The Basics of Estate Planning

There are certain estate planning imperatives that you should get squared away no matter what your circumstances. A will is chief among them.

Death Taxes On Your Estate

Many people think that estate taxes were abolished by the 2001 Tax Act. But actually, estate taxes at the federal level were scheduled by the 2001 law to stick around through 2009 (see Figure 3), and then be replaced with some loss in step-up in basis. The loss in basis step-up means that your heirs will not receive your assets with a basis which is equal to the fair market value of those assets. As a result, when the heirs sell those assets they must pay capital gains taxes on the gain (profit). That gain is the difference between what you paid for the assets and what your heirs sell them for. Under pre 2001 tax law, heirs received a full basis step-up to fair market value, and never had to pay a capital gains tax. Further, estate and inheritance taxes at the state level are often quite significant, and they were not abolished by the federal Tax Act of 2001.

Figure 3

Scheduled Changes  in Estate and GST Tax Exemptions & Rates  (Gift Taxes Not Included!)
Year	Rate	Exempt Amount
2002	50%	1,000,000
2003	49%	1,000,000
2004	48%	1,500,000
2005	47%	1,500,000
2006	46%	2,000,000
2007	45%	2,000,000
2008	45%	2,000,000
2009	45%	3,500,000
2010	0%	Unlimited
* Unchanged from prior law

This is all very complicated, but the bottom line is this: If you as an individual expect to be worth upwards of $1 million by the time of your death, or the year 2010 if that comes first, or if you are married, and worth upwards of $2 million, then your estate faces death taxation issues. And, if you did pre-2001 estate planning, your existing trust or other estate planning needs to be revisited and probably updated.

The 2001 Tax Act did increase the amount of exemption from federal estate taxes which is allowed to estates (see Figure 3). But what if that exemption is not enough for your estate? Or what if your estate faces capital gains taxes due to the loss of basis step-up? There could be a problem considering the appreciation and growth that your estate will enjoy before your death, especially when you add in the inheritances you may receive, death benefits from your life insurance and remainder amounts of your pension plan. Good estate planning can easily increase death tax exemption amounts by several million dollars for married couples, but some type of trust is required for maximum reduction of death taxation. Neither a will, beneficiary arrangements nor joint tenancy ownership of property are sufficient to take care of death taxation issues for either married or single estate owners.

Figure 4

Scheduled Changes  in Gift Tax Exemptions & Rates
Year	Rate	Exempt Amount
2002	50%	1,000,000
2003	49%	1,000,000
2004	48%	1,000,000
2005	47%	1,000,000
2006	46%	1,000,000
2007	45%	1,000,000
2008	45%	1,000,000
2009	45%	1,000,000
2010+	0%	1,000,000**
* Unchanged from prior law ** Permanent?

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Gift Taxes

Gift taxes were not eliminated from the 2001 Tax Act, though the Act allows larger gifts and lower tax rates (see Figure 4). Anyone can make a gift to any other person of up to $10,000 per year with no federal gift taxes. A married couple can then give 20,000 to one person in any given year. A married couple can give 40,000 to another married couple or to two children. For annual gifts within those limits there is little tax planning to do and no gift tax return to be filed. In many of the cases of gifts which exceed those limits, they are made because the estate is too large for estate tax purposes and the estate owner is likely to die before 2010 (die before the elimination of federal estate taxes). These extra large gifts then will usually be made to provide estate tax relief, by reducing the size of estate that will be left to the heirs. Gifts exceeding the $10,000/$20,000 annual exemption do require special planning and gift tax returns. Many of these larger gifts will need to be done with special trust programs to reduce or avoid gift taxes altogether.

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Estate Transfer & Heir Planning

One of the big benefits of pre-death estate planning is the ability to name your heirs, specify the share of your estate they will receive, and dictate the manner and timing at which the heirs get their share. Generally speaking this part of estate planning may be done with either a will or a trust. But as mentioned above it takes a trust to avoid probate, protect the estate from judgments and liens, and to minimize death taxes.

Some of the heir planning issues to consider are as follows:

* W=Will, T=Trust, B=Beneficiary Arrangements, JT=Joint Tenancy Arrangements. These codes indicate what estate transfer methods can possibly be used to accomplish this goal. Trusts are the only method which cover all situations listed, and which will work as desired in all cases. NOTE: Beneficiary and joint tenancy arrangements will not necessarily work, or work well enough, in your individual case. Be sure to see the above specific topics on these issues.

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Trusts vs. Wills, Which Is Best For You?

