Estate planning is primarily about people and their desire to provide for their loved ones. Given proper motivation, most clients will devote the time and energy that is necessary to develop and adopt an effective estate plan.
The nontax reasons for estate planning. The primary objectives of most estate plans involve estate creation, support and care of a surviving family and the orderly transfer of property during lifetime or at death. This often involves providing for the care of minor children, support for disabled children and elderly parents, and protection of loved ones from creditors. For some individuals the motivation to plan their estates is found in a strong desire to assure the survival of a business, or to provide for their church or a charity.
Life insurance. Are there enough life insurance proceeds, liquid assets, and other sources of income to maintain the current living standards of your client’s surviving family? Unfortunately, all too many individuals remain underinsured. For those clients needing insurance to pay taxes, delaying the purchase of currently needed life insurance could be disastrous.
Valuation of today’s life insurance products is very unsettled. The IRS has not provided clear guidance and carriers use inconsistent methodology. The “net cash value,” “interpolated terminal reserve,” and statutory “book” reserve methods have all been used.
Coordination is important. It is often difficult, if not impossible; to design an effective estate plan without considering your client’s employee benefit programs and business disposition plans. Effective planning cannot be achieved unless there is an awareness of the interplay between the various strategies and techniques of estate planning, business planning, and employee benefits. For example, the liquidity needs of a business owner’s estate plan are directly influenced by whether the business is to be sold, continued, or liquidated. If the business is to be sold, then a funded purchase agreement may well provide all of the dollars needed for estate liquidity and family income. If the business is to be continued, then an employee benefit, such as split-dollar, could provide the necessary funds.
1. Revocable living trust
The revocable living trust (RLT) is a will substitute that can accomplish many estate planning objectives. It is an agreement established during the grantor’s lifetime that may be amended or revoked at any time prior to the grantor’s disability or death. The primary advantages of the RLT include: (1) providing for the management of grantor’s assets upon his mental or physical disability thus avoiding conservatorship proceeding; (2) reducing costs and time delays by avoiding probate; (3) reducing the chances of a successful challenge or election against a will; (4) maintaining confidentiality by not having to file a public will; and (5) avoiding ancillary administration of out-of-state assets.
Two additional documents are typically executed together with the RLT:
- The durable power of attorney authorizes the power-holder to act for the grantor when the grantor is disabled.
- The pour-over will functions asa “fail safe” device to transfer at death any remaining probate assets into the RLT, to undergo minimal probate as a means of clearing the estate of creditor claims, and to appoint guardians of any minor children.
DURING LIFETIME. The grantor establishes the RLT and typically names himself as the sole trustee. Following creation of the trust the grantor retitles and transfers his property to the trust. Because the grantor maintains full control over trust assets there are no income, gift, or estate tax consequences.
UPON DISABILITY. If the grantor becomes disabled due to legal incompetency or physical incapacity, a designated successor trustee steps in to manage the grantor’s financial affairs. Disability is determined under trust provisions providing a standard of incapacity (e.g., certification by two physicians that the grantor is unable to manage his financial affairs). Also, during the grantor’s disability, the holder of the durable power of attorney is authorized to transfer additional grantor-owned assets to the trust.
UPON DEATH.The RLT becomes irrevocable when the grantor dies. Under the grantor’s pour-over will, any probate assets not previously transferred to the RLT during lifetime are transferred to the RLT as part of the grantor’s residuary estate. Assets held in trust are then disposed of according to the terms of the trust. This can include an outright distribution to the trust beneficiaries, or the trust may contain provisions establishing separate tax-savings subtrusts similar to the marital and family trusts under the exemption trust will.
Although the RLT is not for everyone, it clearly offers substantial benefits for many individuals. The utility of a funded revocable trust increases with the grantor’s age, when there is an increased likelihood of incompetency or incapacity and the need for asset management.
Information required for analysis & proposal
Attorney Drafting Trust Instrument Must Know
1. Name of trust grantor.
2. Name of trust grantor’s spouse.
3. Name of individual who will be successor trustee.
4. Name of institution that will be alternate successor trustee.
5. Name of beneficiaries other than grantor.
6. Ages of minor beneficiaries.
7. Approximate size of grantor’s gross estate (i.e., will estate be subject to federal estate taxes or state death taxes).
8. To who, in what amounts, and when trust income is to be paid.
9. To who, in what amounts, and when trust corpus is to be paid.
Attorney Drafting Pour-Over Will Must Know
1. Name of testator.
2. Name of testator’s spouse.
3. Name of individual who will be personal representative or executor.
4. Name of individual or institution who will be successor personal representative or alternate executor.
Attorney Drafting Durable Power Of Attorney Must Know
1. Name of grantor.
2. Name of individual to be given the power.
3. Type of power to be given (e.g., general durable power of attorney or special durable power of attorney).
With large estates the QTIP trust provides a way to defer estate taxes by taking advantage of the marital deduction, yet “control from the grave” by directing who will eventually receive the property upon the death of the surviving spouse.
