Category: Alerts

In the face of litigation, there are proven strategies that will ethically preserve your wealth. Your most powerful weapons will be a variety of estate planning tools, including the Family Limited Partnership, the Irrevocable Life Insurance Trust, the Children’s Trust, and Foreign Asset Protection Trusts.

THE CHILDREN’S TRUST

One way to place asset beyond the reach of potential plaintiffs is to transfer property to your children. Like most parents, you’ve probably been acquiring an estate not only for your benefit while you are alive but also to help your children and grandchildren. The IRS will allow you to give up to $15,000 per person per year absolutely free of gift tax. If both spouses join in the gift, you can give up to $30,000 per person a year, gift tax-free. (As indexed for inflation.)

By giving property to a Children’s Trust each year, you can shift the income from your high tax bracket to the lower tax bracket of your children or grandchildren who are age 14 and older. Unfortunately, children under age 14 must pay most of their taxes at the same rate as their parents.

Once the Children’s Trust is sufficiently funded, it can pay the cost of a child’s education. That way the expenses are paid with discounted tax dollars. (However, remember that parents or grandparents can pay tuition costs directly as a tax-free gift.)

If you own a business, you can gift its equipment and furniture to the Children’s Trust and have the trust lease it back to the business. Under this plan, the business gets a legitimate tax deduction, and the rental income is earned by the trust potentially at lower tax rates. Plus, the benefit of the depreciation is given to the trust.

Having a Children’s Trust or a Family Limited Partnership also promotes family investment values. The children now have an identifiable stake in the family’s financial success. It goes a long way toward helping them understand the value of money and wise investments.

How does the Children’s Trust protect assets? Well, all assets transferred to the trust are no longer in your name or owned by you, and are, therefore, outside the reach of plaintiffs or creditors, whether yours or your children’s. However, you can’t transfer assets when you have pending claims or lawsuits against you. Transfers at that time will violate something called the fraudulent transfer law. This will allow the courts to ignore the gifts to the trust and permit your creditors to seize them.

The Children’s Trust also has probate avoidance and estate tax reduction benefits. All assets transferred to the trust are no longer a part of your estate. That means when you die, those assets will not go through probate and they will not be subject to federal estate tax.

If you had three children and gave each of them $30,000 in trust per year for 10 years, that would amount to $900,000 of tax-free gifts to their trust. At death, none of that $900,000 would be subject to federal estate tax.

Before creating a Children’s Trust as part of an asset protection program, ask yourself whether you can permanently do without the benefits of the property. Once title is transferred into the trust, there is no going back. This trust can’t be revoked or amended, so only transfer the assets that won’t be needed by you to meet your personal expenses.

THE IRREVOCABLE LIFE INSURANCE TRUST

You probably already know several reasons why life insurance is important. Young families need it to replace part of a breadwinner’s income. Mature Americans find it provides their heirs with a source of funds to pay estate taxes.

Life insurance can do all this and shield assets from litigation at the same time. How? By use of the Irrevocable Life Insurance Trust (ILIT). An ILIT is a good idea even if you don’t worry about suits or creditors, because it allows the full value of your life insurance to pass tax-free to heirs. Without an ILIT, the government will count the face value of an insurance policy in calculating your taxable estate. Anything over the estate tax exclusion is subject to “death tax” at a 40% rate.

When you set up your ILIT, you name a trustee other than yourself, most likely a beneficiary. The trustee purchases a life insurance contract on your life with funds you provide. If you have an existing policy, you can assign ownership of it to the ILIT, but there are conditions imposed on these transactions that should be carefully considered before you do so. For instance, if you die within three years of the transfer, the life insurance contract will be included in your estate.

As we saw in the case of the Children’s Trust, a taxpayer may give up to $15,000 (indexed for inflation) annually to another person free of gift taxes. Other than the per-person rule, there’s no limit on the total amount you can give away. For example, if you have five children and eight grandchildren, you and your spouse could give each one $30,000, for a total of $390,000 annually, gift tax-free. That can buy a lot of life insurance. By carefully following the IRS rules, you can employ this gift tax exemption to make the policy’s premium payments.

Reducing your estate tax liability is a powerful incentive for considering the ILIT. But that’s just the beginning of the long list of benefits it provides.

The ILIT gives you control over how proceeds from your life insurance policy are spent. You control who receives the proceeds and how they receive them. Whatever distribution strategy makes most sense for you and your loved ones, the ILIT gives you the opportunity to put it in effect.

And, of course, there’s its important asset protection benefit. Over the years, your premiums and interest earnings can accumulate to considerable sums, making cash value policies a tantalizing target for creditors. When the policy is owned by the ILIT, however, it is out of the reach of creditors.

FAMILY LIMITED PARTNERSHIP

A Family Limited Partnership (FLP) is one of the most popular estate tax and asset protection planning devices. An FLP is simply a limited partnership similar to the real estate or business operating limited partnerships with which many are familiar. When you transfer your business and investment assets into an FLP, you receive in return:

General Partnership Interest: Generally, you receive just 2% of the total partnership interests in the form of general partnership interests. That means that you control all of the decision-making for the FLP’s activities.

Limited Partnership Interest: You receive the remaining 98% of the FLP in the form of limited partnership interests. Limited partnership interests give the limited partner very limited rights in partnership income and activities. While general partners may not treat a limited partner unfairly, a limited partner essentially has no meaningful control or rights.

You are now the proud owner of your very own FLP. You are the 2% general partners and control the partnership. Now what happens? You will give your children some of your limited partnership interests. That means that the partnership has partners other than just you.

As a general partner, you have complete control and access to the assets and income of the FLP in accordance with terms you designed. If you have given your children 10% of the FLP, they are entitled to 10% of any distributions that you decide to make, but they cannot force you to make any distributions.

Note: If estate tax reduction is one of the other purposes of the FLP, additional restrictions may be required.

HOW DOES THE ASSET PROTECTION BENEFIT WORK?

If you are successfully sued, all the plaintiff is able to receive is a “charging order.” That’s a judgment against the partner that tells the partnership that any distributions of profit that would otherwise be made to the debtor partner must instead be paid to the plaintiff/creditor. But the plaintiff has no power to interfere in partnership matters.

