How Can I Minimize My Probate Estate?

Having a properly prepared estate plan is especially important if you have minor children who would need a guardian, are part of a blended family, are unmarried in a committed relationship or have complicated family dynamics—especially those with drama. There are things you can do to protect yourself and your loved ones, as described in the article “Try these steps to minimize your probate estate” from the Indianapolis Business Journal.

Probate is the process through which debts are paid and assets are divided after a person passes away. There will be probate of an estate whether or not a will and estate plan was done, but with no careful planning, there will be added emotional strain, costs and challenges left to your family.

Dying with no will, known as “intestacy,” means the state’s laws will determine who inherits your possessions subject to probate. Depending on where you live, your spouse could inherit everything, or half of everything, with the rest equally divided among your children. If you have no children and no spouse, your parents may inherit everything. If you have no children, spouse or living parents, the next of kin might be your heir. An estate planning attorney can make sure your will directs the distribution of your property.

Probate is the process giving someone you designate in your will—the executor—the authority to inventory your assets, pay debts and taxes and eventually transfer assets to heirs. In an estate, there are two types of assets—probate and non-probate. Only assets subject to the probate process need go through probate. All other assets pass directly to new owners, without involvement of the court or becoming part of the public record.

Many people embark on estate planning to avoid having their assets pass through probate. This may be because they don’t want anyone to know what they own, they don’t want creditors or estranged family members to know what they own, or they simply want to enhance their privacy. An estate plan is used to take assets out of the estate and place them under ownership to retain privacy.

Some of the ways to remove assets from the probate process are:

Living trusts. Assets are moved into the trust, which means the title of ownership must change. There are pros and cons to using a living trust, which your estate planning attorney can review with you.

Beneficiary designations. Retirement accounts, investment accounts and insurance policies are among the assets with a named beneficiary. These assets can go directly to beneficiaries upon your death. Make sure your named beneficiaries are current.

Payable on Death (POD) or Transferable on Death (TOD) accounts. It sounds like a simple solution to own many accounts and assets jointly. However, it has its own challenges. If you wished any of the assets in a POD or TOD account to go to anyone else but the co-owner, there’s no way to enforce your wishes.

An experienced, local estate planning attorney will be the best resource to prepare your estate for probate. If there is no estate plan, an administrator may be appointed by the court and the entire distribution of your assets will be done under court supervision. This takes longer and will include higher court costs.

Reference: Indianapolis Business Journal (Aug. 26,2022) “Try these steps to minimize your probate estate”

What Jackie Kennedy Knew about CLATs and Estate Planning

What most people don’t know about Jackie Kennedy was her role as an innovative steward of her family’s wealth and philanthropic legacy, reports a recent article from Forbes titled “Elevating Your Estate And Legacy: A Lesson From Jackie Kennedy.” After her husband’s assassination, she was in charge of a $44 million plus estate and her actions spoke volumes about her values and view for the future.  Jackie Kennedy initiated a Charitable Lead Annuity Trust (CLAT), which today many refer to as the Jackie Onassis Trust.

She created a CLAT receptacle through her will, so her children could elect to transfer some or all of their inherited assets in exchange for significant charitable, tax and non-tax benefits. They were not required to do this. However, it was an option for assets including stock, real estate and other capital. The CLAT offered her children three possible benefits: avoiding federal estate tax on all and any assets transferred to the CLAT, tax-efficient philanthropic giving for a limited number of years and continued investment of CLAT assets, which could be ultimately returned to the child or gifted to future generations at the end of the CLAT’s charitable period.

In addition, during the charitable term, the annual payments required to be distributed via the CLAT to charities would have created income tax deductions against the CLAT’s taxable income.

Despite their mother’s recommendations, the first lady’s children opted against funding the CLAT.

According to an article from The New York Times in 1996, if the Jackie Onassis Trust was worth $100 million and if the beneficiaries had executed the CLAT, the family would have inherited approximately $98 million tax-free in 2018, with charities receiving $192 million.

Instead, the children paid $23 million in estate taxes, leaving the estate with $18 million.

