Plan Your Estate
Denis Clifford, Attorney
April 2012, 11th Edition
When you're thinking about estate planning, you want to make sure that you choose the right plan for your family. Turn to Plan Your Estate, Nolo's bestselling book of estate planning essentials. Get straightforward, plain-English explanations of every significant estate-planning option available, so you can make the best decisions for you and those you love.
Let attorney Denis Clifford show you how to:
- avoid probate
- leave property through a will or trust
- use life insurance to provide for your loved ones
- name a guardian for your minor children
- leave property to a young person
- plan for incapacity
- implement strategies specific to business owners
- reduce estate taxes
- make final arrangements
The 11th edition is completely revised with the latest federal and state laws, plus updated estate and gift tax information, and enhanced discussions about 529 plans, same-sex marriage, tax-saving trusts, and retirement benefits.
Good in all states except Louisiana.
“An excellent source of information on wills and estate planning.”-The New York Times
“Particularly helpful are a series of ‘profiles’ that illustrate how estate plans can benefit various individuals and families.”-The Wall Street Journal
“A clear, comprehensive and even charming book.”-The Los Angeles Times
Denis Clifford, a graduate of Columbia Law School, where he was an editor of The Law Review, is a practicing lawyer who specializes in estate planning. He is the author of many Nolo titles, including Quick and Legal Will Book, Make Your Own Living Trust and Plan Your Estate, and a coauthor of A Legal Guide for Lesbian and Gay Couples. He has been interviewed by such major media as The New York Times, Los Angeles Times, and Money Magazine.
Part I: Setting Your Goals
1. Selecting Your Estate Planning Goals
- Part I: Setting Your Goals
- Part II: Laying the Groundwork
- Part III: Children
- Part IV: Wills
- Part V: Probate and How to Avoid It
- Part VI: Understanding Estate and Gift Taxes
- Part VII: Reducing or Eliminating Estate Taxes
- Part VIII: Imposing Controls Over Property
- Part IX: Taking Care of Personal Issues
- Part X: Family Business Estate Planning
- Part XI: Going Further
- Part XII: Sample Estate Plans
2. Personal Concerns and Estate Planning
- Avoiding Conflict
- Leaving Unequal Amounts of Property to Children
- Providing Care for Minor Children
- Subsequent Marriages
- Long-Term Care for a Child With Special Needs
- Concerns of Unmarried Couples
- Worries About the Effect of Inheriting Money
- Disinheriting People, Including Children
- Communicating Your Decisions to Family and Friends
Part II: Laying the Groundwork
3. Special Property Ownership Rules for Married People
- What You Need to Know
- Marital Property in Community Property States
- Marital Property in Common Law States
- Moving to a Different State
4. Inventorying Your Property
- Instructions for the Property Inventory Worksheet
- Your Property Worksheet
5. Your Beneficiaries
- Types of Beneficiaries
- Primary Beneficiaries
- Life Estate Beneficiaries and Final Beneficiaries
- Alternate Beneficiaries
- Residuary Beneficiaries
- Gifts Shared by More Than One Beneficiary
- Establishing a Survivorship Period
- Explanations and Commentary Accompanying Gifts
- Simultaneous Death
- Property You Give Away by Will or Trust That You No Longer Own at Your Death
Part III: Children
- Naming Someone to Take Custody of Your Minor Children
- Naming an Adult to Manage Your Child’s Property
- How Your Children’s Property Should Be Managed
- Tax-Saving Educational Investment Plans
- Naming Children as Beneficiaries of Life Insurance
- Leaving Property to Children Who Are Not Your Own
- Children Conceived After a Parent Dies
Part IV: Wills
- A Will as the Centerpiece of Your Estate Plan
- A Backup Will With a Comprehensive Estate Plan
- What Makes a Will Legal?
- Types of Wills
- What Property Cannot Be Transferred by Will?
- Explanatory Letters Accompanying Your Will
- Can My Will Be Successfully Challenged?
- Keeping Your Will Up to Date
Part V: Probate and How to Avoid It
8. Probate and Why You Want to Avoid It
- What Is Probate?
- Probate Fees
- Avoiding Probate
- When You May Want Probate
- Debts, Taxes, and Probate Avoidance
- Probate Reform
9. Living Trusts
- Does Everyone Need a Living Trust?
- Living Trusts Explained
- Major Decisions in Creating a Living Trust
- Creating a Valid Living Trust
- Keeping Your Living Trust Up to Date
10. Joint Tenancy and Tenancy by the Entirety
- What Is Joint Tenancy?
- Joint Tenancy Bank Accounts
- Joint Tenancy Safe Deposit Boxes
- Tenancy by the Entirety
- Joint Tenancy in Community Property States
- Tax Concerns Affecting Joint Tenancy
- Drawbacks of Joint Tenancy
- When Joint Tenancy Makes Sense
- Creating a Joint Tenancy for Property With Documents of Title
- Creating Joint Tenancy for Personal Property Without Documents of Title
11. Pay-on-Death Designations: Bank Accounts, Securities, Stocks and Bonds, and Motor Vehicles
- Choosing Beneficiaries
- Pay-on-Death Bank Accounts
- Naming a Pay-on-Death Beneficiary for Government Securities
- Naming a Beneficiary for Stocks and Bonds
- Vehicle Registration
- Transfer-on-Death Deeds for Real Estate
12. Life Insurance
- Do You Need Life Insurance?
