Why Everyone Needs an Estate Plan, Part 1: The Basicsby
The biggest mistake people make is thinking that estate planning is only for the ultrawealthy. That couldn’t be further from the truth.
The fact is that we are all going to die, and if you don’t leave some sort of instructions on how your estate will be distributed, then the government will step in and disburse your estate in accordance with state law. Simply writing down your wishes, in some states, is all that you have to do.
In this article, we are going to explore the world of basic estate planning.
When I meet with a client who wants to do estate planning, the first thing I do is see if they are subject to the estate tax. The tax professional part of me wants to protect all assets from the reach of the government. The fact of the matter is that the estate tax floor is $5.49 million in 2017. That is almost $11 million for married persons. Most people don’t have anything close to that amount in assets, so the estate tax is not an issue.
Why I Prefer Trusts Over Wills
Once the tax obligations are met, I then plan for death. There are a few ways that you can go. Most people know about wills, which are simply instructions to the probate court letting them know what to do with your assets. The downside to a will is that they need to go through a probate court and can be contested.
For example, let’s say there is someone who you want to exclude from your estate’s assets. That person can then contest the will with the state, and low and behold, he or she could gain rights to your property. For that reason alone, I like to use trusts.
A revocable living trust is my estate planning method of choice for those who are not subject to the estate tax. Revocable means that it can be changed, living means you are alive, and trust is just a legal contract. There are three parties that make up a trust:
- The grantor – the person making the trust.
- The trustee – the person who controls the assets.
- The beneficiary – the people or entities that will benefit from the assets.
Because you are alive, you are the grantor and the trustee. You would then need to name a trustee for when you die. Typically, a contingent trustee can be anyone who you trust. It can be your spouse, your children, a trusted friend, your attorney, or even a corporate trustee. It should be someone who will carry out your wishes. A contingent trustee shouldn’t be one of the beneficiaries.
What I like most about a trust is that you have ultimate control over your assets, even after you die. For instance, let’s say that the beneficiaries are your children. No one under the age of 18 should have control of assets. When I was 18, if I would have gained access to large sums of money, I would have bought a sports car or something like that, not thinking about my future. With a trust, I can name as beneficiary my minor children, but I can control when they get the assets and under what conditions.
For example, if I want them to inherit 25 percent of my assets at age 24, I can additionally state that in order to access the assets, they must be full-time students and have a B average. Note that it is common to put a drug and alcohol provision in your trust for minor children. You could say that they can have the assets unless they are addicted to drugs and alcohol as witnessed by the trustee.
Another reason to use a trust is that it is a legal document and doesn’t go through the probate process, nor is it made public. Every estate will go through some form of probate.
For example, if you die intestate (without an estate plan), the probate court will determine the manner in which your assets are disbursed. Probate proceedings are public. All of the creditors are alerted that you have died, and they show up at this hearing to make claims against your estate. If your assets are in a trust, the creditors will have a hard time obtaining those assets.
With a trust, you will also have something called a pour-over will, which encompasses all the assets that the trust doesn’t capture. This can be any assets that are not titled to the trust. Normally, this should be a small portion of your assets because most would be caught by the trust.
Once the assets are planned for, you have to take into account other considerations. If you have minor children, you need to name a caretaker. This is typically done in the will or pour-over will. This same caretaker would also be the contingent beneficiary of the trust. The caretaker would only inherit the assets should he or she have to care for your minor children.
Another thing that you have to think about is whether to have a do not resuscitate (DNR) document or a medical surrogate. I have a medical surrogate who can make decisions for me based on my condition. A DNR gives instructions to medical-care providers that they are not to try to save your life regardless of your condition.
Some common terms to become familiar with in estate planning include intestate, as I mentioned before, which means dying without a will or trust. Testate means that you have an estate plan. An executor or executrix are the people responsible for the estate.
Now that we have the basic estate plan, let’s go a little further. There are different reasons to give money before your death. One of them is to remove assets from a taxable estate.
Even without a taxable estate, there can be valid reasons to remove assets. The most that you can gift to any one person in a year is $14,000. Any more than that and you would have to file a gift tax return.
You can give in your lifetime up to your estate tax exemption. In 2017, that would be $5.49 million if you are not married, and just shy of $11 million if you are married and elect portability. With portability, you combine both spouses’ estate tax exemptions. If you give over this amount in your lifetime, then you must pay a 40 percent gift tax on the additional amount.
If you are married, you can elect to split your gifts, meaning you can give $14,000 to one person, and then your spouse can give another $14,000 to the same person. With gifts, you do lose control of the assets; the recipients can use the money however they want, unless of course you put it in a trust.
There are ways to skirt the gifting rules. For instance, some people do self-canceling intrafamily loans. This allows a family to loan a sum to a family member with the lowest applicable federal rate. At death, the note would cancel, meaning the repayment would cease. It would be common for someone to make a loan of, say, $500,000 at age 75 with a balloon payment in 15 years, self-canceling at death. This would accomplish removing assets at a larger clip than $28,000, without a repayment.
This is just the tip of the iceberg. There are a ton of things that you can do within an estate plan. But it is important to have some sort of plan for death. If you don’t, then the disbursement of your estate will be determined by the government.
Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...