WHERE ESTATE PLANNING FITS INTO THE EQUATION
Building financial freedom isn’t all about you. It’s also about your loved ones, significant other, or even a charity that you might want to benefit when you’re gone. Trust me—if you don’t have a plan, your hard-earned money could end up going to lawyers, the government, or bickering family members. Leave a legacy. Leave a plan to make the world just a little better place by strategically planning where your wealth will end up after your death.
I included this chapter about estate planning in the book for an important reason. A Revocable Living Trust (RLT) and Will doesn’t protect your assets from a creditor in a lawsuit, but it does protect your assets from the government or your family wasting your hard-earned assets. Millions of Americans die each year without any type of estate plan in place, and this forces their families into the court system, where they experience the high cost and time delay characteristic of probate proceedings.
In fact, more than 50 percent of Americans don’t even have a will or any type of estate plan. With that said, does everybody need to be scared into a RLT? Certainly not. Here’s the truth: not everybody needs an RLT, and a simple Will may be all some of us need to plan for our estate upon our demise.
RANDY LUEBKE
While you are alive, having an advance health-care directive takes the burden and pressure off those who love you and want to do what is best for you. If you are unable to make and verbalize your choices and decisions due to your physical condition at present, wouldn’t it truly be better for everyone if you had created a set of instructions for everyone to follow in the past? This is true when you pass away. Plan your estate and direct your assets, and you will help to mitigate the quarrels and frustration that may otherwise evolve among the survivors. Hey, they may still fight over your stuff, but you won’t be around to hear it. At least you will have the opportunity to get your way just one last time.
There are three main reasons to implement an RLT:
1. You have provisions you may want to implement for minor children or special-needs adult children for managing their finances.
2. You wish for your family to avoid probate because you own a personal residence, a business, or rental properties.
3. You wish to minimize estate tax with a marital bypass trust.
A quality estate plan typically includes an RLT, as well as a number of ancillary documents, such as a will, powers of attorney for finances and health care, an advance medical directive or living will, burial instructions, a directive for organ donation, final instructions, etc.
One of the key reasons for using an RLT is to avoid probate, which means avoiding attorneys, judges, courts, and the state sticking their noses into the family affairs. Probate is essentially the court’s process of determining if the will is valid and then executing its provisions. If there isn’t a will, then the court distributes the assets according to state law.
In addition to helping your family avoid probate, the RLT becomes the instruction manual for how the estate is to be distributed among the beneficiaries. The process is administered by the trustee you appoint and avoids a tremendous amount of wasted time and money spent going through court.
In order to make sure the trust does its job, it needs to be funded by a holding title to four main assets:
1. Real estate (typically your personal residence)
2. Entities (such as corporations and LLCs for rentals)
3. Investment accounts (including retirement accounts with see-through provisions)
4. Life insurance (so that minor children receive it constructively)
Figure 25.1 on page 274 shows an example of a typical family trust structure.
Estate Tax and the A-B Trust Strategy
In the late hours of December 31, 2012, lawmakers in Washington, DC, passed the American Taxpayer Relief Act of 2012. Under the “fiscal cliff legislation,” as it came to be known, the estate and gift tax exemption was set at $5 million. This means that the first $5 million of an individual’s estate may be inherited (at death) or gifted (during life) before any estate or gift tax is due. This exemption amount is, has been, and continues to be adjusted each year for inflation.
Figure 25.1—Typical Family Trust Structure
With a marital bypass trust, often referred to as an A-B Trust, a married couple can take advantage of both personal exemptions and thus double how much they can leave to their family without estate tax. This is a special trust that creates two subsequent trusts upon the death of the first spouse and thereby doubles the estate tax exemption of approximately $5.5 million. Obviously, this is a very complex aspect of estate planning and is typically only undertaken when a family’s net worth is more than $5 million to $6 million.
Don’t Give Property to Children—Let Them Inherit It
When you gift property during your lifetime, the tax basis in the asset transfers to the person who receives the gift. In other words, if you have a property you bought for $100,000 that is now worth $300,000, the person receiving the gift would get your $100,000 tax basis, so that when they sell the property, they pay capital gains taxes on anything above $100,000.
However, when someone inherits property upon death, they receive tax basis in the property at the fair market value at the date of death. So if the basis to the owner was $100,000, but the fair market value was $300,000 at their death, the heir would get the property at a $300,000 tax basis. When they later sell the property, they will only pay taxes on any gain above $300,000—as opposed to $100,000 if the gift had been made during the lifetime of the donor. Make sure these types of properties are transferred to the trust and inherited by the family—not gifted to them during life.