The charging order is a very hollow victory. Because the general partners decide if profit is to be distributed to the partners, the general partners can withhold distributions for partnership purposes and the creditor receives nothing.

Obviously, the creditor does not just go away, but because the charging order provides so little leverage, creditors frequently settle the claim for less than face value. Those who might consider filing an unjustified lawsuit may change their minds when they realize that all they will receive is a hollow charging order.

FOREIGN ASSET PROTECTION TRUST

The ultimate asset protection tool is a Foreign Asset Protection Trust.

What is a Foreign Trust? In many ways a Foreign Trust looks exactly like a Domestic Trust. The trustor is you, the person who transfers the assets to the trust. The trustee is a trust company, experienced in asset management, whose business is operated outside of the United States in a jurisdiction that does not recognize United States judgments.

In a typical trust, the trustee is given discretion to accumulate or distribute trust income among a specified class of beneficiaries. You may be one of the named beneficiaries, together with your spouse, children, or grandchildren.

One unique feature of this kind of trust is the role of the “Protector.” The trust protector is a person who has the power to take virtually any actions necessary to protect your trust. The term of the trust may be limited to a period of years. You can often specify that the trust will last for a term of 10 years with several optional renewal periods.

One way to use a Foreign Trust is to set it up and then transfer your cash, securities and other liquid portable assets to an account established under the name of the trust at a bank of your choice in a foreign jurisdiction.

We’ve found that many people are reluctant to transfer their assets out of the country or give up the day-to-day control of their investments unless it’s absolutely necessary. To solve these concerns, planners combine the best elements of the Foreign Trust with the management and control of the limited partnership. Under this arrangement, you and your spouse are the general partners with total management and control over the partnership assets. But instead of you and your spouse holding a limited partnership share, you transfer that interest to a trust in a favorable foreign jurisdiction.

As the holder of the limited partnership interest, the foreign trustee has no right to interfere with management of the partnership. You alone manage your finances. Even though the trustee holds the limited partnership certificate, the assets themselves are physically located in the United States. This set-up provides maximum flexibility and sound lawsuit protection.

One of the most appealing features of a Foreign Asset Protection Trust is that it produces absolutely no income tax benefits. Under current tax law, the trust is simply ignored for tax purposes. Like the Living Trust, all of the income is reported and tax is paid on your personal income tax return. The reason this is attractive is that it allows you to create your foreign trust without interference or objection by the IRS. Because it doesn’t affect your income tax liability, the government really pays little attention to these trusts.

We’ve seen that the Foreign Asset Protection Trust is easy to set up and there are little or no tax consequences. We’ve also seen that when the Foreign Asset Protection Trust is combined with a domestic limited partnership, you retain complete management and control over your finances.

So what role does the Foreign Trust play and why is it touted to be the ultimate in creditor protection? The simple answer is that U.S. courts and judges have no jurisdiction over the foreign trustee and the limited partnership interest.

Let’s say a judgment has been handed down against you. Your first move would be to liquidate the limited partnership and make a distribution of each partner’s share. The Foreign Trustee would receive the vast majority of partnership assets, and these would now be held offshore.

Obviously, if your creditor wants to get his hands on the property, he will have to travel to the foreign jurisdiction and ask the local court to enforce his U.S. judgment. Whether he wins or loses in the foreign court depends on the laws of the jurisdiction you chose as the home of your trust.

Selecting a Jurisdiction

That’s why selecting the proper jurisdiction for your Foreign Trust is a matter of critical importance. You should consider the following factors:

• Communicating with the trustee must be very convenient.
• Look for a well-developed telephone system and for a country that conducts its business affairs in English.
• Look for an area with a long tradition of trust law and for experienced trustees who understand their role in asset protection planning.
• Find a country that does not tax income earned by your trust.
• Your jurisdiction should impose harsh penalties on anyone who discloses confidential trust and banking information.
• The country should make it very difficult for a creditor to file suit against your trust and should not recognize or enforce U.S. judgments.
• There should be no restrictions on your right to move currency or assets in or out of the country and, finally, the jurisdiction should have a stable government built on sound English and American legal principles.

Here’s a list of some of the more popular jurisdictions for your asset protection trust that have all of the important features we mentioned. The first four, the Bahamas, Bermuda, Barbados and the Cayman Islands, are located right offshore and are easily reachable by air. They have long been known for their international banking and asset protection activities. For example, the Cayman Islands is home to more than 530 operating banks and trust companies and has in excess of $425 billion in total assets under management.

The Cook Islands are a group of islands in the South Pacific. Between 1901 and 1965, they were part of New Zealand. In 1965, they became independent and self-governing under their own constitution. The Cook Islands have no income tax and have been developing in recent years into the jurisdiction of choice for asset protection planning.

© American Academy of Estate Planning Attorneys, Inc.

WHY CHOOSE A LIVING TRUST?

The desire to ensure that an heir is provided for materially is the most common reason for creating a Living Trust. In the case of minors, a trust allows a parent to provide for a child without giving the child control over the property. The parent can also mandate how the property is to be distributed and for what purposes.

A trust is also a useful tool for taking care of heirs who have mental impairments or lack investment experience. The trust document can establish that all money is controlled by a trustee with sound investment experience and judgment. Likewise, a trust preserves the integrity of funds when the recipient has a history of extravagance. It can protect the property from an heir’s spendthrift nature as well as from his or her creditors.

This is also true of persons who may feel pressure from friends, con artists, financial advisors and others who want a slice of the pie. A Living Trust can make it extremely difficult for a recipient to direct property to one of these uses.

A “spendthrift” provision in a Living Trust is often used to further preserve the integrity of assets. It prohibits the heir from transferring his or her interest and also bars creditors from reaching into the trust. Living Trusts are relatively easy to update, modify or revoke in most cases. A will, however, is difficult to change, and establishing one requires many formalities.

SHORT-CIRCUITING THE ORDEAL OF PROBATE

Many Americans think that the benefit of a Living Trust is the avoidance of probate. Because property in the trust is not considered part of an estate, it does not have to undergo this sometimes lengthy process. The property is instead administered and distributed by the trustee, according to the specific terms of the trust.

Probate expenses can be significant. Costs vary according to the size of the estate and what it includes. It also varies by state. Some have very expensive and onerous procedures, while others offer a streamlined version of probate.