- Types of Life Insurance
- Life Insurance and Probate
- Choosing Life Insurance Beneficiaries
- Reducing Estate Tax by Transferring Ownership of Life Insurance Policies
13. Retirement Benefits
- Social Security
- Individual Retirement Plans
- When You Retire
- Retirement Plans and Estate Planning
- Using Disclaimers for Retirement Accounts
- Probate and Taxes
14. State Law Exemptions From Normal Probate
- Will Your Estate Qualify?
- Using These Rules to Plan
- Summary of State Law Exceptions to Normal Probate
- California Exemptions From Normal Probate
- New York Exemptions From Normal Probate
- Texas Exemptions From Normal Probate
- Florida Exemptions From Normal Probate
Part VI: Understanding Estate and Gift Taxes
15. Estate Taxes
- Federal Estate Tax Exemptions
- The Big Picture: Estate and Gift Taxes
- Will Your Estate Have to Pay Taxes?
- Calculating and Paying Estate Taxes
- Reducing Federal Estate Taxes
- The Federal Income Tax Basis of Inherited Property
- State Inheritance and Estate Taxes
16. Gifts and Taxes
- The Federal Gift Tax: An Overview
- What Is a Gift?
- How the Federal Gift Tax Works
- Using Gifts to Reduce Estate Taxes
- When Not to Give Property Away: Tax Basis Rules
- Using Gifts to Reduce Income Taxes
Part VII: Reducing or Eliminating Estate Taxes
17. An Overview of Ongoing Trusts
- Trusts to Reduce Estate Taxes
- Ongoing Trusts Used to Control Property
- Ongoing Trusts and Avoiding Probate
- What Ongoing Trusts Can’t Do
- When Ongoing Trusts Begin and End
- The Trustee
- Taxation of Ongoing Trusts
18. Estate Tax–Saving Bypass Trusts
- Overview of Bypass Trusts
- IRS Restrictions on Bypass Trusts
- AB Trusts: Bypass Trusts for Couples
- Bypass Trusts for Unmarried People
19. Other Estate Tax–Saving Marital Trusts
- QTIP Trusts
- Trusts for Noncitizen Spouses: QDOTs
- Marital Deduction Trusts
20. Charitable Trusts
- An Overview of Charitable Trusts
- The Income Tax Deduction
- A Closer Look at Charitable Remainder Trusts
- A Closer Look at Charitable Lead Trusts
- Types of Charitable Trusts: A Comparison
21. Other Estate Tax–Saving Trusts
- Generation-Skipping Trusts
- Irrevocable Life Insurance Trusts
- Grantor-Retained Interest Trusts: GRATs, GRUTs, and GRITs
22. Disclaimers: After-Death Estate Tax Planning
- Advantages of Disclaimers
- Disclaimers and AB Trusts
- IRS Rules for Disclaimers
- Including Disclaimers in Your Estate Plan
23. Combining Estate Tax–Saving Trusts
- Combining Two Estate Tax–Saving Trusts
- Combining a Charitable Trust With Other Estate Tax–Saving Trusts
- Combining Three Different Estate Tax–Saving Trusts
- Using Ongoing Trusts and Gift Giving to Reduce Estate Tax
Part VIII: Imposing Controls Over Property
24. Property Control Trusts for Second or Subsequent Marriages
- Evaluating Your Situation
- How a Marital Property Control Trust Works
- Restricting the Surviving Spouse’s Rights Over Trust Property
- The Role of the Trustee
- Savings on Estate Taxes
- Working With a Lawyer
25. Trust and Other Devices for Imposing Controls Over Property
- Educational Trusts
- Trusts for People With Special Needs
- Spendthrift Trusts
- Sprinkling Trusts
- Trusts to Manage Your Own Property
- Powers of Appointment
- Combining Property Control Trusts With Estate Tax–Saving Trusts
Part IX: Taking Care of Personal Issues
26. Incapacity: Making Medical and Financial Decisions
- Medical Decisions
- Financial Decisions
- Guardianships and Conservatorships
27. Body and Organ Donation, Funerals, and Burials
- Making Your Own Choices
- Leaving Written Instructions
- Donating Your Body or Organs
- Death Notices
- Services and Ceremonies Following a Death
Part X: Family Business Estate Planning
28. Family Business Estate Planning
- Operation of the Business
- Reducing Estate Taxes
- Avoiding Probate of a Family Business
Part XI: Going Further
29. Using Lawyers
- Hiring a Lawyer
- Doing Your Own Research
30. After You Complete Your Estate Plan
- Storing Your Estate Planning Documents
- Revising Your Estate Plan
31. After a Death Occurs
- Probate Avoidance Living Trusts
- Ongoing Trusts for Estate Tax Savings or Property Management
- Preparing and Filing Tax Returns
- Trustee’s Reports to Beneficiaries
- Collecting the Proceeds of a Life Insurance Policy
- Obtaining Title to Joint Tenancy Property
- Personal Matters
Part XII: Sample Estate Plans
32. Some Estate Plans
- A Prosperous Couple in Their 60s and 70s
- A Wealthy Couple in Their 70s
- A Single Man in His 60s
- A Younger Couple
- A Single Woman in Her 30s
- A Widow in Her 80s
- A Couple in Their 60s, in a Second Marriage
- An Unmarried Couple in Their 40s
Appendix: State Inheritance Tax Rules
Selecting Your Estate Planning Goals
Part I: Setting Your Goals................................................................. 4
Part II: Laying the Groundwork......................................................... 4
Part III: Children................................................................................ 6
Part IV: Wills..................................................................................... 6
Part V: Probate and How to Avoid It.................................................. 7
Part VI: Understanding Estate and Gift Taxes................................. 10
