The Importance of Estate Planning: Planning Beyond The Will

January 11th, 2014

Planning ahead is the best way to assure, protect and manage your estate upon your demise.  You have worked your whole life to accumulate the property that you own.  Who do you want to decide regarding how your life’s work will be distributed when you are gone?  A will can dictate the distribution of your assets and in most cases discourage a contest over your estate, but there are many other issues to be considered.  If you do not plan your estate, Texas will do it for you without looking back.

The two most common documents that accompany a Will are the Living Will and Power of Attorney.  A Living Will specifies whether you would like to be kept on artificial life support if you become permanently unconscious or otherwise unable to speak for yourself.  It allows you in advance to control your healthcare decisions should the circumstances prevent you from doing so.  The Power of Attorney gives someone you trust the legal authority to act on your behalf.  There are generally two types of powers of attorney.  A specific power of attorney imposes limits on the named representative and may restrict the scope of that person’s power.  A general durable power of attorney is unlimited in scope and duration and permits the representative to act on your behalf in legal matters until such time as the power of attorney is revoked even should you be unable to do so because of disease or disability.

You may think that a will is the beginning and the end to estate planning. However, without a comprehensive estate plan, a significant part of the work you’ve done throughout your life, both at your job and with your investments can be lost or given to unintended beneficiaries.  Estate planning used to be of importance only to the very wealthy. But even middle-income earners who do a good job investing throughout their lifetimes can benefit from estate planning.  It is important to understand the basics of estate planning to ensure your financial and philanthropic goals are met after you are gone.

An essential element of advanced estate planning is tax planning.  The purpose of tax planning is to reduce estate taxes, gift taxes, and generation skipping transfer taxes. A well-formulated estate plan utilizes various trusts and other estate planning vehicles to reduce tax liability. 

Litigation, divorce, malpractice and other potential claims may damage your net worth far more than potential taxes. So protecting assets from potential claims has become an additional planning objective.  Many techniques can be implemented to reduce your estate for tax purposes while also protecting your assets from creditors. Yet these measures won’t protect against existing creditors if a transfer constitutes a “fraudulent conveyance” under the Uniform Fraudulent Transfer Act. A fraudulent conveyance occurs if you had actual intent to hinder, delay or defraud a creditor when you made the transfer.

Below is a list of ways to safely protect transferred assets from creditors:

1. Outright gifts. An outright gift protects a transferred asset from creditors. But you’ll lose all economic interest in and control over the asset

2. Family limited partnerships. A Family Limited Partnership is an excellent asset-protection device because it restricts a creditor’s ability to attach partnership assets to satisfy a debt and avoids personal liability beyond your original investment.

3. Irrevocable life insurance trusts. From the standpoint of protecting your assets, an irrevocable life insurance trust removes insurance proceeds from your estate for federal estate tax purposes. And the trust protects from creditors the cash value of the policies during your lifetime and the policy proceeds when you die.

4. Qualified personal residence trusts. A qualified personal residence trust lets you transfer a primary or vacation residence to a trust while you reserve the right to live in the home for a term of years. The value of the interest you retain (that is, the right to live in the house for a term of years) is calculated using Internal Revenue Service tables. The value of the property transferred into trust, minus your term interest’s value, is a gift known as the “remainder interest.” This gift can be sheltered from gift tax by your $1 million dollar or current exclusion gift tax exemption. If you survive the term of years, the trust is not included in your estate for federal estate tax purposes.

5. Inter vivos qualified terminable interest property trusts. You create this trust during your lifetime for your spouse. It qualifies for the gift tax marital deduction. The federal estate tax benefit to this technique is that when your spouse dies, the qualified terminable interest property trust is included in his or her estate for federal estate tax purposes. If your spouse lacks sufficient assets in his or her own name to use his or her federal estate tax exemption, the qualified terminable interest property trust assets will achieve this.

6. Charitable remainder trusts. A charitable remainder trust usually provides for distribution of a percentage of the trust principal, at least annually, to a person, usually the grantor, for his or her lifetime. The charitable remainder trust can provide that when the grantor dies, the grantor’s spouse shall become the charitable remainder trust annuitant for his or her lifetime. When this period ends, the charity receives the remaining charitable remainder trust assets (the “remainder interest”).

Creating a CRT provides several income tax benefits. An additional benefit is that the charitable remainder trust is exemption from all income tax. So a grantor owning assets subject to a large capital gain can transfer these assets to the trust, and it can sell them without the grantor or the trust having to pay any tax on the gain. Or a grantor holding highly appreciated assets that aren’t producing much income can contribute them to the charitable remainder trust and create an income stream and owe tax only as annuity payments are received. It sells them and reinvests the proceeds to service the annuity.

Another key component of estate planning is asset protection.  Use of creative asset protection strategies provides a shield against various threats which could potentially deplete an estate. These threats include: creditors; scammers who prey on the wealthy and their heirs and beneficiaries; and lawsuits arising from acts of negligence.

A trust is the best way to achieve asset protection. Depending on your short and long-term financial goals, the types of assets you have, and your individual and familial circumstances, the following trusts might be appropriate asset protection mechanisms:

• Lifetime trusts;
• Continuing trusts;
• Spendthrift trusts;
• Beneficiary protection trusts;
• Foreign asset protection trusts;
• Discretionary trusts; and
• Special needs trust (when you have a disabled or ill family member).  A special needs trust often includes clauses relating to the provision of housing, medical care, legal assistance, and other essential needs as well as for supplemental needs such as vacations, hobbies, and social activities.

Business succession planning is also an essential element of advanced estate planning. Business succession planning allows you to formulate a plan for the transfer of ownership and control of a closely held business in the event of your disability or death.  There are important questions to ask yourself when it comes to creating a business succession plan:  1) What are your financial goals?; 2) When will you retire?; 3) What is the current value of your business? 4) Will the value of the business increase and, if so, how much? 5) What are the pros and cons of selling the business?

You need a business succession plan which should include a contingency plan for unexpected events.  A good succession plan includes:

• Business buy-sell agreements
• Business, disability and life insurance policies
• Key employee incentive programs
 
Proper estate and business planning will give you confidence that your assets are protected when the proper time comes and assist family members and loved ones with difficult decisions they may not be prepared to handle.  It is a sound investment for both you and your loved ones.

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