Estate Planning 101

Every year during the month of February, we buy flowers, cards, and gifts to celebrate the people that we love. Sometimes we forget that there are other important things we need to take care of to ensure that those same people have the resources that they need after we’re gone, and that we maximize the potential benefit to our heirs. Talking about end-of-life plans and discussions on drafting wills, trusts, medical directives, and powers of attorney are oftentimes either pushed into the future or avoided completely. As is the case with financial planning, it is never too early to create and implement an estate plan, and it can be a process that creates peace of mind for you and your family knowing that if something happens, there is a plan. Below are a few general concepts which can help you start thinking through an estate plan before going to visit with your attorney. 

Last Will & Testament

Purpose of a last will and testament:

• Avoid assets passing via laws of intestacy
• Name your preferred Executor
• Name guardians for minor children
• Establish testamentary trusts

The will is the first piece of a comprehensive estate plan. If you pass without a Will in place, there is obviously no method to discern how you would have preferred your assets be distributed, and they will likely pass by laws of intestacy according to the state. This distribution pattern may align with your wishes, or it may not, but it can create more complications in the estate administration process than if you had a will in place. 

Throughout the drafting process, you have the ability to name an individual or corporate Executor, who will be the party responsible for managing the estate administration. (In naming an Executor, you should name a person or entity that you trust, that you believe is competent to administer the estate, and that has a reasonable probability of surviving you.) You have the opportunity in drafting a will to not only determine how assets will be distributed, but within the same document you can also name guardians for minor children (a decision which you do not want to leave to the courts) and setup testamentary trusts if needed (more information below). The ability to name guardians for minor children is a good reason for even younger couples to establish a will.

Revocable Living Trust

Purpose of a revocable living trust:

• Potential for decreased expenses over probate
• Potential for more privacy than probate
• Likelihood of expedited distribution of assets
• Ability to provide for financial needs in the event of incapacity

Establishing a Revocable Trust during life requires an initial cost (hiring an attorney to consult and draft the document) as well as a time burden (generally most significant assets need to be transferred into the name of the trust).  Typically, the person or couple establishing the Trust would name themselves as initial Trustee (or Co-Trustees), and name Successor Trustees to take control in the event of death of disability. The primary reasons for establishing a revocable trust during life are to avoid probate and provide for yourself in the event of incapacity. Avoiding probate can entail many benefits, including the potential for lower estate administration expenses, increased privacy, and a more expedited distribution of assets. 

If the individual who establishes the Trust becomes incapacitated, a Successor Trustee can step in to manage the assets for the benefit of the person who setup the Trust. The Revocable Trust typically does not provide for any reduction in income or estate taxes. Even though the assets avoid probate, they are still included in the estate for estate tax purposes. (Similar to the Will and/or the Testamentary Trust, the Grantor of a Revocable Trust could also dictate that, at death of the surviving Grantor, the assets remain in Trust for-the-benefit of the beneficiaries, giving the Grantor some control after their passing.)

Testamentary Trusts

Purpose of a testamentary trust:

• Ensure competent management of assets beyond death (investment, tax, etc.)
• Control disposition of assets (distributions during the term of the Trust and upon termination) 

As mentioned above, a testamentary trust is typically established during the drafting of the last will & testament. In other words, this can be accomplished in the same document as the will. The Testamentary Trust is only established at the death of the person who established it through their will (the Testator), so it offers none of the benefits of the Revocable Trust outlined above. Similarly to the Revocable Trust, the Testamentary Trust offers no benefits as it relates to the goal of reducing estate taxes. 

The primary focus of the Testamentary Trust is for the Testator to have some level of control over the assets after their passing. If the heirs of the Testator are not particularly financially-minded, the testator can leave their assets in a trust for the ultimate benefit of his or her heirs, but with another individual (or corporation) named as trustee. The testator can dictate through the terms of the Will (and the corresponding trust) what the trustee may make distributions for, and when the trust will terminate (which is the point when the assets will be distributed outright to the beneficiary). (Typically a specific age or at death.)