Part VII: Reducing or Eliminating Estate Taxes............................... 12
Part VIII: Imposing Controls Over Property..................................... 13
Part IX: Taking Care of Personal Issues......................................... 14
Part X: Family Business Estate Planning......................................... 14
Part XI: Going Further.................................................................... 16
Part XII: Sample Estate Plans.......................................................... 16
There are a number of ways to leave property to those you want to have it after your death. The peculiarities of our system of inheritance mean that substantial amounts of money and time can often be saved if property is labeled and transferred by certain legal methods rather than others. But to choose wisely among these methods, first you must clearly define your estate planning goals.
This book is divided into 12 parts; each part covers a different estate planning goal or purpose. This chapter gives you an overview of each goal, so you can select the ones that matter to you. It also presents a sample estate plan of a couple in their 50s, so you can get a feel for what kinds of decisions you may have to make and what types of documents you may end up with.
I urge you to read all chapters of every part that concerns you before you actually begin to formulate your own estate plan. Different aspects of estate planning are often intertwined. For example, it just doesn’t make sense to decide what property should pass under your will—and so go through probate—until you understand that some of it might be better left by other probate avoidance methods. Similarly, if you are wealthy, you’ll need to understand how estate taxes work before you can determine the wisest ways to transfer property to your loved ones. The point is that you need a good overview of all the parts of estate planning that concern you before you begin to make your plan.
Part I: Setting Your Goals
Use Part I to focus on your estate planning goals. After reading the first chapter, you should be able to decide which other parts of the book probably apply to your situation.
You should also take some time to mull over important personal concerns that can arise in estate planning—such as leaving unequal amounts of property to different children or avoiding potential conflicts. Chapter 2 discusses some of these concerns. Read this chapter unless you’re very confident that your personal situation is clear and not conflicted.
“Thrift is a wonderful virtue,
especially in an ancestor.”
Part II: Laying the Groundwork
This part covers the primary concerns of any estate plan: what you own and to whom you want to leave it.
Obviously, you’ll need to be sure of what you own. Also, sensible planning usually requires at least a rough idea of what your property is worth. Chapter 4 contains a worksheet you can use to list all your major items of property or just use as a safety check to make sure you haven’t overlooked anything.
Your “estate” includes all the property you own, minus anything you owe (assets minus liabilities). You may find it useful to use the worksheet to make a rough estimate of the dollar value of your estate, which can be helpful both for general planning purposes and to predict whether or not your estate is likely to be liable for estate taxes. Of course, your estate will very likely have a different worth when you die, so precise figures aren’t necessary.
You can’t leave what you don’t own. Ownership rules for single people are simple. Except as limited by contract (such as a partnership agreement or another form of shared ownership), you can leave all property you own outright. For these purposes, the fact that some institution has a claim on the property, such as a mortgage on a house or a loan lien on a car, doesn’t create shared ownership.
Property ownership rules for a married person can be more complex. Read Chapter 3 before you start inventorying your property. Rules affecting ownership of property acquired during marriage may restrict your right to leave property. There are two basic systems that govern a married couple’s property; which one applies to you depends on what state you live in. The majority of states follow the “common law” system where, in general, the owner of the property is the person whose name appears on the ownership document. The other system, applicable in nine states, mostly in the West, is “community property,” where most property acquired during a marriage is owned equally by both spouses.
In common law states, laws limit a spouse’s right to disinherit the other spouse. As explained in Chapter 3, in these states, a surviving spouse has the right to receive a certain portion of a deceased spouse’s property, no matter what that spouse provided or intended. If you plan on leaving your spouse more than half your property, these laws can’t affect you.
For most people, the heart of estate planning is deciding who gets what. You may have a very clear idea of who should inherit your property. If so, fine. Still, there are a number of issues that you may want to consider, from naming alternate beneficiaries to leaving shared gifts to forgiving debts. Chapter 5 discusses these and other concerns about your inheritors.
