The Keys to Estate Planning – Taxes and The Law

In fewer than 10 years Estate Planning changed dramatically and still is changing. When I first wrote about estate planning, estate taxes were the driver of most plans. Even middle class Americans – modest millionaires we called them – needed plans to avoid estate taxes.

The estate tax code changed dramatically. The 2001 tax law began to phase out the tax. In 2009, estates up to $3.5 million in value are exempt from the tax, and the top tax rate is 45%. Gifts totaling up to $1 million during your lifetime are tax free. The gift tax exemption is used only for gifts exceeding the $13,000 annual gift tax exemption per person. This annual exemption is indexed for inflation.

More changes are scheduled. In 2010, the estate tax is slated for elimination, but in 2011 the 2001 tax law is supposed to return with its lifetime exemption of only $1 million.

Those last changes are not likely to occur. Some time this fall, Congress probably will extend the 2009 rules for another year. Then, I suspect those rules will be made permanent during 2010. The estate tax will not be eliminated in 2010, and the 2001 law will not return.

The unfortunate effect of the tax changes is many people believe estate planning is less important. They think estate planning is tax planning. If their estates are too small to owe taxes, they don’t need to plan.

That view is wrong and will cause problems for many families. The tax changes do not mean estate planning is less important. Estate planning is about much more than taxes. With the Baby Boomers in middle age and nearing retirement, they are in the most important years for estate planning. The amount of wealth in their hands makes planning very important for them, their loved ones, and the nation.

Instead of making estate planning less important, the changes steadily shifted the focus from tax reduction to other matters. That shift will continue.

An estate plan should transfer your property to the recipients you intend with the least delay, fewest problems, and the lowest cost in taxes and other expenses. While estate taxes are on the back burner or out of the picture for most of you, there are many other issues to be wary of.

Many states still impose inheritance or estate taxes, and they often are imposed on much smaller estates than the federal estate tax. State taxes now could be the biggest cash drain for your estate.

Probate is another cost. Probate is the legal process by which the title to assets is transformed from one owner to the next, and it ensures the debts of the deceased are settled. A number of states now have streamlined probate processes, so the cost and delay are reduced. Even so, probate in those states costs both time and money. In other states, probate can be long and expensive, perhaps the biggest cash drain from your estate.

There are ways to avoid probate, and you should consider whether or not to use them. You can avoid probate with most assets by putting them in a revocable living trust (or any other trust). The trust terms, not your will or the probate court, determine who takes over the assets.

Certain types of assets also avoid probate. Annuities, life insurance, and retirement accounts (including IRAs) all pass automatically to your designated beneficiary. Jointly-owned property often avoids probate.

Another function of estate planning is to answer the question: Who decides? If you do not have a plan in place, state law decides who receives your estate and how much is drained in taxes and costs. You can decide all these issues or let the mechanisms of state law take over.

An estate plan also should ensure the estate has enough cash and liquid assets to meet various obligations. Any debts must be paid in addition to estate taxes, legal fees, funeral expenses, and other costs of processing the estate. Otherwise, assets might have to be sold at fire sale prices to meet obligations.

Your estate plan also is where you decide if assets should be given directly to others or placed in a trust. Trusts are not only for reducing estate taxes. They can be used to protect assets from creditors or mismanagement or to hold assets until younger beneficiaries mature. Trusts can be used to support a first beneficiary with income and principal as needed but ensure any remaining value goes only to the beneficiaries of your choice. If you opt for a trust, you set the terms of the trust and select the trustee.

In the estate plan you also name the guardians of any minor children and designate how any personal property or special assets (such as collections) are distributed.

An estate plan is not only about what happens after you are gone. A good estate plan begins with a financial or retirement plan and coordinates the plans. You schedule lifetime gifts and project the value of the final estate by estimating your income and expenses during retirement. The estate plan also should include powers of attorney that designate people to act on your behalf in financial and medical matters when you are unable to.

When developing your estate plan, you organize your assets and debts. For many people, putting together the estate plan makes them better managers of their assets and debt for the rest of their lives. They have a better handle of what they own, where it is located, what it is worth, and how to preserve or grow the value.

An estate plan can bring a family together and establish a strong legacy. Or an estate plan (or lack of a plan) can drive a family apart and tarnish your memory. Estate taxes now are in the background for most people, but estate planning should not be.