There are cases where a will is the best choice and cases where a trust is. Generally a will is indicated under the following circumstances (also see #11 on the list in the prior topic):

- Or -

- And -

Some examples of where a will is likely the best choice are: (1) A young married couple whose net worth (assets minus liabilities) is probably less than $50,000. Joint tenancy and beneficiary arrangements are desirable here, coupled with general purpose wills for each spouse. If one of the young spouses dies the survivor is likely to live many more years and is likely to provide the best possible care for minor children the couple had together, making a trust unnecessary. A trust would probably be too cumbersome in this situation. (2) Individuals or couples of any age whose estate is less than $75,000 to $100,000 total, and where the estate can avoid probate by safe beneficiary and/or joint tenancy arrangements (see the earlier topic, “Joint Tenancy Ownership of Property”). General purpose wills for each individual or spouse should be created. 

Even though a will is not required for assets which are transferring by beneficiary and joint tenancy arrangements, a general purpose will should still be prepared. The will makes sure that the non-beneficiary/joint tenancy property passes to the heirs of your choice, and that they receive the amounts or specific assets you wish them to have. The will handles the disposition of personal effects. The will serves as a catch-all, in the event that there are assets you forgot about, received after the will was prepared, or there is a problem or mistake with a beneficiary or joint tenancy arrangement. Most heirs will re-distribute their inheritance appropriately to the other heirs if they realize the beneficiary arrangement you set up was wrong and that your will indicates your real choice.

A trust is generally indicated under the following circumstances (also see #11 on the list in the prior topic).

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What Is a Trust?

The major family estate planning functions that trusts are required for are:

A trust is a legal entity or device used to take care of property in special ways. Trusts are created by a legal agreement, basically a contract, between two parties. These parties are known as the grantor and the trustee. The grantor and trustee create the agreement for the benefit of a third party known as the beneficiary. (See Figure 5) This agreement is private and is not an arrangement created by state statutes (as are corporations, for example). This is an important feature because private agreements have tremendous flexibility in their provisions. Even though a trust is a private agreement, it is recognized by the laws and courts as an independent legal entity. In fact, trusts are independent entities very much like corporations. Through their trustee they may own property, they may file tax returns and pay taxes, they may own bank and investment accounts, earn income, distribute profits to the beneficiaries, conduct business activities, etc.

Figure 5:

As stated above, trusts have three parties to them: grantor, trustee, and beneficiary. Grantors are the individuals who own property which they wish to have managed, controlled, protected and transferred to heirs by a trust. Once their property is in the trust the grantors no longer hold the legal title to the property, though they usually retain the exclusive rights to use the property or its income and usually retain full control of the property. The trustee is the legal administrator of the trust and the legal title holder of the property. The grantors' relationship to the trust is determined by the language which they put into the trust agreement. The beneficiaries are the individuals or charities that receive benefits or income from the trust property, and eventually receive the property itself. When the grantors retain for their lifetime the rights to the income and use of the trust property, then the beneficiaries will receive their benefits after the grantors die. In still other cases the grantors and beneficiaries both receive benefits from the trust simultaneously.

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Living Trust

A family trust in which the grantors hold all three positions -- grantor, trustee, and beneficiary -- is known as a living trust. This is the type trust that forms the NAFEP Premier I Living Trust. The living trust really isn't a trust though because it is not an agreement between two separate parties, grantor and trustee. There is in fact just one party in the living trust, the grantor or grantors. Since one party cannot write a legally binding agreement with itself, the living trust is not a contract, not a complete trust during the lives of the grantors (even if there are two grantors, legally they are still one party). Therefore the living trust arrangement is not recognized by the laws and the courts as an independent entity. It is simply thought of as an extension of the grantors and as a special way the grantors have titled their property. However, if the grantors appoint an independent or separate trustee to administer the revocable trust and to hold legal title, there is then a real contract and a real trust regardless of who the beneficiaries are.

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Beneficiaries

If the grantors retain the rights to the benefit, use or income of the property in the trust, then the grantors are also the primary beneficiaries. In that case the heirs who are named to inherit the trust property after the deaths of the grantors are known as remainder or secondary beneficiaries. If the grantors do not retain economic benefit or control of the trust property, then their heirs are named as the current beneficiaries.

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Revocable and Irrevocable

An arrangement where the trust may be revoked or canceled at will by the grantors is known as a revocable trust. If a trust cannot be canceled by a family member without permission of the other parties to the trust, the arrangement is called an irrevocable trust. Irrevocable trusts are recognized as independent legal entities whereas revocable trusts are not.

The well known living trust referred to above is almost always a revocable type. However the grantors may choose to have an irrevocable trust and then receive some special or extra benefits. The irrevocable, grantor controlled trust is the basis for many arrangements that are set up for clients using the Premier Plan II Life Estate Trust.

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