Estate Planning: Protecting Your Assets, Part II

Part II of overcoming misconceptions, identifying blind spots, and successfully navigating the current political climate.

In part I of this article, Andrew Howell addressed the misconception that estate planning is only a tool for the ultra-wealthy. Then Mr. Howell addressed the procrastination factor around this issue. I have heard him remark on many occasions that “estate tax is only a tax on those who didn’t prepare properly.”

I recently interviewed Andrew on this topic, and we committed to keep our conversation entertaining, understandable, and informative. Stay tuned to see how you can access that interview and go into even more depth on this topic. For now, here are some of the most important things for you to know.

Blind Spot #1: Failing to Move Assets Into Your Trust

The most common issue I see is people failing to move their assets into their trust.

One primary goal of a trust is to avoid probate and increase the ease of administration of your estate. The only way this is effective is if you put your assets in your trust.

Each asset should be handled differently when moving it into the trust, and my experience with most estate planning attorneys is that as soon as the trust has been signed, the attorney feels his or her job is complete.

I am militant about trust funding and insist my clients go through this exercise with me. Are you sure your trust is fully funded?

Blind Spot #2: Flawed Distribution Guidelines to Children and Other Beneficiaries

In 99 percent of the estate plans I see from other planners, assets are held in trust for the benefit of children until they reach an older age. In most cases, they will stipulate that at age 25 or so, the children will receive one third, and another third at age 30, and so on.

I advise my clients to never make an outright distribution to any beneficiary. Instead, assets should be held in trust for the benefit of your children and other beneficiaries, for their entire lifetime. Never make outright distributions or gifts to your children. You are only hurting them.

In a trust, your children can still use your assets for health, maintenance, support, buying a home—whatever you dictate. But by holding it in trust, you can 1) keep it from being included in your children’s estates so as to avoid estate tax problems for them as they build their own estate and have their own families, and 2) keep the assets you leave for their benefit protected from their potential creditors. If your child goes through a divorce, you can ensure that the assets you left them are protected from the divorcing spouse in a property division, but also potentially in determining alimony support.

The purpose of this isn’t to restrict trust assets for their use, but rather to protect them for their benefit.

I have my estate planned this way. I don’t think Garrett would mind me stating that he has planned this way. In fact, my own mother’s trust is established this way as well. Should something happen to my mother, my share of her estate will continue to be held in trust for my entire lifetime. I practice what I preach.

Estate Planning in the Current Political Environment

There’s no way around it: our current political environment is going to create an overall tax regime that is particularly hard-hitting to the high–net worth individual and high income earner. This will most likely apply across the board to many different taxes, and, in particular to the less understood “estate tax.”

The current federal estate tax rate, which most recently changed on January 1, 2013, is 40 percent on assets you leave to someone other than your spouse (spouses, generally speaking, are not subject to gift or estate taxes) in excess of $5,250,000 (to be adjusted for inflation in future years). Last year, there was a deep concern that Congress would allow the American tax payer to fall off the “fiscal cliff,” by failing to pass legislation to stop this. As you may remember, we did fall off this cliff for roughly 26 hours, with Congress finally passing legislation to divert large portions of tax increases set to automatically come into play. While the entire “fiscal cliff” debacle was, in this author’s opinion, simply the best marketing campaign in the history of the world, everyone seemed to focus on the income tax issues. Far fewer focused on the estate tax implications. This is not surprising, as the estate tax is disguised in the media as a tax that only affects the ultra-wealthy members of our society. This feeling is a result of the perception that US citizens are entitled to a tax exemption of $5,250,000, in which they would be able to pass along either during their lifetime (the gift tax exemption) or at their death (the estate tax exemption) to someone other than their spouse, such as their children.

While it is true that a very strong majority of our population will not have to worry about estate taxes due to their net worth, there are still many people affected by the estate tax who may not know it. This is due to the failure to realize a number of issues on the part of the tax payer. First, many people do not understand the overall size of their estate when it comes to determining estate taxes owed under the Internal Revenue Code. A person’s estate consists not just of the typical assets that they may own, such as their home, money in the bank, business interests, retirement accounts, personal possessions and collectibles, but can also consist of assets they did not own but simply exerted enjoyment or control over.

One item in particular that can dramatically affect the size of your and your spouse’s estate is life insurance. When most life insurance is sold, the agent will undoubtedly tell you that the life insurance death benefit is not subject to tax. This is generally true in regard to the income tax but can vary widely in regard to the estate tax, depending on how the policy is owned, who pays the premium, and who is the designated beneficiary of the death benefit. The vast majority of clients I speak with who have purchased life insurance have listed the surviving spouse as the designated beneficiary. For example, let’s assume that the husband has a life insurance policy for $3,000,000 of death benefit to be paid to his wife, should the husband pass. Upon his death, his wife would receive $3,000,000 in cash that would not be subject to income or estate taxes. However, now the wife has, as part of her estate, $3,000,000 of cash, along with her share of the marital estate, and this amount will count against her exemption at the time of her death.

A new concept to estate planning was adopted on December 17, 2010, when changes were made to the estate tax laws to avoid going over the “fiscal cliff” in 2011. Yes, this had happened before. However, with this wave of tax changes, Congress implemented the concept of “portability.” Portability is generally the idea that when one spouse passes away and fails to use all of his or her estate tax exemption, the surviving spouse inherits the unused portion. This has led many to the perception that old theories of estate planning and the use of a trust to shelter the estate tax credit of the first spouse who passes away is somehow not needed anymore. Nothing can be further from the truth, as portability should not be relied upon, being that there are many ways that a widow or widower will actually lose the inherited portability. In addition, many states have adopted their own state death tax. The state death tax exemptions are significantly lower than the federal exemptions and affect many more estates.

I am a firm believer that the “estate tax” is a negligence tax. There are many legitimate and well proven proper estate tax avoidance techniques that can be implemented. Almost without question, the earlier someone begins to plan his or her estate, the more meaningful estate tax plan can be implemented. Regardless of net worth, everyone needs some level of estate planning. It is the responsible thing to do, to avoid creating problems for your survivors. And, it is a vital way to continue producing value for the world even after you pass away.

My grandfather, Max B. Lewis, was an estate planning attorney and Harvard Law graduate who practiced in this area for 50 years. He had a very simple phrase that I really like: “Estate planning is an act of caring, but you have to care enough to act.”

If you want to take a peek at how your estate and financial plan is shaping up, take our free Financial Health Assessment at www.freedomfasttrack.com/cfw.

Andrew Howell is an estate planning attorney and partner in the Salt Lake–based firm of Callister, Nebeker & McCullough (www.cnmlaw.com). Although not a member of the Accredited Network, he works closely with those advisors appointed to achieve the best results for Freedom FastTrack Members.

Mr. Howell represents clients with respect to estate planning, probate and estate administration matters, and business planning/corporate structure. He is being interviewed by Garrett for the upcoming Curriculum for Wealth Series in order to cut through the complexities of this planning and give the details necessary to understand and know the components of estate planning.