Written by P. Mark Accettura

INTRODUCTION

When we are married, our spouse is our logical and default caretaker. Forged in the wedding vows, and perhaps never ratified thereafter, it is agreed that each will watch over the other in sickness and in health. The law, in fact, recognizes the presumed authority of a competent spouse to speak for an incompetent one, and a surviving spouse to speak for the estate of a deceased spouse.

Now that you are single, you have no logical, or presumed caretaker. You must provide for your own sickness and death. You must decide who will make your medical and financial decisions in the event you become incapacitated, and who will manage your estate at death.

Other important questions must also be answered. If you have minor children, who will care for them, Sheppard them through their youth, teens, twenties, and perhaps beyond? Who will care for your handicapped children, children in bad marriages, children who are substance abusers? The answers to these questions are found in the process of estate planning, the subject of this chapter.

Estate planning is the process of assessing one’s lifetime and testamentary goals. Lifetime goals typically include providing for your own care in the event of incapacity. Testamentary goals include whom, when and how to distribute your assets at death, as well as planning to avoid probate and to minimize estate tax.

A typical Estate Plan, to the extent there is such a thing, begins with a Will, a durable power of attorney and a revocable trust. Each of these documents allows for the appointment of trusted individuals, or institutions, known as “fiduciaries,” to carry out your wishes at the time of your incapacity or death.

The scope and complexity of your estate plan is individual to you, and increases with the size of your estate and the degree to which your family deviates from the traditional nuclear family.

This Chapter discusses the following important estate planning topics:

1. Estate planning building blocks: Wills, durable powers of attorney and revocable trusts.
2. How to get started.
3. Why joint ownership and beneficiary designations should NOT be used as substitutes for estate planning.
4. The importance of “funding” your revocable trust.
5. Sizing up your estate and avoiding estate tax.
6. Gifting to avoid estate tax.
7. Planning for children of all ages with special needs.

LAST WILL AND TESTAMENT

A personal representative (also know as “executor” or “executrix”) is appointed to make funeral arrangements, disburse personal property, and if necessary, to represent your estate in probate court. Your Will is the proper document to appoint the Guardian of minor children. When used in conjunction with a revocable trust, the Will is known as a “pour over Will,” and serves to transfer un-funded assets (see “Funding Your Revocable Trust” below) into trust at death. A pour over Will acts as a safety net to catch any asset not transferred to trust during life and “pour” them over to your trust. Unfortunately, assets transferred into trust via the pour over Will must pass through probate.

DURABLE POWER OF ATTORNEY

Durable powers of attorney permit you to name trusted individuals to act on your behalf in the event you become incapacitated. Durable powers of attorney fall into two broad categories: powers pertaining to general personal matters (general powers), and powers pertaining to health care (health care powers). General powers permit you to appoint an “agent” to handle all of your personal affairs such as banking, preparation of tax returns, sale of an automobile, and application for employee or government benefits as if you yourself were present. Health care powers allow you to appoint someone (sometimes called a “patient advocate” or “health care surrogate”) to make your medical decisions including “pulling the plug” in the event of terminal illness.

The Patient Self Determination Act requires all federally funded healthcare facilities to inform patients of their right to appoint a health care surrogate. All fifty states now allow for the appointment of a substituted decision maker with life cessation powers. Each state has its own terminology and rules. Your state may recognize “Durable Powers of Attorney,” “Living Wills,” “Health Care Proxies,” or “Advance Directives.” You should be aware that health care powers executed in one state are not necessarily effective in other states. Accordingly, separate health care powers should be drafted if you are splitting time between or among states.

Most powers of attorney come into effect at the time of your incompetence (some non-medical powers come into effect at their creation), and in all cases, end at your death. The term “durable” signifies that the power being granted continues to be effective despite your disability. A general non-medical power of attorney grants your agent the power to handle all of your personal affairs.

The power of the agent does not extend to assets owned by your revocable trust, since assets owned in trust are not considered to be personally owned by you. Your revocable trust addresses the issue of your disability by appointing a successor trustee to manage trust assets in such event.

Since the likelihood of becoming incompetent dramatically increases with age, it is important that you have powers of attorney. Absent proper planning, your affairs would come within the jurisdiction of the probate court. If you become incompetent without durable powers of attorney in effect, a public hearing must be held to determine your in-competency before appointing a family member, friend, or a court appointee to act as your Guardian and Conservator. Powers of attorney avoid such costly and intrusive probate proceedings.

