Clients and potential clients are often deterred from doing estate planning by a perception that the process is complicated and involved. The complexity of a client’s estate planning usually depends on where the client is on the estate planning hierarchy, which may indicate the planning isn’t as complicated as first thought.
Factors impacting a client’s position on the hierarchy include:
? The size of the client’s estate. Generally, the larger is the estate, the higher up the estate planning hierarchy the client will be.
? The client’s estate planning goals. The more things that clients want to accomplish as part of an estate plan, the farther up the estate planning hierarchy they will be.
? The client’s planning tolerance. For some clients, a simpler plan is a higher priority than saving the last penny in taxes or trying to cover every possibility. Many clients eventually reach a point of estate planning exhaustion where the benefits of additional planning do not justify the time and cost required.
The estate planning hierarchy consists of 4 levels. The number of clients on each level diminishes the higher up the hierarchy you go while the complexity increases.
? Level One–Basic. The first level consists of basic estate planning documents: a will, durable power of attorney, health care power of attorney and a living will. Almost every estate plan will require these documents, regardless of the client’s situation.
The client’s situation will impact the complexity of the will. For a single person with no children and few assets, an uncomplicated will may be sufficient. A married client with a taxable estate may require a will designed to minimize estate and generation-skipping taxes.
? Level Two–Enhanced Basic. Many clients may need to move up a level on the estate planning hierarchy to simplify the estate administration process for their heirs using a revocable trust or to give heirs the flexibility needed to take retirement plan distributions.
Most clients have heard horror stories about the time and cost of the probate process and how revocable trusts can simplify the transfer of assets. While both the horror stories and benefits of revocable trusts may be exaggerated, attorneys in many states recommend revocable trusts as part of standard estate planning for their clients.
Retirement plan assets, whether in a qualified plan, an IRA or 403(b) account, often are a client’s largest asset other than their house. The benefits of tax-deferral on inherited retirement assets can be lost if an heir decides to not take distributions over his life expectancy. Loss of tax deferral can also result if the assets are left to a trust that does not qualify as a designated beneficiary or if the trust contains provisions that reduce the distribution period. So many attorneys and advisors recommend using a separate trust designed to qualify as a designated beneficiary to receive retirement plan assets, even if a revocable trust is also part of the estate plan.
? Level Three–Basic Estate Tax Strategies. Level three is the first level that deals with estate taxes. The tools and strategies may incorporate 4 basic strategies to deal with estate taxes. These strategies defer and minimize estate taxes without using advanced planning techniques and then provide cash to pay any taxes due. Among the strategies:
(1) Using the estate tax exemption equivalent through the creation of a bypass or credit shelter trust.
(2) Using the gift tax annual exclusion to transfer wealth to children or other heirs (or trusts for them).
(3) Adding marital deduction planning. The type of marital deduction planning may vary (including an outright bequest to the surviving spouse, a general power of appointment trust, a QTIP (qualified terminable interest property) trust, and a QDOT (qualified domestic trust). Regardless of the type of planning, the objective is to defer estate taxes until both spouses have died.
(4) Purchasing life insurance, which is normally owned by an irrevocable life insurance trust. This strategy can provide access to cash for payment of the taxes without having to sell estate assets or borrow. If the policy is owned by ILIT from the time the policy is issued, the death benefit is excluded from the insured’s estate. (Transferring a policy to an ILIT requires the insured to survive 3 years from the transfer for the proceeds to be excluded from the estate.)
? Level Four–Advanced Estate Tax Strategies. Clients on the top level of the estate planning hierarchy have significant estates, generally at least $5 million. Estate planning for these clients usually involves the creation of sophisticated trusts and other entities to manage and reduce estate taxes. Clients in level four are candidates for “squeeze and freeze” techniques and charitable planning.
“Squeeze and freeze” techniques take advantage of entities and trusts that, under current law, can be used to reduce the value of assets included in the client’s estate (“squeeze”) and then transfer the right to the appreciation on the assets out of the estate (“freeze”). These include the use of entities that may qualify for valuation discounts, such as family limited partnerships; trusts, such as grantor retained annuity trusts and qualified personal residence trusts that allow transfers to family members with retained interests; plus other techniques, such as sales to intentionally defective trusts.
Charitable planning techniques include charitable remainder trusts, charitable lead trusts, charitable gift annuities and private foundations.
While clients at any level may not have sufficient planning tolerance to do all of the planning appropriate for that level, the amount of planning that could be done for clients on level four requires a greater level of planning tolerance. Often the planning is done in phases and spread over several months or years.
The estate planning hierarchy provides a guide to the amount and type of estate planning a client may require. While clients may resist at any level, techniques above the client’s level are more likely to meet with resistance.
Bruce A. Tannahill, JD, CPA/PFS, CLU, ChFC is a member of the board of directors of the Society of Financial Service Professionals, Newtown Square, Pa. He can be reached at .