With a threshold of $11 million per person, the estate tax has become a concern mostly for the very wealthy. While most of us don’t need to think about an estate tax when we die, there is still plenty of estate planning to be done, whether it is more financial, practical, or logistical in nature. Essentially, the goal of estate planning is to arrange the maximum transfer of the enjoyment and control of your assets (and the payment of your debts), with the minimum cost in money or trouble to the people you are leaving behind.
The Importance of Having a Will
Even the more than half of Americans who don’t have a will unwittingly have an estate plan, thanks to state intestacy laws. Even with a will, if for some reason the court determines that a will is invalid, then the intestacy laws would come into play. Although most people have chosen intestacy, consciously or otherwise, it is extremely limiting. And with no will to name an executor, the court has to appoint an administrator, which can cost extra time and expense.
Aside from a desire to depart from the state’s rules for who should inherit what, and naming an executor, there are plenty of other good reasons to make a will. If you have small children, you can name a guardian for them in your will. Even if you have set up a living trust (discussed later in this article), it is still crucial to make a will to control the disposition of those assets that were not transferred into the trust. A will can also provide guidelines for the disposition of assets like personal property, to set up distributions to be equitable among the beneficiaries who are to receive them.
Estate Planning Options to Help Avoid the Cost of Probate
Virginia probate is not very expensive compared with other states, but the cost of probate is not only measured in dollars. Probate involves the filing of an inventory of the decedent’s assets, and annual accountings until the assets have been distributed to the beneficiaries of the estate. This can involve a lot of additional time and effort, as well as cost if the executor has to hire a professional to assist with the filings. In addition, these filings are public record, and some people prefer that knowledge not to become public. Only assets that will pass according to the will are subject to the probate process. One way to avoid probate is to set up and fund a revocable living trust (RLT).
The RLT is a popular estate-planning tool, for good reason. A will only determines the disposition of assets at death; there is no allowance for incapacity, or for voluntarily allowing another to control the assets. Titling assets to an RLT allows the grantor to continue to exercise control over his or her assets, even to the point of revoking the trust, while providing for those other eventualities. Titling out-of-state assets to a trust can help avoid ancillary probate in those states. The downside is the initial expense to set up the trust.
Other kinds of planning can also help avoid the cost of probate, with or without a revocable living trust. The two largest assets of most Americans are their house and their IRA. If the house is owned jointly with their spouse (either with right of survivorship or as tenants by the entirety), and the IRA account has a properly designated beneficiary, those assets will never be part of the probate estate.
There are other ways that assets can be titled to avoid probate. Transfer on death, or pay on death, designations can be made on financial assets such as bank or brokerage accounts. With those designations, the bank or brokerage will transfer the asset to the designated recipient upon notification and proof of death of the original owner. The transfer of ownership through survivorship, titling, or beneficiary designation takes place by operation of law, and not according to the will.
Gift Planning as Part of Estate Planning
Decisions about making gifts during life can also be part of an estate plan. Inherited assets have a “stepped up” (or occasionally, stepped down) basis and a long-term holding period regardless of when they were purchased or sold. This means that the asset’s appreciation between the acquisition date and date of death never gets taxed. Gifts, however, have “carryover basis” meaning that the donee takes on the donor’s basis and acquisition date.
The difference in the determination of an asset’s basis in the hands of a beneficiary can make a big difference in the capital gains taxes that the beneficiary will eventually pay on the sale of the asset. The best assets to gift are those with minimal or no appreciation, such as cash or recent purchases, while highly appreciated assets generally should be held, so they can be inherited and reduce the beneficiary’s tax liability when the assets are sold.
Life Insurance as an Estate Planning Tool
Life insurance can be a useful planning tool and provide needed liquidity. A life insurance policy can provide the funds to pay expenses or for paying a decedent’s outstanding debt from a largely illiquid estate. For a small business owner with only one child involved in the business, life insurance can provide funds to equalize the inheritances of the other children. Life insurance premiums are not deductible, but the proceeds are not taxable to the beneficiary. With properly designated beneficiaries, life insurance policies will also avoid probate.
Putting the Plan into Action
Having an estate plan is like having a game plan. If the players sit in the locker room, there’s no chance of winning the game. To be a good plan, an estate plan needs to be implemented. A will has to be drafted and signed, and any other documents also need to be executed. A trust document works as a vehicle for the distribution of assets, but does nothing to avoid probate, or to provide for incapacity or transitions during lifetime, if it has not been funded. Beneficiary designations on life insurance, retirement plans (and broker and bank accounts, if using designations on them) need to be properly made with the custodians of those assets.
Estate planning is not a once and done kind of project. Laws, families, assets and wishes change. If you have already made a will and have named beneficiaries for your accounts, then you are ready for the next step of reviewing and updating your plans to account for changes in the law and in your own circumstances. PBMares is here to help and we welcome the opportunity to be part of your estate planning team.