[Editor's Note: This is a guest post from a regular reader and an attorney who wishes to remain anonymous. I love guest posts where I learn something new, and this is one of those. Lots of pearls here, although the article is a bit long. The pearls are all in the first half, and the second half contains excellent examples illustrating them. I have no financial relationship with the author. The usual caveats apply. He is an attorney, but not your attorney. This article, like the rest of this website, is for general informational purposes. The author would like me to point out that he is not an estate planning expert and is not providing legal or other advice with respect to the tax or other planning considerations of any individual reader.]
I’m a BigLaw partner in my early fifties, contemplating retirement in the near-term. As part of our retirement preparation, my wife and I recently have taken a close look at estate planning considerations and, with the assistance of an estate planning attorney, have revamped our estate plan. While I’m certainly not an estate planning expert, I used this process to educate myself regarding how the federal estate tax could potentially apply to us and the pros and cons of various estate planning approaches. The last few years have brought significant changes to the federal estate tax regime, including a substantial increase in the individual estate tax exemption amount, as well as the addition of a “portability” feature that allows a surviving spouse to take advantage of the unused portion of the exemption amount of the spouse who dies first. The changes have caused many doctors and other highly compensated professionals to conclude that the federal estate tax is now completely “irrelevant” to them and applies only to the extremely wealthy. In reality, however, the changes in law have not made things quite that simple.
The Old Estate Tax Regime-Prevalence of A/B Trusts
Not that long ago, the federal estate tax was a real issue that impacted even people of relatively moderate wealth. Going back 10 years to 2006, the individual exemption amount was only $2 million. After including life insurance proceeds and other assets, a significant number of doctors and other high-income professionals faced potential estate tax liability upon their deaths. Although a spouse had an unlimited exemption for anything he or she left to the surviving spouse, the deceased spouse’s unused $2 million exemption amount could not be transferred to the surviving spouse; in other words, it was not “portable” to the surviving spouse. For example, assume that a couple had combined assets of $2.5 million and that those assets were owned 50/50 by each spouse, meaning that each spouse owned assets worth $1.25 million; this was well less than the $2 million exemption for each spouse. However, if one spouse died and left his or her $1.25 million of assets to the surviving spouse, then the surviving spouse would own more than the $2 million exemption amount and there could be federal estate taxes owed on the second spouse’s death.
Because of this result, historically it was very common to employ so-called “A/B trusts” or “credit shelter trusts” to attempt to minimize the potential tax. In the example above, at the death of the first spouse, the deceased spouse’s $1.25 million might go into the A/B trust, where the income (and principal, if needed by the surviving spouse) would be available to the surviving spouse during that spouse’s lifetime and then pass to the trust beneficiaries (usually the couple’s children) at the death of the second spouse. In that scenario, the $1.25 million that went into the trust when the first spouse died did not trigger any federal estate tax because it was less than the $2 million exemption, and when the second spouse later passed away (assuming that he or she continued to have assets of $1.25 million at that time) no estate tax would be owed because such surviving spouse’s total estate also was less than the $2 million exemption amount.
The New Estate Tax Regime-Much Larger Exemptions and Portability
Traditional estate tax planning was turned on its head in many ways in 2013, when a change in law increased the individual estate tax exemption to more than $5 million, with the amount being automatically indexed for inflation in future years, This was combined with the addition of portability to the surviving spouse of any unused exemption amount from the first spouse to die. Because of increases for inflation, a spouse passing away in 2016 could pass $5.45 million to anyone without triggering any tax, and to the extent that spouse left everything to the surviving spouse the portability feature could permit the second spouse, upon his or her subsequent death, to potentially take advantage of the first spouse’s $5.45 million exemption in addition to the second spouse’s own exemption, allowing the couple to pass more than $10 million of assets without incurring federal estate tax.
Does the New Estate Tax Regime Mean that a Couple Can Ignore Federal Estate Tax With Less than $10 Million in Assets?
Not quite so Fast!
As my wife and I began to consider our estate plan as part of our plan for a potential retirement, I saw quite a few articles, posts and other statements from fairly knowledgeable people essentially saying that the federal estate tax is now “dead” or “irrelevant” to anyone other than the very wealthy (those with more than $10 of combined assets, if married). As I continued my research, however, I found that these conclusions are, at best, an oversimplification. The increase in the personal exemption is very helpful, but the advantages of portability are not as straight-forward as might be assumed.