REVOCABLE TRUSTS

Today, most estate plans employ revocable trusts. Their versatility and ease of administration make them indispensable for small and large estates alike. Revocable trusts may be used to avoid probate, provide for children of current or prior marriages, and to minimize federal estate tax. Revocable trusts are effective upon execution, and continue for so long as mandated by their terms. Assets passing at your death avoid probate since your death does not affect the continued existence of the trust.

For income tax purposes, your revocable trust is not a separate taxable entity while you are alive. It operates under your social security number, is not taxed, and is not required to file a separate income tax return. Income of the trust is taxed to you at your individual tax rate. Thus, while you are alive the trust is ignored for federal and state income tax purposes.

CHOOSE FIDUCIARIES

Start by identifying the people you wish to act on your behalf in the event of your incapacity or death. Your appointees should be competent to act, understand your wishes, and be likely to carry them out. The three most important jobs tend to be the guardian of minor children, your patient advocate charged with making medical decisions, and your successor trustee appointed to manage trust assets after your disability or death. It is advisable to choose both primary and contingent fiduciaries for all appointments in the event your first choice is unable or unwilling to act.

NAME BENEFICIARIES

Who is to inherit your estate? If you have children, treat them equally, except in extremely rare circumstances. Unequal shares will surely leave a legacy of hurt feelings and estrangement among your children. If your late spouse has children from a previous marriage, you must decide how to remember them. If your late spouse has a trust, stepchildren may already be remembered.

How you treat step-children will depend on a number of factors including what your conscience tells you, and whether your late spouse remembered them in his trust. Ideally, you and your late spouse executed trusts balancing the needs and expectations of your children and the surviving spouse. If so, those trusts must be strictly administered according to their terms.

The relationship between step-children and a step-parent is often strained. Latent hurt and resentment matures to outright anger and mistrust over what will happen to “dad’s money.” If your late spouse made no provision for his children, you should consider making a gift of money or personal property as an olive branch to encourage continued involvement with them.

CONTROL FROM THE GRAVE

Young beneficiaries shouldn’t inherit too early. If you have small children, you are now the last line of defense between them and the outside world. Having their inheritance held in trust will facilitate their secure future. A trustee of your choosing should manage your assets in the event of your premature disability or death.

Trusts permit you to postpone your children’s inheritance and encourage college attendance. Certainly, eighteen year olds (the age of majority in most states) cannot be permitted unfettered control of their inheritance; nor can beneficiaries with emotional or substance abuse problems or beneficiaries who are either unable or unwilling to work, or who have a predilection for gambling, or otherwise wasting money.

It is your duty to protect your children in the event you aren’t around to parent them. You have the opportunity to speak to them through the words of your trust.

Assets that pass by operation of law, such as jointly owned assets and assets that name a beneficiary, are not governed by the terms of your Will or trust. Instead, they pass automatically at your death, and as a result can have unintended results. For example, if your Will and trust reflect your wish that your entire estate be distributed to your three children equally, your assets will nonetheless pass to a single child added as co-owner on a bank or brokerage account, merely as a matter of convenience.

A great many married couples own some or all of their assets jointly. At death, the couple’s assets automatically pass to the surviving spouse. Although the automatic transfer may have seemed smooth and painless at the time, couples with a net worth in excess of Applicable Exclusion Amount ($1,000,000 in 2002) have permanently lost a significant tax planning opportunity. Had both spouses prepared revocable trusts and transferred one-half of their assets to each trust, the couple could have doubled the amount they can leave to their children free from federal estate tax.

A couple whose combined net worth is likely to remain below the Applicable Exclusion Amount, should consider adopting a “joint trust.” A joint trust combines the benefits of joint ownership with those of a trust. Both spouses are the grantors and trustee of the joint trust. On the death of the first spouse, the surviving spouse is in complete control of the trust and even retains the power to amend the trust.

Since the trust does not become irrevocable on the first spouse’s death, none of the trust administration discussed in Chapter Seven is required at the first spouse’s death. Probate is avoided on the death of both spouses. Unlike joint ownership, joint trusts (like other revocable trusts) can hold assets for the benefit of children beyond the age of 18.

If your late spouse did not have a trust, and you are now the sole owner of your marital assets, you should avoid the temptation of adding your children’s names to your accounts. Although jointly held assets pass to the surviving tenants by operation of law, and therefore avoid probate, there are a number of reasons not to use joint ownership as a form of estate planning.