Besides the clear adage of “Mother knows best,” this is an example of the potential power of a CLAT to satisfy the charitable and family wealth transfer of the trust creator and individual beneficiaries. Since the 1960s, more sophisticated trust variants have been created to improve on the original CLAT.

One of these is the Optimized CLAT, a tax-planning trust which accomplishes four goals. It generates a dollar-for-dollar tax deduction in the year of funding, returns an expected 1x-5x of the initial contribution back to the contributor, immediately exempts contributed assets from the 40% federal gift and estate tax and exempts the transferred assets from the contributor’s personal creditors.

These complex estate planning strategies will become increasingly popular as federal estate taxes return to lower levels in near future. Your estate planning attorney will guide you as to which type of trust works best for you and your family, for now and for generations to follow.

Reference: Forbes (Aug. 19, 2022) “Elevating Your Estate And Legacy: A Lesson From Jackie Kennedy”

Can Beneficiary Designations Be Challenged?

The demise of traditional pension plans in the U.S. has been followed by a surge in assets held in participant directed retirement accounts, like IRAs and 401(k)s. The responsibility for investment decisions now belongs to the owners, says a recent article “Did you really intend for your ex to get your IRA?” from Chattanooga Times Free Press. The owner is also responsible for beneficiary distributions after death, which doesn’t always go well.

Retirement accounts are outside of the probate estate. Therefore, assets pass to heirs directly. When people first enroll in a retirement plan or open an IRA account, it’s up to the account owner to stipulate who will receive the asset upon their death, known as the beneficiary. This sounds easy enough. The heirs don’t need to worry about probate and if the ownership transfer is done correctly, they can get some tax advantages from the accounts.

When the owner doesn’t pay attention to beneficiary designations, expensive problems occur.

Failing to name a beneficiary. This is the simplest and most commonly made mistake when enrolling in a company’s retirement plan or rolling assets into an IRA. More than a third of all IRA death claims submitted for processing are lacking a named beneficiary, according to a national retirement plan administrator company. Instead of assets passing directly to heirs, the IRA account flows into the estate and becomes subject to probate and estate taxes.

Once included in the estate, the assets are subject to the will. While IRA assets have up to ten years to be withdrawn, the time limit for distributions in an estate can be as short as five years, and the resulting taxes will be much higher. Even worse, the assets in the IRA are now available to creditors of the estate. Until the estate is fully distributed, it must pay tax returns. Even a modest IRA is going to generate more estate taxes than if it were outside of the estate.

If there is no will, the state decides where the assets go.

Failing to name contingent beneficiaries. If the account owner and primary beneficiary are both dead, there should be at least one contingent beneficiary named on the account. Lacking contingent beneficiaries, the account flows to the estate as if no beneficiary had been named.

Neglecting to update beneficiaries after major life events. Divorce and death happen. Account owners often forget to update beneficiary designations, leading to unintended recipients. In some states, but not all, a divorce decree nullifies the prior designation. However, don’t count on it. If the state does nullify the prior designation, the asset will flow into the probate estate.

Naming a minor as a beneficiary. Most state laws do not permit minors to inherit significant assets without the oversight of a conservator. If a conservator is named by the court, the inheritance will be reduced substantially by court fees and the conservator’s salary. This may not be the worst part, if the asset is big. Here’s what’s worse: at age 18 or 21, a young adult will inherit the entire amount, with no restrictions.

After you’ve updated your beneficiaries, consult with an experienced estate planning attorney to learn how to protect assets, including retirement accounts and pensions.

Reference: Chattanooga Times Free Press (July 9, 2022) “Did you really intend for your ex to get your IRA?”

How are Capital Gains in Irrevocable Trust Taxed?

Putting a home in an irrevocable trust may be done to protect the house from estate taxes, explains a recent article from Yahoo! Life titled “Do Irrevocable Trusts Pay the Capital Gains Tax?” However, what effect does this have on capital gains taxes?

An irrevocable trust is used to protect assets. Unlike a revocable trust, once an asset is placed within the trust, it’s difficult to have the asset returned to the original owner. The trust is a separate legal entity and has its own taxpayer identification number.

