What Everyone Should Know About Estate Planning

Many people think of estate planning as something only needed by a few wealthy individuals. As such, a good number of people simply believe they do not need an estate plan. This could be a costly mistake that may be passed on to the family members and loved ones of an individual without an estate plan. We invite you to read further to gain a better understanding of estate planning and how an estate plan may benefit you, your family, and loved ones.

A will is the most basic estate planning tool. A will identifies who acquires a person’s property when they die. A will can also serve as a device designating a personal guardian to rear an individual’s child or children. Unfortunately, there is a significant downside to having a will. Property transferred by a will must usually go through a probate. Probate is a process whereby a court supervises the transfer of assets from a deceased person to his or her heirs. For most people, the very mention of the term “probate” conjures up thoughts of being taken advantage of by “high priced” lawyers. Unfortunately, the probate process can be notoriously difficult. The probate process often requires the filing of particularized forms which tend to be complicated. In addition, the probate process usually takes at least six months. To make matters even worse, the probate process can take substantially longer in the event of a will contest, heirs not being timely notified, or if the estates of the estate at issue are not timely sold.

Since probate can be costly and time-consuming, many individuals choose to establish estate plans that bypass the probate process. There are six methods most individuals use to either eliminate or reduce the probate process. These methods are trusts, joint tenancies, pay-on-death designations, life insurance, individual retirement plans, and state law exemptions. A trust is a legal entity that individuals transfer property of value to. The individual who transfers property to the trust keeps control of the trust during their lifetime. Upon the grantor’s death, the property transferred to the trust goes to the beneficiary of the trust. There are two types of trusts available: revocable and irrevocable. Property that is transferred into a revocable trust is subject to the grantor’s creditors during his or her lifetime. However, if properly established, a grantor could transfer his or her assets into an irrevocable trust that cannot be reached by his or her creditors.

Joint tenancy is another way many people avoid the probate process. Joint tenancy can be used by a couple who own a share of property. Joint tenancy usually contains a “right to survivorship” clause. This means that when one joint tenant dies, his or her ownership is transferred to the other joint tenant. In some circumstances, this can be a very effective way to avoid the probate process. Like joint tenancy, individuals have successfully used pay-on-death designations to avoid probate. Pay-on-death designations have been used extensively with bank and security brokerage accounts. Under a pay-on-death designation, when the holder of the account dies, the account is transferred directly to the named beneficiary. In addition, individuals have successfully used life insurance and retirement accounts to avoid probate. However, any individual contemplating using life insurance or retirement accounts to avoid probate must consider the tax consequences of utilizing these vehicles. Finally, some individuals may avoid the probate process altogether if state law allows property to be left by will to be transferred up to a certain dollar threshold. It should be noted that in most states this amount is usually very small.

Many people do not understand transferring property before and after death can result in a significant assessment of Estate and Gift Taxes. To make matters worse, Estate and Gift Taxes are confusing and complex. Compounding this problem are the recent changes in the Internal Revenue Code. Recent changes in the Tax Code have made the understanding Estate and Gift taxes even more difficult.

All United States citizens and individuals who own property in the United States are subject to the Estate Tax. The Estate Tax is levied on all property owned by a decedent whether it goes through probate or not. Currently, an individual can distribute as much as $2 million in property at death. This amount increases to $3.5 million in 2009. The Estate tax is completely repealed in 2010. However, in 2011, an individual can only transfer $1 million in property at death without being subject to the Estate Tax. Although the Estate Tax exclusion is scheduled to decrease to $1 million dollars in 2011, this amount could change.

The amount of the estate subject to tax depends on the value of the property in the estate. The taxable estate includes the value of all the property in the estate at the time of death. In addition, for Estate Tax purposes, the taxable estate will include the following:

  • Life insurance proceeds payable to the decedent’s estate or if the decedent owned the policy with his or her heirs listed as beneficiaries;
  • The value of certain annuities payable to the estate or his or her heirs;
  • The value of certain property that was transferred out of the decedent’s estate within 3 years of death;
  • Trusts or other interests established by the decedent to others that he or she may have had certain powers.

Some people may believe that they can give away their property before they die to avoid the Estate tax. Unfortunately, Congress has also levied a tax on gifts made during one’s life. This is referred to as the Gift Tax. Currently, the Internal Revenue Code exempts from federal tax the first $12,000 given away as a gift to others annually. This amount can be combined for married couples. All annual gifts over $12,000 or $24,000 for married couples must be reported to the Internal Revenue Service. Aside from this annual exclusion, the federal Tax Code imposes a $1 million lifetime exemption on the gift tax. If an individual gives away more than $1 million of gifts in his or her lifetime, that individual will be subject to the gift tax. While the Estate Tax exemption increases to $3.5 million in 2009. There are no provisions in the Internal Revenue Code to increase the maximum Gift Tax Exclusion.

Given the complexities of the Estate and Gift Tax, careful tax planning is critical for individuals with moderate to larger estates.