Avoiding probate means not only avoiding hassle and expense, but also saving time. Probate can extend the amount of time before an heir receives an inheritance by months, years – even longer if the will is contested. Not only can this create hardship among the heirs, but the property in the estate may also suffer. Many assets must be carefully managed to preserve and enhance their value. Losses may easily occur during this interim period.

There is an emotional price to pay, too. Survivors may be continually reminded of the loss of a loved one as the process drags on.

Probate can also lead to loss of privacy. Wills and probate are public matters, whereas a Living Trust keeps the estate private. Typical probate documents list all assets, appraised value and names of new owners. This information becomes available to marketers, media, creditors and con artists.

If the estate includes real property in more than one state, the process becomes even more complex. An ancillary administration is required to probate out-of-state real estate. As you can imagine, “double probate” is even more time-consuming, expensive and emotionally taxing than a single probate process.

Probate also allows the original owner’s creditors a shot at the property. Although there is still some controversy about the extent of its creditor-shielding benefits, a Living Trust generally makes it much more difficult for an estate to be consumed by creditor claims.

MAINTAINING CONTROL

Living Trusts are harder to contest than wills. Part of the reason is that trusts usually involve ongoing contacts with bank officials, trustees and others who can later provide solid evidence of the owner’s intentions and mental state. A Living Trust that has been in place a long period of time is less likely to be challenged as having been subjected to undue influence or fraud. And because it is a very private document, the terms of the trust might not even be revealed to family members, allowing less opportunity for challenges to its provisions.

A Living Trust also avoids the painful ordeal of “living probate.” That’s what happens when a person is no longer competent to manage property, whether because of illness or other causes. Without a Living Trust, a judge must examine whether you are in fact incompetent, and all of the embarrassing details of your incompetence will be dragged out in court. The judge will appoint a guardian – perhaps someone you would not want to manage your affairs. Guardians act under court supervision and often must submit detailed reports, meaning that the process can become quite expensive.

With a Living Trust, your designated trustee takes over management of trust property and must manage it according to your explicit instructions in the trust document. The terms typically set standards for determining whether you are incompetent or not. For example, you may specify that your doctor must declare you can no longer manage your financial and business affairs.

MANAGING ASSETS, EASING TAX BURDENS

Living Trusts also provide a way for beneficiaries to receive the guidance of professional asset managers. A bank may be named as a Successor Trustee or Co-Trustee, allowing an experienced trust department to manage the assets.

Of course, eliminating or reducing taxes is one of the primary goals of estate planning. Trusts allow for a highly flexible approach to taxes. Income taxes can be slashed by transferring income-producing assets to a recipient in a lower tax bracket. Through the use of trusts, the state and federal government’s estate tax exclusions can be doubled, without the filing of an estate tax return unless the decedent had more than the current estate tax exclusion. Note, the estate tax exclusion for the state may be lower than the federal exclusion.

 

WHY DO I NEED AN ESTATE PLAN?

Most of us spend a considerable amount of time and energy in our lives accumulating wealth. As we do this, there also comes a time to preserve wealth both for our enjoyment and for future generations. A solid, effective estate plan ensures that your heard-earned wealth will pass intact to those you intend to be your beneficiaries.

IF I DON’T CREATE AN ESTATE PLAN, WON’T THE GOVERNMENT PROVIDE ONE FOR ME?

YES. But your family may not like it. The government’s estate plan is called “intestate probate” and guarantees government interference in the disposition of your estate. Documents must be filed and approval must be received from a court to pay your bills, pay your spouse an allowance, and account for your property and it all takes place in the public’s view. If you fail to plan your estate, you lose the opportunity to protect your family from an impersonal, complex governmental process that is a burden at best and can be a nightmare.

Then there is the matter of the federal government’s death taxes. There is much you can do in planning your estate that will reduce and even eliminate death taxes, but you don’t suppose the government’s estate plan is designed to save your estate from taxes, do you? While some estate planners favor wills and others prefer a Living Trust as the Estate Plan of Choice, all estate planners agree that dying without an estate plan should be avoided at all costs.

WHAT’S THE DIFFERENCE BETWEEN HAVING A WILL AND A LIVING TRUST?

A will is a legal document that describes how you want your assets distributed at death. The actual distribution, however, is controlled by a legal process called probate, which is Latin for “prove the will.” Upon your death, the will becomes a public document available for inspection by all comers. And, once your will enters the probate process, it’s no longer controlled by your family, but by the court and probate attorneys. Probate can be cumbersome, time-consuming, expensive, and an emotional trauma in a family’s time of grief and vulnerability. Con artists and others with less than pure financial motives have been known to use their knowledge about the contents of a will to prey on survivors.

A Living Trust avoids probate because your property is owned by the trust, so technically there’s nothing for the probate courts to administer. Whomever you name as your “Successor Trustee” gains control of your assets and distributes them exactly according to your instructions.

There is one other crucial difference. A will doesn’t take effect until you die, and is therefore no help to you with lifetime planning, an increasingly important consideration now that Americans are living longer. A Living Trust can help you preserve and increase your estate while you’re alive, and offers protection should you become mentally disabled. Read on.

THE POSSIBILITY OF A DISABLING INJURY OR ILLNESS SCARES ME. WHAT WOULD HAPPEN IF I WERE MENTALLY DISABLED AND HAD NO ESTATE PLAN OR JUST A WILL?

Unfortunately, you would be subject to “living probate,” also known as a conservatorship or guardianship proceeding. If you become mentally disabled before you die, the probate court will appoint someone to take control of your assets and personal affairs. These “court-appointed agents” must file a strict accounting of your finances with the court. The process is often expensive, time-consuming and humiliating.

IF I SET UP A LIVING TRUST, CAN I BE MY OWN TRUSTEE?

YES. In fact, most Living Trusts have the people who created them acting as their own trustees. If you are married, you and your spouse can act as Co-Trustees. And you will have absolute and complete control over all of the assets in your trust. In the event of a mentally disabling condition, your hand-picked Successor Trustee assumes control over your affairs, not the court’s appointee.

WILL A LIVING TRUST AVOID INCOME TAXES?

