Estate Plan

- Investing and Planning - RealEstates

Estate Planning

Estate planning is very important and requires some time and effort. Without a comprehensive estate plan, a significant part of the work you've done throughout your life, both at your job and with your investments, can be lost or given to unintended beneficiaries.
The purpose of estate planning is to prepare to transfer your assets to others upon your death. Estate planning allows you to specify where each of your assets goes upon your death. This involves deciding who the beneficiaries will be, what each will get, and how to perform those transfers with the minimum tax consequences, while making sure that the estate has enough liquidity to meet its obligations.
Estate planning used to be of importance only to the very wealthy. But even middle-income earners who do a good job investing throughout their lifetimes can benefit from estate planning. Regardless of how much you have, it's important to understand the basics of estate planning so that your financial and philanthropic goals are met even after you're gone.
The level at which estate taxes begin is set to increase over the next several years: $1 million in 2003, $1.5 million in 2004-5, $2 million in 2006-8, $3.5 million in 2009, and a full repeal of the estate tax is currently planned in 2010. (Of course, this is subject to change, as any tax law is.) Estate taxes become very expensive at about $2 million, and can reach as high as 55% for very wealthy individuals! Before going any further, it is important to point out that property laws can vary widely from one state to another, and that estate planning is a very complex subject. This section is intended to inform rather than to advise, and should be used only as an introductory guide. As you begin the estate planning process, be sure to consult with an estate attorney and financial professional in your state.

Net Worth

- The first step in estate planning is to figure out what you have (or guess as accurately as possible what you will have when you die). Your estate includes all of the assets you own-such as investments, real estate and other property, cash retirement accounts, life insurance, personal possessions, interest in a business, and anything else of value. If you have any debts, these should be subtracted from your assets to determine your overall net worth.
Keep in mind that the seemingly simple concept of 'ownership' isn't always so simple. Sometimes an asset is owned by more than one person. For example, 'joint tenancy with right of survivorship' means that if one owner dies, the other becomes the full owner. 'Tenancy by the entirety', which only exists in some states, covers property owned jointly by spouses. And some states recognize 'community property' between spouses as distinct from separate property. Laws vary from one state to another, and the laws can be confusing, so be sure to know which laws apply to you if you own any shared property.
Once you've determined what you own, estimate how much you'll have to pay in taxes. In addition to federal taxes, some states have estate taxes (paid by the benefactor) and some states have inheritance taxes (paid by the beneficiary). Once you've estimated the tax impact, you'll have a better idea of how much your beneficiaries will actually receive.

Wills and Living Trusts

Wills and living trusts perform almost the same function: specifying who gets each of your assets when you die. Just about everyone will benefit by having one or the other. If you have neither when you die, your assets will be distributed to your family according to the laws of the state you live in, which quite possibly won't be the way you want them divided up. That distribution would be performed without regard to each beneficiary's financial situation or ability to manage the assets. Furthermore, if the state can't find your relatives, the assets could end up going straight to the government. Additionally, if you have children, you'll want a will, because that's the only legal way to transfer guardianship of minors.
The most important difference is that property bequeathed through a will must go through a process called probate (unless the value of the assets is very small), while property bequeathed through a living will bypasses this step. In probate, the government makes sure that your will is authentic and valid, that your debts, taxes, and legal fees are paid, and that your assets are cataloged and appraised, before the assets are distributed. This process often takes more than a year.
By avoiding probate, a living trust gets your assets distributed significantly more quickly than a will does. It also offers a higher level of confidentiality, as probate proceedings are a matter of public record. Additionally, trusts are usually harder to contest than wills.
On the downside, a living trust takes longer to put together than a will, and requires more ongoing maintenance. Although both a will and a living trust can be modified or revoked at any time before you die, such changes are slightly more time-consuming for a living trust. Additionally, assets that you want to move to a living trust, such as real estate and bank or brokerage accounts, have to be retitled.
So which is better, a will or a living trust? That depends on your situation. The biggest factor is the size of the estate. Very wealthy individuals can save their beneficiaries more by opting for a living trust to avoid probate than those with smaller estates could. A secondary factor is the extra ongoing work that a living trust requires. This is why experts say that those under age 60 and in good health are probably fine with a will. One other factor is the type of assets in the estate. If you own a small business that you don't want tied up during probate you might prefer to have a living trust.
Another option is to have both a living trust and a will. Some people specify all of the important assets in the living trust, and use a will to cover everything else. If the value of the items in the will are below a specific amount, probate is not necessary. This amount varies from state to state, but is generally very low. Another option is to have a "pour over will", which specifies that any assets not in the trust at the time of death go into the trust. (These assets would, however, still be subject to probate.) Finally, as we mentioned, you will want a will if you have children, so you can specify a legal guardian and change it easily later if circumstances warrant.

Wills

Be explicit in your wishes. Most states don't let the executor guess what you wanted if it's not specified, so be sure to spell it out in the will.
In the previous section we emphasized that probate can be avoided by choosing a living trust rather than a will. If you do opt for a will, you might still be able to partially avoid probate. One way is by jointly owning property with your spouse (or children). Another way is to have a life insurance policy payable to a specific person, rather than to your estate.
Assets that you bequeath to your spouse are tax-free.
The choice of an executor to carry out your instructions is very important. Be sure to select someone you can trust. Most people choose their spouse or a close friend or relative. For complex estates, some people choose an attorney to be their executor.
Be sure that your will is in a safe place. Tell your executor, spouse and other important beneficiaries where it is. Have a copy in another safe place, just in case. If it can't be found, it will be the same as if you didn't have a will at all.
Although you are able to specify the distribution of nearly all of your assets, there are a few exceptions: life insurance, annuities, and retirement plans such as pensions, IRAs and 401(k)s.
Once you have your will set up, it's important to talk to your beneficiaries about it. While the conversation might be a little uncomfortable, it will benefit them in the long run.