Assets moved into a trust are permanently owned by the trust, until the trustee distributes assets to named beneficiaries or their heirs. Irrevocable trusts are often used to protect assets from litigation.

Capital gains taxes are the tax liabilities created when assets are sold. Typical assets subject to capital gains taxes include stocks, homes, businesses and collectibles. These taxes are usually lower than earned income taxes. For example, the top federal income tax rate is 37%, and the top capital gains tax rate is 20%. A single investor might pay no capital gains taxes if their taxable income is $41,675 or less (in 2022). Married copies filing joining also pay 0% if their taxable income is $83,350 or less.

Irrevocable trusts are the owners of assets in the trust until those assets are distributed, including any earned income. While it would seem that the irrevocable trust should pay taxes on earned income, this is not necessarily the case. If irrevocable trusts are required to distribute income to beneficiaries every year, then that makes the trust a pass-through entity. Beneficiaries pay taxes on the income they receive from the trust.

Capital gains are not considered income to such an irrevocable trust. Instead, they are treated as contributions to principal. Therefore, when a trust sells an asset and realizes a gain, and the gain is not distributed to beneficiaries, the trust pays capital gains taxes.

One of the tax benefits of home ownership is the ability to avoid the first $250,000 in capital gains profits on the sale of the home. For married couples filing jointly, the exemption is $500,000. The home must be a primary residence for two of the last five years.

What happens if you transfer your home to an irrevocable trust as part of your estate planning? Who pays the capital gains tax on the sale of a home in an irrevocable trust? Remember, the trust is a legal entity and not a person. The trust does not receive the $250,000 exemption.

Placing a home into an irrevocable trust can protect it from creditors and litigation, but when the home is sold, someone will have to pay the capital gains on the sale. Although irrevocable trusts are great for distributing assets to beneficiaries, they are also responsible for paying capital gains taxes.

An experienced estate planning attorney will help you to determine which is more important for your unique situation: protecting the home through the use of an irrevocable trust or getting the tax exemption benefit if the home sells.

Reference: Yahoo! Life (July 7, 2022) “Do Irrevocable Trusts Pay the Capital Gains Tax?”

What Happens to Stock Options when Someone Dies?

Once your business grows, so does the pressure to make good financial decisions in the short and long term. When you think about the future, estate and succession planning emerge as two major concerns. You’re not just considering balance sheets, profits and losses, but your family and what will happen to them and your business when you’re not around. This thinking leads to what seems like a great idea: transferring stock or LLC membership units to one or more of your adult children.

There are benefits, especially the ability to avoid a 40% estate tax and other benefits. However, there are also lots of ways this can go sideways, fast.

Executing due diligence and creating an exit plan to minimize taxes and successfully transfer the business takes planning and, even harder, removing emotions from the plan to make a good decision.

An outright transfer of stock or ownership units can expose you and your business to risk. Even if your children are Ivy-league MBA grads, with track records of great decision making and caring for you and your spouse, this transaction offers zero protection and all risk for you. What could go wrong?

  • An in-law (one you may not have even met yet) could try to place a claim on the business and move it away from the family.
  • Creditors could seize assets from the children, entirely likely if their future holds legal or financial problems—or if they have such problems now and haven’t shared them with you.
  • Assets could go into your children’s estates, which reintroduces exposure to estate taxes.

No family is immune from any of these situations, and if you ask your estate planning attorney, you’ll hear as many horror stories as you can tolerate.

Trusts are a solution. Thoughtfully crafted for your unique situation, a trust can help avoid exposure to some estate and other taxes, allocating effective ownership to your children, in a protected manner. Your ultimate goal: keeping ownership in the family and minimizing tax exposure.

A Beneficiary Defective Inheritance Trust (BDIT) may be appropriate for you. If you’ve already executed an outright transfer of the stock, it’s not too late to fix things. The BDIT is a grantor trust serving to enable protection of stock and eliminate any “residue” in your childrens’ estates.