NO. The purpose of creating a Living Trust is to avoid living probate, death probate, and reduce or even eliminate federal estate taxes. It’s not a vehicle for reducing income taxes. In fact, if you’re the trustee of your Living Trust, you will file your income tax returns exactly as you filed them before the trust existed. There are no new returns to file and no new liabilities are created

CAN I TRANSFER REAL ESTATE INTO A LIVING TRUST?

YES. In fact, all real estate should be transferred into your Living Trust. Otherwise, upon your death, depending upon how you hold title, there will be a death probate in every state in which you hold real property. When your real property is owned by your Living Trust, there is no probate anywhere.

IS THE LIVING TRUST SOME KIND OF LOOPHOLE THE GOVERNMENT WILL EVENTUALLY CLOSE

DOWN?
NO. The Living Trust has been authorized by the law for centuries. The government really has no interest in making you or your family go through a probate that will only further clog up the legal system. A Living Trust avoids probate so that your estate is settled exactly according to your wishes.

ISN’T A LIVING TRUST ONLY FOR THE RICH?

NO. A Living Trust can help anyone protect his or her family from unnecessary probate fees, attorney’s fees, court costs and federal estate taxes. In fact, if your estate is greater than $100,000, you’ll find a Living Trust offers substantial benefits for you and your family.

CAN ANY ATTORNEY CREATE A LIVING TRUST?

NO. You should choose an attorney whose practice is focused on estate planning. Members of the American Academy of Estate Planning Attorneys receive 36 hours of extensive continuing legal education annually on the latest changes in any law affecting estate planning, allowing them to provide you with the highest quality estate planning service anywhere.

IN ADDITION TO WILLS, WHAT ARE THE BASIC ESTATE PLANNING TOOLS CONSUMERS HAVE
AVAILABLE TO THEM?

• Revocable Living Trust: Device used to avoid probate and provide management of your property, during life and after death
• Property Power of Attorney: Instrument used to allow an agent you name to manage your property if you become incapacitated
• Health Care Power of Attorney: Instrument used to allow a person you name to make health care decisions for you should you become incapacitated
• Annual Gift Tax Exclusion: Technique to allow gifts each year without the imposition of estate or gift taxes. Check out our website for current figure
• Irrevocable Life Insurance Trust: A trust used to prevent estate taxes on insurance proceeds received at the death of an insured
• Family Limited Partnership: An entity used to: 1) provide asset protection for partnership property from the creditors of a partner; 2) provide protection for limited partners from creditors; 3) enable gifts to children but parents maintain management control; and 4) reduce transfer tax value of property
• Children’s or Grandchildren’s Irrevocable Education Trust: A trust used by parents and grandparents for a child’s or grandchild’s education
• Charitable Remainder Interest Trust: A trust whereby donors transfer property to a Charitable Trust and retain an income stream from the property transferred; the donor receives a charitable contribution income tax deduction, and avoids capital gains tax on transferred property
• Fractional Interest Gift: Allows a donor to transfer partial interests in real property to donees and obtain fractional interest discounts for estate and gift tax purposes
• Private Foundation: An entity used by higher wealth families to receive any otherwise taxable property so as to eliminate estate taxes on the death of a surviving spouse

© American Academy of Estate Planning Attorneys, Inc.

It’s nearly incomprehensible for a parent to consider, but part of loving and protecting your family is providing for the possibility of events unfolding differently than you’ve envisioned. The question of what will happen to your children without you or your partner will be answered one way or another. The amount of control you have over how that question is answered is entirely up to you. Without sufficient planning, your family’s future will be decided by the judicial system. Setting up an estate plan makes sense for any individual, no matter their financial or personal situation, but for families with young children, drafting an estate plan is absolutely essential.

WHAT IF I DON’T HAVE AN ESTATE PLAN?

If you pass away without an estate plan, you die intestate, which means that your estate will be distributed by predetermined state guidelines, and the courts get to decide who is awarded custody of your children and who controls the inheritance you’ve left for them.

Custody of Your Children

Without even a basic Will, you won’t have any say about who assumes custody of your children. A judge who has no knowledge of your wishes will appoint a guardian for them in family court. Initially, the judge will appoint a temporary guardian, with a full hearing being held possibly months later to award final custody and guardianship to the person the court deems to be the most capable. Potentially, your family and friends could end up battling over custody arrangements, causing emotional rifts among your loved ones for years to come. Or, worse yet, your children could temporarily or permanently be placed in foster care.

If you had nominated a guardian in a Will or the Pour-Over Will of your Living Trust, the judge would have taken into consideration the person you named and most likely awarded custody to that individual, unless that person were deemed unfit to care and support your children.

Control of Your Children’s Inheritance

To make matters even more complicated, there may be a separate court hearing to determine who will be in charge of the inheritance that you leave for your underage children. The financial guardian, or guardian of the estate, may or may not be the same person who was awarded custody.

The financial guardian will be in control of your children’s inheritance until they come of age. At which point they will receive their full inheritance outright. Due to the young adult’s financial inexperience and immaturity, their inheritance may be squandered.

Probate of Your Estate

Furthermore, without a Will or a Revocable Living Trust, any assets including life insurance proceeds will be divided according to predetermined state guidelines for intestacy in probate court. These guidelines are based on a one-size-fits-all approach to division of wealth. This formula, written by state legislators, does not take into account non-traditional families, such as those with children who are not yet adopted or unmarried partners, and may instead distribute the estate only to legally-recognized relatives. Additionally, each state has different rules, so if you own physical property in more than one state, it can become excessively difficult and expensive to sort out. Even without this complication, probate may be an extremely costly, time-consuming, and potentially distressing process in many states and can be avoided easily with a proper estate plan.

Moreover, having your estate settled in probate court makes all of your finances and personal information a matter of public record. Not only is this embarrassing and invasive, but it can also be dangerous for your surviving family members, as it makes them easy targets for predators, solicitors, and scam artists.

Joint Tenancy Property Ownership

When you and your spouse open a checking account, buy a car, purchase a home, or acquire just about any other asset you can think of, the first — and usually only — impulse is to put the title in both your names as Joint Tenants.

