The New Focus of Estate Planning

The tax deal made in Washington in late 2012 and early 2013 should change the way many people will view estate planning. It shouldn’t make anyone ignore estate planning, but for many it should cause them to take a broader view.

Estate planning isn’t dead, not by a long shot. Traditionally, for many people estate planning means estate tax reduction. They figure if their estates aren’t going to be hit with federal estate taxes, they don’t need a plan. Now, with estates up to $5 million ($10 million for married couples, and the numbers are indexed for inflation) exempt from the federal estate tax, few estates will be subject to federal taxes and many people are tempted to think they don’t ever need to visit an estate planner.

As I’ve said for many years, estate planning is about much more than taxes. You need a plan even when estate taxes will be zero. Perhaps the best effect of exempting most estates from federal taxes is that planners and their clients can focus their time on the non-tax issues of estate planning. Here’s a review of the top issues that should be considered in your estate plan regardless of the value of your estate.

* Deciding who benefits. The primary goal of estate planning is determining who inherits your wealth and when. A typical plan leaves all or most of the estate to the surviving spouse first. After that spouse passes away, the assets pass to children of the marriage. Your state law most likely does not automatically provide for that outcome. You need a will or living trust or both to reach your goals.

Of course, if you don’t have the stereotypical family and goals, you definitely need to meet with an estate planner to hammer out a will that transfers the assets the way you want.

* Mixing in trusts. A secondary decision is whether you want a beneficiary to receive assets directly and immediately. If not, the assets likely will be put in a trust for that person’s benefit.

There are many non-tax reasons to use trusts in an estate plan. The person might be too young to legally own the assets. Or you might be concerned about how the person would spend or manage the property. A trust allows a person or entity (such as a charity) to benefit from the wealth while the trustee manages it and the trust terms put some restrictions on distributions. A trust also can protect the assets from creditors of the beneficiary. You’ll want to use it when the beneficiary is in a high-risk occupation, might lose assets in a divorce, or has a substance abuse or other problem.

Another reason to use a trust is to ensure wealth finds its way to your contingent or secondary beneficiaries. You may want to leave your entire estate to your surviving spouse and also ensure your children receive what’s left after his or her demise. A trust does that. Trusts for this purpose are especially useful to someone in a second or subsequent marriage with children from a previous marriage.

* Setting formulas and disposition schemes. When a will doesn’t leave the entire estate to one person, there must be instructions to divide the estate. A problem with many of the formulas and other schemes is they work fine the day they are written but deliver unwanted results over time as asset prices change.

This is particularly true when people are designated to receive specific property. But it also can happen when they receive a percentage of the estate without a dollar limit or specific dollar amounts. Suppose you have a $3 million estate and leave 90% of it to your spouse and 10% to your brother. You believe that would leave your spouse comfortable. An economic calamity occurs, however, and the estate suddenly is worth $1.5 million. Now, your spouse needs all of the estate to meet expenses, and that 10% left to your brother seems like a lot more money, more than your spouse can bear to do without. A good estate planner will craft your dispositions to avoid such unwanted results and account for changing circumstances. But not all changes can be anticipated, so you also want to review your plan periodically.

* State taxes. Federal estate taxes aren’t the only potential leak out of your estate. There still are states with estate or inheritance taxes, and most of those taxes kick in at lower levels than the federal tax. If you live in such a state (or own property in one), you’ll want to look for ways to reduce the bill.

* Probate. Some states have a modern streamlined probate process that nicks the estate for fairly reasonable expenses and doesn’t take too long. Other states retain the old-fashioned slow and expensive probate systems. You should meet with an estate planner to learn which type of state you’re living in. When you live in a state with a long or expensive probate process (or both), then discuss ways to avoid probate. These methods include trusts, jointly-owned property, life insurance, and annuities.

* Debts and cash flow. An estate plan determines how debts will be paid and how that will affect inheritances. Some people have life insurance or liquid assets to pay debts so heirs can take title to unencumbered assets. Otherwise, taxes must be paid by the estate. Suppose you want one person to inherit a particular asset and another to inherit the rest of the estate. If the asset has a debt attached to it, how will that debt be paid and how will that affect the amount inherited by each person?

An estate planner also will examine the cash flow of the estate to ensure bills can be paid, assets maintained, and dependents taken care of during the estate settling process.

* Life insurance. Some people own life insurance to pay taxes, debts, or other expenses of the estate. Life insurance also can be a way to leverage your inheritance. Your estate planner will help determine if you have too much or too little life insurance. When you already own life insurance or the planner believes insurance is a good idea, you’ll also look at strategies such as a life insurance trust or partnership to own the policy and keep it out of your taxable estate.

* Charitable gifts. Many people leave something to their favorite charities in their wills. A charitable gift is fully deductible from the estate, so it reduces the estate tax. But when your estate won’t be taxable, you might not want to make the gift in your will. It might make more sense to make charitable gifts each year and deduct them on your income tax return. This is another issue a good estate planner will explore with you.

* IRAs, annuities, and more. A number of assets pass to the next owner outside the probate estate, the will, and a living trust. These include IRAs, employer retirement plans, annuities, and life insurance. For these, you need to review the beneficiary designations with an estate planner and coordinate them with the rest of the estate. Most estate planners say few of their new clients have done their beneficiary designations right.

* Special assets. Small business interests, collections, antiques, real estate, and other assets all require special consideration and planning even when taxes are not an issue. An experienced planner can explore the issues and options with you.

These are just a few of the non-tax issues that are fundamental to every estate plan. Other key elements of a plan we’ve discussed in past visits are health-care documents, a financial power of attorney, and guardianship designations for any minor children. You and your estate planner have a full plate of actions to consider long before federal estate taxes are considered. If you’ve been postponing your planning, it’s time to meet with a planner and discuss these issues.