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Estate Planning

Estate planning is the preparing of legal documents to carry out your testamentary intent.  Estate planning does not just take into account the high net worth individual who is primarily concerned about estate taxes, but rather planning for everyone’s testamentary intent.   Testamentary intent is what you want to happen when you die.  Notwithstanding, the general definition estate planning can include sophisticated gifting options to reduce one’s taxable estate and avoid or diminish federal and state estate taxes.

Estate Planning

A Confusing But Common Estate and Life Insurance Decision

by Evan

I participate in a lot of financial and estate plans, and there is a common distribution technique I never understood.  The worst part, is that it almost always unintentional.  I think most people would would agree that a child who has lost both of his or her parents should not receive money outright, and as such, his or her inheritance should be held in a trust.  The terms of that trust may will vary depending on the age of the parents, age of the children, responsibility of the children, other family dynamics, experiences of the parents, etc., however, most people do not have their largest liquid assets passing pursuant to this testamentary intent.

Your Will only controls those assets that don’t pass by deed, operation of law or beneficiary status.  It has been my experience that for young families the largest amount of money to be left to children are their life insurance policies.  This makes logical sense as most young families haven’t had the opportunity to create a diversified and liquid balance sheet, however, for pennies on the dollar a term policy could be purchased.

With that being said, how are most policy beneficiary statuses filled out?

  • Primary Beneficiary – Spouse
  • Contingent – My Children

So depending on the State, your life insurance proceeds will fund either an UTMA Account (usually outright at 21) or UGMA Account (outright at 18).  This is a terrible idea.  I know 21 year old Evan would have been a terrible person to give a large amount of money to especially when you compound the situation with losing both parents.

If you were thorough enough to create trusts that match your testamentary intent then match your beneficiary statuses accordingly!  It is imperative that you check with your insurance professional or attorney as some companies prefer you to just name your estate or to identify the testamentary trust to be created at death.

So What’s the Drawback? Why isn’t Naming a Trust/Estate as Beneficiary Common Place?

The main drawback to naming your estate or testamentary trust as beneficiary is that the life insurance becomes part of your probatable estate.  This could increase fees and is likely to increase the time before your heirs receive their check.  It should be noted that probate fees are in addition to an estate’s federal or state estate taxes.

 

What does the beneficiary status of your life insurance look like?

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Estate Taxes

Why Most People Should Be In Favor of the Federal Estate Tax

by Evan

I think it is a very easy and popular position to be against the federal estate tax (affectionately known as the “death tax”).  The arguments against the estate tax range from the simple, “the government should death tax it is hard enough” to the bit more sophisticated, “the decedent was already taxed on all earnings and capital gains.”  Despite being a libertarian I think I could even make an argument, albeit a weak one, that there may be societal good in preventing a further concentration of wealth.  It is weak because even with the estate tax there has been an obvious concentration of wealth.  So why should people be in favor of the federal estate tax?  Hint: it has to do with income taxes.

A Simple Explanation of the Federal Estate Taxes

The federal estate tax went through some pretty unbelievable, politically charged, changes in the past 15 or so years.  For purposes of a paragraph within a blog post I am going to focus on the current state of affairs as of March, 2014.  Currently, each decedent can leave up to $5,340,000 to any non-spousal beneficiary.  Spouses may receive an unlimited amount.  So through the use of the portability statute and certain types of testamentary trusts a decedent can leave up to $10,680,000 without incurring any estate taxes.  The number becomes MUCH higher if one is working with a reputable financial planner or estate planning attorney. After that amount the tax rate is an effective 40%.

Want to know how many estate tax filings there were in 2012?  9,400.  Want to know how many people died in the US in 2008? 2,400,000.  There were more cases of TB in 2012 than there were estate tax filings.  The odds that you or anyone you know will be hit with the Federal Estate Tax are slim at best and are even lower than slim if you don’t live in Illinois, TX, NY, FL or Cali, which have the highest filings.

But Evan, I care because taxing someone at death is still wrong.