Additionally, many families, including parents with young children, choose Joint Tenancy as their estate plan because they’ve heard it is a cost-free replacement for a Will and that it avoids probate. These individuals focus on the fact that at the death of one of the owners, Joint Tenancy immediately passes full ownership of an asset to the surviving Joint Tenant by operation of law. So, yes, it does circumvent probate and avoid the need for a Will, at least temporarily. Unfortunately, they’re overlooking the fact that upon the death of the surviving Joint Tenant, the entire estate will have to pass through probate. It also brings with it a slew of problems that more than offset any short-term convenience it provides. In fact, Joint Tenancy can end up costing you — and your loved ones — many times the expense and headaches you thought you were avoiding.

For example, if you should pass away unexpectedly and your surviving spouse remarries, your jointly owned assets may end up being considered community property, causing you to lose control on how you would have wanted your children’s inheritance to ultimately be distributed.

A solution many rely on is to establish a Revocable Living Trust and re-title their assets in the name of the Trust. The Trust will avoid probate and provides protection in case your surviving spouse remarries, allowing you to specify when and how you want your assets distributed to your children.

Estate Tax Liability

Lastly, in addition to enduring the expense and delay of probate, without an estate plan, your beneficiaries may have to pay unnecessary federal estate taxes on their inheritance. Additionally, many states have state estate or inheritance taxes at much lower levels. The survivor of a married couple might be able to use the exclusion of the predeceasing spouse, as well as their own. However, in order to be able to get “portability” of the deceased spouse’s exclusion, a federal estate tax return must be timely filed, even if it would not otherwise be necessary to do so. There are many reasons that a couple might plan to have the first spouse leave their assets in a “Family” or “B” Trust for the benefit of the survivor and children, rather than relying on portability. A Family Trust not only locks in the deceased spouse’s exclusion amount, even growth of the Trust would be excluded from the survivor’s estate. Further, the Trust could be exempt from tax even in the estate of the children. Portability does not allow for this.

A separate Family Trust allows for many protections that portability does not provide. The Trust can provide creditor protection, both in the event of remarriage and divorce from other creditors. Also, a Family Trust can lock in the ultimate beneficiaries of the assets. This can be important to blended families.

Special Considerations FOR Divorced Parents and Blended Families

In this age of divorce, remarriage, and blended families, parents who are divorced or remarried have an even greater need for estate planning – and more difficult challenges to overcome. Without a carefully designed estate plan there is much at stake for blended families and the children involved.

Naming a Guardian

Single and divorced parents have a higher need for estate planning than anyone because they may not have a partner to care for their children if something should happen to them. The guardianship or custody of children whose parents are divorced usually falls to the ex-spouse, as long as he or she is the biological parent. However, in the rare case of that individual being unable or unwilling to care for the children, then another guardian would be appointed by the court. Nominating a guardian in a Will would allow you to have a say in who should take care of your children.

Problems with Outright Distribution of Assets

Another concern is the management of the minor children’s inheritance. When assets are distributed outright to minor children being cared for by an ex-spouse, the ex-spouse may have control over how the inheritance is managed. Similarly, if a step-parent has been appointed as the guardian, then he or she has authority to manage the inheritance of the children. In either case, your wishes regarding your children’s inheritance may not be followed. However, your minor children can’t be expected to manage their own money at such a young age. So what’s the solution? Holding assets in Trust with a Successor Trustee to manage those assets, instead of outright distribution, ensures that your children’s inheritance is handled fairly and distributed in exact accordance with your wishes.

Dying Intestate

As we’ve discussed before, if you die without an estate plan, your estate will be subject to the intestacy laws in your state and go through probate court. The division and distribution of your estate will be subject to a predetermined formula, usually providing half of your estate to your new spouse, and the remaining half being allocated in equal portions to your biological children. For many parents in blended families, the state’s distribution plan is worlds apart from how they would have chosen to distribute their assets themselves.

For example, if your blended family includes your spouse’s children from a prior marriage, whom you have raised, but never formally adopted, this formula would not provide an inheritance for them. Similarly, if you have adult children from a prior marriage and minor children with your new spouse, you may want to provide more financial support to your minor children than provided by state guidelines.

Ownership of Property

When it comes to ownership of property, most married couples are joint owners of all of their assets. However, with blended families, this may not be the wisest choice. If you’ve remarried and established joint ownership of property with your new spouse, you may be unintentionally disinheriting your children from a prior marriage. In the event that you pre-decease your new spouse, they will get the ultimate say in who inherits your jointly-owned property or if your new spouse dies intestate, the state will decide for them. This could very likely result in those assets being inherited exclusively by your new spouses’ children from their prior marriage – completely disinheriting your children. A proper estate plan can help address matters of property ownership among blended families and ensure that your children’s inheritance is preserved.

Each blended family is unique, and similarly, each couple has its own set of goals to accomplish. Preserving the relationships between the step-parent and the step-children after the death of the parent and spouse is usually one of those goals. Proper estate planning can tailor a solution to help meet those goals.

Choosing a Guardian

Guardians of minor children are “nominated” in the Will by the last parent to die. Guardians are typically “nominated” rather than appointed because the courts will give preference to the nomination but are not bound by it. If a court determines that the best interest of the child would be better served by another choice, they need not heed your suggestion. However, while the nomination of a guardian is not a guarantee, it does allow you to give the court guidance, which it will use to make its determination. If all other things are equal, the court will heed your advice.

Nominating a guardian for your children is the most important – and, in many cases, the most challenging – part of the estate planning process. Here are some factors that you should consider when choosing a guardian:

