Estate planning is the process whereby you ensure your assets go where you want them to after you death, you minimize the required estate taxes paid to the government, you avoid the costly and time-consuming probate process, and you ensure your desires are carried out even after you are no longer capable of making decisions.   It can be a simple and inexpensive task, or it can require the assistance of costly specialists to complete properly, all depending on your individual situation and desires.

An Introduction to Estate Planning

Probate

Probate, meaning the official proving of a will, is a legal process whereby the estate (property of the deceased) pays off its creditors and distributes the assets of the estate as specified in the validated will.  It can be expensive and time-consuming, often consuming a significant portion of the estate in legal and administrative fees and lasting months or even years.  Much of estate planning is geared toward avoiding this process as much as possible.

Federal Estate Tax


Besides avoiding probate, estate planning is focused on avoiding the estate tax, also known as gift taxes, inheritance taxes, and “the death tax.”  Unfortunately, estate tax laws can be a moving target.  They have changed half a dozen times in the last decade, ensuring a good income for estate planning attorneys and much confusion for everyone.  As of right now (2011) the estate tax is due on any estate larger than $5 Million unless the amount over $5 Million is left to a spouse or a charity.  Although there are some slightly lower brackets and a few deductions, basically you’ll pay 35% of everything over $5 Million to Uncle Sam.  The good news is that this will only affect a very small percentage of families and is dramatically better than it used to be.  Just ten years ago, in 2001, only $675,000 was exempt from taxation and the maximum tax rate was 55%!  The bad news is that there is a reasonable chance that it will affect a high-earning/high-saving physician, especially a two-physician family.  The gift tax is a related tax.  Basically, the IRS doesn’t want you to avoid estate tax by giving all your money to your family just before you die.  So it limits the amount you can give to any person to $13,000 per year.  Above and beyond that, the amount is subtracted from your exempt amount at the time of estate settlement.  You don’t have to pay gift taxes until you reach that total exemption amount.  One way of reducing your estate tax is by reducing the size of your estate above the exemption by giving money away little by little.  For example, if you have 4 kids, all married, you and your spouse could each give $13,000 to both the children and their spouses each year without reducing their exempt amount.  You could reduce the estate by $13,000 x 16 = $208,000 per year in this manner.  This might be the only “trick” most doctors need to avoid the estate tax completely.

State Estate Tax

Unfortunately, the states also like to get into the estate tax game, and even worse, some of them don’t use the federal exemption amount.  For example, the exempt amount in Ohio is only $338,333.  You can look your state up here.  Some states prefer to use an inheritance tax rather than an estate tax.  This means that the tax is levied on those who RECEIVE the inheritance, rather than on the estate itself.  New Jersey seems to be the most strict, in that it taxes 11-16% of what the heir receives, due 8 months after death.  Spouses are usually exempt from this, and in some states, so are direct descendants.  You can see if your state has an inheritance tax here.

Will

A will is usually the first estate planning tool that most people need.  If people die “intestate” (without a will), their assets are distributed in accordance with state law, usually to the spouse, or, if not applicable, to the children.  If you want your assets to be distributed in some other manner besides to the next of kin, you need a will.  Another important function of a will is to name someone to care for your children in the event of your death.  Even a medical student with a hugely negative net worth needs a will if he has children.

Living Will/Power of Attorney

There is one type of will that most doctors are familiar with, and that is a living will.  This generally dictates your wishes in the event you become unable to make your own decisions about your health care.  It also generally names a health care proxy who will make decisions for you when you cannot.  I see these on a daily basis, and find them generally useless because they are so vague.  They never seem to mention the real decisions I need made- Would he want antibiotics?  IV fluids?  Pressors?  Intubation/Ventilation?  CPR?  etc.  I don’t see a real need for a living will unless you don’t want your next of kin making your health care decisions.  Better than having a written, generic piece of paper is discussing your wishes with your family beforehand.  “Don’t you dare leave me on a ventilator longer than a week” etc.


However, it probably is worth you naming a trusted family member, friend, adviser etc to manage your finances when you become unable to.  This is called a durable financial power of attorney.  Studies show our ability to manage our own finances peaks in our 50s.  We’ve all known elderly folks who have done stupid things with their money that they would have never done 10 or 20 years earlier.

Retirement Accounts

Although sometimes going through probate is better than the hassle and expense of avoiding it, as a general rule one goal of estate planning is to avoid probate.  There are many ways to do this.  One of the main ones is to designate beneficiaries of your retirement accounts.  For instance, if the beneficiary of your IRA is your son, upon your death he gets the proceeds without them ever passing through probate (they are, of course, still subject to estate and inheritance taxes, and if a traditional IRA, eventually to income taxes.)  As you recall, when you opened up a 401K or IRA, you were asked for beneficiaries.  If you choose someone besides your spouse, you’ll need your spouse’s written approval.  Don’t forget, if you get divorced or become estranged from a beneficiary, or simply change your mind, don’t forget to go back and change the beneficiaries to the account.  It often happens that an ex-spouse after a bitter divorce ends up with retirement accounts that the decedent would have never left to him or her knowingly.  Be aware, that if you live in a community property state (AZ, CA, ID, LA, NM, NV, TX, WA, WI, and sometimes AK) you cannot give more than half your retirement account money away to someone besides your spouse because half of the account is considered to belong to your spouse.