First, joint ownership accords significant lifetime rights to the new joint tenants, and exposes your assets to the claims of their creditors. For example, if you add your children as joint tenants on your home, you cannot sell or mortgage your home without their consent. Even if the children consent to the mortgage or sale of the home, they would technically be entitled to their share of the proceeds from the sale, a result you certainly did not intend.

Your children’s creditors will lick their chops when they learn that your children have an ownership interest in your assets. In the event one of your children divorces, a son-in-law or daughter-in-law may claim a spousal interest in your home.

You cannot provide for contingent beneficiaries through joint ownership. For example, parents often wish to leave their assets to their children equally, with the share of a deceased child passing to his or her children (i.e. grandchildren). This objective cannot be achieved by titling assets jointly.

Under joint ownership, only the surviving named beneficiaries inherit, leaving the children of deceased children out in the cold. The share of a child who predeceases you will be allocated only to your surviving children.

In short, don’t gamble on joint ownership and other operation of law transfers. The best way to minimize estate tax, retain control of assets, insulate assets from children’s creditors, and ensure that assets pass to the intended beneficiaries, is to re-title assets into the name of your revocable trust.

The preparation of revocable trust documents is only the first step in eliminating probate and minimizing estate tax. Once drafted, you must “fund” your trust. The process of funding assets into trust can be somewhat laborious, but is essential to achieving the full benefit of revocable trusts.

Funding is the process of transferring ownership (or a beneficial interest) in assets into trust during life. Assets owned in trust during life avoid probate at death.

The procedure for funding depends on the type of the asset being funded. Real estate, brokerage accounts, business interests, and bank accounts are funded by making the trust the owner of the asset. The trust name must contain the name of the Grantor, the Trustee(s), and the date the trust was created.

A typical trust name would be “Wendy Barnes as Trustee for the Wendy Barnes Trust dated September 1, 2001.” However, in light of the space limitations on typical ownership and beneficiary forms, it may be necessary to abbreviate the trust name down to its most important elements. The following name can be used in place of the full trust name described above: “Wendy Barnes Trust dated 9/1/01.”

REAL ESTATE

A “Warranty Deed” or “Quit Claim Deed” is used to transfer ownership of real estate into trust. Some advisors favor “recording” funding deeds, (i.e. filing the deed with the county register of deeds), while others prefer to record deeds only upon the death of the grantor. The fact that property is subject to a mortgage does not prevent you from transferring it to trust.

Ownership of your principal residence in trust does not affect your eligibility for the $250,000.00/$500,000.00 forgiveness of gain on sale available under federal Law. However, for Medicaid eligibility purposes, a principal residence owned by a revocable trust is not eligible for the homestead exemption.

QUALIFIED PLANS AND IRAs

Ownership of qualified retirement plans and IRAs cannot be changed without causing the entire account to become immediately taxable. Artfully drafted beneficiary designation forms are necessary to properly fund such retirement accounts into trust. As a general rule, married participants should name their spouse as primary beneficiary, with the revocable trust of the participant named as the contingent beneficiary.

A two-part beneficiary designation allows the greatest flexibility in negotiating the complex and perilous income and estate tax rules that apply to retirement plan assets. Unmarried participants should either name their revocable trust as primary beneficiary or their children directly. Retirement plan and IRA distributions are discussed in greater detail in Chapter Six.

PERSONAL PROPERTY

Other than automobiles and other vehicles whose title is regulated by state motor vehicle law, no action is required to fund personal property into trust. Since personal property (e.g., furniture, jewelry, art work and other items) cannot be re-titled (i.e., there’s no title for a table or chair!), such property cannot be transferred into trust. Instead, the disposition of personal property is governed by your Will.

Rather than addressing items of personal property directly in the document, most Wills permit the use of a “separate writing,” disposing of items of personal property. Automobiles and other items capable of being re-titled should not be transferred into trust. For liability purposes, automobiles, recreation vehicles, and other motor vehicles should be owned by the user of the vehicle.

OFTEN MISSED ITEMS

Savings bonds, stock certificates and undeveloped real estate lots tend to be overlooked during the funding process. Overlooked assets require a probate proceeding to transfer title. For this reason, it is important to be diligent in identifying all of your assets and then make sure that they are all transferred to trust.