Unmarried Couples: Who Owns What?
Unless an unmarried couple—gay, lesbian, or heterosexual, it makes no difference—agrees to share ownership of specified property, each member of the couple owns only his or her own property. An agreement to own property together must often be in writing to be enforceable. In some states, an oral agreement is effective if it can be proved, but that can often be difficult. In short, it is best for unmarried couples to put any property-sharing agreement in writing.
If you’re part of an unmarried couple where each person has kept all property separate (a written agreement to do this, listing the property of each person, is a good idea here as well), each of you is free to give your property to whomever you wish. However, if property ownership is shared, either under the terms of a written contract or in a tenancy in common or partnership, you’re free to dispose of your share only, unless the contract or partnership agreement provides otherwise.
Property held by unmarried couples in joint tenancy goes to the survivor automatically.
For more information on property ownership problems of unmarried couples and sample property-sharing agreements, see Living Together: A Legal Guide for Unmarried Couples, by Ralph Warner, Toni Ihara, and Frederick Hertz (Nolo), a detailed guide designed to help unmarried couples minimize their entanglements with the law.
Part III: Children
If you have minor children, you’ll want to plan for what would happen in the unlikely event that you and the other parent (if there is one) die before the children become legal adults. Indeed, for many new parents, concern for their child is what moves them to begin estate planning. Chapter 6 focuses on minor children, because a number of special estate planning issues affect them.
Most likely your first concern is who would raise the children if you couldn’t. In your will, you can name someone to serve as the “personal guardian” for your children—the adult who would be responsible for raising them if neither parent could. Your nomination isn’t automatically legally binding, but courts normally confirm the person you name if the other parent isn’t available. Chapter 6 also discusses what you can do if you do not want the other parent to obtain custody.
The second big issue is who will manage any property you leave to your minor children. Minors cannot legally own more than a minimal amount of property without adult supervision. So, leaving property to your minor children requires you to choose a method for adult management. Chapter 6 explains the four legal methods you can use to impose adult supervision over property you leave to minors and the advantages and drawbacks of each.
Finally, Chapter 6 also addresses estate planning issues pertaining to adult children.
Part IV: Wills
Everyone should have a will, the most basic estate planning device. Chapter 7 explains why and shows you what you can accomplish in your will.
In your will, you name your “executor,” the person with legal authority to administer the transfer of your will property. Chapter 7 discusses the responsibilities of an executor and presents some thoughts on selecting yours.
Wills do have one big drawback: Property left by a will must go through probate. So don’t decide what property to transfer by your will until you’ve looked at transfer methods that avoid probate, which are discussed in Part V.
Whatever you decide about avoiding probate, you still need a will. At a minimum, a will is a backup device essential to the transfer of any property that somehow wasn’t transferred by other methods, such as property you overlooked or that you unexpectedly acquire (e.g., a surprise inheritance or lottery winnings) after setting up your probate avoidance devices.
In almost all states, a will is the only document you can use to name a personal guardian for your minor children. Also, a will is best for transferring some types of property, like personal checking accounts or vehicles that may not be convenient to transfer by any other method.
Legal Rights for Same-Sex Couples
Same-sex couples can marry in Connecticut, the District of Columbia, Iowa, Massachusetts, New Hampshire, New York, and Vermont. In these states, married same-sex couples receive the same state law rights as other married couples in that state. However, federal law does not recognize any rights for same-sex couples, regardless of state law. So a lesbian or gay couple cannot file a joint IRS tax return, receive Social Security surviving spouse benefits, or obtain any other federal right available to heterosexual married couples—even if they are legally married.
California, Colorado, Delaware, Hawaii, Illinois, Maine, Maryland, New Jersey, Nevada, Oregon, Rhode Island, Washington, and Wisconsin have passed laws that provide same-sex couples with some or most (depending on the state) of the property rights granted to married couples, but not the right to marry. These domestic partnership laws vary from state to state, so check your state’s laws to learn what the specific rights are. Generally, to obtain these rights, a same-sex couple registers with a state agency.
Keep in mind that despite the rights available to same-sex couples in some states, relying on these laws should never be a substitute for doing your own comprehensive estate planning. It is not wise for any persons—gay, straight, married, or single—to allow the state to do their estate planning for them.
Part V: Probate and How to Avoid It
Probate is the name given to the legal process by which a court oversees the distribution of property left by a will. The probate process is examined in detail in Chapter 8.
Probate proceedings are generally mere formalities, because there’s rarely any dispute about a will, but they are nevertheless usually cumbersome and lengthy. During probate, your assets are identified, all debts and estate taxes are paid, fees for lawyers, appraisers, accountants, and for filing the case in court are paid, and the remaining property is finally distributed to your inheritors. The average probate proceeding drags on for at least a year before the estate is actually distributed.
The word probate has acquired a notorious aura. This is because in probate, it’s common for lawyers, and sometimes other officials or executors, to charge large fees for what in most cases is routine, albeit tedious, paperwork. For example, if a father leaves his estate equally among his three children and no one contests the will, a lawyer might be paid a hefty sum just to shuffle papers through a bureaucratic maze.
