Essential Estate Planning Insights
Sometimes, we forget that there are other important things we need to take care of to ensure that those same people have the resources they need after we’re gone. 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 altogether. 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.
Review these general topics to 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 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 young 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 an 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.
One approach in gifting assets would be to gift $18,000 or less per-year to avoid any gift tax consequences. A married couple may be able to work with their CPA to gift-split and together make a gift of $36,000. Another strategy that some have utilized is to gift above-and-beyond the annual exclusion. In 2024, an individual may gift up to $13.61 million. If a gift is made in excess of the annual exclusion ($18,000 or $36,000 if gift-splitting), there are generally no immediate gift or estate tax consequences (up to the lifetime exemption); however, it is recommended that the individual’s CPA is notified in order to file a gift tax return. Any gifted assets above-and-beyond the annual exclusion will reduce the lifetime exemption. 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 appreciating to a significant degree.
One important caveat is the step-up in basis. Under current tax law, the assets that remain in the estate at the time of death receive a step-up in basis, meaning the cost basis of the asset is increased to the current market value on the date of death. In a world of perfect timing, this would entail that the heirs could sell the assets without paying any capital gains taxes (although oftentimes it doesn’t work perfectly due to the time it takes it administer the estate and transfer ownership of the assets to the heirs). Regardless, the step-up can effectively erase all or a significant portion of the gain on inherited assets. When assets are transferred to an irrevocable trust, they do not receive a step-up in basis at the date of death. The trade-off here is that the appreciation is removed from the estate for estate tax purposes, but the trust or the heirs will pay taxes on the gain if it is sold. Similar to the Testamentary Trust, the Irrevocable Trust can also provide for expert management (investments, administration, distributions, etc.) following the grantor’s passing.
All gift limits as of 2024
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 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 it 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.
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.