Intro to Estate Planning
The primary objective of estate planning is to ensure that the property of a decedent will be used by the people the decedent is most interested in, for the purposes which he or she is most concerned, and over an extended period of time, if desired. To accomplish these overriding objectives, an individual must formulate his specific objectives and desires about the disposition of his or her property, while attempting to also minimize federal estate and income taxes. Since federal estate taxes currently consume about 50% of the value of an individual’s estate which exceeds the decedent’s applicable exclusion amount, currently $2,000,000 (2006-2008), the use of a marital trust based upon the marital deduction, has become an extremely popular provision to include in a revocable trust in order to minimize the payment of federal estate taxes.
Estate planning involves the preparation of a will, or wills for a married couple, and usually a revocable trust, especially for estates which are or would otherwise be subject to the federal estate tax, or, for example, for second marriages with blended families. A revocable trust is a trust created by an individual or married couple during life to hold assets over which he and/or she retains complete control, which can be amended from time to time, or even revoked, but which becomes irrevocable upon the death of an individual, or first spouse to die, at least with respect to that spouse’s assets which are part of the trust. A revocable trust is also called a “living” trust, since it goes into effect when executed and funded, as opposed to a testamentary trust which only becomes effective upon death, and is also subject to probate. Testamentary trusts have become highly disfavored as compared to living revocable trusts.
A revocable trust has several advantages over a will. If the trustor becomes disabled, the designated successor trustee of the trust is able to manage the trustor’s assets for his or her benefit, without court appointed guardian and/or conservatorship proceedings, which are very expensive. In addition, the use of a trust means that the trustor’s assets are distributed in accordance with the provisions of the trust, and are not subject to probate administration and public disclosure. Probate administration is expensive, and also untimely delays the distribution of assets. A trust is also generally harder to challenge than a will. A trust can also protect assets from creditors. A revocable trust also maintains its validity even if trustors change the state in which they reside. A trust, unlike a will, can be used to administer and distribute assets (both income and principal) over an extended period of time after death for children and grandchildren, or other beneficiaries, unlike a will. A revocable trust can also provide for professional fiduciary management of assets by trust companies or banks either initially, or upon the death of the decedent or surviving spouse.
In addition to preparing a will(s) and/or revocable trust, other legal documents are also usually prepared as part of the estate planning process, including a “living will;” a healthcare power of attorney; and a financial “durable” power of attorney for each individual. A durable power of attorney enables an individual called the principal to designate someone as his or her agent to continue to handle his or her financial and personal affairs in the event of disability.
If a revocable trust is created, legal title to property must be changed to that of the trust. In the case of real property, deeds must be prepared and recorded to convey title to the trust. At the same time, the form of ownership in real estate may be changed to that of community property (without right of survivorship) to minimize both federal estate and income taxes. Title to other assets, such as, bank and investment accounts, must also be changed to that of the trust. Life insurance polices must also be changed to name the trust as the beneficiary. Separate personal property owned by spouses might also be changed to that of community property for tax purposes through a separate document known as a “declaration of community property.”
This process is known as the “funding” and “titling” of the revocable trust, and is time-consuming, but constitutes an essential part of the proper establishment of a revocable trust as soon as the revocable trust has been executed. Revocable trusts are only effective as to property that the trustor(s) transfer to the trust. Attorneys and clients usually work together during this funding process, and attorneys customarily charge some additional fees for arranging title transfers and working on funding the trust. Integration of retirement benefits, such as, IRAs, and retirement plans, is also an important part of the estate planning process to accomplish the primary objectives of the parties, while maximizing income tax deferral and achieving estate tax minimization. The use and advice of C.P.A.s and wealth managers is often recommended or even required as an essential part of the over-all estate planning process, especially with respect to the integration of IRAs, retirement benefits, and other investments.
A revocable trust can save literally hundreds of thousands of dollars in federal estate taxes, by incorporating a “marital trust” which primarily benefits the surviving spouse, and transfers part of the decedent’s estate (that part which exceeds the decedent’s applicable exclusion amount, currently $2,000,000) to a marital trust, which is then not included in the decedent’s gross estate for estate tax purposes because of the marital deduction. The marital trust is usually established as a “qualified terminable interest property trust” (”QTIP” trust) under IRC (Internal Revenue Code) ยง 2056(b)(7). When a QTIP marital trust is used, there are then three separate trusts created for married couples which are part of a revocable trust, namely, the decedent’s trust, the marital trust, and the surviving spouse’s trust, consisting of his or her separate property, and his or her one-half interest in community property.
To qualify a QTIP trust for the marital deduction, the surviving spouse must be entitled to all of the income for life, payable annually or at more frequent intervals; no one, including the surviving spouse, may appoint the property to any person during the spouse’s life; and the decedent’s personal representative (executor) must make an irrevocable election on the estate tax return. The decedent, not the surviving spouse, however, controls the ultimate disposition of assets in the marital trust after the surviving spouse’s death. QTIP trusts usually also permit discretionary distributions of trust principal to the spouse by the trustee, which can be limited to a certain standard, such as, health, maintenance, support, and education. The trust can also provide, however, that there shall not be any invasion of principle from the martial trust as long as there are any readily marketable assets in the survivor’s trust, to attempt to preserve principal in the marital trust for the benefit of the decedent’s beneficiaries upon the surviving spouse’s death. Any remaining assets in the marital trust at the death of the surviving spouse also constitutes part of his or her estate, and is subject to estate taxes if the value of the entire estate exceeds the applicable exclusion amount.
A revocable trust can therefore provide income to the surviving spouse for life from all trust assets, including the marital trust, the decedent’s trust, and the survivor’s trust, and also provide for the invasion of principal for the surviving spouse from decedent’s trust and the marital trust, subject, for example, to an ascertainable standard of living, such as, health, maintenance, support, and education. Upon the surviving spouse’s death, the remainder of all trust assets are then distributed to all beneficiaries, according to the distribution provisions of the revocable trust.
While the creation of a revocable trust involves an initial investment of time, considerable thought, expense, periodic review and potential modifications to the trust, the intangible and tangible benefits, including the saving of expenses to avoid probate, guardianship, and conservatorship proceedings, and the minimization of estate and income taxes, are often compelling reasons to establish a revocable trust. Once a person becomes mentally incapacitated, it is then too late to establish such a trust.
For more information, see my Estate Planning Services section. This article is subject to the Terms, Conditions and Privacy Policy posted on my web site.