Knowing What to Review Your Estate Planning Strategy

Congress still is dithering and debating what the estate tax will be after 2010. That’s no reason for you to procrastinate and delay starting your estate planning if you don’t have one or taking a look at your existing plan. There could be many dangers and pitfalls other than taxes lurking in your plan, and with greater negative consequences than estate taxes.

One pitfall we covered in past visits is the formula for distributing assets. Many wills were written with a standard clause transferring a portion of the estate equal to the federal tax exempt amount to a credit shelter trust for the children. The rest of the estate goes to the surviving spouse.

The provision works fine when the federal tax exempt amount is only a portion of the estate and the rest of the estate can support the spouse. But when the entire estate is exempt from taxes, then the entire estate goes into the trust and the spouse receives nothing. When a new estate tax is enacted, the exempt amount is likely to be either $3.5 million or $5 million. Then, the trust will absorb all or most of many estates.

There are many other potential problems with asset distribution clauses that are unrelated to the tax law. Extreme changes in the economy and markets affect your estate. Of course, personal and family changes also mean your plan needs work. These are reasons to start estate planning or revise your existing Estate Planning Strategy without waiting for Congress to get its act together.

Estate liquidity is remarkably overlooked. The estate needs enough cash or liquid assets to pay the expenses, debts, and any taxes. All of your planning could be for naught if the estate has to raise cash by selling assets you planned on going to loved ones, especially when they have to be sold in a hurry or in poor markets. When there could be a cash shortage, you need to consider buying life insurance or restructuring your asset ownership. You also could leave the executor advice on the order in which to sell assets and how to get the best price for any unconventional assets.

Specific dollar and asset bequests often are an important issue, and they’re even more important given the asset price volatility of the last decade. A will may state, for example, that someone is bequeathed a specific dollar amount or specific assets (such as all your shares in DoubleLine Total Return Bond fund). At the time the will is written, this bequest fits your goals. It gives someone a certain percentage of the estate or the same amount as someone else, such as a sibling.

Over time, the size of the estate or the relative value of the asset can change. When that happens, an heir receives a greater or lesser amount, or a greater or lesser percentage of the estate, than you planned. Or siblings you intended to inherit equal shares of the asset could inherit unequal shares because you assigned them specific assets that were equally valued at one time but no longer are.

Also, the remainder beneficiary, who usually is your spouse, could receive a much smaller amount than you intended. The specific bequests could become a greater share of the estate. The specific bequests are paid first, so your remainder or residual beneficiary receives what’s left.

Estates with real estate, collectibles, or small businesses are especially prone to these valuation shifts.

Your heirs often are better off if you limit specific dollar or asset bequests. Except for nominal bequests, most bequests should be made by a specific percentage of the estate’s value, or by a formula that gives a specific dollar amount or asset provided it doesn’t exceed a certain percentage of the estate.

A related clause to review is the tax apportionment clause. This clause states whether any taxes related to a particular asset will be paid from the share of the individual inheriting that asset or by the residuary estate (the estate left over after specific bequests). If you do not state how the taxes will be shared, they will be paid out of the residuary estate. That means less for whoever gets the residuary estate, usually your spouse or children.

The same philosophy applies to the payment of debts clause. Will each heir in effect pay a share of the estate debts, or will they be paid out of the residuary estate? Or will you buy enough life insurance to cover the debt payments? Do not overlook this issue, or your residuary beneficiary will end up with less than you intended.

A simultaneous death clause is standard in most wills, but be sure yours has one. This clause states that if you and your spouse die within a certain time of each other, then each spouse will be treated as having predeceased the other. This is important for avoiding multiple estate taxes and other costs. Without this clause, if you and your spouse are in a common accident many state laws say to assume that each survived the other. That means all your assets go through your estate, and then go through your spouse’s estate before they go to your children or other heirs.

You probably want to set the time period in the simultaneous death clause at 90 days. Some state laws put the period at 24 hours or 72 hours, which means if you and your spouse are in a common accident but one of you dies a week after the other, your assets will be hit with double estate costs. Most estate planners find that 90 days is a better time period for the simultaneous death clause.

The will is not the only part of a plan that needs attention. Beneficiary designation forms control who inherits certain assets. You need to review the designations of your IRA, 401(k), any other employer retirement plans, annuities, and life insurance. Be sure these designations are up to date and still meet your goals.

Other documents that need to be reviewed are powers of attorney (both financial and health care), trusts, life insurance policies, shareholders agreements, business buyout agreements, real estate titles, and any marital agreements. The estate tax law has some effect on these documents, but most of these documents are unrelated to the estate tax picture, and you need them to be up to date.

Consider estate planning strategies that may be appropriate now but weren’t in the past. Some examples: You may want to make gifts to children or grandchildren, or change the established gift plan. You could take advantage of today’s interest rates to make low-interest loans to family members or refinance existing loans. We’ve discussed Roth IRA conversions in the past, and it’s something to be considered as part of an estate plan review.

Business owners should consider succession strategies such as family partnerships, giving shares to the next generation of owners, or other estate planning strategies suggested by your estate planning advisor.

Charitable gifts should be reviewed. Do you want to make them through the estate, even when there is no estate tax? Or do you need to give at a different time or a different amount? Do you want the gifts to be direct, or do you want loved ones to participate in the gift through a charitable trust? Your charitable giving strategy is influenced by fluctuations in asset values as well as the tax law.

You can’t wait for Congress to act on the estate tax. An estate planning strategy has many components other than taxes, and these influence the legacy left to your heirs at least as much as taxes. Congress dithers. You shouldn’t.