Don’t be lulled into a false sense of security by the fact that no estate or inheritance tax was due at your spouse’s death. As a general rule, no estate tax is imposed on the death of the first spouse, irrespective of the couple’s net worth.

Federal estate tax is built on the belief that the surviving spouse shouldn’t be burdened by estate tax. Instead, the estate tax is imposed at the death of the surviving spouse, that is, your death.

Since a good number of estates exceed $1,000,000, it is important that spouses plan together in order to fully utilize their respective Applicable Exclusion Amount. A properly planned estate for a married couple allows the couple to leave up to $2 million to the next generation free of Federal estate tax.

To accomplish this result, and gain the full benefit of each spouse’s Applicable Exclusion Amount, each spouse must prepare a revocable trust during his or her lifetime.

Each trust is drafted to allow the surviving spouse nearly full access to the trust assets during the surviving spouse’s lifetime, without having the trust assets included in the surviving spouse’s estate. As the Applicable Exclusion Amount goes up, you may not need to each have a trust. A joint trust may suffice.

However, you should be aware that changes in the estate tax law could reduce the Applicable Exclusion Amount in the future, or halt its increase. For those in second marriages who want to lock in their children’s inheritances, a two trust arrangement may be necessary. If you didn’t do any estate planning while your spouse was alive and your spouse left you more than the Applicable Exclusion Amount, you will have to play catch-up.

With your spouse gone, more sophisticated estate planning strategies will be required to reduce your estate tax liability. They include outright gifts to your children and grandchildren, use of irrevocable trusts, family limited liability companies, as well as a number of charitable options described below. These more sophisticated estate planning techniques are discussed in Chapter Ten: “Advanced Estate Planning.”

The following chart illustrates the scheduled increases in the Applicable Exclusion Amount between the years 2001 and 2010. If your estate exceeds these figures, or if your late spouse has a trust and your combined estate exceeds two times the figure shown for the year of your spouse’s death, estate tax will be owed at your death unless you take action.

The starting point in determining whether you exceed the taxable limit is to determine your “gross estate.” Items included in your gross estate include all property in which you have a beneficial interest at the time of death. The most obvious examples are cash, stocks, bonds, real estate, business interests, artwork and other personal tangible property. The following is a more complete list of property included in your gross estate:

The full face value of life insurance is included in your estate if you maintained any “incidents of ownership” over the policy, such as the right to change the beneficiary or borrow from the policy. To avoid estate tax, it may be advisable to own life insurance in an irrevocable trust (see “Irrevocable Trusts” in Chapter Ten). An irrevocable trust separates you from any incidents of ownership in the policy, thereby excluding the proceeds from your estate.

The full value of your IRA, 401(k) and other retirement plan is included in your estate. Distributions from these plans are also subject to income tax. The possibility of double taxation on retirement type assets requires special planning described in Chapter Six.

Debts and certain expenses are subtracted from your gross estate to arrive at your “adjusted gross estate.” Further deductions reduce the adjusted gross estate to arrive at the taxable estate. The tentative tax is computed using tables provided by the IRS. The tentative tax is then reduced by your unified credit.

The practical effect of all of these calculations and manipulations is that the first $1,000,000 (2002) of your taxable estate can be left to your beneficiaries tax-free. The estate tax begins to apply only to the extent your taxable estate exceeds $1,000,000 (in 2002). The following diagram illustrates the circuitous journey from the gross estate to the estate tax due.

GIFTING

You may make gifts of up to ten thousand ($10,000) dollars per calendar year per beneficiary gift tax free. The right to make annual tax-free gifts is known as the “annual exclusion.” The tax code does not limit the number of beneficiaries to whom gifts can be made nor does it require that the recipient (“donee”) be related to the person making the gift (“donor”). Gifts may be made in cash or other property. Non-cash gifts are valued at their fair market value on the date gifted.

There is an unlimited exclusion (in addition to the $10,000 annual gift tax exclusion) for direct payment of a donee’s medical expenses or tuition. Both the medical and educational exclusions are allowed without regard to the relationship between donor and donee, meaning the recipient need not be related to you.

However, the payment must be made directly to the school, doctor or hospital that provides the service. The “unlimited marital deduction” allows unlimited gifts between spouses, as long as the donee spouse is a U.S. citizen. Unlimited gifts may be made to charities, even though there is a limit on their deductibility for income tax purposes.