If you haven’t yet transferred stock to children, don’t do it. The risk is very high. If you’ve already completed the transfer, speak with an experienced estate planning attorney about how to reverse the transfer and create a plan to protect the business and your family.

Bottom line: business interests are better protected when they are held not by individuals, but by trusts for the benefit of individuals. Your estate planning attorney can draft trusts to achieve goals, minimize estate taxes and, in some situations, even minimize state income taxes.

Reference: The Street (June 27, 2022) “Should I Transfer Company Stock to My Kids?”

Can Estate Planning Reduce Taxes?
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Can Estate Planning Reduce Taxes?

The estate tax exemption won’t always be so high. The runup in housing prices may mean capital gains taxes become a serious issue for many people. There are solutions to be found in estate planning, including one known as an “Upstream Power of Appointment” Trust, as explained in the article “How to Use Your Estate Plan to Save on Taxes While You’re Still Alive!” from Kiplinger.

The strategy isn’t for everyone. It requires a completely trustworthy, elderly and less wealthy relative, such as a parent, aunt, or uncle, to serve as an additional trust beneficiary. First, here is some background information:

Basis: This is the amount by which a price is reduced to determine the taxable gain. This is often the historical cost of an asset, which may be adjusted for depreciation or other items. Estate planning attorneys are familiar with these terms.

Step-up (in-basis): If you bought a house for $100,000 and sold it for $400,000, your taxable gain would be $300,000. However, if the house had belonged to your father and was being sold to distribute assets between you and your siblings, the basis (cost) would be increased to the fair market value at the date of your father’s passing. This increase is known as the “step-up in basis” and here’s the benefit: there would be no capital gain on the sale and no taxes owed.

Lifetime estate tax exemption: This is currently at $12.06 million per person or $24.12 for married couples. This is the amount of assets which can be passed to children or others free of any federal estate tax. However, the number will take a deep dive on January 1, 2026, when it reverts back to just under $6 million, adjusted for inflation. Plan for the change now, because 2026 will be here before you know it!

Upstream planning involves transferring certain appreciated assets to older or other family members with shorter life expectancies. Since the person is expected to die sooner, the basis step-up is triggered sooner. When the named person dies, you obtain a basis step-up on the asset, saving income taxes on depreciation and saving capital gains on a future sale of the property.

Most Americans aren’t worried about paying estate taxes now, but no one wants to pay too much in income taxes or capital gains taxes.

To make this happen, your estate planning attorney will need to give an elderly person (let’s say Aunt Rose) the general power of appointment over the asset. Section 2041 of the Internal Revenue Code says you may give your Aunt Rose a power to appoint the asset to her estate, creditors, or the creditors of her estate. Providing the power will include the value of the property in her estate, not yours, ensuring the basis step-up and income tax savings.

Don’t do this lightly, as a general power of appointment also gives Aunt Rose ownership and the right to give the property to herself or anyone she wishes. Can you protect yourself, if Aunt Rose goes rogue?

While the IRC rule doesn’t require Aunt Rose to get your permission to control or change distribution of the property, a trust can be crafted with a provision to effectuate the desired result. The IRC doesn’t require Aunt Rose to know about this provision. This is why the best person for this role is someone who you know and trust without question and who understands your wishes and the desired outcome.

Proper planning with an experienced estate planning attorney is a must for this kind of transaction. All the provisions need to be right: the beneficiary need not survive for any stated period of time, you should not lose access to the assets receiving the basis increase, you want a formula clause to prevent a basis step down if the property or asset values fall and you want to be sure that assets are not exposed to creditor claims or any other liabilities of the person holding this broad power.

Reference: Kiplinger (July 3, 2022) “How to Use Your Estate Plan to Save on Taxes While You’re Still Alive!”

What are Benefits of Putting Money into a Trust?

For the average person, knowing how a revocable trust, irrevocable trust and testamentary trust work will help you start thinking of how a trust might help achieve your estate planning goals. A recent article from The Street, “3 Powerful Types of Trusts that Can Work for You,” provides a good foundation.