If a corporate trustee is named, the testator may have a higher degree of peace-of-mind knowing that the trustee is capable of asset management (investments), prudent distribution decisions, and the timely filing of tax returns.

Irrevocable Trust

Purpose of an irrevocable trust:

• Avoidance or reduction of estate taxes
• Ensure competent management of assets beyond death (investment, tax, etc.)
• Control disposition of assets (distributions during the term of the Trust and upon termination)

While the above two trusts (Revocable and Testamentary) do not offer any benefit as it relates to reducing estate taxes, the Irrevocable trust established during life is usually setup for this express purpose. Oftentimes you will see an individual or couple establish this trust during life and begin gifting assets to the trust in order to remove future appreciation of those assets from their estate, with the goal of ending life with a lower total estate value than if they had never removed the appreciation of those gifted assets. 

In 2025, an individual may gift up to $13.99 million (the lifetime exclusion). There are generally no immediate gift or estate tax consequences (up to the lifetime exemption); however, the gifts do reduce the lifetime exemption amount. It is recommended that the individual’s CPA is notified in order to file a gift tax return. The goal of these gifts is typically to remove future appreciation of those assets from the estate. From that perspective, it is often recommended to transfer assets which the Grantor anticipates have a high probability of material appreciation.

Irrevocable Life Insurance Trust

Purpose of a irrevocable life insurance trust:

• Remove life insurance death benefits from the estate for estate tax purposes
• Provide liquidity to the estate
• Create legacy wealth for heirs
• Ensure competent management of assets beyond death (investment, tax, etc.)
• Control disposition of assets (distributions during the term of the Trust and upon termination) 

An Irrevocable Life Insurance Trust (ILIT), has similar goals to the irrevocable trust outlined above. The grantor of the trust can create a trust during life, and either have the trust purchase a life insurance policy on their life or transfer a policy to the trust. Generally (even if owned outside of Trust) the death benefit of a life insurance policy is not taxed (from a federal income tax perspective), but if the insured also owns the policy on his life, the death benefit can be included in the value of the estate for estate tax purposes. If done correctly, transferring ownership to an ILIT can remove the value of the death benefit from the estate for estate tax purposes. 

Once established, the grantor will usually make periodic gifts to the trust which the trustee can use to pay premiums to keep the life insurance policy in force. The goal is to make gifts to the Trust that are equal to or less than the annual exclusion ($19,000 in 2025) so as to avoid gift tax consequences on those amounts. At death, not only is the death benefit excluded from the estate, but oftentimes the trust is written such that the trust can make loans to the estate during the estate administration process. This is helpful if the majority of the estate is illiquid (real estate, farm, land, etc.) and the executor needs cash to pay attorneys, accountants, taxes, and other expenses. 

After administration is completed, the trust can continue to be administered for the benefit of the grantor’s heirs, per the distribution terms that he or she outlined when drafting the document. Even if liquidity for the estate is not a concern, this can be a good method to establish a significant source of legacy wealth for heirs which is not included in the estate for estate tax calculation purposes.

The Bypass and Trust Portability

• Portability allows the second spouse to utilize his or her current exemption, plus the frozen exemption amount of the first spouse to pass (as enacted by election on Form 706).
• Bypass Trusts are not as common after portability was introduced but continue to offer a method of protecting assets after the passing of the first spouse.
• Bypass Trusts remain an effective tool for capturing the exemption amount and sheltering future appreciation on trust assets from estate taxes.
• Assets that transfer outside of trust to the surviving spouse would generally receive a step-up in basis at both the deaths of the first and second spouse to die, whereas assets funded to a bypass trust would only receive the first step up.
• Income generated on assets funded into a bypass trust would be taxed at the trust tax brackets, which are more compressed than the individual or married rates.