If annual gifts to a single donor (other than a spouse or charity) exceed $10,000, the gift tax exclusion covers the first $10,000 and the excess is “taxable.” However, rather than having to pay tax on the excess, taxable gifts reduce your Applicable Exclusion Amount dollar for dollar.

The following example shows the effect of taxable gifts on the Applicable Exclusion Amount:

Example: Mary gifts her son, Sam, $40,000 in calendar year 2001. The portion of the gift that exceeds $10,000 ($30,000) is a taxable gift. Accordingly, Mary’s Applicable Exclusion Amount is reduced by the amount of the taxable gift, to $970,000 ($1,000,000 - $30,000). Thus, Mary may leave $970,000 free of estate tax at the time of her death.

To qualify for the annual $10,000 exclusion, a gift must be of a “present interest.” A present interest is defined as the current right of a donee to the unrestricted enjoyment of the gifted asset. For example, Mary’s $10,000 outright gift to her son Sam, described above, would qualify for the gift tax exclusion.

However, a transfer of $10,000 in trust for Sam to be distributed to Sam at a future date, would not qualify as a gift of a present interest, since Sam would have no present right to the gift. Sam would have only a future interest in the property. Sam’s gift could have been converted to a present interest had Mary’s trust contained a “crummy” provision (see “Irrevocable Trusts,” in Chapter Ten).

The Economic Growth and Tax Reconciliation Act of 2001 increased the amount of lifetime taxable gifts you may make to $1,000,000. Unlike changes in the estate tax that would increase the amount one may leave at death to $1,500,000, then $2,000,000 then $3,500,000 followed by repeal of the estate tax, the limit on taxable gifts is not scheduled to increase beyond $1,000,000.

SPECIAL NEEDS TRUSTS FOR DISABLE CHILDREN

Parents with disabled children face special estate planning challenges. The cost of supporting disabled children, especially ones with severe disabilities, is typically well beyond the financial means of most parents. They must rely on government programs to at least supplement the care they themselves are able to provide.

All but the wealthiest families must rely on government support to care for their disabled children. Supplemental Security Income (SSI), Medicaid, Medicare, and Social Security Disability Insurance (SSDI), though minimal, provide core support to disabled children. Eligibility for these programs is conditioned on both the child’s in-competency as well as financial need.

It is not advisable to leave an outright inheritance to a disabled child or grandchild since it would disqualify the child from government benefits. The child’s inheritance would have to be exhausted (to no more than $2,000 in most cases) before the child would again be eligible for government support.

The disabled child, having lost his or her inheritance, would be worse off than when his or her parents were alive, since the safety net provided by the disabled child’s parents would be gone. Only poverty level government benefits would remain.

The planning device that best addresses the needs of disabled children is known as a “special needs trust” (SNT) or “amenities trust.” These trusts make inherited assets available to a disabled child without disqualifying the child from government benefits.

Basically, a SNT directs the trustee to hold and administer trust assets to supplement, rather than replace, government benefits available to a disabled child. As a result, assets held in a properly drafted SNT are not considered part of the child’s resources for SSI purposes.

To avoid disqualification, a SNT must provide that

1. expenditures from the trust are wholly within the discretion of the trustee and the beneficiary does not have the right to demand either income or principal; and
2. the trust cannot be used to provide for basic needs such as food clothing or shelter.

SPECIAL NEEDS TRUSTS FOR ELDERLY PARENTS

Special needs trusts may also be used to provide for elderly parents. Monies left outright to aging parents will quickly disqualify them from Medicaid benefits. If you wish to provide for your parents in your estate plan, you should do so through a special needs trust. If you predecease them, your bequest will be used to supplement rather than disqualify them, from government benefits.

Example: Jim, a fifty-five year old husband and father of two pre-teen children died leaving two parents in a nursing home. He had named his parents as beneficiary on life insurance policies totaling several hundred thousand dollars, thinking that as an only child it was his responsibility to care for his parents. Unfortunately, Jim’s wife was not aware that Jim had left his life insurance to his parent. She stood by helplessly as money she could have used to raise her children was instead used to disqualify her in-laws from government benefits. Only after the life insurance proceeds were totally exhausted did the in-laws begin to receive Medicaid benefits. Had Jim used a SNT, Medicaid would have paid for his parent’s basic care (with the money in trust used for specialized medical and dental care, clothing, and other non-government provided benefits). At the death of her in-laws, Jim’s wife could have used the balance remaining in the SNT to raise her children.