By Alexander J. Gross, CPA/PFS, CFP®
Do you own waterfront property in Palm Beach or do you vacation at Grandma’s house every year? Whether you have a Lamborghini collection that spans every color of the rainbow or you drive an old beater, you should pay attention. Contrary to popular belief, people with all levels of wealth need an estate plan. Although the Tax Cuts and Jobs Act passed at the end of 2017 eliminated the federal gift and estate tax for the majority of people, there are several reasons why everyone should consider putting an estate plan in place.
What is Estate Planning?
Estate planning is a process designed to help you manage and protect your assets while you are alive and to conserve and control who gets those assets at your death in accordance with your goals and objectives. Having an estate plan in place makes the settlement of your estate a whole lot easier, which can minimize costs and delays so that your beneficiaries inherit assets and not headaches. Properly drafted documents can also help minimize or eliminate estate taxes.
Without an estate plan, state laws dictate where your assets go upon your death. Such laws might not align with your intentions. Regardless of your age, health, or wealth, you should consider having the below documents in place as part of your estate plan.
A will documents where your property goes upon your death. Only the assets and liabilities in your name are controlled by your will. Jointly held property and IRAs are examples of property that bypass a will. You also name a Personal Representative (sometimes referred to as an Executor) in your will. Your Personal Representative is responsible for wrapping up your affairs and ultimately distributing the assets remaining after all of your debts have been paid. This process requires public notice to ensure all creditors are notified as well as court supervision.
If you have minor children, you should also name a guardian in your will. If you do not name a guardian, your family may find itself fighting in court over who will take care of your children in the event of your death. The court might place your children with a guardian whom you didn’t choose.
A revocable trust, sometimes called a living trust, is an optional companion document to your will. It works like a will but has many advantages to relying solely on a will. These include:
- Assets held in your revocable trust avoid probate upon your death. Probate is the legal process used to value your estate, settle debts, pay taxes, and distribute assets to your heirs. It can be time consuming and costly. Assets that pass through probate also become public record, and you might not want the contents of your estate available for everyone to see.
- A revocable trust can help protect inheritances directed to your children from irresponsible spending, future divorces, and creditors. You can also provide for a child with special needs (such as autism or Down syndrome) while preserving any government benefits that they might be receiving.
- A revocable trust can provide for your spouse in a second marriage without disinheriting your children from a prior marriage.
- Revocable trusts can be structured so that trust property can be managed in the event of incapacity without the need for court intervention.
Despite having revocable trust documents prepared, many people make the mistake of not funding their revocable trusts during life. Funding your trust is the process of transferring your assets from yourself to your trust. To do this, you physically change the titles of your assets from your individual name (or joint names, if married) to the name of your trust. Assets to consider when funding your revocable trust include investment accounts, real estate, checking/savings accounts, and business interests.
Advance Medical Directives
Advance medical directives generally include the following documents:
- Health Care Proxy – names a “Health Care Agent” who can make health care decisions on your behalf in the event you are unable to do so
- HIPAA Release – authorizes the release of your medical information to your agent (or others)
- Living Will – details end of life treatment and can serve as a guide to your agent regarding your wishes (i.e., forgo artificial respiration, do not resuscitate order, and organ donation)
It is a good idea to have Advance Medical Directive documents in place for your children prior to sending them off to college. That way, if a medical situation arises while they are at school, you will be able to access their medical conditions and speak with their doctors.
Durable Power of Attorney (DPOA)
A DPOA delegates the power to legally manage and protect your property should you become disabled or incapacitated. Your named individual can do things like pay everyday expenses, collect benefits, watch over your investments, and file taxes. Without this, no one may be able to access your bank account or other property in your name without lengthy legal proceedings.
There are two types of DPOAs: (1) an immediate DPOA, which becomes effective upon signing, and (2) a springing DPOA, which only becomes effective upon the occurrence of an event, such as incapacitation. Springing DPOAs can become problematic as they generally require one or more physicians to sign off on incapacity in order for the DPOA to become enforceable. The definition of incapacity can vary significantly throughout the medical community, particularly with brain injuries (strokes, accidents, etc.) and dementia. Note that DPOAs are legally binding documents that can be revoked at any time. Their power ceases at your death.
What About Estate and Gift Taxes?
Besides income and other taxes, everyone’s assets are subject to estate and gift taxes. The estate tax is levied when you die and transfer your assets to heirs. The gift tax applies when you transfer property while you are alive. The maximum federal rate under this system is 40%.
However, the Tax Cuts and Jobs Act significantly reduced the number of individuals and estates subject to estate and gift taxes. This is because the law now allows individuals and estates to transfer up to $10 million (indexed every year for inflation) estate and gift tax-free either during life or at death. This is called the federal estate and gift tax exemption. The indexed exemption amount in 2019 is $11.4 million per person.
Note, however, that many states don’t follow federal law when it comes to estate and gift taxes. Massachusetts and the District of Columbia (in addition to 16 other states) still assess gift or inheritance taxes upon death. For example, in Massachusetts estates larger than $1 million are subject to Massachusetts estate tax, which has a top rate of 16%.
Other Estate Planning Considerations
It is important to take a look at your beneficiary designations on assets such as retirement accounts (IRAs, 401Ks, etc.), life insurance policies, Transfer on Death (TOD) accounts, Payable on Death (POD) accounts, and assets held through joint tenancy. These assets pass to their beneficiaries by contract and not under the provisions of your will or trust. For example, failing to update beneficiary designations on a life insurance policy or on an IRA started 20 years ago may result in your account going to your ex-spouse instead of the three children you designated as heirs in your estate plan.
Estate planning is not a “one size fits all” process. Plans need to be customized based on your specific needs, goals, and objectives. Whether you spend your weekends on a yacht or a rowboat, whether you’re 98 or 18, you should consider the benefits of crafting a well thought out estate plan.
Print version: Do I really need an estate plan?