Creative Provisions for Children
Many parents and even grandparents don’t realize how creative they can be in distributing their assets upon their passing. I realize that some folks believe it’s immoral to control their children or family with money after their passing, but others feel they have a duty to leave their hard-earned assets in a constructive manner for their descendants’ posterity. Whatever your position may be on the degree of control you want to exercise from the grave, here are a few options to consider:
Require your trustee to hold children’s inheritance in a trust until they reach the age of 25, 30, or 35. Give it to them in stages, e.g., a third at age 25, a third at age 30, and the final third at age 35.
Use a joint trust for minor children until the oldest reaches age 18. Then split up the trust into individual trusts for each child. This makes it easier for the trustee to manage the trust while the children are minors. Then when different children pursue business, education, marriage, or even world travel, their trust is accounted for separately from the others.
Consider having the trustee give the guardian of your children a specific amount each month to take care of the living costs of your minor children (room, board, clothing, school supplies, etc.). It could be something like $1,000 a month, adjusted for inflation as of the date of your trust.
Place restrictions on inheritance if there is drug or alcohol abuse. An attorney can insert a provision that prevents a distribution to any child with an abuse problem and allow for the trustee to hold their funds in the trust until they have their life under control.
RANDY LUEBKE
Ideally, life should be like a banana split. You know, the banana split comes with all those great toppings and the ice cream, all that good stuff. The goal is, on that very last bite, to get just the right amount of everything on the spoon, and then it’s gone. It’s a terrible thing, to have a nut or two or a large pool of fudge left over with no ice cream to swallow along with them. It’s just not right!
Life should be like that, too. You work, earn money, save some, stop working, spend some, and then on your last day on the planet, you spend the last dollar you have or give it away to anyone besides the IRS. Right? Wouldn’t that be ideal?
Well, life is not as predictable and manageable as a banana split, so as this relates to your estate planning, follow my rule once again: “Plan for the worst, hope for the best, and know that you are going to likely end up somewhere in between.” The operative word being “plan”—make one.
Give the inheritance in matching funds, distributing $1 for every $1 the child earns.
Give them a bonus for graduating from certain levels of college or do not allow full distribution until they obtain a certain level of higher education. However, still distribute funds for school or any secondary education program, skills training course, etc.
Distribute funds for education, or use their GPA as a “carrot”: distribute funds only if children maintain a minimum GPA that you set. You could also tie funds for tuition or books to GPA to help keep the children focused on finishing school rather than becoming career students.
Distribute a certain amount of funds for a wedding.
Distribute funds for a church service, volunteering for the Peace Corps, or joining the military for a certain number of years.
Distribute funds to start a business upon the presentation of an acceptable business plan to the trustee. Name a board of advisors to approve any small business or investments by the children.
Perhaps you have a child whom you’d like to disinherit from your estate. If so, don’t just leave their name out of the will and think this will accomplish your goals, as the laws in most states will presume you intended to have them inherit unless you specifically state otherwise.
After your spouse, your children are the presumed heirs to your estate by law in the absence of an estate plan. As a result, it is important to include a complete list of your children in the estate plan and to specifically mention any child who will not be an heir by stating something like, “It is the intention of the settlor [you] to disinherit the following child from the estate.” It’s that simple; just clearly indicate in writing that you specifically intend them not to inherit your estate, and they’re out.
The Living Will/Health-Care Directive
A Living Will (or Health-Care Directive, as they are referred to in some states) is a legal document that can be used to make decisions as to whether you want to be on life-sustaining support or whether you want someone to pull the plug if you are brain dead or in a persistent vegetative state.
Dealing with the death of a spouse or other close family member is one of the most difficult situations a person will face. However, that experience is made even more difficult when family members must make life-ending decisions for their loved ones. A well-drafted estate plan includes a Living Will, aka health-care directive, whereby a person makes a legal decision for themselves about whether they want to be placed on life-sustaining support or whether they want to be removed from life support.
The Living Will can be relied on by family members and medical professionals. It also allows a person to declare if they wish to be an organ donor and/or want their body to be used for medical research. Hospitals are authorized and protected by law when they rely on a Living Will, and it makes family decisions at a hospital so much easier.
Top Three Mistakes with “Do It Yourself” Estate Plans
Families can easily and affordably prepare basic estate planning documents online these days. However, this increase in affordability and convenience found on the web has created a false sense of security and inadequate planning that has caused disasters for many families. Many do-it-yourself estate plans fail to provide the benefits and protections that are included in a well-drafted and carefully planned estate.
