Many estate plans look solid on the surface, but a deep dive into a plan, and especially into the dynamics around it, often reveals a plan with a serious problem or two.
Estate owners are surprised when these problems are pointed out to them. If they aren’t fortunate enough to have the problems revealed, their loved ones are left to deal with the effects. Changes in your wealth, family circumstances and other factors can cause significant changes in the results of your estate plan, often without your even knowing it.
The results can be called surprise problems. Here are the most common surprise problems. All of them can be fixed, often easily. Be alert, because your plan might have one or more of them, now or in the future.
Outdated trust provisions. Many events can cause trust provisions to be obsolete or adverse to your goals. What was once a very effective trust provision now might be one that defeats your goals. A common case is a trust that was written when the children were minors or young adults. The trust was written to protect the wealth when the children were too mature to know how to handle the money.
For example, the distributions might be restricted or left to the discretion of the trustee. Now, the children are older and have shown they are mature enough to handle money. It is time to have the trust rewritten to reflect the changes. Another common problem is that your goals or values have changed, but that isn’t reflected in the trust agreement. For example, many people now want investments that are in line with their values.
This used to be called socially conscious investing but now is called ESG (environment, social and governance) investing. If that’s your situation, spell out the investment guidelines for the trustee. Sometimes, the terms of a trust are set to encourage the beneficiaries to become educated. Distributions would be made for the general support of the beneficiaries, but additional distributions would be made to help pay for education. You might want to expand the incentives of the trust.
For example, entrepreneurship could be encouraged by allowing distributions to be made to provide capital to beneficiaries who want to start businesses or invest in small businesses.
In the last few decades, incentive trusts have been popular. In these trusts, distributions would be increased when a beneficiary achieved certain goals, such as enrolling in or graduating from college or being employed. Some trusts would make distributions based on the salary of a beneficiary.
Such provisions need to be reviewed regularly to be sure they remain relevant and don’t create the wrong incentives. Dealing with the passion assets. Assets that are special to the estate owner often can be problems for the estate. Such assets include collections and vacation homes or other specialty real estate, such as ranches, farms and undeveloped land. A vacation home creates difficulties when there is more than one beneficiary.
A goal often is to have the home continue in the family because the family enjoyed time there together, and the parents would like that tradition preserved. Also, the succeeding generations might not have the re- sources to purchase a similar property on their own. But when the children inherit a vacation home jointly (whether in their own names or through a trust or other entity) a lot of joint decisions have to be made.
How will the use of the property be shared?
How will the expenses of the property be split?
Who will make decisions about repairs and improvements? What if one beneficiary lives much further away from the property than the others? What happens when one beneficiary wants to cash out and the others don’t? That’s only a small sampling of the issues.
Collections and similar passion properties have other issues. The beneficiaries might not derive the same enjoyment from the property that you do. Caring for and managing the assets might be more of a burden or obligation to them.
Also, specialized knowledge often is required to manage such assets properly. Other complicating factors with passion assets are that they are hard to value, difficult to sell and expensive to maintain.
Perhaps one or more of your loved ones shares your interest and knowledge in the asset. If so, that person should inherit it. But consider whether that would result in an unfair division of the estate. The asset might be valuable, but while it is owned it generates expenses but no income.
Carefully consider whether the best decision for your family is to pass on the assets to them. The best choice often is for you to negotiate during your lifetime a sale of the assets to capture their real value or make a gift to a charity that is interested in them. The unprepared heirs.
It is not unusual for beneficiaries to be surprised by the size of an estate and how much wealth is bequeathed to them. The heirs often are unprepared to handle the wealth wisely. You accumulated the estate gradually over time. You became used to handling it.
Frequently, assets have been owned for years and appreciated in value without affecting your lifestyle or the attention you pay to them. The bull market in stocks and real estate in recent years compounded the wealth of many families.
Federal Reserve data indicate that the average household is wealthier than ever. The estate has compounded to a meaningful amount, and you’ll be passing it on to heirs who have no experience with that amount of wealth and perhaps not with those types of assets.
Sudden wealth becomes quite a burden for many people. You might want to take time now to make the heirs familiar with the wealth they’re likely to inherit eventually and how it should be managed.
Perhaps a portion of your estate should be bequeathed to a trust where it can be managed by a professional trustee for a period of years. Annual distributions could be made to the beneficiaries.
The beneficiaries can have some time to get used to the amount of money they’ll inherit and prepare themselves. Your trust can provide that lump sums will be distributed in stages over the years or that the bulk of the trust will be distributed after five years or so have passed. Hard-to-market assets.
Many estates have assets that create two big problems for the estate administrator and for heirs. These assets include small businesses, commercial real estate and investments that aren’t publicly traded. You’ve done well with these assets, and they’re very valuable.
But they can create problems for your heirs. The first problem is that, because they’re valuable, they could trigger estate taxes. This is more likely as the economy grows and these assets increase in value, while there’s a strong potential the lifetime estate tax exemption will decline. The second problem is these assets are difficult to sell in a hurry for a fair price.
So, you have assets that potentially trigger estate taxes (at both the state and federal levels) but that are hard to turn into cash to pay those taxes. You need to plan for this situation instead of leaving it to your heirs and executor to solve. You might begin selling some assets to raise cash. Or you could buy permanent life insurance to pay the taxes, so assets don’t have to be sold in a hurry.
Maybe you can arrange a line of credit to pay the taxes. There are other potential solutions. Estate liquidity is one of the most overlooked estate planning issues. Failure to ensure the estate has access to the cash it needs often diminishes inheritances. Assets have to be sold at fire-sale prices to pay taxes. Be sure your plan considers liquidity issues.
Unused tax breaks.
Many estate owners are complacent about estate and gift tax planning because of the high lifetime exemptions enacted in 2017. The result is that tax breaks aren’t used or aren’t used wisely. Unused estate and gift tax breaks will be more of an issue as Congress moves forward on proposals to reduce them.
Even if Congress doesn’t agree on actions, the 2017 tax law will expire after 2025 if Congress doesn’t act. The lifetime estate and gift tax exemption will be cut in half overnight. Estimate the likely rate of increase in your assets and where that will put your estate’s value in a few years.
Many of you will have estates that will be taxable after 2025 if Congress does nothing, and before then if Congress decreases the lifetime estate tax exemption.
Determine how much wealth you need to retain to maintain your standard of living under most economic scenarios. Then, implement a plan to remove some of the excess assets from your estate. The most underused tax break is the annual gift tax exclusion.
In 2021 you can give up to $15,000 to an individual without using part of your lifetime estate and gift tax exclusion. The amount is indexed for inflation each year. You can make such gifts to as many people as you want. A married couple can jointly make gifts up to $30,000 to an individual. Another overlooked tax break is the generation-skipping transfer tax exemption.
The general rule is the tax law doesn’t want you to make gifts directly to grandchildren or following generations. Congress wants the wealth taxed in your estate and your children’s estates before it gets to the grandchildren. So, it imposed the generation-skipping transfer tax (GST) on gifts and bequests made directly to grandchildren.
But there’s an exemption for the GST. Carefully consider whether you want to use the GST exemption to benefit your grandchildren directly.