Part 1: Estate Planning Guide |
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Introduction: methods for distributing your estate |
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Most people have a basic understanding that the primary purpose of a will is to provide for the distribution of their property upon death. What people often fail to fully grasp is that they may have very important assets that WILL NOT be distributed according to their wills. Instead, these assets will be distributed in accordance with trusts, life insurance and retirement plan designations, and as joint property. JOINT PROPERTYNo doubt you have some property that is owned solely by you. It is also possible to own property jointly with one or more other persons. There are several ways to own property jointly:
Joint Tenancy (with rights of survivorship) A joint tenancy is created when two or more people own property together by including a provision in their deed that they hold the title to the property jointly. For example, a husband and wife may declare on a deed that they are taking title to their residence as joint tenants. The important aspect of this type of ownership is the result that occurs upon the death of the first joint owner. When the first joint owner dies, the surviving joint tenant becomes the owner of the deceased tenant’s share of the property. For example, if a husband and wife own their residence in joint tenancy and the husband dies, the wife becomes the sole owner of the residence. It does not matter what the husband’s will may or may not say about the residence. Without any regard to the will whatsoever, the residence belongs to the wife as the surviving joint tenant. Joint tenancy can be a valuable tool for avoiding probate in small estates, particularly if the joint tenancy is between spouses. However, it can cause unintended results if the joint tenancy is between a parent and child (or other third party). Furthermore, joint tenancy can cause serious tax planning problems for spouses whose combined estates exceed the federal estate tax applicable exclusion amount ($3,500,000 in 2009). The rules on joint tenancy vary from state to state. In some states, a joint tenancy can only be established through a written document, and not by a mere oral agreement. In other states, the language of the written document must specifically state that the parties own the property “jointly with rights of survivorship.” Tenants In Common In contrast to owning property "jointly with rights of survivorship," two or more people can own property as “tenants in common.” As tenants in common, each joint owner owns an equal share in the property. However, when the first owner dies, the surviving owner does not automatically become the owner of the entire property, as is the case when property is owned jointly with rights of survivorship. Instead, the share of the deceased owner passes under the deceased owner's will to whoever the deceased owner designated in the will. This result is very important in estate planning for spouses who wish to minimize estate taxes through the use of trusts, and for any other individuals who wish to set up trusts under their wills for any other purposes. Consequently, individuals with wills that create tax savings trusts often own their joint properties as tenants in common to make sure that their share of joint property passes under the tax savings provisions of the will, instead of automatically to the survivor. Community Property There are ten states that have community property laws that affect ownership of property between spouses. These states are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Community property laws are optional in Alaska. Community property generally refers to property acquired by either spouse during the marriage, except property that is received as a gift or an inheritance. The community ownership rule applies even though the property may be titled in only one name. Spouses may also have separate property, which includes gifts and inheritances, as well as property acquired before the marriage. Each spouse is considered as owning one-half of the community property, and generally, has the right to dispose of his/her half of the property through a will or trust, similar to ownership as tenants in common in other states. Life insurance proceeds, retirement plans benefits, payments under annuity contracts, and IRA accounts are paid in accordance with beneficiary designations that are part of your contracts for those arrangements. Your will does not control how those benefits are paid, unless your designations specifically refer to your will with appropriately worded designations:
Life Insurance Life insurance is a contract between you and a life insurance company. In very simple terms, you promise to make premium payments to the life insurance company. In exchange, the company promises to pay a specific dollar amount to your beneficiary (or beneficiaries) upon your death. You decide who will be the beneficiaries by completing a beneficiary designation form. Your first choice as to who will receive the proceeds at your death is the primary beneficiary. You can name more than one primary beneficiary, in which case, each primary beneficiary will each receive an equal share, unless your designation specifically provides for some other allocation. You should also name a contingent beneficiary. If your primary beneficiary is not living, or if for some other reason the policy proceeds cannot be paid to your primary beneficiary, the proceeds will be paid to the contingent beneficiary. It is very important to remember that your will (or living trust) will not directly control who receives your life insurance proceeds. Rather, your beneficiary designation form controls the distribution