• Age: You need to consider both the age of your children and the age of the potential guardian. If your kids are young, you need to select someone who will be emotionally and physically able to care for them in the long-term. While a grandparent may have the best emotional connection, they may not be able to make the kind of commitment necessary to raise your children to adulthood. On the other hand, it’s also possible to choose a guardian that’s too young to handle such a large responsibility. Therefore, it’s important to consider both the age and emotional maturity of your guardian candidates.
• Parenting Style, Religion and Values: Every parent has differing opinions on discipline, education, and even curfew. Therefore, it’s vital that you take these things into consideration when choosing a guardian. Ask yourself what’s most important to you in terms of values and religion, and then assess whether the guardian you have in mind shares those views. If you’re unsure, ask them. You might be surprised by their answers.
• Stage of Life: Think about the stages of life your potential guardians are in. Are they married or single? Are they likely to get married or divorced? Do they have their own children, and if so, are yours likely to fit in? If they are single now, is a future spouse going to be supportive of their guardianship? What about their career? Are they married to their job, or close to retirement? All of these factors will have a tremendous impact on your children’s lives, so take your time and choose carefully.
• Location: Sometimes we underestimate the effect of a location on our everyday lives. But, where a child grows up has an enormous influence on the person they become later in life. Things like neighborhoods, school systems, and nearby relatives seem like obvious variables when thinking about the location of a potential guardian. But what about less obvious factors like climate? Moving from a warm climate to a cold one, or vice-versa, can be a big adjustment for a child. Lastly, it’s important to weigh the likelihood of frequent changes in location. Will the guardian have recurrent moves or job changes? In some cases, this is impossible to predict, but nevertheless helpful to consider.
• Relationship: It’s not necessary for your chosen guardian to be a blood relative, but it’s best if they are at least familiar to your children. If you have never seen this person interact with your kids, how will you know what kind of parental role this person would play with your kids? It would be much easier for both the guardian and your children to grieve and adjust if they already had a good relationship with each other. Obviously, in rare cases, it is necessary to choose a person who is distant from your family. This option should be exercised only as a last resort. It’s important to note that even if your children are particularly close to one aunt, uncle, or friend, remember that this person would potentially fill the role of parent, not best friend. So be sure to keep all of the other considerations in mind as well.
• Willingness: Speak to all of your guardian candidates before you make a decision. After all, having to assume a guardianship is a life-changing responsibility, and not to be undertaken lightly. Although, in reality, it’s unlikely that your chosen guardian will need to fulfill that role, it’s important to secure their consent before naming them.
• Financial Position and Responsibility: An important part of the estate planning process is making sure that your loved ones are provided for financially. Ask yourself whether your chosen guardian is financially stable enough to raise a family. Do they have problems hanging on to money? What are their spending habits? If you have doubts about their abilities to manage finances, but you’re convinced that they would make the best guardian for your children, you may want to consider talking to a qualified attorney about Trust provisions that can make this easier.

In addition to discussing your wishes with your chosen guardian, it is recommended that you and your partner write letters of intent for your children. These letters can vary significantly, but most people use the opportunity to describe their expectations and hopes for their kids. A letter can be a much more comfortable format for expressing these desires than a verbal discussion, and it also serves as a permanent record. It is recommended that individuals update their letters of intent yearly or bi-yearly as their circumstances evolve.

Whether you have several guardians in mind or just one, it’s vital that you weigh each and every variable to determine if he or she is the right person to care for your most valued treasures: your children.

DISABILITY PLANNING AND POWERS OF ATTORNEY

In addition to naming a guardian for your children, every parent needs a Power of Attorney to authorize someone to make financial decisions in the event you become incapacitated by an unexpected accident or illness. The appointment of a trusted individual to make these financial decisions helps ensure financial stability for your spouse and your children during your incapacity. The Power of Attorney and nomination of a guardian allow someone you have chosen to care for your minor children in a loving and attentive manner, rather than as the subject of a cold impersonal court bureaucracy.

When executing a financial Power of Attorney, you will want to discuss the implementation of a Health Care Directive and Health Insurance Portability and Accountability Act (HIPAA) Authorization Form with your estate planning attorney. A Health Care Directive will allow you to select an agent to make health care decisions for you, in the event that you are unable to do so for yourself, and to state your wishes for the types of life-sustaining or invasive medical treatments that you do and do not want administered. A HIPAA Authorization Form will allow the individuals you select to have access to your medical records and authorize doctors to release information to them about your current medical status.

FINANCIALLY PROVIDING FOR YOUR CHILDREN

If you are like many Americans and do not currently own sufficient assets to secure your minor children’s financial future, you may want to purchase, at the very least, a term life insurance policy. For as little as a few hundred dollars a year, you can gain several-hundred-thousand dollars in coverage. It is wishful thinking and risky to assume that whomever you name as a guardian will be willing and able to financially provide for your children. Taking out an insurance policy is truly one of the easiest and most beneficial things you can do to protect them.

However, selection of life insurance beneficiaries is an often-misunderstood process with potentially devastating consequences. Unfortunately, directly naming minor children as the beneficiaries will seldom achieve your estate planning goals and creates unnecessary delay and expense in providing for your children. A better option is naming a Trust as beneficiary of the policy and providing terms to a Successor Trustee for management of the children’s inheritance. Consult with an estate planning attorney to determine the best way to ensure your life insurance proceeds are used for the benefit of your children, while maximizing asset protection and minimizing taxation.

Estate Tax Planning

When you pass away, all assets you own, including your home, vehicles, life insurance policies, retirement plans, and even personal belongings are considered part of your estate. When you total the full value of those assets, it may be quite easy to exceed the federal estate tax threshold. With a proper estate plan in place, various tax planning strategies can be employed to reduce or even eliminate, in some circumstances, the need to pay federal and state estate taxes.

PLANNING OPTION #1 – PLANNING WITH A WILL

A Will is oftentimes one of the most basic and widely used estate planning tools. Simply put, a Will is a legal document that describes how you want your assets distributed at your death. It also names the guardians of your children.

A Will only goes into effect at your death. Upon your passing, an executor, whom you name in your Will, oversees the distribution of your estate to any heirs named, however, the actual distribution of your assets is controlled by the probate court. Additionally, a Will also does not provide you with lifetime planning, an increasingly important consideration now that Americans are living longer. Of course, passing away with a Will expressing your wishes is much better than dying with no plan at all.

A Contingent Trust for Your Child’s Benefit

An estate planning strategy popular among parents who choose to plan with a Will is the setup of a contingent Trust for a child’s benefit. In the case of the parents’ death, the Will initiates the formation of a Trust to hold your child’s inheritance and functions in the same way as a Living Trust, with the ability to hold assets for distribution when your child comes of age or reaches milestones which you stipulate. The assets are managed by a Trustee that you appoint. This type of Will-based plan is called a Testamentary Trust.

The main drawback to this type of planning is that assets must still go through probate prior to being transferred to the Trust. However, a Testamentary Trust is still far superior to a Simple Will and avoids any problems that may result from outright distribution of assets to children, which may be supervised by the court, as a result of using only a simple Will.

