Estate Planning - Some Guideposts

While there are several reasons for planning an estate, your primary goal is to implement a plan that will provide for your family, as well as strategies to reduce your estate tax exposure. Based on these objectives, you should consider the following:

  • Basic estate planning documents, including Wills, Durable Powers of Attorney and Health Care Powers of Attorney
  • Effective use of your respective unified credits, either through the creation of a unified credit shelter trust in each of your Wills or by establishing revocable trusts
  • The use of a Life Insurance Trust to create wealth or as a source to pay estate taxes

Importance of Wills

Without valid Wills, your estates would be subject to the State of New Jersey intestacy laws upon your death. What this means to you, is that your assets will be distributed according to state law, which could result in your assets going to different individuals (and in different amounts) than you may actually desire. Therefore, it is obviously important for your attorney to prepare Wills that state how you wish your property to be distributed. As a reminder, remember that a Will generally applies to "probate property," which includes such things as your personal belongings, automobiles, and investment accounts in individual names. Other property, such as life insurance policies, retirement plans, investment accounts held by Joint Tenants with Rights of Survivorship, all transfer to the designated beneficiary and are not generally controlled by the Will. A jointly owned marital residence passes to the surviving spouse by operation of law.

In addition to Wills, you will also need Durable Powers of Attorney, which authorize each of you to make financial decisions for the other if one of you is incapacitated or suffers a disabling illness, and Health Care Powers of Attorney, so that medical decisions can be made on your behalf if you are incapacitated.

Unified Credit

While married couples often have Wills that leave all of their property to one another, individuals with assets in excess of the unified credit (currently $675,000 in 2000) generally need Wills that also include provisions for saving estate taxes. Currently give and estate tax transfer laws allow married individuals to transfer an unlimited amount of property between them either while they are alive or upon death. However, the same transfer laws also allow every individual to transfer $675,000 (increasing to $1.0 million in year 2006) worth of property to a non-spouse without taxes. This is what is known as the unified credit.

Thus, were you to leave everything to one another outright, you would avoid taxes upon the first death, but in reality would only be deferring them since your entire estate would then be subject to taxes upon the survivor's death. While the survivor would then be able to transfer $675,000 free of taxes to your beneficiaries, the first spouse's unified credit would not have been utilized.

This can be accomplished by either transferring $675,000 worth of property to your beneficiaries upon the first death, either outright, or in trust. Alternatively, you can leave your unified credit in trust, with the surviving spouse as the initial beneficiary and the children (or other individuals) as the remainder beneficiaries. Since it is impossible to know who will pass away first, you should have matching Wills. In addition, it is important for each of you to have at least $675,000 worth of property in your names individually. As a reminder, property held in Joint Tenants with Right of Survivorship would pass 100% to the survivor, and thus not be available to go to the children or to fund a credit shelter trust.

The unified credit, or the amount of property that is exempt from estate taxes, will gradually increase from $675,000 this year to $1,000,000 in 2006. However, you have to consider the size of your estate currently, and to assume that your assets will appreciate significantly more than the increase in the unified credit.

Some individuals also prefer to leave the assets outside the credit shelter trust to the surviving spouse in a QTIP trust. A QTIP trust essentially allows you to leave assets in trust for a spouse, generally providing the spouse with the income generated by the trust with principal available under certain situations, while guaranteeing that the balance of the trust assets go to your designated beneficiaries. Since the assets are left to a spouse, they qualify for the unlimited marital deduction. In general, assets that qualify for the marital deduction must then be made available to the surviving spouse without restrictions, or in the words of the IRS, property qualifying for the unlimited deduction must not be "terminable interest property." The QTIP, or "qualified terminable interest property," is an exception to the rule in that the surviving spouse does not control the property and instead, you each determine to whom your property is eventually distributed.

Life Insurance Trust (LIT)

You are entitled to make annual gift of $10,000 to any person without payment of a gift tax; if your spouse joins in the gift it can become a $20,000 annual exclusion. This is one important way to reduce estate taxes. Even if you decide to implement a strategy to minimize estate taxes through an annual gifting program, your estate may still be subject to estate taxes upon the death of the survivor. Therefore, you should consider purchasing a life insurance policy to provide your beneficiaries with liquidity from which this tax liability could be satisfied. Furthermore, we would recommend that you create an irrevocable life insurance trust to buy and hold the policy. Such a trust is designed to provide your beneficiaries with tax-free dollars (estate and income tax free) to pay any taxes that may be due. As a reminder, any life insurance owned by either of you at the time of your deaths will be part of your taxable estate. Thus, you should also consider transferring your existing policies to any life insurance trust you establish to keep these outside of your taxable estate, or buying new life insurance policies through a trust.

Summary

These are summary guideposts only. First, you need to evaluate your assets and how they are titled. You need to consult with your financial advisor and attorney to discuss your specific estate plan and the documents necessary to implement the plan. Estate taxes are significant, up to a 55% rate. You risk the loss of a substantial portion of family assets to the government if you do not properly plan this out.