Estate Planning

Estate planning is another area that is ripe for exploitation by various huxters.  You have all seen ominous advertisements in your local newspaper warning you that you must attend a certain financial advisory seminar or risk having the federal government confiscate 50% of your wealth at your death.  It is true that the federal estate tax (which is a tax separate and distinct from the federal income tax) has rates of taxation as high as 50%.  What the hustlers don't tell you is that only a very small fraction of the population is subject to federal estate taxation.  Why?  There is a large credit against the federal estate tax liability that insulates the first $1,000,000 of wealth (rising to $3,500,000 prior to the repeal noted below) from estate taxation. Additionally, there is an unlimited ability to transfer wealth between spouses on an estate and gift tax-free basis. Lastly, there is a fairly bipartisan effort within Congress to permanently eliminate the Federal estate (but not gift) tax.  A recent legislative change results in the estate tax being phased out and encourages Congress to eventually repeal it in its entirety as of December 31, 2010.

NOTE:  If you are a small business owner or have accumulated a fair amount of wealth, do not ignore the federal estate tax. Unlike the income tax that is levied on an annual basis, the federal estate and gift tax is a tax on the cumulative wealth you have transferred during your lifetime and at death. Things that might increase your estate are common, big-ticket items like the fair market value of the home, life insurance policies, and retirement plan assets.  For the small business owner and family farmer, the federal estate tax is something to be particularly wary of if death occurs before it is phased out.

Example:  Joe and Jane Smith incorporated a manufacturing business 30 years ago.  The business has done very nicely and has expanded a number of times over the years.  Joe and Jane, however, do not think of themselves as being particularly well-to-do.  Between the two of them, they have never taken more than $100,000 of salary out of the incorporated business, but rather have left the business earnings in the corporation to fund future growth and expansion of the business.  Joe predeceases Jane, leaving all of his stock ownership outright to her at his death.  Jane plans on leaving all of the stock at her demise to their son, Dick, who is active in the business.

Although the owners have derived limited current income from the business, that does not mean the value of it is insignificant.  Say the value of the bricks and mortar, inventory, going concern value and goodwill of the company at Jane's death is $5,000,000.  Although at Joe's death there was no federal estate tax because of the unlimited ability to transfer wealth between spouses, at Jane's death the federal estate tax will come home to roost, based on a $5,000,000 valuation of the business.  The business may have to be sold, rather than transitioned to the next generation, in order to pay the resulting estate tax.

Controlling probate expenses and stress

As we just noted, the typical American will not be subject to the federal estate tax.  However, as the old saying goes, two things are certain in life-death and taxes.  A dead person is legally known as a decedent.  Although not typically subject to estate tax, a decedent's estate frequently will be subject to probate.  Probate is the legal procedure for managing the distribution of a decedent's estate.  The law is state (not federal) law and the court that has authority in probate matters is typically a county level court, designated the Probate Court.

 

There are a number of potential problems with the administration of a probate estate.  First of all, the probate records are public records.  Therefore, if the decedent's family desires to insulate the estate from public scrutiny, the probate estate needs to be limited.  Also, expenses associated with the administration of the estate may rise as the value of the probate estate rises.  Even if the probate estate is fairly small, there may be a Probate Court authorized minimum probate fee that is relatively significant.  Lastly, surviving family members may be in need of assets which are tied up in the probate estate and are not released until approval of the Probate Court is obtained (frequently a lengthy process).

 

How do we reduce the probate estate?  It is actually a very simple thing to do, particularly between spouses.  Any property that passes by contract at death avoids probate.  What are examples of wealth transfer in this category?  What we are looking for are contractual provisions like the beneficiary designation on life insurance contracts and qualified retirement plans, or property that is owned by title or deed in "joint ownership with a right of survivorship." The "joint ownership with right of survivorship" form of ownership noted in a title or deed must use the correct survivorship language in order to work the way I will illustrate for you.  Without the "right of survivorship" clause, jointly owned property is deemed to be owned by the owners as "tenants in common," which has very different legal implications and will not affect the avoidance of probate illustrated below.

