The New Estate Planning

The New Estate Planning

by John McDermott
MidAm Bank

In the old days “estate planning” simply meant making a will.New needs have sparked new thinking.

Andy Ames just did some planning:He placed his securities in a living trust.If anything happens to him, his trust will grow to include the proceeds of his life insurance.The enlarged trust fund then would be invested and managed as a unified source of income for Andy’s wife and children.

Barbara Bates desires estate planning privacy.Also, there are certain relatives for whom she is not providing, so she wants to minimize the risk of challenges from disgruntled heirs.She too has built her estate plan around a Revocable Living Trust.

Carl Crowell long intended to leave a substantial bequest to the School of Music where his mother has taught.Recently he found a better way.Carl transferred stock in which he had a large paper gain to a Charitable Remainder Trust.The trust will pay him a dependable annuity for life.Then the trust assets will go to the school.Meanwhile, Carl benefits from important tax advantages.

Doris Danielson owned a summer home at the shore that her children and grandchildren enjoyed.To pass along the house to the younger generations without heavy gift or estate taxes, Doris has set up a Qualified Personal Residence Trust.

And oh, yes.Andy, Barbara, Carl and Doris made wills too.

Names used above are fictitious; the situations are true to life.They illustrate a major trend. Although everybody still needs a “Last Will and Testament,” the new estate planning often takes advantage of alternative methods of transferring assets.Probably the most widely used alternatives are living trusts, either revocable or irrevocable.

Planning With Revocable Trusts

For example, Andy and Barbara have estate plans built around Revocable Trusts–the kind you can alter or revise whenever you wish.Revocable Living Trusts avoid probate.That can lead to lower estate settlement costs overall.Except in a few jurisdictions, however, probate-related fees are not that high.As articles in Consumer Reports and elsewhere have pointed out, other advantages of living trusts are likely to be more helpful in most cases, such as estate tax savings, investment advice and special family concerns.

Andy’s plan:Andy’s living trust enables him to organize the two main elements of his estate: his stock and bond investments (bought with the proceeds of some property he and his brother sold) and his life insurance.The insurance portion is sizable, for it includes insurance provided by his employer as well as Andy’s personal insurance policies.

If Andy is survived by Allie, his wife, his trust is designed to shelter as much as $600,000 from estate tax at her death.In the unlikely (but not impossible) event that both Andy and Allie should die while the children are still young, the trust would serve as a unified source of funds for the children’s support and education.

Barbara’s plan:Unlike a will that has been admitted to probate, a living trust agreement generally does not go on public record.For Barbara Bates the issue of confidentiality is important.She also feels that her trust will minimize the risk of legal disputes when she dies. Estate planning lawyers caution that no will or trust can be guaranteed against lawsuits by disappointed heirs.

Nevertheless, many legal advisers believe that living trusts are less likely than wills to trigger legal battles.For one thing, a will must be offered for probate, a legal proceeding in which those who object to the will are virtually invited to step forward.Barbara also has a will to dispose of personal things and any miscellaneous assets that are not held in her trust at the time of her death.But her will is fairly simple and unrevealing, and the possessions that pass under its terms probably won’t be worth going to court to argue about.

Planning With Irrevocable Trusts

Some living trusts are fixed.Irrevocable.Once you create an Irrevocable Trust, you may not revise its terms or take back the trust assets.What’s done is done.

Why are Irrevocable Trusts established?One reason in that trusts can be used to divide the benefits of owning securities, real estate or other property into “income” and “remainder” interests.When trusts are made irrevocable, this methods of splitting up property can lead to interesting tax savings.Take Carl and Doris, for example.

Carl’s plan:To make his deferred donation to the music school. Carl transferred appreciated stock worth $400,000 to a Charitable Remainder Trust, reserving an 8% lifetime annuity.If Carl had sold the appreciated stock, he would have realized a $350,000 gain.After 28% capital gains tax, that would have left Carl with little more that $300,000 to reinvest for higher income. If invested in bonds yielding 8%, the after-tax proceeds would have paid him about $24,000 a year.

With Carl’s Charitable Remainder Trust, however, the trustee can sell the appreciated stock and reinvest the proceeds, for the eventual benefit of the music school without capital gains tax. Meanwhile, the entire $400,000 is available to pay Carl an 8% annuity.Instead of little more than $24,000 yearly, he can count on $32,000.

Tax Bonus:Carl could treat the discounted present value of his deferred gift to the School of Music as a current donation to generate an income tax deduction.The degree of discount depends on the age of the donor-life beneficiary, the level of annuity selected and fluctuations in bond yields.For someone like Carl, age 65 and reserving an 8% annuity, typically about a third of the deferred gift is deductible.

Carl’s income tax deduction was sharply reduced because, based on his life expectancy, the deferred donation won’t pass to the music school for many years.Wouldn’t it be nice if one could make a deferred family gift and have it sharply discounted for federal gift tax purposes? It’s possible, and Doris’ plan illustrates one way to do it.

Doris’ plan:Doris transferred her summer place to an Irrevocable Trust.Instead of an “income” interest, she retained the right to live there rent free for 12 years.Then the trust will terminate, passing ownership of the summer home to her children as remainder beneficiaries. For gift tax purposes, Doris was not charged with making a taxable gift equal to the value of the summer home. Only the deeply discounted “present value” was taxable–and because Doris could use part of her unified tax credit (it’s equal to a gift-and-estate-tax exemption of $600,000) to cover the tax, her out-of-pocket tax expense was zero.

As long as Doris outlives the 12-year term of the trust, the summer home will not be subject to estate tax at her death.

Gift tax on securities and other assets also can be minimized by structuring the transfers as deferred family gifts in trust.Where the beneficiaries are children or grandchildren, however, the donor’s retained income interest must be structured as an annuity or as annual payments of a fixed percentage of the trust fund’s changing market value.And here again,the donor must outlive the term of the trust in order to produce the tax benefits.

Put Our Experience To Work

The new estate planning is highly personalized.Don’t expect to buy a plan off the shelf.With literally dozens of planning approaches and tax-saving techniques to choose from, you and your advisers will need to pick and choose, based on a careful analysis of your estate, your family situation and your special goals.