Volume 7, Issue 3
The Wealth Counselor
An Overview of Estate Planning
Our clients expect their estate planning will cause their property to go to whom they want, the way they want, when they want and that it will minimize the impact of taxes, professional fees and court costs. They also expect their estate planning will help them keep control of their property while they are alive and well and provide for themselves and their loved ones if they become disabled.
Traditional estate planning often falls short of some of these goals. In this issue of The Wealth Counselor, we will examine the traditional estate planning process, some of its shortfalls, how modern estate planning overcomes them, and the pros and cons of modern versus traditional estate planning.
The advisor who understands the advantages and disadvantages of various modern and traditional estate planning techniques will be able to influence not just their client, but their client’s family for generations to come, bringing considerable value to both their client and to the advisory team.
Traditional Estate Planning
In today’s world, with a proliferation of non-probate assets, a more mobile society, and increased longevity, traditional estate planning often falls short of your clients’ goals. It does not provide for your client’s disability; it does not necessarily give what they have to whom they want, the way they want, and when they want; it will not avoid probate; and it too often ignores or inadequately deals with non-probate assets.
Where once defined benefit retirement plans for the worker and the worker’s spouse were the norm, today the norm is the defined contribution plan, which passes by beneficiary designation. Today’s planners must also deal with right of survivorship property, IRAs, and all sorts of annuities. Moreover, non-probate assets are typically a much larger portion of today’s client’s total wealth than they were in the days of traditional estate planning.
The proliferation of the types of no-probate assets, especially accounts with transfer on death or right of survivorship provisions, have likely led many of your clients to the false conclusion that they do not need to invest their time and money in estate planning to avoid probate and meet their estate planning goals. Nothing could be further from the truth.
Reliance on the most typical non-probate account provision, joint ownership with right of survival, for example, creates risks for the asset owner that are seldom considered.
Adding a joint or co-owner exposes the affected asset to the joint or co-owner’s liabilities, increasing the owner’s risk of being named in a lawsuit or losing the asset to a creditor of the joint or co-owner. There is also the risk that the joint or co-owner will not be able to resist the temptation to take or use the property while its original owner is still living.
With some assets, especially real estate, all owners must sign to transact business. If a co-owner (including an owner’s spouse) is unable to do so because of incapacity, a guardianship may be required to have someone able to act for the incapacitated owner.
With right of survivorship property, when one owner dies, full ownership usually does transfer to the surviving owner without probate; but what if that owner dies without adding a new joint owner, or if both owners die at the same time? Then the asset must pass through probate before it can go to the heirs. And because a will does not control most jointly owned assets, someone in your client’s family could become unintentionally disinherited when the property transfers automatically on death.
Planning Tip: Joint ownership with right of survivorship is often relied upon as a probate-avoidance mechanism, but its risks are often not even considered.
Moreover, avoidance of probate is not guaranteed with non-probate transfers. If “my estate” is listed as the beneficiary, or if a valid beneficiary is not named, the affected non-probate assets will have to go through probate, which will determine who gets what part of the estate. So, too, if a minor is the beneficiary, the asset holder will probably insist on there being a court-appointed and supervised guardian to receive the assets and manage them for the minor.
There is, however, one kind of non-probate asset system that has been demonstrated to work exceedingly well to meet all of the client’s estate planning goals. That is the revocable living trust. Property that is held in a client’s revocable living trust will bypass probate and can be used by the trustee to care for the incapacitated owner without court involvement or interference. Other non-probate assets that name the client’s revocable living trust as the beneficiary will also bypass probate.
Modern Estate Planning
Typically the cornerstone of a modern estate plan is a revocable living trust, because a properly funded revocable living trust can avoid both the huge expense of guardianship if the client becomes incapacitated and the expense and delays of probate when the client dies. But a revocable living trust plan is not a Ronco appliance – your client can’t just “set it and forget it.” Over time your client’s assets change, their family members’ circumstances change, and the law changes. There is truth in the saying, “There is nothing as certain as change.” Failure to fund a revocable living trust and keep it properly maintained is an almost sure fire way to get to a probate court.