The Revocable Trust is one of the more flexible trusts. The person who creates the trust can change anything about the trust at any time. You may add or remove assets, beneficiaries or sell property owned by the trust. Most people who create these trusts, grantors, name themselves as the trustee, allowing themselves to use their property, even though it is owned in the trust.

A Revocable Trust needs to have a successor trustee to manage the assets in the trust for when the grantor dies or becomes incapacitated. The transfer of ownership of the trust and its assets from the grantor to the successor trustee is a way to protect assets in case of disability.

At death, a revocable trust becomes an Irrevocable Trust, which cannot be easily revoked or changed. The successor trustee follows the instructions in the trust document to manage assets and distribute assets.

The revocable trust provides flexibility. However, assets in a revocable trust are considered part of the taxable estate, which means they are subject to estate taxes (both federal and state) when the owner dies. A revocable trust does not offer any protection against creditors, nor will it shield assets from lawsuits.

If the revocable trust’s owner has any debts or legal settlements when they die, the court could award funds from the value of the trust and beneficiaries will only receive what’s left.

A Testamentary Trust is a trust created in connection with instructions contained in a last will and testament. A good example is a trust for a child outlining when assets will be distributed to them by the trustee and for what purposes the trustee is permitted to make the distribution. Funds in this kind of trust are usually used for health, education, maintenance and supports, often referred to as “HEMS.”

For families with relatively modest estates, a trust can be a valuable tool to protect children’s futures. Assets held in trust for the lifetime of a child are protected in the event of the child’s going through a divorce because the child’s inheritance is not subject to equitable distribution when not comingled.

Many people buy life insurance for their families, but they don’t always know that proceeds from the life insurance policy may be subject to estate taxes. An insurance trust, known as an ILIT (Irrevocable Life Insurance Trust) is a smart way to remove life insurance from your taxable estate.

Whether you can have an ILIT depends on policy ownership at the time of the insured’s death. In most cases, the insurance trust must be the owner and the insurance trust must be named as the beneficiary. If the trust is not drafted before the application for and purchase of the life insurance policy, it may be possible to transfer an existing policy to the trust. However, if this is done after the purchase, there may be some challenges and requirements. The owner must live more than three years after the transfer for the policy proceeds to be removed from the taxable estate.

Trusts may seem complex and overwhelming. However, an estate planning attorney will draft them properly and make sure that they are used appropriately to protect your assets and your family.

Reference: The Street (May 13, 2022) “3 Powerful Types of Trusts that Can Work for You”

Why Have a Joint Revocable Trust?

If you’re married, you are eligible to use a joint trust instead of having individual trusts. This recent article, “Joint Revocable Trust: Estate Planning” from aol.com, looks at the pros and cons to see if it makes sense for your estate plan.

A trust is a legal entity where a grantor, the person creating the trust, gives a trustee control over assets in the trust, usually to distribute them when the grantor has died. The person receiving the trust is the beneficiary. They have no control over the assets until they are distributed. In the case of a revocable living trust, the grantor and the trustee are often the same person.

A revocable trust, also known as a revocable living trust, can be changed many times, or even dissolved whenever the grantor wants. However, when the grantor dies or becomes incapacitated, the trust becomes irrevocable, meaning it cannot easily be changed. It also becomes inaccessible to creditors.

Why would you need a “joint” revocable trust? As its name implies, a joint trust has multiple co-trustees. This is a commonly used trust for spouses, especially when the wish is for the surviving spouse to receive 100% of the couple’s assets when the first spouse dies. The joint trust is revocable while both spouses are living and, depending on the trust terms, may continue to be revocable after the first spouse dies.

When one spouse dies, the surviving spouse becomes the sole trustee. On the death of the second spouse, the trust becomes an irrevocable trust. This is when an appointed successor trustee takes control of the trust, including distributing assets to beneficiaries as directed in the trust documents.

To decide whether you and your spouse need a joint revocable trust, you’ll want to discuss the pros and cons with an estate planning attorney.