The Capital Gains Tax is Tied to the Estate Tax

Say what? But you said I wasn’t going to get hit by the federal estate tax.

When someone dies they get a step up in basis on their assets.  Investopedia defines step up basis as,

The readjustment of the value of an appreciated asset for tax purposes upon inheritance. With a step-up in basis, the value of the asset is determined to be the higher market value of the asset at the time of inheritance, not the value at which the original party purchased the asset.

An example

  • Dad buys 10 shares of ABC Stock worth $1
  • ABC appreciates to $100/share – so the account has increased in value from $10 to $1,000
  • Dad dies and leaves this account and other assets totaling $100,000 son
  • Son sells shares the day after dad dies
  • What does he pay in a capital gains? Nothing
  • What does son pay in estate taxes? Nothing

That step up in basis exists as a direct tie in to the estate tax.  In 2010 when we didn’t have an estate tax we had a modified step up which only provided $1,300,000 of step up to be applied.  There is no guarantee we would get a modified system.  In our example above without a modified step up son would owe a capital gains tax of $1,000 minus dad’s original basis of $10 (or $990 x cap gains rate – 15%/20%).

If there is a total repeal of the estate tax there is likely to be at least a partial repeal of the step up basis rules which will affect a whole hell of a lot more people than 9,400…and THIS IS WHY MOST PEOPLE SHOULD BE IN FAVOR OF THE FEDERAL ESTATE TAX.

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Estate Planning

When’s the Last time You Reviewed your Beneficiaries?

by Evan

It isn’t often discussed, but estate planning (or lack of estate planning) isn’t the only way assets pass to heirs.  A very common way an heir receives assets is pursuant to a beneficiary election or payable upon death contract.  Passing assets via a beneficiary status is not limited to just qualified retirement accounts and life insurance; many banks and brokerage sites will provide you with an option to skip probate and pass the assets directly to a beneficiary.  While beneficiary statuses makes it easy for an heir to inherit property it comes with an added level of responsibility.

Everyone Should Review Their Beneficiary Statuses Yearly

It was almost a year ago when I decided to talk to my brother about buying investments for my niece’s birthday instead of another garbage toy that she won’t care about 6 weeks later.  The conversation went fantastic, so we opted to have the same conversation when my sister-in-law had her baby girl.  While I was creating the account I took a look at my beneficiary statuses (I have a number of accounts with my broker for different purposes).

Two things came about that shocked

  • Some beneficiary statuses were not filled out
  • My Traditional IRA’s beneficiary status was wrong when considering my current testamentary intent

If a beneficiary status or terminable upon death provision is not filled out the asset likely passes to your estate.  As with everything there are exceptions. A particular company can elect who the money or investment will go to if the beneficiary status is left blank.
The blank beneficiary status was of less concern to me since the account would fall back into my estate and be left to my son anyway, however, the wrong beneficiary status was alarming.

 

My traditional IRA was created in 2002 or 2003.  It doesn’t have a lot of money in it since most of my retirement funds were acquired with my current employer so they are stuck in my 401(k).  Notwithstanding the lack of funds, the beneficiary status had The Wife has primary beneficiary and then my parents as contingent!  This is obviously not my testamentary intent anymore.  This led me to checking every single account I owned.

When is the last time you checked your beneficiary statuses or terminable on death provisions?

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Estate Planning

Everyone has a Default Estate Plan

by Evan

It is amazing how many people believe that when someone dies without a Last Will and Testament the surviving family (and mistresses) are paraded in front of a judge and possibly even a jury to argue who the decedent loved more.  I hate to burst the bubble of anyone who loves “legal” TV shows but is not what happens.  When someone does without a Last Will and Testament they are said to die intestate and their is an estate plan.

What is Intestacy? What is the Default Estate Plan?

Intestacy, much like a Last Will and Testament, only controls those assets which do not pass by deed, operation of law or contract.  So your 401(k) or life insurance would only pass pursuant to your State’s intestacy law if you didn’t have a named beneficiary (or you named your Estate as beneficiary). Every State has some sort of distribution schedule based on the family dynamics of the decedent to avoid the made up TV scenario above.

