will or during your lifetime (provided he or she is a United States citizen) is fully exempt from any federal estate and gift tax, even if that amount exceeds the applicable exclusion amount, currently $1,500,000. It is therefore important to plan for both your and your spouse's deaths. While you can frequently defer all estate taxes on the first death by transferring all property to the surviving spouse, there may be a tax on the death of the survivor.

GENERATION-SKIPPING TRANSFERS

Any property given to (or held in a trust for) anyone more than one generation below you (grandchildren and more remote descendants) will be subject to a "generation-skipping transfer" (GST) tax. Each person has a limited exemption from the GST but when the tax applies it is punitive. The tax is designed to make sure that transfers that "skip a generation" are taxed as though they had passed into the hands of that generation. Gifts that qualify for the annual gift tax exclusion are exempted from the GST tax. If you are planning to have grandchildren or more remote descendants inherit from your estate at any time, or even if there is a possibility (no matter how remote) that they will inherit, you must consider the GST tax consequences of your estate plan.

TRUSTS

A trust is a legal arrangement through which you give property to a trustee to manage for the benefit of a person, persons, or a class of persons you name. There are two main types of trusts:

• Testamentary, which go into effect when you die.
  
• Living ("inter vivos"), which take effect during your lifetime. Living trusts may be revocable or irrevocable.

Trusts can be vehicles to provide for certain actions to take place with the best possible tax consequences. Trusts, if used, should be prepared in conjunction with a Will, which ensures that any remaining assets (such as furniture) are transferred to your beneficiaries.

While there are many benefits to trusts, there are also some disadvantages. Most trusts involve some degree of loss of flexibility or control over your assets.

The following are some of the more common types of trusts:

Revocable (or "Living") Trust: A revocable trust will not save estate taxes and frequently saves little, if any, money in probate costs. Probate in Virginia, and in many other states, is relatively simple and inexpensive. These trusts have received much publicity but are not always advantageous. A "living" trust can appoint someone to handle your financial affairs on your behalf should you become incompetent. Privacy is frequently cited as a reason to create a living trust. However, Wills rarely list a testator's specific assets and therefore rarely will anyone reading a Will get any sense of a testator's estate.

Irrevocable Trust: An irrevocable trust is sometimes created by individuals who have the ability and inclination to relinquish control over a sizable part of their estate. If you use up your applicable exclusion amount ($1,500,000 exemption equivalent), or a part thereof, during your lifetime, the property, and the appreciation on that property, between the time you gift the property to the trust and the time you die escapes estate tax in your estate. The income on the property transferred is also outside the estate. You may name the recipient of the assets, income, or principal of the trust. Because the transfer is considered a gift to the trust, a gift tax will be imposed (and offset by the applicable exclusion amount described above). One popular use of an irrevocable living trust is to shelter the proceeds of a life insurance policy from federal estate tax. The most effective way of using life insurance in conjunction with a trust is to have the trust buy the policy. In the alternative, if you transfer existing policies to a properly designated trust and survive at least three years after the transfer, the proceeds will pass to the beneficiaries of the trust free of federal estate tax.

Bypass (Family) or Credit Shelter Trust: The key in estate planning is to utilize both the unlimited marital deduction (if you have a spouse) and the applicable exclusion amount ($1,500,000 exemption equivalent described above). This is done by having all of a descendant's estate, except for the applicable exemption amount, pass to (or in trust for) the surviving spouse. The excess over the applicable exclusion amount will not be taxed because of the unlimited marital deduction. The applicable exemption amount is then frequently placed in trust for the benefit of the surviving spouse. This trust is known by many names, among them being the exemption equivalent trust, the bypass trust, the Family trust and the credit shelter trust. The assets in this trust are taxed in the estate of the first spouse to die and the surviving spouse is not considered to have control over it. Because the value of the trust equals the descendant's then applicable exemption amount, no tax is paid on that amount. The surviving spouse can now use his or her own applicable exemption amount to the best advantage. This allows the spouses to pass on a combined $3,000,000.

Marital Trust: Through this vehicle, you can provide for your spouse without leaving your property directly to him or her. You may appoint another individual to act as trustee or co-trustee with your spouse (in some instances the spouse may serve as sole trustee), with your spouse as sole beneficiary, and the trust will qualify for the marital deduction.

Other trusts which may be useful under certain circumstances include:

Minor's Trust: If you and your spouse both die, a minor's trust will hold your assets for your children until they reach the age of majority.

Charitable Trusts: A charitable remainder trust provides you with an income-tax deduction while the income from the assets are paid to you or a beneficiary; upon the termination of the trust the charity receives the principal. A charitable lead trust provides a charity with the income from your assets, paid over a certain amount of time, after which the assets pass to your heirs.

CONSIDERATIONS IN ESTATE PLANNING

Obviously, this memorandum only scratches the surface of estate planning. Many legal and tax requirements apply to the general principles discussed. Legal guidance should be sought before taking any action.

The following are matters you should consider in planning your estate:

• If you leave assets directly to minor children, the guardian (even the child's surviving parent) must keep records of even routine use of the inheritances and petition the court for any unusual expenditures on the children's behalf. Instead, you may be wise to bequeath your property to a trust established for the benefit of your children, and to name their guardian as trustee.
  
  
• If you give your executor broad powers to settle disputes or sell property as he or she sees fit, the executor will not have to seek permission from the court for each activity.
  