Living Trusts

With a living trust, some or all of your assets are transferred to the trust. The management of the trust is handled by a trustee that you designate. If you designate yourself as trustee (as is typically done), then you continue to own the assets (and pay any appropriate taxes on them) until you die. This is why a living trust is sometimes called a revocable trust, or an inter vivos (Latin for "between the living") trust. You also designate a successor to act as trustee when you die.
Setting up a living trust is a two-step process: filling out the necessary paperwork, and then transferring ownership of the assets to the trust.
Spouses are usually equal trustees, meaning that the surviving spouse retains his/her trustee status after the first spouse dies. Some married couples set up a single joint living trust to cover them both, but this limits the ability of the surviving spouse to make changes after the first spouse dies.
The choice of a successor trustee to carry out your instructions when you die is very important, even more important than choosing an executor of a will, because unlike an executor, the trustee will be managing your assets without court oversight. Most people choose their spouse or a trusted friend or relative.
Since a living trust doesn't require that your creditors be notified (as a will does), a creditor could make a claim against the beneficiaries of the trust well after you die.
Be sure that your living trust is in a safe place. Tell your executor, spouse and other important beneficiaries where it is. Have a copy in another safe place, just in case. If it can't be found, it will be the same as if you didn't have it at all.
Although you are able to specify the distribution of nearly all of your assets, there are a few exceptions: life insurance, annuities, and retirement plans such as pensions, IRAs and 401(k)s.
Once you have your living trust set up, it's important to talk to your beneficiaries about it. While the conversation might be a little uncomfortable, it will benefit them in the long run.

Irrevocable Trusts

As mentioned above, a living trust is also called a revocable trust, because it enables the person who sets up the trust to subsequently make changes to it, including revoking it. This section discusses irrevocable trusts, which are similar in that they're also legal entities that hold assets for its beneficiaries and act as instructed by their grantors, but different in that the contributions are irrevocable and therefore cannot be taken out of the trust by the grantor. Given this downside, why would anyone opt for an irrevocable trust rather than a revocable trust? Because they offer tax advantages that revocable trusts don't, for example by enabling you to give money and assets away even before you die.
Of course, you can give away money while you're still living even without a trust. However, there will be tax consequences if the amount is sufficiently large. You can give any amount to your spouse tax-free, and you can give up to $11,000 per year to anyone else without incurring a tax, but above this level you will incur a gift tax, and the amount will usually be the same as the estate tax you would have paid if you bequeathed the gift upon your death. Irrevocable trusts are a way to further reduce the bite of estate The rest of this section describes some of the more common types of irrevocable trusts.

CRT Charitable Remainder Trust - The beneficiaries receive the income and the charity receives the principal after a specified period of time. The grantor avoids any capital gains tax on the donated assets, and also gets an income tax deduction for the fair market value of the remainder interest that the trust earned. In addition, the asset is removed from the estate, reducing estate taxes down the road. While the contribution is irrevocable, the grantor may have some control over the way the assets are invested, and may even switch from one charity to another (as long as it's still a qualified charitable organization).
CRTs come in three types: charitable remainder annuity trust (which pays a fixed dollar amount annually), a charitable remainder unitrust (which pays a fixed percentage of the trust's value annually), and a charitable pooled income fund (which is set up by the charity, enabling many donors to contribute).

Charitable Lead Trust

This is similar to a Charitable Remainder Trust, except that the charity receives the income and the beneficiaries receive the principal after a specified period of time.

Credit-Shelter Trust (also called a Family Trust or a Bypass Trust) - This is designed to enable a married couple to effectively double the amount they can protect from estate taxes by setting up a trust with an amount equal to the estate tax exemption ($700,000 in 2002). There are some important restrictions on such trusts, most notably the fact that they can only be funded with assets that the spouses own separately rather than jointly (although retitling circumvents this limitation).

Generation-Skipping Trust (also called a Dynasty Trust) - This enables a grantor to transfer up to $1 million (or $2 million for a married couple) to family members at least two generations younger (usually grandchildren). Grants in excess of this amount are subject to a 55% generation-skipping transfer tax.

Irrevocable Life Insurance Trust - This enables the shielding of life insurance from estate taxes.

Qualified Personal Residence Trust - This enables the shielding of a home from estate taxes.
Many of the same suggestions for living trusts also apply for irrevocable trusts: get help from a qualified professional; keep all the relevant documentation in a safe place; choose the trustee carefully; and talk to the beneficiaries about the trust.
Future Healthcare Decisions - Although strictly speaking it's not part of estate planning, another important activity is making decisions about future healthcare. A living will is a description of how you want future healthcare decisions handled in the event that you become incapacitated and are unable to make those decisions on your own. Although this possibility isn't pleasant to think about, it's important to address this issue so that your wishes can be followed even if you aren't able to communicate them at that time. Living wills specify such things as the use of life-sustaining procedures and artificially provided nutrition.
"Durable power of attorney" is a status which you can confer to another person (such as a spouse or other close relative), enabling them to make decisions on your behalf if you can't make them on your own.
An "advance directive" (sometimes called a "healthcare directive") combines a living will and durable power of attorney, either in one document or two separate ones.
In addition to an advance directive, you might also want to consider conferring power of attorney for your assets, to be sure that your financial wishes can be acted on in the event that you become incapacitated.
If you don't have any of these documents set up, the state laws will make these important decisions for you if you ever can't do it on your own.