Below are the top three mistakes I’ve seen made by individuals who have completed their estate plan on their own. Two of the mistakes listed below are based on actual clients who hired our firm to represent them in a lawsuit with other heirs in probate court, due to the fact that their parents made the drastic error of completing their estate plan on their own.
1. Improper signatures and witnesses for wills. Most states require the signature of the person creating the will as well as two witnesses to the will. The only exception to the two-witness requirement in most states is a holographic will, which is a handwritten will with the signature of the person creating the will. No matter how good it looks or how many terms are included, failure to adhere to the signature and witness requirements invalidates the entire will.
2. Failure to fund the trust. Most individuals who create an RLT on their own fail to actually fund it with their assets. Funding a trust means that you put the assets you want to be controlled by the trust in the name of the trust. For example, if you want your home to be subject to the terms in your trust, then you need to deed the home out of your personal name and into the name of the trust. If the property is not deeded into the trust, it falls outside the trust terms, and your heirs will need to go to probate court to get a judge to approve any transfers of title following your death.
3. General do-it-yourself forms may not address your unique situation. Most families have at least one situation unique to their estate that is typically not covered by standardized documents found on the web. For example, you might have a child who is financially irresponsible, but the rest of your children are not. Do you know how to use prepackaged forms to create an adequate plan that takes into account the financially troubled child while not adversely affecting the inheritance of your other children? Or maybe you have an estate that has more debt than assets. Do you know how to plan the estate to leave the most to your family and the least to your creditors? The list could go on and on. My point is that the unique situations that arise are rarely handled properly when you’re doing your estate plan on your own.
The real benefit of a revocable living trust is that the structure allows a grantor or grantors to control, affect, and influence future generations. Think of your own family. How many of us can say we know the detailed life history of a grandparent or great-grandparent? I suspect very few. However, if that same relative had created a trust for our education and tried to positively influence our lives through an inheritance, I would argue that many of us would be very interested in the life history, personality, and character of such a grandparent.
TIP FOR FINANCIAL FREEDOM
Your trust isn’t worth anything if you don’t fund it.
RANDY LUEBKE
From a financial planner’s perspective, one of the biggest areas of concern is my clients not having proper beneficiary designations in place for those accounts that allow for them. The purpose of the beneficiary designation is to provide legal authority to take specific actions with an asset when it is inherited. Most people give very little thought as to who should be named as a beneficiary. In addition, over time, changes may need to occur so that the beneficiaries represent what you would want to do today versus 20 years ago when your brother was still alive. Now that he has passed, his ex-wife who you detest is going to inherit your money. Do you understand the potential problem? The solution is to review your beneficiary statements regularly. Like a trust, they should be revisited every five to ten years. You need to get copies of the actual beneficiary statements on file with the financial institutions to ensure their accuracy. You may have filled out the paperwork to establish the beneficiaries in the correct manner. However, the financial institution may not have recorded your requests correctly, or they may even have lost your documentation.
The other area to consider with beneficiary designation is when dealing with retirement accounts. Unless your attorney has the skill and knowledge to draft a trust that will allow your retirement account to pass through the trust to designated beneficiaries, then they do not belong in your trust. Many trusts do not have the appropriate language to facilitate that transfer. The result is that your retirement assets will lose their ability to retain their tax-deferred status, and a distribution of those assets is forced over a very short period of time, creating unnecessary and often unwanted income tax issues.
Leaving your family with an organized estate plan for your affairs is something they will truly appreciate. After your passing, that plan will allow them to focus on mourning and emotional wellness, rather than financial or court issues.
If you’ve already completed your estate plan on your own, consider having a lawyer review your documents and goals to ensure you have the right plan for your family. Or, if you know you’re in need of a new plan, you can revoke the old do-it-yourself plan and replace it with one that has been carefully considered by an attorney experienced in estate planning. At the very least, complete a handwritten will. Then, create a binder, and organize a list of your financial affairs for your family. Also, consider a comprehensive estate plan to organize your affairs and make sure it’s been reviewed in the past five years. Finally, make sure your trust is funded.
TAKEAWAY 1—You need a carefully thought out estate plan so that the assets you have planned to go to your family end up in their hands and not in legal battles in the courts. Estate planning is imperative.
TAKEAWAY 2—Work with a professional when doing estate planning as there are too many frequent mistakes that occur when you use do-it-yourself plans.
TAKEAWAY 3—Ensure that you have all the pieces and parts to a well-drafted estate plan, for example, a will included with your trust, powers of attorney for health care and finances, health-care directive, funeral and burial instructions, etc.