Estate taxes are far from the biggest expense for most estates. If the 2001 tax law is allowed to take full effect, in 2010 estate taxes won’t be an expense for anyone. Yet, Estate Planning is critical for estates of all sizes, because other expenses can take a big bite of every estate.
The largest expense most estates are likely to face is Probate and its related costs. Fail to account for this in your estate planning and 3% to 5% or more of your estate might disappear.
Probate is the process of ensuring that your debts are paid and legal title of your assets is shifted to the appropriate heirs and beneficiaries. Each state sets its own probate process, but the general outline is very similar around the nation. The executor or administrator of the estate presents the probate court with an inventory of the estate’s assets and liabilities. A notice is published to give other creditors an opportunity to make their claims. The debts are paid and proof presented to the court.
Then a schedule of how the net assets will be distributed to the beneficiaries is presented. If the court approves and no one challenges the plan, the estate is distributed. State and federal tax returns also must be filed, but this technically is not part of probate.
Probate can take time, but the time depends on the state in which the estate is located. As long as the estate is in probate, the executor is handling the assets. That could include paying the bills for and providing spending money to your spouse and other loved ones. In a few unusual cases, probate drags on for years.
While a friend or relative can be appointed executor of the estate without a fee, a lawyer’s help often is needed. Traditionally, the lawyer who drafted the will is named executor, and states often allow the executor or lawyer helping the executor to charge a percentage of the estate as a fee. Now, some states outlaw the percentage fee. Many lawyers will do the work at an hourly rate. To ensure the hourly rate, however, reach an agreement with the lawyer as part of your estate plan and put the agreement in the will.
All of your assets are not required to go through probate. There are a number of strategies that will help you avoid the costs and delays of probate. Almost everyone knows a probate horror story involving a friend or family member. Before deciding to avoid probate, however, consider a few points.
Probate, estate taxes, and state inheritance taxes all are separately determined. Strategies that avoid probate often incur estate taxes. If your estate is more than $1 million, you might owe taxes that exceed the probate costs.
In planning your estate, first determine if the estate as it is might be taxable and what the taxes would be. Then, decide if you want to avoid the taxes and, if so, choose from among the options offered by the estate planner.
Probate should be the next concern. Don’t immediately jump into probate avoidance strategies. Many lawyers automatically recommend a living trust to avoid probate. Instead, have your lawyer explain the probate process in your state, how long it should take, and what the cost would be. You might not want to bother avoiding probate.
I live in Virginia, close to the Maryland border. Most lawyers in the area know both Virginia and Maryland law. Virginia simplified its probate process some years ago. For most estates, probate is relatively fast and low cost. The costs of trying to avoid probate in Virginia might exceed the costs of probate. Maryland, however, still has the old probate laws. It is time-consuming and expensive for most estates. Local lawyers often recommend probate-avoidance in Maryland but not in Virginia.
If probate-avoidance is for you, there are several strategies to consider.
Retirement plans. Qualified retirement plans are not subject to probate or covered by your will. Ownership of the plan is transferred according to the beneficiary statement on file with the plan sponsor. This includes IRAs and 401(k)s.
Annuities and insurance. These insurance products also avoid probate. The money goes to whomever you designated as beneficiary with the insurer.
Joint property. Property that is held as tenants in the entirety or joint title with right of survivorship passes to the surviving owner without being subject to probate. These forms of ownership might apply only to real estate and financial accounts, depending on the state. Not all states recognize both types of title, so have an estate planning lawyer check how your property should be titled.
Living trusts. This is the main way to avoid probate. A trust is created, usually with you and your spouse as co-trustees. All or most of your property is transferred to the trust. During your lifetime, the property is managed almost the same as before the trust was created. At your death, the terms of the trust determine who gets the property. The probate court is not involved.
A living trust can cost hundreds of dollars or more to create. In addition, title to all your property must be officially transferred to the trust. This includes real estate, financial accounts, cars, and anything else that has a legal title. Property without a legal title recorded anywhere, such as household furnishings, is transferred by the declaration establishing the trust and the schedule of assets attached to it.
There are many living trusts that aren’t effective because the work of transferring title wasn’t done. Financial services firms often want a copy of the trust document on file and might require that their own form be completed. In addition, after one of the spouses has died, financial services companies will require detailed information before transferring title to or accepting directions from the new trustee.
Because of the cost and inconveniences of living trusts, you should be sure that probate in your state is worth avoiding before choosing to avoid probate.
Avoiding probate is not the only way to reduce estate costs. Being organized and having complete records helps.
Whether or not you choose to avoid probate, be sure you have a will. All property cannot be covered by probate-avoidance strategies. The will should designate who will receive any property that goes through probate. Likewise, check the beneficiary designations on your retirement accounts, annuities, and insurance policies.
Simplifying your estate is another good move. A complicated estate increases expenses and delays. If you have hard-to-value or hard-to-sell assets, consider getting rid of them soon. Real estate also complicates an estate. Any collectible or illiquid asset also gums up the works.
As I’ve frequently recommended in the past, create a notebook with a letter of instructions for your executor, inventory of your assets, list of important contacts, and the location of all important documents and items. Also include a copy of your latest will, tax returns, and financial account statements.
Finally, don’t leave surprises for your heirs. Surprises tend to result in bad feelings and contested estates. An estate contest will deplete your estate much more than taxes or probate.