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Estate Planning: The Essentials

Last update on: May 27 2020
estate planning

Estate Planning need not be as complicated as many people make it. Sophisticated tools are needed by the very wealthy, business owners, those with children from more than one marriage, and others with special needs. For most of us, a good estate plan is fairly straightforward. We need only the basics.

Most estate plans can be developed by choosing from among the six essential estate planning tools. Select those that best achieve your goals. Then, finish the plan with the items that are essential for every plan. Other tools can be considered to meet additional goals or enhance your estate planning. Let’s review the options.

marital deduction. The marital deduction is an important consideration for all married couples. Any property that is passed from one spouse directly to the other is deducted from the estate before estate taxes are computed. The deduction can be taken for property that passes through the will, through a living trust, as jointly-owned property, and by beneficiary designations such as retirement accounts.

Property that qualifies for the marital deduction avoids estate taxes. An entire estate can be tax free, regardless of its size, if it is passed to the surviving spouse.

Of course, you might not want to take full advantage of the marital deduction. That would push the tax planning burden to the surviving spouse and deprive the joint estate of the benefit of your lifetime estate tax credit and other options. You also could lose control over the ultimate disposition of your assets. Some might end up with a second family or other interest of your spouse.

That’s why the marital deduction should be only part of an estate plan.

Gift giving. A gift of cash or property can avoid both estate and gift taxes. As I’ve said in past visits, it pays to give property now instead of later. Estate and gift taxes are imposed on the value of property. The longer you hold appreciating property, the higher the eventual taxes will be. That is why it can make sense to give away now some property that is not needed to maintain your lifestyle. It could cost more to give it later.

Each spouse can give each person tax free up to $11,000 of cash or property annually. In addition, each person has a $1,000,000 lifetime gift tax exemption equivalent for gifts above the $11,000 annual exemption. Only after the lifetime exemption is exhausted are gifts above the annual exclusion taxed.

It is best to give property that is likely to appreciate, so that the future appreciation is out of your estate. If the donee is in a lower tax bracket and will sell the property, you might want to give property that already has high built-in capital gains so the gains will be taxed at a lower rate.  Otherwise, property with high built-in gains should be kept in your estate when possible. When the property is inherited, the new owner gets to increase the basis to its fair market value and can sell the property without incurring capital gains.

Don’t give property with losses. Sell the property, deduct the loss yourself, and give the after-tax amount in cash.

Equalize estates. The lifetime estate tax exemption equivalent of each spouse cannot be used unless each spouse has legal title to enough assets. Too often, most of the assets of a couple are in the name of one person or are jointly-owned. As we discussed in last month’s visit, it usually is better for each spouse to own half of the assets or at least the estate tax exempt amount, currently $1.5 million.

Marital deduction trust. This trust pays income to the surviving spouse. The spouse also can be paid principal as needed. The trust is drafted to qualify for the marital deduction, so none of the assets are taxed in the estate of the first spouse to pass away. But the trust is included in the estate of the surviving spouse. The surviving spouse has the right to decide who eventually inherits the trust remainder.

The maintain advantage of the trust is that it gives management and control of property to a trustee instead of the spouse, while qualifying the property for the marital deduction.

The bypass trust. This classic tool ensures that your spouse is taken care of, that the assets end up with your children or other objects of your affection, and that full advantage is taken of your lifetime estate tax exemption. Other names include the credit shelter trust and A-B trust.

Your will puts into the trust an amount up to the estate tax exemption equivalent, currently $1.5 million. The trust provides that your surviving spouse receives money from the trust on terms you set. Some trusts pay the spouse all income. Some pay a set amount. Most trusts provide that the spouse can receive whatever additional amount is needed to pay for shelter, food, medical care, education, and perhaps other needs. After the second spouse passes away, the trust remainder goes to your children or other beneficiaries you named.

The bypass trust ensures that your spouse’s lifestyle is maintained while the assets are protected from mismanagement. It also ensures that the assets eventually pass to the objects of your attention. The bypass trust also takes advantage of your lifetime estate tax exemption, so its assets pass free of estate taxes.

Qualified Terminable Interest Property (QTIP) Trust. This trust protects assets for the next generation, like the bypass trust, but also qualifies for the marital deduction.

To qualify for the marital deduction, the trust must provide that all income is paid to the surviving spouse at least annually. The trustee can pay additional amounts to cover other needs of the spouse, under terms established by you in the trust agreement. But you determine who eventually inherits the trust remainder. The main disadvantage of the QTIP trust is that it is included in the estate of the second spouse.

A QTIP trust generally is used when the surviving spouse is young enough that remarriage is likely or when there already is a first marriage with children for at least one of the spouses.

Those are the basic building blocks of of the estate planning process. The items you choose from this list should be accompanied by the essentials of all estate plans: a health power of attorney, financial power of attorney, and letter of instructions to your executor. In some states, you will want to put a portion of your estate in a living trust to avoid probate.

If your joint estate is less than $1.5 million, you might use only the marital deduction, marital deduction trust, or QTIP trust. When the estate is a bit more valuable, consider adding a bypass trust and perhaps making some lifetime gifts to your children or grandchildren.

With an even larger estate, consider other ways to get assets out of the estate early plus charitable giving strategies. Business owners and those with complicated estates or special assets will consider a host of other strategies. Additional strategies are in my book, The New Rules of Estate Planning (available for $39.95 by calling 800-552-1152).

For all estates these tools are the essentials. Everything else in estate planning builds on them. Most of you can put together an effective, clean, simple estate plan using only what is described in this article.

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