"Top Ten" Myths of Estate Planning Dispelled
 
November 24, 2004
 

As estate planners, we have met with a number of clients who begin the estate planning process with misconceptions that must be dispelled. In considering your estate plan, consider the following common myths of estate planning. This list is far from exhaustive, but it will supply you with facts essential to ensuring implementation of a successful estate plan.

A Will Disposes of All My Property

A Will is only a vehicle for disposing of property titled in your individual name. Property held in joint tenancy with right of survivorship or with a spouse in a tenancy by the entirety, such as real property and bank accounts, will pass by operation of law at the death of a tenant to the surviving tenant. A Will also does not dispose of property that is controlled by beneficiary designation, such as insurance proceeds, individual retirement accounts (IRAs) and retirement plans. This is important to keep in mind because you want to ensure that all of your property is disposed of according to your wishes and that estate tax obligations are properly allocated between testamentary property and non-testamentary property.

A Revocable or Living Trust Saves Taxes

A revocable or living trust is a trust established during the grantor’s lifetime that may be altered, amended or revoked by the grantor. We often recommend revocable trusts as a means of minimizing probate expenses, planning for potential incapacity, and providing a greater degree of privacy. In and of itself, however, a revocable trust saves its maker nothing in taxes. As a freely revocable trust, it is treated as a “grantor trust” and the owner therefore is taxed on all trust income during life, even if other beneficiaries actually receive the income distributions. Additionally, avoidance of probate does not necessarily equate to a reduction in estate taxes. Assets not subject to the probate process are still included in the creator’s gross estate for estate tax purposes. While estate taxes may be minimized in a revocable trust by including provisions for the establishment of a “bypass” or “credit shelter” trust on the grantor’s death in order to take advantage of each testator’s applicable exclusion amount, this technique can also be used in a Will.

A Revocable or Living Trust Allows My Estate to Pass Free of Probate

A revocable trust in and of itself does not entitle you to a free pass from the probate system. Establishing a revocable trust is only the first step. For property to pass to your beneficiaries outside the probate system, your property must be titled in your name as Trustee of your revocable trust. You have to fund the trust for it to serve its purpose. Funding your trust is an integral part of the estate planning process, and along with ensuring that beneficiary designations of IRAs, insurance policies, and retirement plans are properly structured, encompasses what we often refer to as Phase II of the estate planning process.

I Have Less Than the Applicable Exclusion Amount and Therefore Do Not Need Estate Planning

The applicable exclusion amount is the amount of property an individual can transfer during life or at death without incurring gift or estate taxes. In 2004, the applicable exclusion amount is $1.5 million. Clients often have more property includable in their gross estate for estate tax purposes than they think. Considering home equity, life insurance proceeds, retirement plans, and assuming a modest growth rate, many individuals will find themselves in a situation where estate tax planning is a necessity. “Estate planning” also encompasses more than tax planning. A Will provides an opportunity to dispose of your property according to your own wishes and desires, which may run contrary to the default disposition scheme provided under state law. A Will also provides parents of minor children the opportunity to appoint a guardian. Use of a trust can ensure that beneficiaries who would otherwise be entitled to property at age 18 do not obtain property until they attain a more responsible age. A trust can also provide a means of managing assets for disabled or elderly beneficiaries, or ensure a beneficiary is not disqualified from public assistance as a result of benefiting from your estate. Estate planning also encompasses much more. An estate planner can gauge the future liquidity needs of your estate, assist in properly structuring beneficiary designations, and provide guidance on asset protection issues.

The Death Tax Has Been Repealed

The media deserves much of the blame for this misconception. The 2001 Tax Act features gradually increasing applicable exclusion amounts and decreasing maximum estate tax rates. However, under the Act estate and generation-skipping transfer taxes are only “repealed” for decedents dying in 2010. The gift tax is never repealed. Additionally, many states have retained some form of an estate tax. A number of states have also decoupled from the federal regime, meaning that if you own property in one of these states you could end up owing estate taxes when you believed you were safely under the federal limit. Significantly, the Act also features a sunset provision, which ensures that changes instituted by the Act will come to an end after December 31, 2010, and the law as in effect before 2001 will be resurrected (i.e., a $1 million applicable exclusion amount). Moreover, if the estate tax is repealed on a more permanent basis, decedents’ estates will no longer be entitled to a step-up in the basis of all assets owned by the decedent and thus the estate tax will be replaced, in essence, by a capital gains tax. Predicting where the law in this area will eventually settle is next to impossible. It is important to recognize, however, that an estate tax repeal does not equate to total tax repeal and that the law in this area is constantly changing.

Holding Property in Joint Tenancy Is Great for Estate Planning

Property held in joint tenancy with right of survivorship (or with a spouse as a tenancy by the entirety) will pass by operation of law at the death of the first tenant to the surviving tenant. Holding title to property in this manner often seems to be the prudent thing to do. It can often, however, wreck havoc on an estate plan. Because joint property passes by operation of law it is not available to fund a “credit shelter trust,” a prime tool for minimizing estate taxes. This can result in underutilizing the first spouse’s applicable exclusion amount, often resulting in greater inclusion in the surviving spouse’s estate than was anticipated. Titling property jointly also may result in gift tax consequences if the new joint tenant is not a spouse, while also exposing the property to creditors of the new joint tenant.

I’ve Executed the Documents, Now the Process Is Complete

Drafting and executing documents is only the first phase of the estate planning process. A complete estate plan also encompasses proper titling of property, funding of your revocable trust, and ensuring that beneficiary designation forms on life insurance policies, IRAs, retirement plans and the like are accurately completed. We refer to this as Phase II of estate planning and it is an essential part of the process.

I Have an Estate Plan In Place and Therefore Can Forget About It Forever

While the law in this area is constantly changing, you will also find that your family circumstances, goals and desires will also change over time. In short, life is a journey. When circumstances in your life change, your estate plan should be updated accordingly. We recommend that clients have their estate plan reviewed at least every five years. It is important, however, to also be mindful of major shifts in tax laws and to seek review of your estate plan when laws change.

My Estate Plan Should Be Simple and Inexpensive

There really is no such thing as a simple estate plan. There are usually complicating circumstances that are not always readily apparent. Many clients who do not consider themselves wealthy will find themselves in a situation where planning for estate taxes is necessary. Property may have to be retitled, a trust may need to be drafted for the special needs of a disabled or elderly beneficiary, and beneficiary designations will undoubtedly have to be restructured. For clients in high risk occupations, asset protection planning is also an important consideration. Proper selection of fiduciaries and planning for children of a prior marriage also are factors that may complicate an estate plan. In short, ensuring that taxes are minimized and that transmission of your wealth to future generations occurs smoothly is not likely to be a simple and inexpensive undertaking.

I Can Only Give Away Up to $11,000 Per Year Tax Free

Clients are often under the misconception that the maximum amount that they can gift is $11,000 per year (i.e., the annual exclusion amount). An individual, however, can gift up to $11,000 per year per donee. If your spouse joins in the gift you can give up to $22,000 per donee per year. Additionally, amounts paid for qualified tuition and medical expenses are not considered taxable gifts. Above these amounts, you can also give away up to $1 million tax free during your lifetime. In estates with rapidly appreciating assets, this can be an important tool, as removing future appreciation from your estate will become an important part of minimizing transfer taxes.

While this collection of common estate planning myths is far from complete, dismissing these often encountered estate planning myths will serve you well in implementing a successful estate plan.

For more information, e-mail Tye J. Klooster at tye.klooster@hklaw.com or call toll free, 1-888-688-8500.