- Portability is Not Automatic and Will Not Apply for the Vast Majority of People. Portability does not apply unless the personal representative of the first spouse to die actually files a federal estate tax return. Although a “simplified” version of the return can be used if being filed purely for portability purposes where no estate tax is owed, this still costs some money and is a hassle. In fact, depending on the type of assets in the deceased spouse’s estate, appraisals and other mechanics could be necessary. The evidence shows that the vast majority of estates simply are not filing these estate tax returns and therefore are foregoing the benefit of portability. According to the IRS, only 11,931 federal estate tax returns were filed in 2014, with the number of deaths in the US for a typical year number in the millions (more than 2.5 million in 2014, according to the CDC). That amounts to returns filed, and the preservation of portability if the deceased was married, for less than half of one percent of all Americans dying in a typical year. Wills and estates attorneys with whom I’ve spoken have told me that they have a very hard time convincing the surviving spouse (who is usually the executor of the deceased spouse’s estate) to go to the trouble and expense of filing an estate tax return when no tax is owed and the surviving spouse sees this as perhaps speculative and unnecessary; these attorneys are having to be very careful to protect themselves by documenting that they have given adequate notice to the executors/surviving spouses the potential impact of failing to file the estate tax return.
- The Portability Amount Available to the Surviving Spouse is Uncertain. Unlike an A/B trust scenario, where the deceased spouse’s assets are out of the estate upon death, when relying on portability the amount of the exemption available for the surviving spouse is entirely dependent on what the exemption/portability amounts are at the time of the surviving spouse’s death. Since the current law was put in place, the Obama administration already has proposed lowering the individual exemption amount, and there can be no certainty that portability will not be legislatively done away with all together by the time the second spouse dies. Also, even if the deceased spouse’s executor files an estate tax return to preserve portability, the surviving spouse only gets to look to his or her most recently deceased spouse when determining the portability amount. So, if the surviving spouse remarries and the new spouse passes away during the surviving spouse’s life, the surviving spouse will only be able to use the amount of the exemption not already used up by the last spouse. The new spouse might have children from a prior marriage and may use up some or all of his or her exemption amount leaving assets to those children.
- The Portability Amounts Is Not Indexed for Inflation After the First Spouse’s Death. Although under current law the exemption amount increases automatically each year with inflation, the same is not true for the portability amount passed along to the surviving spouse. That amount is “locked in” on the date of the first spouse’s death, thereby diminishing the portability benefit in real terms each year until the surviving spouse’s death. If the first spouse died at age 60, for example, and the surviving spouse lived another 30 years, the portability amount in real terms could be only a fraction of what it was worth on the date of the first spouse’s death.
Examples Involving Two Couples
The examples below highlight the differing estate planning considerations that may apply for couples at different asset levels – but both examples involve couples with assets substantially less than the $10.9 million current joint exemption amount. For purposes of the illustrations, I assumed that one spouse dies at age 60 and that the other spouse lives an additional 30 years. If the timing of the second spouse’s death is in close proximity to the death of the first spouse, then the highlighted issues are much less significant. I intentionally assume a long period between the deaths of each spouse to highlight the potential issues that may result. I assume that the husband is the one dying early, as that is statistically more likely.
Couple A – $4 million in total assets.
Couple A has $4 million in assets (divided 50/50 between spouses) when Husband dies at age 60 shortly after his retirement. Wife lives 30 more years. At first blush, it would appear that there would be no potential federal estate tax issue for Couple A if Husband simply leaves his entire $2 million of assets to Wife, as their combined assets are less than even the individual exemption applicable to one spouse. If Husband’s executor fails to file a federal estate tax return, however, there will be no portability. This means that Wife now has $4 million in assets and a $5.45 million exemption amount. Assuming that the law doesn’t change, the exemption amount will increase with inflation. Assuming that Wife invests in a balanced portfolio and lives off the $4 million, withdrawing 4% per year and increasing withdrawals for inflation, an “average” outcome historically would have her asset level in real terms increase to around $8 million, which obviously would exceed the exemption amount ($5.45 million adjusted in real dollars), with a 40% estate tax rate applying to the excess, for a total bill to Uncle Sam of over $1 million in today’s dollars. Wife could perhaps give money away during her lifetime to get her assets below the exemption amount, subject to annual gift limits that are imposed, but the point is that the estate tax is not simply “irrelevant” for Couple A.
This estate tax also could be avoided if Husband’s executor (who likely is Wife) files an estate tax return to preserve portability. In that case in the above example, the assets at Wife’s death would be below the combined exemption amounts and no federal estate tax would be owed. This assumes, of course, that the law doesn’t change to eliminate portability or to change Wife’s exemption amount. This also assumes that Wife does not remarry, or that if she does, either her new spouse outlives her or her new spouse does not “use up” his exemption amount if he dies before Wife does. Even with these uncertainties, however, it seems reasonable that Couple A might decide to avoid the traditional A/B trust approach and simply rely on portability. That avoids the additional complexity of having to document and administer an A/B trust, and it also has other benefits. When Wife dies, Couple A’s heirs will get a stepped-up basis for federal income tax purposes in all of her assets, so they would not incur federal income tax if they sold those assets immediately. In contrast, if Husband had transferred his assets into an A/B trust, the amount transferred into the trust does not get a stepped-up basis when Wife dies, as it does not belong to Wife and is not part of her estate. Given that federal estate tax seems unlikely for Couple A, relying on portability might be a sensible plan.
Couple B – $8 million in total assets.