PLANNING OPTION #2 – PLANNING WITH A REVOCABLE LIVING TRUST

Why It Is Often the Best Choice

One of the most comprehensive and well-designed estate plans is the Revocable Living Trust. A Living Trust is set up in such a way that the Trust owns the assets to be left to the heirs, thereby avoiding probate. In most cases, the parents name themselves as the Trustees and someone else (a family member, friend, guardian, banker, or investment expert) is named as the Successor Trustee. Upon the death of the Trustee or Co-Trustees, the Successor Trustee becomes responsible for the management of the Trust assets. Like the executor of a Will, he or she is required to manage and distribute the estate strictly according to the terms of the Trust.

With a Living Trust, or a Testamentary Trust under a Will, you can choose to delay the distribution of the inheritance to your heirs until they reach certain milestones, earmark it for college tuition, or reward hard work and career achievements. A Living Trust may also be drafted to protect your assets from your heir’s creditors and future ex-spouses, and any financially inexperienced or irresponsible decisions.

In the case of very young children, regular disbursements from the Trust can be arranged to cover expenses such as medical costs, maintenance, or travel. A Living Trust ensures that your children will be provided for until adulthood and beyond.

Provisions for keeping assets in Trust, such as the examples above, can also be included in a Will, directing the creation of a Testamentary Trust after death.

Avoiding Probate

Because the Living Trust technically owns the assets, they are not considered part of the probate estate, and therefore, are not subject to the probate process. Instead, the Trustee oversees the distribution of the property according to the specific terms of the Trust. This arrangement yields several important benefits.

Avoiding probate means not only avoiding the hassle and expense, but also saving time. When young children are depending on an inheritance, the last thing they need is to have their livelihood tied up in the court system. Even though your children may get a small allowance while your estate is in probate, the time delays of the court process can extend the amount of time before your heirs receive their full inheritance significantly—by months or even years—especially if the Will is contested. A Trust is a better way to give your family faster, unfettered access to the funds they need.

Your privacy is also maintained through a Living Trust, whereas in the probate system, your personal matters could be broadcasted to the masses. The average Joe off the street has no business knowing the names of your children, who has custody of them, and how much inheritance they are to receive.

Maintaining Control

Living Trusts may be harder to contest than Wills. Part of the reason is that Trusts usually involve ongoing contacts with bank officials, Trustees, and others who can later provide solid evidence of the owner’s intentions and mental state. A Living Trust that has been in place for a long period of time is less likely to be challenged as having been the product of undue influence or fraud.

Pour-Over Will

Every Living Trust has what is called a “Pour-Over Will” as part of the complete estate plan. It has two functions within the plan. First, this is where you will nominate a guardian for your underage children. Secondly, it functions as a safety net for any assets not transferred into your Trust, stating that any such assets should be transferred and owned by the Trust.

Special Needs Circumstances

A Trust can be especially appropriate in the case of heirs with special needs. A Special Needs Trust can be set up to financially provide for your special needs child without jeopardizing their government benefits. Additionally, if your child will be unable to make financial decisions for him or herself even as an adult, then a Trustee can be an indispensable aid in making sure he or she will be well taken care of.

THE ROAD AHEAD

One thing should be clear by now; we do our families a great disservice when we fail to plan for every contingency. That’s why a critical first step in your planning process should be a consultation with an attorney who focuses their practice in estate planning. Taking the time to form a thoughtful, detailed, and durable estate plan will ensure that you, your spouse and your children are provided for in the event of a tragedy.

© American Academy of Estate Planning Attorneys, Inc.

Why Create An Estate Plan?

As 2013 started, the estate planning world had a new law: The American Taxpayer Relief Act of 2012 (ATRA), enacted January 2, 2013. In order to understand the current estate tax situation, we have to go back to 2001, and look at how we got to the current state of affairs.

Historical Review: The Repeal of the Estate Tax

During the first half of 2001, both houses of Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001, or “EGTRRA,” and President Bush signed the Act into law. EGTRRA made changes to a wide range of tax laws, including far-reaching changes to the federal estate tax system.

It gradually increased the amount of money that people could pass on, tax-free, at death. In 2002, the amount an individual could pass on without paying estate tax was $1 million. By 2008, the amount excluded from estate tax increased to $2 million, and in 2009, the estate tax exclusion amount jumped to $3.5 million.

Finally, in 2010, the federal estate tax was repealed altogether.

Because of budgetary issues, the repeal was designed to be effective for one year only. The estate tax repeal, and EGTRRA itself, were scheduled to “sunset” on December 31, 2010. But that didn’t happen.

2011: The Estate Tax is Back

At the end of 2010, no one quite knew what, if anything, Congress was going to do about the estate tax. Initially, 2010 marked a one-year repeal of the estate tax. If Congress chose to do nothing, we were facing a return to the $1 million estate tax exclusion, with a top tax rate of 55%.

On December 17, 2010, after lengthy discussion and debate, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which became known as “TRA 2010.”

ATRA made TRA 2010 permanent and changed the rate of taxation.

In late 2017, Congress passed yet another tax law, which doubled the exemption to $10 million (adjusted for inflation from the 2011 base year).  However, after 2025, that law “sunsets” or expires, and the law reverts to the prior law’s “permanent” $5 million exemption (adjusted for inflation from the base year of 2011).

The Good News

When it comes to the estate tax, TRA 2010 made three major changes. These involve the estate tax exclusion amount, the tax rate and a new portability provision.

Federal Estate Tax Exclusion

As you know, not everyone’s assets are subject to the estate tax. Each person gets what’s called an “estate tax exclusion.” This is the amount of property that can be passed to your heirs and beneficiaries free of the estate tax at the time of your death. For the years 2010, 2011, and 2012, the temporary exclusion amount was set at $5 million (inflation adjusted). ATRA made this amount permanent and adjusted it for inflation. The 2017 law doubled the ATRA exclusion amount (temporarily). In 2018 it is 11.2 million.

Federal Estate Tax Rate

If the value of your estate exceeds your exclusion amount, and therefore ends up being subject to the estate tax, the top tax rate was 35% through 2012. ATRA increased the rate for 2013 and later to 40%.