Because probate lawyers are expensive, I’ve been asked many times by will beneficiaries if they can safely handle probate without an attorney. Unfortunately, except in California and Wisconsin, the answer is normally “no,” at least not without considerable difficulty. In California, simple estates can be probated without an attorney by using How to Probate an Estate in California, by Julia Nissley (Nolo).Wisconsinhas a simplified probate system, with court clerical assistance for completing the forms. Legally, it’s permissible in most states (but not, for example, in Florida) for the executor named in a will to act for the estate, appear in probate court, and handle the proceedings without an attorney. But probate is a technical and tedious area of the law. Without good instructions, which are unfortunately nonexistent outside of lawyer texts (except, to repeat, in California and Wisconsin), the forms can seem very complicated to the uninitiated. Further, in some situations, there are court hearings to attend. In short, learning how to do probate from scratch normally takes considerable time and risks continuing frustration. Worse, the courts and clerks can be unhelpful, or even hostile, to laypeople.
A wiser choice is to reduce or eliminate probate fees by transferring property outside of probate. If you have a moderate estate, you can probably prepare probate avoidance devices and documents yourself, without an attorney. Chapters 9 through 14 explain the major probate avoidance methods:
Living trusts allow you to retain full control over trust property while you live. After your death, your living trust property is transferred quickly to your beneficiaries.
Joint tenancy is a form of shared property ownership with the key element that the surviving owner of joint tenancy property automatically inherits the share of a deceased owner. No probate is required.
Pay-on-death designations let you name a beneficiary to quickly and easily receive, without probate, assets such as bank accounts or stocks when you die.
Pay-on-death deeds and vehicle registrations pass real estate or vehicles to named beneficiaries without probate.
Life insurance proceeds go directly to the policy beneficiary, without going through probate.
Individual retirement programs, such as IRAs, profit-sharing plans, or 401(k) plans, allow you to leave any money remaining in the account to a named beneficiary. The money is transferred outside of probate.
State law exemptions from normal probate allow smaller estates to go through a simplified probate procedure or avoid probate altogether. These rules apply to estates ranging from less than $5,000 to $200,000, depending on the state. A list of each state’s rules is in Chapter 14.
Reading about probate avoidance doesn’t mean that you must decide to pursue it. Some people intelligently decide that all the estate planning they want for now is a will.
Although you may find it surprising, limiting estate planning to making a will can, in the right circumstances, make good sense. For example, many younger people in good health often sensibly decide to postpone detailed estate planning for later. A will naming a personal and property guardian for minor children and leaving their relatively modest amount of property to a spouse, partner, and perhaps also a few close friends or relatives, is all they want, and need, now. Since probate doesn’t happen until death, a younger person should have plenty of time to plan to avoid it later in life.
In contrast, for older people with a reasonable amount of property, or people in ill health, it makes little sense to depend on a will alone. The amount of time and effort it takes to plan to avoid probate is just not that much—certainly far less than will be consumed going through the probate process, not to mention the significant costs saved.
Providing Ready Cash
One goal of estate planning can be to provide ready cash for immediate family needs or, later on, to pay any estate taxes or other debts. Particularly if you are your family’s main provider, your survivors will need immediate cash for their living expenses, or for the “costs of dying”—hospitalization, funeral, and burial expenses—and other debts and taxes that are due promptly.
If most of your property is transferred by will, your family won’t get it while probate moves on. Immediate family members can ask the probate court to release limited amounts for necessities, but it’s wiser to plan to have money available without going to court and paying attorneys’ fees.
If most of your property will be transferred outside of probate, there is much less reason to worry about arranging for ready cash, because cash is usually accessible promptly. However, if most of your assets aren’t “liquid”—that is, cannot easily be converted to cash—you may still need to provide a source of ready cash. For example, if your worth is in real estate and shares of a private corporation that can’t readily be sold, your family might have trouble obtaining cash for daily expenses. Traditional sources of cash are life insurance policies or money in a pay-on-death bank account.
Aside from avoiding probate altogether, if you significantly reduce the value of property transferred by probate, you’ll likely reduce the attorneys fee as well. A useful concept here is the “probate estate,” the portion of your estate that must go through probate. Anything that is transferred by probate-avoiding methods is not part of the probate estate; it goes directly to inheritors without court proceedings. If you plan wisely, you can reduce considerably the size of your probate estate, or even eliminate it entirely.
Some reasons for probate. In unusual situations, probate can be useful. If your estate will have many debts or claims by creditors, probate provides a forum for resolving those claims with relative speed and certainty. And if creditors who are notified of the probate do not file claims within a set period (usually a few months), the claims are barred forever.
Part VI: Understanding Estate and Gift Taxes
Many people who engage in comprehensive estate planning want to know about estate and gift taxes. Will your estate be liable for taxes? If so, what can be done to reduce or avoid them? In Chapter 15, you’ll learn how both federal and state estate taxes work and whether or not your estate is likely to be subject to a tax.
