Estate Planning - Who Needs IT?
By Angela Polk, CPA

Estate planning means different things to different people. Some think of it only in terms of avoiding estate taxes. But it means much more than that. In the simplest of terms, it is a process through which you determine how you want personal and financial matters handled at your death. Your estate will generally consist of probate and non-probate assets. The probate estate consists of those assets which will be transferred under the terms of your will or by local intestacy laws, if there is no will. The non-probate estate consists of any assets that are transferred at death by any means other than your will, such as retirement accounts with designated beneficiaries, life insurance policies with you as the insured and designated beneficiaries, certain revocable trusts for which you are the grantor, jointly held property, etc. Estate planning will involve determining how you want to handle all of your assets.

As a part of this process, it is important to focus on goals and objectives with respect to family, business, investments, home, and any other assets. Saving taxes and reducing estate administration expenses are not the only motive for estate planning. You will find with the changes in the estate tax laws, fewer and fewer people are impacted by estate tax. However, people will continue to be motivated to provide financial security for loved ones, provide for a favorite charity, want succession planning for their businesses, provide a means of caring for loved ones who are disabled mentally or physically, provide a means to take care of loved ones who are not financially responsible, or establish ways to avoid disputes amongst the survivors, etc. The estate planning process should be viewed as a combination of minimizing the tax consequences (income, estate, and gift), if any, in conjunction with accomplishing your goals for disposing of your assets.

As a part of the process, you should review how your assets are actually titled. Disposition of assets held jointly (meaning with rights of survivorship) with a spouse or other individual are not controlled by your will. Such assets are not available to pay specific bequests. Titling of assets can also have a substantial impact on estate tax liabilities. Imagine a couple, with assets of $1 million each, titled as joint with rights of survivorship. The first to die has in effect left his/her million all to the surviving spouse in early 2004. The threshold before an estate became taxable in 2004 was $1.5 million. The surviving spouse dies a few months later. By not sheltering the $1 million of the first to die, the second to die was left with a taxable estate and the estate will pay tax at a rate of 45% on $500,000 (representing the combined estate of $2 million, less the $1.5 million unified credit amount). The tax is $225,000. With proper planning with titling of assets, etc. there would have been no tax paid at all.

Updating the beneficiary designation forms for life insurance policies, annuities, individual retirement accounts, and/or pension or profit sharing benefits is an important part of any estate plan. For example, if you have married a second time and failed to change the beneficiary properly from your former spouse to your current spouse on retirement plan benefits, the former spouse gets the benefits, and the current spouse gets nothing. Reviewing beneficiary designations can obviously be a very important part of estate planning for reasons other than tax savings.

Liquidity analysis also plays a role in estate planning. Wealth may be tied up in real property, closely held businesses, partnership interests, and other forms of investments not easily converted to cash to pay the taxes. Planning for liquidity not only involves planning for sufficient cash to pay any taxes, but also to pay estate administration expenses. Liquidity analysis also involves planning for the cash-flow needs of family members after the death. Imagine a sole wage earner passing away leaving a spouse with a child to survive without those earnings and no other significant assets. An important part of the planning process means developing a solution to any liquidity problems that exist, such as beneficial use of insurance.

Business succession planning also plays a very important role in estate planning. A business owner needs to determine what control he/she wants over the future management of such a business. Are buy/sell agreements necessary? Should insurance be carried on each of the owners to help fund a buy-out at the death of one? If insurance is desired, who or what entity should own the policy and pay the premiums? Is gifting of interests in the business warranted now? Is the current structure of the business the most beneficial? Did you know that the structure of the closely held business can be designed to help reduce estate and gift taxes? Depending on the organizational structure and other factors, it may be possible to obtain substantial discounts in the value of the business for tax purposes.

Planning for charitable inclinations has a role too. Is it better to reap the income tax benefits now, or at death? Would the use of charitable remainder trusts help accomplish those charitable goals and enable the donor to retain an income stream? How about a charitable lead trust that allows charity an income stream, but passes the remainder interest to grandchildren, children, etc.? Is it possible to use a retirement account to help fund those charitable goals without negative income tax implications? The planning process enables you to answer these questions.

Asset protection is also a part of the overall estate planning process. Whether it is protection from creditors, protection in divorce situations, or simply protection and support of a loved one from themselves because they are not capable of handling their financial affairs, asset protection is an important non-tax reason for estate planning. Trusts are a popular tool used in asset protection.

Trusts are effective tools in the overall estate planning process and can play many roles. As mentioned above, they are an effective tool for asset protection. Trusts can be used to reduce estate tax. Testamentary trusts, such as a credit shelter trust (also known as a By-Pass trust), may be created with the first to die that will allow continued support for the spouse, but allow the principal of the trust to be excluded from the estate of the second to die, thereby effectively using the first-to-die’s unified credit amount. Wealth replacement trusts are a favorite of insurance salesmen. Such trusts are designed to own a policy on an insured, pay the premiums, and be excluded from the insured’s estate.

The insurance proceeds of such trusts can be used to replace what is lost in estate tax, provide liquidity, etc. Dynasty trusts can be used to maintain control over the assets of loved ones for their lifetime and pass the benefits down to another generation and still maintain control. Trusts are also used as a means to support and take care of the mentally and/or physically disabled loved ones for their lifetime. Trusts are unique in that they can be used throughout the estate planning process to meet various goals, such as making charitable contributions, providing asset protection, or avoiding estate taxes, etc.

A part of the process may involve designing an effective gifting program to help transfer wealth down through the generations. Such a gifting program may involve established techniques that transfer wealth, while reducing the overall impact on gift and estate tax. It may be as simple making gifts every year directly to an individual, limited to the annual exclusion amount (currently set at $11,000 per individual). The annual exclusion is the amount by which a donor may give direct gifts to any other individual, and it will not impact his/her unified credit amount mentioned previously.

A gifting program may involve more sophisticated techniques, such as those that involve accepted valuation discounts that enable the donor to transfer assets at reduced costs. For instance, a donor and his spouse set up a family limited partnership with assets from a family business valued at $1 million and 100 units. They start a gifting program with the limited partnership units. One unit’s share of the value would be $10,000. Depending on the type of business, assets involved, etc., a qualified appraisal of the unit would establish a discounted gift tax value that would involve minority
and/or marketability discounts. If the appraisal was $4,500, the donor would be able to effectively transfer $5,500 in value without it affecting the utilization of the $11,000 annual exclusion or the lifetime unified credit amount. A gifting program may also utilize other transfer vehicles, such as qualified personal residence trusts, Section 529 College Savings Plans, charitable trusts, grantor retained annuity trust, etc.

The process involves much more. The will is used to direct who pays the liabilities and the estate tax. Should a person receiving a specific cash bequest pay their share of the tax, or should the residual estate bear the burden of such tax? When trusts are involved, it is necessary to address the apportionment of the estate tax and whether the trust should reimburse the estate for its share of the taxes or be able to reimburse more than its apportioned share. Selection of personal representatives and/or fiduciaries is also an important part of your planning, as well as making adequate provisions for a successor. You should also address how they should be compensated. Consideration also needs to be given to what powers the representatives/fiduciaries are to be granted. Certain powers have negative estate tax implications to the power holder. All are important steps in the process.

As you can see, there are many things to consider in the estate planning process, and reducing estate tax is not the only reason to participate. As noted, it is about a process through which you determine how you want personal and financial matters handled at death. It is about developing plans that meet your goals and objectives for handling assets after your
death.