of the insurance proceeds. However, it is possible to give a will or trust control of life insurance proceeds by naming your estate or naming a trust as the beneficiary on the beneficiary designation form. For example, a married couple might establish a trust in their wills for the benefit of their minor children. A typical life insurance designation for that situation would list the spouse as the primary beneficiary with the trustee under the will as the contingent beneficiary. Many individuals provide in their wills (or living trusts) for one or more trusts that will be created at death if certain circumstances exist. Annuities Annuities are investments under which an individual makes one or more payments to an annuity company, usually a life insurance company. In exchange, the life insurance company agrees to invest the payments and make periodic return payments to the individual (the annuitant). Sometimes the agreement is that return payments will begin as of a certain date and will end at the annuitant’s death. In other cases, the payments will continue after death to a beneficiary designated by the annuitant. Depending on your circumstances, you may have several choices in designating your beneficiary:
Retirement Plans Retirement plans, including pension plans and 401(k) plans, are arrangements established by employers for their employees. Generally, the employer agrees as part of the employment arrangements to make periodic payments for your account to a retirement plan that has been established by the employer. The payments to your account are invested. You do not pay taxes on the payments to your account or the earnings on your account until you start to receive distributions upon your retirement. To provide for the possibility that you may die prior to receiving all of your retirement benefits, a beneficiary designation should be completed. Depending on your circumstances, you may have several choices in designating your beneficiary:
Individual Retirement Accounts Individual retirement accounts (IRAs) are often used by individuals who do not have employer-sponsored retirement benefits. IRA accounts can be set up with banks, brokerage firms and other investment related companies. Payments by the individual are deductible for income tax purposes in some cases. These accumulated payments, as well as the income earned by the IRA account, are not taxed for income tax purposes until the individual begins receiving distributions upon retirement. As part of the process of establishing an IRA account, you must complete a beneficiary designation to provide for the possibility that you may die prior to receiving full distribution from your IRA account. Depending on your circumstances, you may have several choices in designating your beneficiary: If you use a will (rather than a living trust) as your main estate planning document, you will need to:
Specifying Beneficiaries The primary purpose for having a will is to specify the beneficiaries who will receive your property after your death. Often the beneficiaries are family members and friends. They can also be charitable organizations or trusts. Your will does not control the distribution of life insurance and some other types of assets that are paid in accordance with beneficiary designation forms, unless your designations of the life insurance proceeds are specifically designed to cause the proceeds to flow through your will. If you don’t have a will, state law controls who will receive your property. Generally, this means that your property will go to your heirs and spouse (if you have one). Depending on your circumstances, state law would probably require that your property be distributed to the following people:
Choosing an Executor Another reason for having a will is to name someone who will carry out your wishes after your death. The familiar term for this person is "executor", but in some states this person is known as a "personal representative." The primary duties of an executor after your death are to collect your assets, pay your debts and expenses, and distribute your remaining assets to your beneficiaries. Ideally, your executor should be a person who is skilled in financial matters and who has a good understanding of your assets and your family situation. While the executor is often an individual, perhaps a family member or trusted friend, an executor also can be a bank that has a trust department. You can choose two or more executors who will serve together as co-executors. To provide for the possibility that your first choice as executor will refuse or be unavailable to serve, you should also make a second choice. Many states require that your executor (or at least one of your co-executors) be a resident of your state. Naming a Guardian If you have minor children, it is important that you consider who will serve as the legal guardian for them until they reach majority age (18 years). If your children’s other parent (your spouse, or possibly an ex-spouse) survives your death, this person usually will serve as the guardian without the need for any special action. However, you need to provide for the possibility that the other parent will not be available as a natural guardian. Signing Formalities Your will is not valid unless you are mentally competent when you sign the will. Further, in most states you must meet a minimum age requirement of at least 18 years old. Your signature to the will must be witnessed by two other persons who are also required to sign the will. Some states have restrictions on whether or not beneficiaries under the will can also serve as witnesses. In most states, your signature and the signatures of the witnesses should be notarized. Trusts are separate legal entities created by trust agreements and wills for a variety of reasons.