In addition, a handful of states impose estate or inheritance taxes. Chapter 15 explains how estate and inheritance taxes work.
You will almost surely learn that no federal estate tax will be assessed against your estate. Federal law exempts a certain amount of property from tax. For 2012 the exemption is $5.12 million per person.
Estate Tax Uncertainty
The current federal estate tax law applies for only two years, 2011 and 2012. This law expires in 2013, so Congress will need to adopt a new law before then. If Congress does not do that, the estate tax exemption will be lowered dramatically, from $5.12 million to $1 million. It seems likely that Congress will act. But what the precise dollar amount of the exemption will be in future years cannot now be sensibly predicted. Estate taxes are a political issue; the political situation in 2012, especially after the presidential election, will largely determine what happens to the estate tax.
If you have a substantial estate—on the cautious side, anything above $1 million—you should keep up on estate tax law. To check the latest on the federal estate tax exemption, go to Nolo’s website www.nolo.com.
When couples should consider tax planning. If you’re a member of a couple (married or not) with a combined estate exceeding the federal estate tax threshold, you should consider tax planning if each of you plans to leave most or all of your property to the other. Without planning, the survivor could wind up with an estate subject to tax after he or she dies. With sensible planning, this result can often be avoided or reduced. (See Part VII, below.)
Chapter 15 explains this and other major federal estate tax exemptions. Another important exemption is what’s called the “marital deduction,” which provides that all property left or given to a spouse is exempt from estate or gift tax. However, the marital deduction does not apply to property a citizen spouse gives or leaves to a noncitizen spouse.
Chapter 15 also covers the concept of tax “basis” and how that applies to inherited property. Very briefly, the basis of property is the dollar value put on your ownership interest when determining the profit or loss from sale. To simplify here, we can say that the basis of property you own is the purchase price. However, if you inherit property under current federal law, your basis is not the cost to the person who left you the property, but the market value of the property when that person died. This is called a “stepped-up” basis. If you plan to leave property that has significantly increased in value since you purchased it, it’s important to understand how this stepped-up basis works and can be used in estate planning.
To get a solid grasp of estate taxes, you also need to understand gift taxes, which are covered in Chapter 16. At first hearing, the phrase “gift taxes” sounds like something Scrooge came up with. How can you tax generosity? But if there were no gift taxes, estate taxes could be avoided simply by giving away property while you live instead of leaving it when you die. So the federal government, and a few states, impose tax on substantial gifts, currently, those above $13,000 to any person in one year.
Separate taxes and probate. Don’t confuse avoiding probate with reducing estate or gift taxes. Unfortunately, avoiding probate doesn’t have any effect on estate or gift taxes.
Definition of a Gift
A “gift” is property you transfer freely (not by sale or trade) to a person or an institution. Throughout this book, gift is used to describe both property you give away during your lifetime and property you leave at your death. This eliminates the legalese of “bequest,” “devise,” or “legacy.”
Part VII: Reducing or Eliminating Estate Taxes
Chapters 17 to 23 cover major methods of reducing federal estates taxes, aside from tax-free gifts. These methods require using some form of irrevocable trust, or, sometimes, a number of trusts. I call these “ongoing” trusts because they function as independent entities for an indefinite time. This is in contrast to a probate avoidance living trust, which is normally operational only for a brief period, after the death of the person who set it up.
Because an irrevocable trust is an independent legal entity, it must obtain a federal taxpayer ID number. Trustees must keep separate trust financial records and file an annual trust income tax return, paying any taxes due. (See Chapter 17.)
One common estate tax–saving trust is commonly called an “AB” disclaimer trust.
AB disclaimer trusts should be used only with full knowledge of their limits as well as their advantages. (Chapter 18 spells out the pros and cons.)
Other marital estate tax–saving trusts are covered in Chapter 19. A “QTIP” trust enables a surviving spouse to postpone taxes otherwise due on property worth more than the federal estate tax threshold.
This chapter also explains “QDOT” trusts, which can be important if you are married to a noncitizen. As we’ve said, the marital deduction does not apply to property left to a noncitizen spouse. So normally any property over the federal estate tax threshold left by a citizen spouse to a noncitizen spouse is taxable when the citizen spouse dies. A QDOT trust enables the noncitizen spouse to postpone payment of any taxes due until after her or his death.
Whether you’re married or not, if you’re interested in making a large gift to a charity and also getting a tax break, you may want to investigate charitable trusts, covered in Chapter 20. With these trusts, you can leave property to charities and simultaneously obtain income tax as well as estate tax benefits. A charitable trust makes sense, from an estate tax perspective, only if your estate exceeds the federal estate tax threshold. However, Chapter 20 also provides useful information about charitable gifts, no matter how large your estate.