Prior to the year 2011, bypass trusts (or credit shelter trusts) were a common estate planning tool. Portability was introduced in 2011, and in some ways reduced the necessity for creating a bypass trust. In either scenario, there wasn’t much of an issue upon the death of the first spouse to pass away, as that spouse’s assets would pass to the survivor under the marital deduction. However, prior to portability, and if a bypass trust was not put into place, at the death of the second to die, any assets in excess of the individual lifetime exemption for the surviving spouse would be subject to estate tax. The bypass trust was sometimes implemented as a way to capture the lifetime exemption amount of the first spouse to pass allowing the couple to combine exemption amounts at the death of the second spouse to shelter more of the remaining estate.

With the entrance of portability, you are no longer forced to create a bypass trust in order to capture the exemption amount for the first spouse; rather, an election may be made to “port” the exemption of the first spouse to pass to the surviving spouse, such that at the death of the second to die, the survivor can use his or her exemption amount, plus the “frozen” exemption amount of the first spouse to pass. (The surviving spouse’s exemption amount may have been increased by inflation adjustments, whereas the exemption ported from the first spouse to the second is frozen at the amount for the year of his or her passing.) (One important item of note is that, in order to port the exemption to the surviving spouse, an election has to be made on Form 706 (estate tax return).) Typically, these are filed when dealing with a taxable estate, but if it is possible that the estate will grow to be a taxable estate between the dates of death of the first and second spouse to die, it might be beneficial to file Form 706 even though it is not required, if only to make the portability election.

It may seem that the bypass trust is completely irrelevant now that portability is an option, but there may still be reasons to consider it as part of an estate plan. One reason is simply to maintain control of those assets after death. Oftentimes, these trusts are drafted to benefit the surviving spouse during his or her life, and then remain in trust for the benefit of children (or be distributed outright to those heirs at the death of the second spouse). This can help to ensure that biological children are not inadvertently cut out of an estate plan due to a second marriage. Additionally, it was mentioned above that when portability is elected, the exemption of the first spouse to die is frozen at the time of death. The assets which pass to the spouse, however, will likely continue to appreciate.

It is possible that while the exemption limits may cover the total estate today, it is possible for the estate to appreciate in value such that it surpasses the combined exemption amounts in later years, especially if the survivor has a longer life expectancy. A bypass trust, if implemented correctly, would not only capture the exemption amount in the year of death, but all future appreciation on those assets would be sheltered from estate tax at the death of the survivor. This benefit, of course, has to be contrasted with the opposing drawback of a lack of step-up in basis at the death of the second to die.

If portability is elected, the assets would receive a step-up at both the first and second to die; however, if a bypass trust is utilized, the assets funded into that trust would be excluded from the estate, and therefore not receive the step up in cost basis at the death of the second to die. Additionally, it must be considered that trusts have more compressed tax brackets than individuals or married couples, so there could be negative implications from an income tax standpoint if assets were funded into a bypass trust. The complexity of this strategy illustrates the importance of working with a qualified attorney and accountant at all stages of the estate planning cycle.

Ancillary Estate Documents and Strategies

In addition to the strategies outlined above, it is recommended, during the estate planning process to have an attorney draft powers of attorney (financial and healthcare), as well as medical directives. Establishing a power of attorney gives another person or entity the ability to handle your affairs in the event of incapacity. 

The authority given in a power of attorney ends at death. It is important to have both a financial and a healthcare power of attorney in place, so that both financial and health-related decisions can be made during incapacity. Medical directives allow an appointed individual to make healthcare decisions during an end-of-life situation. They are also important documents to have on file, and can alleviate conflict between family members and ensure your wishes are carried out. 

There are many other estate planning strategies that can be implemented to accomplish a variety of goals. Some of those strategies (i.e. marital trusts, bypass trusts, family limited partnerships, charitable trusts, etc.) are effective tactics, and should be included in the discussion with an estate planning attorney. They are outside of the scope of this article, which is meant to address some of the most commonly-used strategies, and establish a baseline of knowledge prior to meeting with a qualified attorney to discuss the specifics of your estate plan.

We understand some of these topics can be complex, so, we are here to help. Please reach out to your local First Financial Trust office for more information on which of the above strategies are right for you.