The vast majority of folks are no longer exposed to the federal estate tax, thanks to today’s ultra-generous $11.18 million exemption for singles or effectively $22.36 million for married couples.
Great! But being exempt from the federal estate tax is not the end of the story. If you have minor children and some assets (maybe just a car or two and some nice furniture), you probably need an estate plan regardless of your tax situation.
And the truth is, even some rich folks pass on without leaving so much as a will.
According to reports, Aretha Franklin (estimated net worth $80 million) died without a will, even though she was in poor health and had a special-needs son. Prince (estimated net worth $200 million) also died without a will, and his heirs have yet to receive any money two years after his death. Don’t let this be you. Here’s what you need to know.
Why you need a will or living trust document
If you die intestate (without a will), the laws of your state determine the fate of your minor children and your assets. Yikes! So unless you have an inordinate amount of faith in your beloved state legislature, you need a written will to make your wishes known.
In addition to a will, you may also want to set up a living trust to avoid probate.
The main purposes of a will are to name a guardian for your minor children (if any), name an executor for your estate, and specify which beneficiaries (including charities) should get which assets.
The guardian’s job is to take care of your kids until they reach adulthood (age 18 or 21 in most states).
The executor’s job is to pay your estate’s bills, pay any taxes due, and deliver what’s left to your intended heirs and charitable beneficiaries.
For wills, good do-it-yourself software is readily available online.
The living trust
Another basic estate planning goal is to avoid probate. Probate is a court-supervised legal process intended to make sure a deceased person’s assets are properly distributed. However, going through probate typically means red tape, legal fees, and your financial affairs becoming public information. These are things to be avoided when possible. That’s where the living trust comes in. Here’s how it works.
You establish the living trust and transfer legal ownership of assets for which you wish to avoid probate (such as your main home, your vacation property, investment accounts, your cars, your antique furniture, and your valuable baseball card collection) to the trust.
In the trust document, you name a trustee to be in charge of the trust’s assets after you die, and you specify which beneficiaries will get which assets from the trust.
You can function as the trustee or you can designate your attorney, CPA, adult child, faithful friend, or financial institution. Whatever works for you.
Because a living trust is revocable, you can change its terms at any time, or even unwind it completely, as long as you’re alive and legally competent.
For federal income tax purposes, the existence of the living trust is completely ignored while you’re alive. As far as the IRS is concerned, you still personally own the assets in the trust. So you continue to report on your Form 1040 any income generated by trust assets and any deductions related to those assets.
For state-law purposes, however, the living trust is not ignored. Done properly, it avoids probate. And that’s the goal.
When you die, the assets in the living trust are included in your estate for federal estate tax purposes. However assets that go to your surviving spouse are not included, assuming your spouse is a U.S. citizen (thanks to the unlimited marital deduction privilege). But as I said at the beginning of this column, you probably don’t have to worry about any federal estate tax hit with today’s huge exemption.
I think you should hire an attorney to draft a living trust document, and you don’t have to be “rich” to need one.
Wills and living trusts are not cure-alls
The benefits of a will or living trust are obvious. However, you won’t get the expected advantages without minding the details.
* If you’re married, you and your spouse should have separate, but compatible, wills and/or living trusts. That’s because you never know for sure who will die first.
* Your will and/or living trust should be compatible with your beneficiary designations and the manner in which your assets are legally owned. For example, when you fill out forms to designate beneficiaries for your life insurance policies, retirement accounts, and brokerage firm accounts, the named beneficiaries will automatically cash in upon your death without going through probate.
The same is true for bank accounts if you name payable-on-death (POD) beneficiaries. It makes no difference if your will or living trust document specifies to the contrary.
So keep your beneficiary designations current to make sure the money goes to the right places. For more on the importance of beneficiary designations, read this.
* When you co-own real estate jointly with right of survivorship, the other co-owner(s) will automatically inherit your share upon your death. It makes no difference if your will or living trust document says otherwise.
* If you set up a living trust, you must transfer legal ownership of assets for which you wish to avoid probate to the trust for the trust to perform its probate-avoidance magic. Many people set up living trusts and then fail to follow through by actually transferring ownership. If so, the probate-avoidance advantage is lost.
* In and of themselves, wills and living trusts do nothing to avoid or minimize the federal estate tax or state death taxes. If you have enough wealth to be exposed to these taxes, additional planning is required to reduce or eliminate that exposure.
Note that some states have death tax exemptions that are far below the ultra-generous $11.18 million federal estate tax exemption. So you could be exposed to state death taxes even though you’re blissfully exempt from the federal estate tax.
Your plan is a moving target
Things change. You may acquire new assets, win the lottery, lose relatives to death, disown relatives, take them back, and gain children or grandchildren.
Any of these events, and more, could require changes in your estate plan. In addition, the federal and state estate and death tax rules have proven to be unpredictable. For all these reasons, you should review your estate plan at least annually and update it as needed.
Now is a good time to review your existing plan or set one up if you don’t yet have one.