Overview Although different trusts may be created to serve different purposes, trusts generally have several basic characteristics in common. What are the components of a trust?
When is a trust created? All trusts are either intervivos (created during your lifetime), or testamentary (created under your will and established at the time of your death). Can I revoke a trust whenever I wish? Trusts also are either revocable (can be changed or revoked by the grantor at any time), or irrevocable (cannot be changed after it has been created). Most revocable trusts become irrevocable at the grantor’s death. Assets in a revocable trust are included in your estate for estate tax purposes, while assets that you transfer into an irrevocable trust are usually excluded from your estate for estate tax purposes. Thus, by giving up control over the assets (or at least most of the control) you can usually gain an estate tax advantage. What types of goals do trusts accomplish?
Living Trusts As an alternative to using a will as your primary document for transferring property at your death, you can transfer all or some of your assets into a living trust that you create during your lifetime. At the time of your death, these assets are distributed according to the trust provisions, not by the provisions of your will. A living trust is both an intervivos trust and a revocable trust. A living trust is established by first signing a written document that includes the trust terms, and then transferring all or most of your assets into the trust. The trust provisions usually provide that you are entitled to all of the trust's income and assets during your life. Upon your death, the trust then provides for the distribution of your assets to your beneficiaries in much the same manner as a will. Typically, you manage the assets of the trust during your lifetime. After your death, a successor trustee that you name in the trust agreement carries out the remaining trust duties, similar to how an executor would handle your will. A living trust only applies to the assets that are actually transferred into the trust. You should make sure that most of your assets are transferred during your lifetime into the living trust. The remaining assets can be transferred at your death by using a pour over will. However, if you have to use the pour-over will, you have defeated the purpose of avoiding probate. The use of a living trust generally does not change your income tax requirements during your lifetime. The tax minimizing provisions that are included in complex wills for larger estates can also be included in a living trust. Although most people create living trusts primarily to avoid the probate process that is required for wills, another important use for a living trust is to plan for the possibility that you may need someone else to manage your financial affairs if you become disabled or incapacitated. Your living trust can provide that prior to your death, your successor trustee may be given responsibility to take over your financial affairs if you are physically or mentally unable to do so. It is possible to create a joint living trust with another person. For example, spouses may decide to create one joint living trust instead of two separate living trusts. It offers the simplicity of just one document. However, unlike the situation where spouses each have their own wills or separate living trusts, a joint living trust offers less flexibility to the surviving spouse after the death of the first spouse to change the terms of the trust in response to changing circumstances. Tax Consequences Whether you choose a will or a trust as your primary estate planning document, there are tax consequences. Income Tax Consequences For income tax purposes, the grantor of a living trust continues to be treated as the owner of the assets that are now part of the trust. Thus, if you are the grantor of your living trust, you report the income from the living trust assets on your individual income tax return in the same manner as you did prior to transferring the assets into your trust. This rule applies when the grantor or the grantor’s spouse is the trustee or co-trustee of the living trust. If some other party is the trustee, then the trustee has additional tax reporting requirements. Estate Tax Consequences Estate tax savings provisions can be included in a living trust, but a living trust has no more estate tax savings possibilities than a traditional will. Because the living trust is a popular “will substitute” alternative to using a traditional will, it is important to understand the advantages and disadvantages of each.
Summary Many people favor the use of a traditional will because of its familiarity and because it is easier to maintain. Individuals who have significant privacy concerns and a desire to avoid probate choose to use a living trust arrangement. Individual circumstances usually help decide how much weight should be given to the various advantages and disadvantages. |
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