 

Thus, in a properly planned situation, the expenses, stress and public disclosure of the probate process can be completely avoided.  Also, most Probate Courts exempt smaller estates from any requirement to log in and be cleared by the local Probate Court.  As I mentioned above, this planning scenario is particularly helpful in the case of spouses (the surviving spouse is typically the wife – on average, women are still killing us men off a few years earlier than when they die).

Example:  Mark's will provides that all assets that he owns outright at his death (assets that do not automatically pass to Debbie by operation of a deed or a contract) will be bequeathed to Debbie if Mark predeceases her.  Mark and Debbie's principal assets are their home, Mark's Section 401(k) retirement plan, a $500,000 term life insurance policy (discussed in the next Section of the book) insuring Mark's life, the couple's automobiles, and their checking and savings accounts.  The home is titled to Mark and Debbie, as joint owners with right of survivorship (see NOTE below on a tenancy in the entireties).  Debbie is named as the beneficiary under the Section 401(k) Plan in the event Mark predeceases her.  Debbie is also named as the beneficiary under the life insurance policy.  The automobiles are titled jointly with right of survivorship, and the checking and savings accounts are in the names of both of the spouses.

If Mark predeceases Debbie, she will by operation of law automatically become the legal owner of all the noted assets.  All of these assets bypass Mark's probate estate.  Other miscellaneous assets that Mark owned at his death (that are in his probate estate) are relatively insignificant in value. Due to the small size of Mark's probate estate, no formal proceeding need be initiated in the Probate Court.  Per Mark's will, Debbie establishes legal ownership in the other miscellaneous assets that are included in Mark's probate estate.  Other than filing a claim with the plan administrator of the Section 401(k) plan and a death claim with the insurance company, Debbie is relieved of the need to do anything further to solidify her legal interest in all of this wealth.

NOTE:  I mentioned before the "tenancy in the entirety" form of ownership of the home between spouses.  A limited number of states allow spouses to own their home as tenants in the entireties.  It is a form of joint ownership with a right of survivorship-on the death of one spouse, the surviving spouse will own the entire property.  The big difference is not on the death of one of the spouses but in the event of insolvency while both spouses are alive.  In the event that one of the spouses becomes debt-ridden and insolvent, the home may not be sold to satisfy that spouse's debt.  If your state law allows spouses to own their home as tenants in the entireties, by all means assure that the home is titled in that manner rather than as joint tenants with a right of survivorship.

Living trusts

A living trust (not to be confused with a living will discussed later in this section) is a trust device used specifically to avoid probate expense.  The idea with the living trust is to transfer legal ownership of all sorts of property to a revocable trust of which the grantor is the trustee.  The trust becomes irrevocable on the death of the grantor and the disposition of the trust property is governed under the trust instrument.  Therefore, since the trust property passes by the contract incorporated into the trust agreement, it bypasses the grantor's probate estate.  This is a much more sophisticated way of avoiding probate.  It is an inappropriate device for the typical American.  For example, my wife and I have attended to our probate avoidance exactly as I just illustrated to you in the last Example.  Therefore, there is not a need to do so by way of a living trust document, which merely adds another layer of complexity, confusion and expense to the mix.

NOTE:  Although the living trust is a legitimate estate planning device for more well-to-do Americans (the legitimate uses of a living trust are noted at my Web site click on Legal Protections, then Living Trust), it is a commonly employed tool by marginal financial planners promoting services to lower-income Americans.  Not infrequently, the living trust will be used by these advisors much like another generally legitimate estate planning tool, the charitable remainder trust (that I discussed along the same lines in the Tax Planning section on page 34).  The simple methods of avoiding probate that I illustrated for you above are generally ignored in lieu of a more complex living trust arrangement.  Additionally, these promoters frequently spin the living trust into something that it is not -- an income tax avoidance tool or, perhaps, an estate tax avoidance tool (without pointing out that most of the people being hustled are not subject to the federal estate tax).  Always remember my advice with regard to these promotions – if it sounds too good to be true, IT IS.  If a promotion is going beyond the simple types of solutions I have outlined in this book and is being marketed to lower or middle-income people, WATCH OUT.  Ninety-nine times out of a hundred it's going to be a con job.