The joint trust is practical and easy to fund and maintain. You and your spouse can both transfer assets into the same trust and you both own it. Assets in the joint trust don’t go through probate, which can get assets distributed faster and easier. The assets in the joint trust and the terms of the trust remain private, since the trust documents don’t become part of the public record. Your will does, through probate. Finally, a joint trust does not need to file a separate tax return, as long as one spouse is still living.

However, there are some disadvantages to a joint trust. It’s harder to leave any assets in the joint trust to non-spousal beneficiaries, like children from a prior marriage. The surviving spouse retains control over all assets in the trust. If there is no language in the trust concerning children, they will not inherit anything from the trust.

In a small number of states, there are state estate taxes with thresholds far lower than the current federal estate tax exemption of $12.06 million per individual. Your estate planning attorney will know what taxes will be due in your state of residence.

A joint trust may offer less protection from creditors than separate trusts, if one of the spouses has financial issues. If spouses combine their assets in a joint revocable trust, assets in both trusts would be vulnerable to creditors.

For couples whose finances are not overly complex, a joint revocable trust may be a great choice. Your estate planning attorney will be able to look at your entire estate and see what tools will serve you best.

Reference: aol.com (May 2, 2022) “Joint Revocable Trust: Estate Planning”

How Does a Trust Fund Work?

To maximize the benefits of a trust fund, you’ll need to understand how trusts funds work and how to create a trust fund the right way, advises this recent article from Yahoo! Money titled “How to Start a Trust Fund the Easy Way.” You don’t have to be a millionaire to start a trust fund, by the way. “Regular” people benefit just as much as millionaires from using trusts to protect assets and minimize taxes.

A trust fund is an independent legal entity created to own assets and ensure money and property are used to benefit loved ones. They are commonly used to transfer assets to family members.

Trust funds are created by grantors, the person who sets up the trust and transfers money or assets into it. An experienced estate planning attorney will be essential, since creating a trust is not like going to the bank and opening an account. You need the assistance of a professional who can create a trust to reflect your wishes and comply with your state’s laws.

When assets are moved into a trust, the trust becomes the legal owner of the property. Part of creating the trust is naming a trustee, who manages the trust and is legally bound to follow the wishes of the trust following the grantor’s wishes. A successor trustee should always be named, in case the primary trustee becomes unwilling to serve or dies.

Subject to compliance with specific requirements, assets owned by an irrevocable trust are not countable towards Medicaid, if someone in the family needs long-term care and is concerned about qualifying. Any transfer must be done at least five years in advance of applying for Medicaid. An elder law attorney can help in preparation for this application and to ensure eligibility. This is a very complex area of law. Do not attempt it alone without the assistance of an elder law attorney.

Trusts can have a long or short life. Some trusts are held for a child until the child reaches age 25, while others are structured to distribute a portion of the assets throughout the beneficiary’s lifetime or when the beneficiary reaches certain milestones, such as finishing college, starting a family, etc.

A revocable trust allows the grantor to have the most control over the assets in the trust, but at a cost. The revocable trust may be changed at any time, and property can be moved in and out of it. However, the assets are available to creditors and are countable towards long-term care because they are in the control of the grantor.

The irrevocable trust requires the grantor to give up control, in exchange for the benefits the trust provides.

There are as many types of trusts as there are situations for trusts. Charitable Remainder Trusts reduce estate taxes and allow beneficiaries to receive an income stream for a designated period of time, at the end of which the remainder of the trust’s assets go to the charity. Special Needs Trusts are created for disabled persons who are receiving means-tested government benefits. There are strict rules about SNTs, so speak with an experienced estate planning attorney to ensure that your loved one continues to be eligible, if you want them to receive assets from you.

Trusts are often used so assets will pass through the trust and not through the probate process. Assets owned by a trust pass directly to beneficiaries and information about the assets does not become part of the public record, which is part of what occurs during the probate process.

Your estate planning attorney will help ensure your trusts are appropriate for your situation, achieve your specific wishes and are in compliance with your state’s laws. A boilerplate template could present more problems than it solves. For trusts, the experienced professional is the best option.

Reference: Yahoo! Money (March 18, 2022) “How to Start a Trust Fund the Easy Way”