The modern estate planning process, therefore, includes education, design, drafting of the documents, and implementation. Like traditional estate planning, modern estate planning includes medical directives. Today those include a health care power of attorney, a living will, and a HIPAA authorization. For asset management if the client becomes incapacitated, modern estate planning uses a revocable living trust, backed up by a durable power of attorney.
Planning Tip: A living will lets physicians know the kind of life support treatment your client would want in case of a terminal illness or injury. But its scope is limited, and in some states physicians are under no legal obligation to follow it. A health care power of attorney is broader; it lets your client give legal authority to another person in advance to make any health care decisions for your client—including the use of life support—should your client become unable to make them.
Revocable Living Trust
Planning for Disability
Planning Tip: Usually, several successor trustees are named in a trust, in the order in which the grantor wants them to serve. It is a good idea for your client to also have a durable power of attorney with the same successors named, in the same order, for even more ease of acceptance.
Why a Revocable Living Trust Works
Planning Tip: Most people name themselves as trustee of their revocable living trust so they can keep control of their assets, naming a successor to step in when they can no longer conduct business due to incapacity or death. Many include a corporate trustee as co-trustee for professional asset management.
As explained earlier, many assets (survivorship and pay-on-death property, life insurance, IRAs, defined contribution retirement plans, and annuities) are designed to pass outside of probate. That can result in an uncoordinated estate plan. Moreover, many clients—and even attorneys and professionals—fail to understand the importance of asset titling and beneficiary designations, and it is not unusual for a non-probate asset to become a probate asset because of a title or beneficiary designation that is incorrect or out of date.
Living trusts can avoid the need for probate altogether if the titles of all assets have been vested in the trustee and all beneficiary designations have been changed to the trustee of the trust. However, probate avoidance requires rigorous maintenance of titling and beneficiary designations. All it takes to require probate is for your client to open a bank or brokerage account in their individual name instead of as trustee. Also, because living trusts are valid in all states, the need for multiple probates can be eliminated.
Planning Tip: It is important to avoid any asset or beneficiary designation not being changed to the trust. If one is forgotten, or the valid reason for not putting it into the trust to begin with no longer exists, probate may become necessary. If that happens, the client’s “pour-over” will, a standard accompanying document to a living trust, will redirect the asset into the client’s trust. The asset may have to go through probate first, but it can then be distributed according to the client’s instructions in the trust.
Planning Tip: It is usually advisable to transfer a client’s home and all their other valuable assets to their trust to make sure they all become part of the unified trust-based estate plan.
Privacy and Confidentiality
Living trusts are not a matter of public record. While some states now do require some notices, a living trust provides more privacy than any other estate planning mechanism.
How to Distribute Assets to Heirs
Basic Estate and Gift Tax Rules
Of course, any exemptions that are not used in planning are lost when the client dies or tax laws change. Speaking of change, there is a major change scheduled for December 31, 2012.
Under current law, on January 1, 2013, the maximum transfer rate will increase from 35% to 55% and the unified exclusion will be reduced from $5,120,000 to $1,000,000.
What can we expect between now and 2013? This is definitely a political issue, and one that the House Democrats have targeted. Possibilities bandied about include a $5 million unified exclusion and 35% tax rate; $3.5 million unified exclusion and 45% tax rate; permanent repeal; the end of the unified exclusion; and a $1 million exclusion with graduated rates up to 55%.
Planning Tip: Some states have their own death/inheritance tax in addition to the federal transfer taxes. Often they begin at a much lower level than the current unified exclusions. So, while a client could be exempt from federal taxes, their estate may have to pay state transfer taxes. Make sure you know your state’s laws.
Law Offices of J.R. Hastings • 1003 Third Street, San Rafael, California 94901 • 415-450-6692