Still other kinds of ongoing trusts can be used by anyone, married or not, to save on estate taxes. These trusts, covered in Chapter 21, include:
generation-skipping trusts, where you leave property in trust for grandchildren and avoid estate taxes on the trust property when your own children die
irrevocable life insurance trusts, which can, in the right circumstances, save a bundle on estate taxes, and
grantor-retained interest trusts, which can yield income and estate tax benefits if you transfer your home to a trust for a set period.
One other strategy that can sometimes lower a family’s overall estate tax burden is the use of a “disclaimer.” A disclaimer is simply a statement that you decline to accept property left to you—a legal way of saying “no thanks.” Disclaimers can be used to direct gifts from a prosperous beneficiary who has ample resources to another person who has less. Aside from any personal goals this may achieve, it also may work to protect the prosperous person’s estate from increased estate taxes. (Chapter 22 explains how to use disclaimers.)
Finally, some people use more than one kind of trust to achieve the most tax savings. (See Chapter 23.)
Part VIII: Imposing Controls Over Property
For one or more reasons, you may want to impose controls over property you leave—in other words, legally prevent the beneficiary from gaining unfettered ownership of the property. (Chapter 6 discusses controls you can use over property left to minors. This part covers restrictions on adult beneficiaries.) These types of controls require use of a trust.
You might want to impose such controls if you’ve remarried and want to balance the interests and needs of your current spouse with those of children from a former marriage. Chapter 24 explains how you can create a trust that leaves your spouse certain defined rights in trust property for his or her life, but preserves the principal for your children who receive the trust property when the surviving spouse dies.
Many issues can come up when trying to balance the rights of the spouse and the children. For example, can the surviving spouse sell trust property? What rights do the children have to see that the trust principal is being preserved? There is no generic solution to these questions. The answers must be worked out individually, fitting your specific desires and needs.
You may want a property control trust in a number of other situations, discussed in Chapter 25, including:
You want to help pay for a child’s college or other schooling costs. Here you’ll need to decide whether you want to define what school costs include and what the criteria for being in school are, or if you’ll let the trustee make those decisions.
You want to establish a “special needs” trust for someone with a disability. Common problems include selecting the trustee and doing all that’s legal to preserve the beneficiary’s eligibility for government assistance.
You want to restrict a beneficiary’s access to his or her inheritance. If you believe an adult beneficiary can’t responsibly handle money, you may want to set up a “spendthrift trust.” It controls the beneficiary’s freedom to use trust property, including the ability to pledge it as a loan.
You want to create a trust allowing the trustee to decide how property is distributed to adult beneficiaries. With a “sprinkling trust,” the trustee is authorized to distribute, within any limits set by the trust, unequal amounts of trust income or principal among the beneficiaries.
You want someone else to decide what happens to some or all of your property after your death. This is called a “power of appointment.” The person you authorize can select your beneficiaries and decide how much of your property they receive, within any limits you’ve set.
Part IX: Taking Care of Personal Issues
When you’re making plans for what happens to your property, don’t overlook two important personal decisions that can affect what happens to you. The first is making arrangements for handling your financial and medical affairs if you become incapacitated and unable to make these decisions yourself. The second is what you want done with your body after you die. What are your choices, and how can you make your decisions binding?
To be sure your wishes are carried out if you become incapacitated, you’ll need to prepare several documents. For health care, you can prepare documents that specify what type of medical care you want if you become incapacitated and cannot express your wishes, and that authorize someone you’ve chosen to make sure your wishes for health care are carried out. These documents normally become effective only if you become incapacitated and can’t communicate your preferences for treatment.
To handle money matters if you become incapacitated, you can prepare a document called a “durable power of attorney for finances.” In this document, you appoint someone to handle your financial affairs and make financial decisions for you. You can include any directions regarding your finances that you wish. Chapter 26 discusses these issues.
The options you have for disposing of your body after death are covered in Chapter 27. Subjects covered include death notices, donation of body parts for transplants or your entire body for medical research, funerals, cremation, burials, and how to leave binding written instructions. Doing this kind of planning can be a great gift to your loved ones, freeing them from burdensome tasks immediately after your death and almost always saving significant amounts of money.
Part X: Family Business Estate Planning
Small business owners have special estate planning concerns. Chapter 28 covers some basic issues: operation of the business after an owner’s death, planning to reduce or eliminate any possible estate taxes on the business, and avoiding probate of business assets. Business estate planning is a complex field and I can delve into only the most central issues, but, at a minimum, this chapter should enable you to determine the areas with which you might want more help.
Protecting Assets in Case of Catastrophic Illness
See an Expert
Many people are concerned that if they become seriously ill, all their savings—indeed, all their assets—will be consumed to pay for health care. To address this valid concern, some people ask for a will clause, or a simple trust, or anything that will prevent their assets from being used for expensive medical bills. Unfortunately, this is not an easy matter to handle. No simple clause or trust can safely accomplish this. The best you can do is:
Seek advice from an expert attorney in your state. The attorney must know applicable federal laws and regulations and also be up-to-date on your state’s laws.