Under such a trust all income must be paid at least annually to the surviving spouse. The trust can be invaded only for the benefit of the surviving spouse, and no conditions can be placed upon the surviving spouse’s right to the income (e.g., it is not permitted to terminate payments of income should the spouse remarry). However, in order to qualify the executor must make an irrevocable election to have the marital deduction apply to property placed in the trust. This requirement not only gives the executor the power to determine how much, if any, of the estate will be taxed at the first death, it also provides great flexibility for post death planning based upon changing circumstances.
Our example assumes that in 2013 we have an estate of $11,500,000.
UPON THE FIRST DEATH, the estate is divided into two parts, with one part equal to $5,250,000 placed in a family or nonmarital trust (“B” trust in the chart). No taxes are paid on this amount since the trust takes full advantage of the $2,045,800 unified credit (i.e., the amount of credit in 2013 that allows each individual to pass $5,250,000 tax-free to the next generation). The remaining $6,250,000 is placed in the QTIP trust.
The executor may elect to have all, some, or none of this property treated as marital deduction property. Assume that in order to avoid appreciation of assets in the surviving spouse’s estate and obtain a stepped-up basis for additional assets taxed upon the first death the executor decides to make a partial election of $5,750,000 (i.e., of the $6,250,000 placed in the QTIP trust only $5,750,000 will be sheltered from estate taxes at the first death). This means that $500,000, the “nonelected” property, will be taxed at the first death. Although $200,000 of estate taxes must be paid, the remaining $300,000 will now be excluded from the taxable estate of the surviving spouse (any appreciation of this property after the first death will also be excluded). If authorized under the trust document or by state law, the executor can sever the QTIP trust into separate trusts.
UPON THE SECOND DEATH, the estate subject to taxation is limited to $5,750,000 (the amount remaining in the trust for which estate taxes were deferred). After paying taxes of $200,000, there remains $5,550,000. This amount, together with the $300,000 from the severed trust and the $5,250,000 from the “B” trust, are passed to the beneficiaries under the terms previously established in these trusts.
Information required for analysis & proposal
Attorney Drafting Will And Trust Must Know
1. Spouse’s name.
2. Children’s names.
3. Name of executor/executrix.
4. Ages of minor children.
5. Information regarding children of prior marriages.
6. Names and ages of other beneficiaries.
7. Trustee after testator’s death.
8. To whom, in what amounts, and when trust income is to be paid.
9. To whom, in what amounts, and when trust corpus is to be paid.
Life insurance trust
The trust is one of the most basic tools of estate planning. When made irrevocable and funded with life insurance, it accomplishes multiple objectives. For example, it can:
- Provide Creditor Protection
- Provide Income for a Family
- Provide Liquidity for Estate Settlement Costs
- Reduce Estate Taxes
- Avoid Probate Costs
- Provide for Management of Assets
- Maintain Confidentiality
- Take Advantage of Gift Tax Laws
DURING LIFETIME, it is possible for a grantor to establish a trust that will accomplish all of these objectives. The beneficiaries of such a trust are normally members of the grantor’s family and likely to be estate beneficiaries.
Once the trust is created, policies on the life of the grantor can be given to the trust. If no such policies are available, then the trustee would obtain the needed life insurance. In either case, funds are given to the trust, which, in turn, pays the premiums to the insurance company.
In order to take full advantage of the gift tax annual exclusion, the beneficiaries must have a limited right to demand the value of any gifts made to the trust each year. However, in order not to defeat the purpose of the trust, the beneficiaries should not exercise this right to demand. In this way, each year up to $14,000 per beneficiary, as indexed for inflation in 2013, can be given gift tax-free to the trust.
UPON DEATH, the grantor’s property passes to his estate. At the same time, the insurance company also pays a death benefit to the trust. If the trustee was the original applicant for and owner of the policies, or if the grantor lived at least three years following the gift of existing policies to the trust, the death benefit will be received free of federal estate taxes.
There are two ways the trustee can provide the liquidity to pay estate settlement costs. Either the trust makes loans to the estate, or the estate sells assets to the trust. In any event, guided by specific will and trust provisions the beneficiaries can receive distributions of income and principal.
Information required for analysis & proposal
1. Name of individual to be insured (usually trust grantor).
3. Date of birth.
Attorney Drafting Trust Instrument Must Also Know