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Estate Settlement Advice: Good Planning Builds Client Loyalty

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A large percentage of adult Americans do not have a will or estate plan, potentially leaving the state to decide how their property will be distributed upon their death. Advisors can fulfill an important role by working in concert with their client’s attorney and accountant to help bring clarity to the big picture.

Though a will is typically the first document considered in an individual’s estate plan, more than 55% of adults in the United States do not have one, according to a March 2007 Martindale-Hubbell survey conducted by Harris Interactive. Of those individuals without wills, 24% believe they don’t have enough assets to justify planning, 10% don’t want to think about dying, and 9%–double the percent from just 3 years ago–do not know whom to talk to.

Don’t assume clients know

People tend to forget they amass wealth from homes, pensions, insurance policies, investments and 401(k)s. Advisors can provide assurance and clarity that estate planning is worth the trouble by assuring the desired distribution of property and reducing or eliminating tax liabilities for married couples.

Unintentional results can occur if documents aren’t reviewed every 3 to 5 years or when a significant life event occurs. Advisors can help clients pull together “must-have” documents and find forgotten “orphaned assets.” And by offering duplicate documentation retention, advisors can develop long-term relationships with heirs.

By not updating beneficiary designations on life insurance, IRAs or annuities, clients might unintentionally leave assets to ex-spouses or others. Reviewing documents with clients offers the opportunity to address settlement issues and assures updated beneficiary selections. If one spouse has the majority of assets, discuss account balancing and the inclusion of children from previous marriages. Otherwise, assets could go automatically to the current spouse.

Life insurance policies are good tools to address liquidity issues and advisors can encourage clients to explore the benefits of establishing irrevocable life insurance trusts. These trusts are commonly used in estate planning to avoid estate taxation on death proceeds, to shelter property from creditors and protect survivor income.

Uncertain tax laws

The 2001 Economic Growth and Tax Relief Reconciliation Act mandates an estate tax exclusion increase from $2 million in 2008 to $3.5 million in 2009 to infinity in 2010. EGTRRA repeals the Federal Estate Tax for the year 2010. Unless Congress takes action before Jan. 1, 2011, the tax will revert to an exclusion of $1 million; and the maximum rate will go from the current 45% back to 55%. There will also be a significant change in the method for determining the cost basis of capital assets transferred at death from the current step-up basis to a modified carryover basis.

In 2011, the first baby boomers will be enrolling in Medicare. As the demand for government services rise, it becomes less likely Congress will act to eliminate federal estate taxes in 2011 and beyond.

While we can’t predict Congressional action, government program costs or budget surpluses and deficits, advisors can offer guidance based on current taxation. Advisors should create estate plans with sufficient liquidity to allow clients’ estates to pay the federal estate tax should Congress preserve it. If Congress ends up repealing it, clients simply leave additional liquidity for their survivors or favorite charity.

Financial advisors can also educate their clients about 2010 tax legislation governing the conversion of traditional IRAs to Roth IRAs. By doing such a conversion, clients can avoid required minimum distributions, allowing their savings to grow income-tax free. At conversion, clients will have to pay income taxes on accumulated earnings and tax-deductible contributions, but these taxes don’t become fully due until 2012 on conversions made in 2010. By paying the conversion tax, clients effectively prepay income taxes for their heirs without owing gift tax; and they reduce the size of their taxable estate.

Traditional IRAs can offer current tax deductions and tax-deferred growth. Withdrawals are subject to ordinary income taxes. Roth IRA contributions are not deductible, but qualified withdrawals and earnings are income-tax free, making Roths a superior choice for many from an estate planning perspective.

Irrevocable life insurance and credit shelter trusts

Estate taxes are assessed based on the value of estate assets. Many clients can benefit by rearranging them. One popular method uses an irrevocable life insurance trust. Created during a person’s lifetime, the trust is designated as trust property. Excluded from the grantor’s estate, the trust reduces clients’ taxable estates and potential estate tax liabilities. To prevent inclusion, grantors should avoid all incidents of ownership.

Clients are often unclear about funded versus unfunded ILITs. Funded trusts have income-producing assets transferred into them, which will pay the premiums on insurance policies from earned income. Unfunded trusts usually just own an insurance policy and the grantor makes annual gifts to the trust with which the trustee can pay premiums.

Contributions to the trust are future versus present interests and typically do not qualify for the $12,000 (2008) annual gift-tax exclusion. The Crummey provision grants beneficiaries limited power to withdraw certain sums from the trust for a short time after the grantor makes a contribution. Crummey holders should be actual trust beneficiaries; however, tax courts have allowed annual gift tax exclusions for contingent beneficiaries who were given withdrawal rights.

If the insured gifts an existing life policy to an ILIT and dies within 3 years of the transfer, the policy proceeds will be included in the insured’s estate. It is better if the trustee uses cash in the trust to purchase a new policy on the insured’s life, because the death benefit will generally be excluded from the client’s estate.

Second-to-die or survivor life policies do not pay proceeds until both spouses are deceased, which is when the death taxes generally become due. Premiums on a single second-to-die policy are generally lower than the combined premiums on two individual policies, allowing a couple to obtain a larger face amount of insurance. But a second-to-die policy should not be recommended if a surviving spouse needs the policy proceeds to live on.

The credit shelter trust leverages each spouse’s applicable credit amount, allowing the surviving spouse to use the assets. When the first spouse dies, that person’s applicable exclusion amount ($2 million in 2008) is placed in the credit shelter trust and is not taxed then or upon the surviving spouse’s death, even with appreciation. The surviving spouse has lifetime access to income. If the estate of a married couple is smaller than the applicable exclusion amount and is not likely to exceed this amount in the future, the estate will generally not benefit from a credit shelter trust.

The first step

Take time to educate clients about estate planning as a way to potentially avoid probate, pass on estates quickly, reduce taxes, protect assets from creditors, and provide for loved ones. Remember, for the majority of Americans, it will probably be their first step.


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