  
• If you plan to be married, you may wish to consider a prenuptial agreement to control the retention or disposition of your assets in the event of divorce or death. This may be particularly important in certain circumstances, such as if you have substantial premarital assets, whether earned or inherited, or if you wish to bequeath your estate to children from a previous marriage.
  
  
• It is wise to avoid provisions likely to be ruled invalid or to cause a challenge from neglected heirs. If you seek to totally disinherit a child, you should say so unequivocally in your Will. You should also be aware that dispositions which appear to be favoritism may cause challenges to the Will or, just as damaging, lasting ill feelings in your family.
  
  
• Early tax planning offers the most opportunities. There is little that can be done after the death of a parent or spouse to relieve the estate from taxes.
  • Any time circumstances in your life change substantially, your estate plan should be reviewed. Changes that may alter your desires significantly include:
  • Marital Status
  • Ownership or Value of Property
  • Birth of a Child
  • Tax Laws
  • Income or Employment Status
  • Business Ownership
  • Relocation

At a minimum, you should have your estate plan reviewed every three to five years. You should also keep your affairs in order and maintain an inventory of all your property. Take some time to educate your executor about your property and where you keep your inventory.

OTHER GENERAL INFORMATION

• Your Will is effective until you change or revoke it. You may alter your Will by executing a new one or by adding a codicil, which is done in the same manner as a Will. By writing on the document itself, you may invalidate the entire Will.
  
  
• Designating a beneficiary of your life insurance policy does not take the place of a Will. Life insurance is only one asset which needs to be considered in your overall estate plan. Under certain circumstances, it is advisable to make your insurance payable to your estate or to a trust created under your Will.
  
  
• If you own your own house and checking account jointly with your spouse, those items will not be probate assets.
  
  
• Married couples should work closely together in estate planning so family objectives can be met regardless of who dies first.
  
  
• If you think your estate might shrink or grow, use percentages instead of dollars to divide your assets.
  
  
• You generally may not exclude your spouse completely from your Will without your spouse's consent. Various states permit a surviving spouse to claim a specified share of a deceased spouse's estate. A spouse may never exercise that right, but a person planning to leave less than a statutory share should consider getting a waiver from his or her spouse of the right to elect that statutory share.
  
  
• The best assets to give as gifts are those which are increasing in value because the appreciation is excluded from your estate for estate tax purposes.
  
  
• Assets that you own at your death will have a basis equal to their fair market value at the time of your death; the basis of those given away during your lifetime will be your cost in acquiring them.
  
  
• Assets that generate ordinary income, such as retirement accounts, do not get a stepped up basis. Retirement Accounts require special planning as they are subject to both income and estate tax.

GLOSSARY

Administrator - A person appointed by a court to manage the estate of a person who dies intestate or without a nominated Executor.

Beneficiary - A person designated to receive the income or principal of a trust or estate.

Bequest - A transfer of personal property by a Will.

Codicil - A document which adds to or changes a Will. Its execution must comply with the formalities required for the execution of a Will.

Decedent - A deceased person.

Devise - Real property given to another by Will.

Estate - An interest in all types of assets, including real and personal property.

Estate Tax - The tax paid by the administrator or executor of a decedent's estate out of the assets of the estate itself.

Executor - A person appointed by Will to carry out its provisions. A woman acting in such a capacity is an "executrix". A "co-executor" acts as executor together with another or others.

Fiduciary - A person in a positionof trust or confidence. The fiduciary is bound by a duty to act in good faith. Examples of fiduciaries are trustees, executors, and administrators.

General Power of Appointment - The power, granted to another, to decide who should receive assets and when.

Grantor - A person who makes a transfer of property. The term is commonly used to describe a person who establishes and transfers property to a trust or a person who transfers real estate.

Guardian - A person legally appointed to manage the rights and/or property of a person incapable of taking care of his or her own affairs, including minors. A "guardian ad litem" is appointed by the court to prosecute or defend an action for an incapacitated person.

Heir - A person entitled to inherit all or a portion of the estate of a person who has died intestate.

Intestate - Dying without a Will.

Legacy - A transfer of money by a Will.

Living ("Inter Vivos") Trust - A trust which goes into effect while the settlor is alive.

Limited Power of Appointment - The power, granted to another, to decide who should receive assets and when, limited by the creator of the power to specific individuals or groups of people.

Personal Representative - An executor or administrator charged with marshaling assets, paying bills and taxes, and ultimately distributing an estate.

Power of Attorney - A document that authorizes a person to act as another's agent. "Durable" powers of attorney continue after a person becomes incompetent. "Springing" powers of attorney become effective when a person becomes incompetent. All powers of attorney end upon death.

Probate - The administration of an individual's estate with court supervision.

Settlor - The creator of a trust.

Testament - A Will.

Testamentary Trust - A trust created pursuant to a Will, which comes into existence only after the testator's death.

Testator - A man who makes or has made a Will. A "testatrix" is a woman who makes or has made a Will.

Trust - A legal relationship where property is transferred to and managed by a person or institution for the benefit of another.

Trustee - The person or institution entrusted with the duty of managing property placed in trust. A "co-trustee" serves as trustee with another. A "contingent trustee" becomes trustee upon the happening of a named future event.

Trustor - One who creates a trust. Also called a grantor or settlor.