Portability

With TRA, Congress also introduced a new “portability” provision. This is where one spouse can add their deceased spouse’s remaining estate tax exclusion to their own exclusion to shelter more from taxes. This portability provision, also known as the “Deceased Spousal Unused Exclusion Amount,” can be used to shelter the assets of the surviving spouse. However, portability only applies if the estate of the first spouse to die files an estate tax return, even if it would not otherwise be required. Further, portability does not provide remarriage protection, asset protection, or other advantages which might be available with proper planning. ATRA made portability permanent.

Federal Gift Tax

What happens to the gift tax under the new law?

Annual Exclusion

The annual exclusion amount for the federal gift tax is $15,000 for 2018, and it will be adjusted for inflation in 2019 and later years. This means the maximum value of gifts you can give to a single recipient without filing a gift tax return and without tapping into your lifetime exclusion, (discussed below), is $15,000 per year. Spouses can combine their annual gift tax exclusions and give gifts of up to $30,000 in value to each recipient each year.

Lifetime Exclusion

What if your annual gifts to one recipient are more than the annual exclusion amount? You can use a portion of your estate tax exclusion to make lifetime gifts, but then your exclusion would not be available at death. You can use your entire exclusion during life. Of course, then you would not have any available at death.

Federal Gift Tax Rate

As with the estate tax, the top gift tax rate for the years 2011 and 2012 was 35%. ATRA increased the rate to 40% for 2013 and later years.

State Estate and Inheritance Taxes

In addition to the federal estate and gift taxes, outlined above, many states have a separate state estate tax or inheritance tax. A state estate or inheritance tax typically applies to those who die when residents of the state or owning property in the state. A state estate tax typically works just like the federal estate tax. You add up your estate and then you get taxed on everything over a certain amount. An inheritance tax is similar but is based on the relationship between the deceased person and the person receiving property. The problem is that the state estate and inheritance taxes typically kick in at a much lower level than the federal estate tax. In other words, an estate which might escape without owing any federal estate tax might end up paying a significant state estate tax.

What is My Estate Worth?

To determine what your “estate” is worth (and could be taxed on), let’s break it down. You’ll need to include all of the following assets for both you and your spouse:
• Checking and Savings Accounts
• Home and Other Real Property
• Timeshares
• Cars and RVs
• 401ks and Other Retirement Accounts
• Deferred Annuities
• Pensions
• Profit Sharing Accounts
• Stocks, Bonds and Trading Accounts
• Life Insurance (full matured face values, not cash values)
• Collections
• Jewelry
• Furniture
• Antiques and Artwork
• All Other Personal Property
• Ownership in Businesses
As you can see, your combined estate value can quickly add up!

Planning and the Uncertainty

While today’s tax law provides for a substantial exclusion, we do not know what the tax law might be in the future. Just as easily as Congress passed prior laws, it could pass another law that changes the exclusion again, or otherwise upsets the apple cart that is your estate plan. That’s why it is important to review your estate plan periodically with an experienced estate planning attorney.

Those with $5.6 Million in Combined Net Worth

If you and your spouse have a combined net worth of $5.6 million or more, or if you are single and have a net worth of $5.6 million or more, having an estate tax plan in place is essential. And remember, the IRS counts assets like life insurance policies and retirement accounts; so, you may have a higher net worth than you realize.
An estate planning attorney can let you know for certain whether you need to worry about estate tax planning, and if you do (and choose not to rely on portability), he or she can help you shelter your estate tax exclusion in a Family Trust so that your hard-earned assets go to your loved ones instead of to Uncle Sam, other creditors, or a future divorcing spouse. An estate planning attorney may also be able to help you save more by using advanced estate planning methods like an Irrevocable Life Insurance Trust, a Family Limited Partnership, or a Grantor Retained Annuity Trust.

With the future of the estate tax in such a state of uncertainty, it’s essential that you stay in touch with your estate planning attorney. He or she can keep you updated on any changes in the law – and let you know if your tax planning strategy needs to change accordingly.

Those with Less Than $5.6 Million in Combined Net Worth

If your combined net worth is under $5.6 million, it doesn’t mean you are off the hook and should not put a plan in place. There are other important reasons families set up estate plans like wills or Living Trusts. Those reasons may include wanting to avoid the public and sometimes expensive process of probate, added complications of blended families and remarriages with step-children, protection from divorce (yours or your children’s) or creditor protection. Consulting with an experienced estate planning attorney can help you sort through your goals and concerns to determine which type of plan is best for your personal situation.

What Should I If I Have an Estate Plan?

As we have seen time and time again, the tax laws continue to change ― sometimes benefiting us and sometimes not. With this in mind, it is important to do regular reviews of your estate plan to make sure you are taking full advantage of all the tax savings opportunities and avoiding paying too much in taxes whenever possible. Also, if you have had changes in your family situation (births, adoptions, divorces, marriages, remarriages or deaths), your estate plan needs to evolve and change, addressing any new goals or concerns you may have.

Those with Simple Trusts

A simple trust, such as a Revocable Living Trust, may not minimize your estate taxes. Your estate planning attorney can help you find an appropriate estate planning method, like an AB Trust if appropriate, to shelter your assets and reduce your estate tax liability.

Those With Wills

A will guarantees that your remaining assets (home and other real property), regardless of their worth, will be subject to a public probate process, which many families wish to avoid. In some states, probate can be a lengthy and costly process which can hold up valuable funds while it runs through the court system. Even if you are not worried about your family having to deal with the probate process, you may want to protect them and your hard-earned assets from other everyday situations which can result in a significant loss of those assets. These asset-losing snags often come into play when you have blended families, remarriages with step-children, creditor problems, divorces (yours or your children) or if you become disabled. Will-based plans often do not provide appropriate provisions to address these common concerns. It is always good to review your will-based plan with an estate planning attorney to make sure it addresses all of your current, and more importantly, future concerns.

Estate Planning is More Than Just Tax Planning

Whether or not you think your estate will be affected by the changes in the tax law, it is essential that you have an estate plan in place. Why? Because tax planning is just one small portion of a comprehensive estate plan.

An estate plan brings certainty and stability to the lives of your loved ones. It gives them direction for how your assets are to be managed should you become disabled or pass away. It allows you to decide who will care for your minor children and to have a plan in place for providing for your children, even after you’re gone. Most of all, it allows you to protect your loved ones from the turmoil and uncertainty that are guaranteed if you fail to plan.

© American Academy of Estate Planning Attorneys, Inc.