Your State’s Intestacy Law

I found a cool website that lists every intestacy statute called, My State Will. Each State distributes assets by intestacy differently. So you will have to check out your own State:

Lets take a look at New York for example.  The intestacy law is covered by EPTL 4-1.1 and distributes assets as follows:

  1. Spouse and No Kids – Spouse gets it all
  2. Spouse and Kids – First $50,000 to your spouse and then one-half to your spouse and one-half to your children;
  3. Kids No Spouse – Kids get it all
  4. No Kids, No Spouse – Decedent’s Parents
  5. No Kids, No Spouse, No parents – Your Siblings
  6. No Kids, No Spouse, No Parents, No Siblings – One half to maternal grandparents and one half to paternal grandparents
  7. Then work your way down to aunts, uncles, nieces and nephews.

Re-read number 2.  Yes, you read that correctly. If a New York domiciliary were to die his assets which do not pass by deed, ownership, or contract would be basically split between the surviving spouse and children.  Whose testamentary intent is that?!

Avoiding the distribution schedule of intestacy is only one of many reasons everyone should have a will.

 

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Estate Planning

What Does the Facebook IPO and the Twitter IPO Have in Common?

by Evan

There is article after article discussing how the facebook IPO will be different than the Twitter IPO, but I came across an article this weekend from the Wall Street Journal that indirectly indicates how the situation may be similar when it comes to estate tax planning.

What does the Twitter and Facebook IPO Have in Common?

While Ms. Saunders doesn’t make the connection she highlights,

The [estate planning] moves could save Messrs. Dorsey, Williams and Costolo a total of at least $115 million, and perhaps far more, in federal estate tax at current rates, assuming a Twitter offering price of at least $28 a share. The current top federal estate-tax rate is 40%, and Twitter’s home state of California has no state estate tax.

Twitter insiders, who made estate-tax moves before the highly-anticipated IPO, could save at least $115 million in federal estate tax.

Those projected savings are less than the estimated $200 million skirted by six insiders who made estate-tax moves before last year’s stock sale. Still, they help show how careful planning can benefit the truly wealthy—people with assets far in excess of the estate- and gift-tax exemption of $5.25 million per individual, or $10.5 million per couple.

As highlighted by Forbes, this forward thinking estate planning was also completed by Facebook executives as

Mark Zuckerberg and Dustin Moskovitz, the co-founders of Facebook and two of the world’s youngest billionaires, may seem too young to be thinking about estate planning. But in 2008, when they were both 24, they used an estate planning tool that is more familiar to people two or three times their age. It involved putting pre-IPO stock into a special kind of trust that will explode in value when the company goes public. In the process Zuckerberg and Moskovitz, by FORBES conservative estimate, will together shift $185 million to trust beneficiaries without having to pay gift tax. Sheryl Sandberg, Facebook’s COO, who was then 39, used the same strategy to transfer at least $19 million tax-free.

While it is likely all guessing both journalists highlight the use of a Grantor Retained Annuity Trust.

What is a Grantor Retained Annuity Trust?

When I have to explain a GRAT I usually draw out the following picture:

Grat

  • Grantor creates a Trust that is defective for income tax purposes (i.e. it is a completed gift for estate/gift taxes but for income taxes the trust and the grantor are often one in the same)
  • Grantor Retains (The “R”) an Annuity (“A”) – remember the definition of an annuity is just a stream of payments.
  • The Annuity is calculated using the government’s Section 7520 rate (assumed growth) and length chosen by Grantor

So in the end the Grantor “gets back” the value of the gift plus growth.  Contrary to popular belief you can’t just gift what you want – there are gifting laws in the United States.  The GRAT allows you to determine how much you “want” to pay in Gift Taxes by playing with the various levers in the calculation.

I think it is fantastic that some estate planning attorney and/or financial planner was able to explain the benefits to all the young CEOs that despite their age estate planning was necessary.

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