If you’re a member of a couple, research how you can best protect the assets of the person who doesn’t become ill. Many states allow one spouse to shield his or her property from liability for medical bills of the other spouse. This is covered in depth in Long-Term Care: How to Plan & Pay For It, by Joseph L. Matthews (Nolo).
Consider transferring some of your property to trusted family members before you become seriously ill. You need to be careful here and work with an expert in the field. Federal law prohibits giving away property and then applying for federal medical aid within five years of the transfer.
All this can be tricky and even dangerous. Both federal and state legal rules change rapidly. Nevertheless, a lawyer experienced in elder law issues in your state should be able to provide you with some measure of asset protection. This is likely to be less than you want, but the best you can do.
For tips on finding a lawyer, see Chapter 29.
Family Limited Partnerships
Some people believe that creating a “family limited partnership” can somehow eliminate all estate taxes, no matter how large the estate and how flimsy the “business.” The notion is that the parents can transfer their property into a partnership business entity with their children and possibly grandchildren, sharing ownership as limited partners. The parents hope that as a result, the partnership will be transferred to younger generations tax free.
For such a plan to succeed, the IRS must be convinced that the limited partnership has some purpose beyond simply reducing estate taxes. Calling your home or stock investments a family business doesn’t make them one. But if you own a real business, there can be estate tax advantages to creating a limited partnership for it and transferring minority interests to future inheritors. The pros and cons of this are discussed in more depth in Chapter 28.
Part XI: Going Further
Once you’ve determined, at least in outline, what your estate planning goals are and how you want to address them, you may want to see a lawyer or other expert.
Chapter 29 discusses the different types of lawyers and other experts who may be helpful, or necessary, for you to pin down the specifics of your plan and prepare the documents you need. The chapter explores how to find a good lawyer and how to work with one, including making fair and sensible fee arrangements. You may also decide to do some legal research on your own; this chapter gets you started.
After your planning is done and the documents you want have been prepared, you’ll need to know what to do with them. Chapter 30 covers how to store them, how to make copies, and when to revise your estate plan.
Doing conscientious estate planning while you’re alive is a boon to your loved ones—but someone must still complete the process after your death. Chapter 31 gives you an overview of how your property will be transferred, depending on how you leave that property—by will, living trust, joint tenancy, pay-on-death account, or life insurance. It next discusses what happens if your estate owes taxes. The chapter also covers some important matters about ongoing trusts, including how they actually are put into gear, and the responsibility of the trustee to report to the trust beneficiaries.
Part XII: Sample Estate Plans
Now that you’ve read this first chapter, you should have some focus on the major issues you want to address in your estate planning. Part XII provides several examples of estate plans, to aid your understanding of how different goals and components can be melded into one plan.
In the hope of giving you a clearer notion now of what the end product of your efforts may be, here’s one sample estate plan.
Abel Rublestam and Lynn Montgomery are married and in their 50s—he’s 58, she’s 51. They live in a common law property state. They have two children, Matt and Rebecca. Matt is married and has two young children. Rebecca is in graduate school.
Their property. The couple shares ownership of all their property. Their estate consists of a home worth $550,000 ($460,000 equity), securities (stocks and bonds) worth $280,000, money market savings of $350,000, life insurance on each spouse that pays $200,000 on death (for a total of $400,000), and their one-half ownership of the Montstam corporation, a family business. It’s hard to determine the exact value of their business. As a rough guess, they decide it’s worth at least $2,800,000. The current net worth of each spouse’s estate, in 2012, is $2,145,000 and the net worth of their combined estate is $4,290,000.
Their estate planning goals. The couple wants to avoid probate. They also realize that their combined estate may be subject to estate tax when the second spouse dies. So they want to eliminate any possible estate taxes.
They consider leaving more property to Matt, because of his family responsibilities. But they decide to leave equal amounts to both children. They don’t want to seem to favor one child or one lifestyle. Also, they don’t want to have to revise their plan if a major family event happens to one of their children—say, Matt has a third child or gets divorced, or Rebecca has a child.
Their plan. The couple prepares a living trust to avoid probate. In that trust, they create an AB disclaimer trust which could save on estate taxes if the federal exemption is lowered for 2013 and thereafter. Each leaves the other all his or her property. Both name their children as the final beneficiaries of their AB disclaimer trusts.
They carefully transfer title to their home, Montstam stock, securities accounts, and money market funds into the living trust’s name, having already checked that the bylaws of their co-op apartment association and the Montstam corporation permit this.
Each spouse names the other spouse as beneficiary of his or her life insurance policy.
When they’re older, if their assets increase significantly in value, the couple intends to make tax-free gifts of $13,000 per year each to each of their children, but decide that they are not ready to do this now.
Each prepares a basic will. Then they prepare health care directives—a declaration and a durable power of attorney for health care for each of them. In their declarations, they each state that they do not wish to be placed on life support equipment if diagnosed with a terminal illness. In their durable powers of attorney for health care, each names the other as attorney-in-fact, with full authority to make medical decisions and to be sure that all wishes for health care are carried out. Finally, each prepares a durable power of attorney for finances, naming the other as attorney-in-fact.