Payable on Death Designations

You can designate a bank account of just about any type as “payable on death” to whoever you want.  This way, when you die, your designated person simply goes to the bank with proof of your death and collects the money, no probate involved.  You can also register securities such as stocks, bonds, mutual funds or even entire brokerage accounts as “transfer-on-death.”  The best part about that is the basis of these securities is updated as of the day of your death, so that if your heir sells them immediately, no capital gains tax is due.  You can even do this with your automobiles in two states, CA and MO.

Joint Ownership

Some forms of joint ownership avoid probate as well, such as joint tenancy.  If the title of real estate, for instance, is done properly, the person with whom you own it can easily transfer the entire property into his own name without going through probate.  One should be careful using this as an estate planning tool.  For instance, adding your child to your bank account as a joint owner involves several issues.  First of all, you’ve given away property-which the joint owner now has use to even before your death.  You may also trigger gift/estate taxes if the amount is more than $13,000.  The money is also now exposed to the joint owner’s creditors, not exactly a good idea from an asset protection point of view.  It may also spawn disputes after death, especially if an older person does it for convenience, while not actually intending to give the asset to the joint owner.  The manner in which an asset is titled can make a difference, so when titling assets such as real estate and cars, realize that there are estate planning implications to the process.  In community property states, sometimes community property goes through probate and sometimes it doesn’t.   In the states in which it does AZ, NV, TX, and WI, you can add the phrase “with rights of survivorship” to ensure that asset doesn’t go through probate.

Small estates

Sometimes, if the value of the estate is below a certain amount (such as $100K in California), probate can be avoiding simply by having the heirs fill out affidavits that the property they are inheriting is specified in a will.  Most physician estates will be above these limits at the time of their death.

Revocable Living Trusts

These trusts are basically designed to avoid probate, not to avoid taxes or to protect assets from creditors.  The money and assets are placed into the trust, and at the time of your death the trustee distributes the assets to your heirs in accordance with the trust document, no probate required.  Of course, the assets in the trust are still subject to estate tax.  The main benefit of a revocable trust is that you can control and use the assets if you want to- you can “revoke” them at any time.  Assets are “put into” a trust by retitling them in the name of the trust.

Irrevocable Living Trusts

These trusts have the main advantage of a revocable living trust, in that they avoid probate.  They also have the advantage of avoiding estate taxes, and often avoiding income taxes.  This is because when you place assets into an irrevocable living trust, you are essentially giving them away.  You can no longer use the assets or the income they produce.  Taxes on the income must be paid by the trust or by the heirs (which may be advantageous if they are in a lower tax bracket.)  Only money you know you will never need should be placed into a trust like this.  Irrevocable means just that.  Keep in mind that gift tax laws apply to the money you put into the trust.  Consult with an experienced attorney in your state to determine just how much you can put in the trust each year without triggering gift/estate taxes.  Keep in mind that irrevocable trusts are also excellent asset protection tools.  The asset no longer belongs to you, and your creditors cannot seize it.  Revocable trusts do not have this advantage.

Life insurance

Life insurance proceeds are not subject to income taxes.  If you leave $1 Million in life insurance proceeds to your wife upon your death, she is not going to pay a cent of that in income taxes.  It can sometimes be a good estate planning (but almost never a good investment planning) tool to have a large permanent life insurance (like whole life) policy.  The proceeds can be used to pay estate taxes, or provide liquidity for a family owned business or farm that is difficult to sell.   They are, however, subject to estate taxes themselves.   The only way to avoid this is to have the owner of the policy be an irrevocable living trust.  In essence, this strategy involves buying a life insurance policy with annual premiums just less than the gift tax amount ($13,000 per person, per year).  The amount of the premium is put into the irrevocable living trust each year, and used to purchase the lift insurance.  Upon death, the proceeds pass to the heirs both income and estate tax free.  It can take some serious number crunching to determine is the tax-saving benefits outweigh the additional costs and relatively poor returns of the life insurance “investment.”  Suffice to say it definitely isn’t a good idea if the estate won’t be subject to estate taxes anyway.   Remember that insurance salemen are going to emphasize these benefits at every opportunity.  Term life insurance is still the best insurance for nearly everyone out there.  I personally wouldn’t even consider buying a permanent life insurance policy (again) until I’m near retirement age.  Of course, that introduces the risk of not being insurable at that age, but there are other estate planning tools that could be used if you turned out to be uninsurable at that time.


I hope this is helpful in outlining the general strategies of estate planning.  There are lots of other tricks and tips involving trusts that I’ll discuss in future posts.  Remember that having a will, naming beneficiaries properly, and titling assets properly is cheap and probably all that most of us will ever need.  If you need more than that, a few thousand dollars spent on an estate planning attorney will be well worth your time and effort.  Also remember that the laws governing this process are state-specific and frequently change, so personalized, up-to-date advice is warranted in this important area.  Anytime you get wind that Congress or your state legislature has changed the laws regarding probate or regarding estate taxes, you ought to consider whether to visit with your estate planning attorney again.

What have you done as far as estate planning? Do you have a will? A trust? Have you at least checked to make sure your designated beneficiaries were right? Comment below!