Couple B has $8 million in assets (divided 50/50 between spouses) when Husband dies at age 60 shortly after his retirement. Wife lives 30 more years. If Husband leaves his entire $4 million of assets to Wife, and if Wife invests in a balanced portfolio and follows the 4% rule as Couple A did, an “average” outcome historically would have Wife dying with very significant wealth of around $16 million in real dollars. If Husband’s executor filed an estate tax return so that the couple could take advantage of portability, under current law Husband’s portable exemption amount available for Wife in real dollars would be substantially less than the current $5.45 million amount provided under law, as Husband’s exemption amount would be locked-in at his death and would not be indexed for inflation. Assuming a 3% inflation rate over the 30 year period, the Husband’s exemption amount at Wife’s death would only be about 41% of the amount at Husband’s death, or about $2.23 million. Assuming a $16 million estate in current dollars, this would mean under current law that there would be a 40% estate tax on about $8.3 million of Couple B’s estate, or more than $3.3 million owed to the federal government. Utilizing an A/B trust wouldn’t completely solve the estate tax problem, as the assumed $16 million estate would still result in a federal estate tax of around $2 million, but obviously it would help.
The numbers likely are overestimated for most couples, as it is unlikely that there will be a 30 year gap in dates of death for the spouses, but the point remains that a couple with $8 million or so in assets at around age 60 has a good chance of having a federal estate tax issue even if Wife does not live a full 30 years after Husband’s death. This issue will be exacerbated if Couple B merely relies on portability, rather than utilizing an A/B trust. Although utilizing an A/B trust will mean that Couple B’s heirs will not get a stepped-up basis in the A/B trust’s assets for federal income tax purposes, that result might easily be outweighed by avoiding the 40% federal estate tax on additional amounts. The heirs may not need to sell everything right away and trigger capital gains tax; in fact, they might live off the assets utilizing the 4% rule or something like it and only sell assets gradually over time. In addition, under current law the income tax rate on capital gains is substantially lower than the 40% federal estate tax rate. A couple with assets in the neighborhood of $8 million clearly needs to do some estate tax planning, including potentially giving away assets, subject to annual limits, during their lifetimes. They can’t simply assume that the federal estate tax is “irrelevant” for them.
Our Own Circumstances
In our own case, we have assets that raise issues similar to what Couple B would face. In addition to that, we are contemplating my retirement while in our early fifties. This means that there may be a very significant amount of time before the death of the last spouse, providing the opportunity for our assets to appreciate a great deal in real terms. This possibility is enhanced by our expected withdrawal strategy in retirement. We have a very flexible budget, with no debt and significant international travel planned, which can be delayed if needed; so our spending can rise or fall as dictated by the performance of our portfolio. Based on that, we plan to spend no more than 4% of our current portfolio balance each year – this is NOT the same as starting with 4% and automatically increasing spending for inflation each year. This kind of flexible withdrawal strategy significantly enhances the likelihood that we may increase our assets, in real dollar terms, very substantially before the death of the surviving spouse. We are planning to have a good chance of preserving and growing our assets for the benefit of our heirs. Given our situation, we have decided to employ a traditional A/B trust, rather than relying on portability. After considering various assumptions and possibilities, this approach when combined with other “giving during life” strategies, seems more likely to minimize federal estate tax and the overall tax bill for our heirs.
In addition to the tax considerations, the existence of the A/B trust provides asset preservation and other protections. If one of us were to die at a fairly young age, it seems unreasonable to expect that the surviving spouse will never remarry over coming decades. Such a remarriage, however, could have significant effects on our estate plan. We happen to live in a community property state; if one of us leaves everything to the surviving spouse and that spouse remarries, the “presumption” is that all property of the new spouses is community property, meaning that the new spouse would be presumed to own half of my wife’s assets. This presumption can be negated by carefully keeping everything separate, but the wills and estates lawyers with whom I’ve spoken say that keeping things sufficiently separate is unusual absent a separate trust that can be clearly traced. Even minor “intermingling” of assets may subject all assets to status as community property. Even in non-community property states, if a spouse who brought assets from a first marriage dies before the new spouse, the new spouse may have the statutory right to a so-called “elective share” of the deceased spouse’s estate even if not left anything through the will of the deceased spouse. Finally, there are many sad examples of a widow/widower being influenced by a new spouse to leave the new spouse the assets that the deceased spouse assumed would go to the initial children. There are many families with very hard feelings (and even histories of litigation) in cases where the first-to-die spouse assumed there was no chance that the surviving spouse would not leave their mutual assets to their children. The effects of age, time and possible diminished capacities have to be considered.
If the couple wants a trust for non-tax reasons and wishes to rely on portability, rather than an A/B estate tax trust, the traditional answer is a so-called QTIP trust (that stands for Qualified Terminable Interest Property trust). The point here is that QTIP trust must provide that 100% of the income (and potentially principal, if needed) may be used by the surviving spouse during that spouse’s life but that the remaining assets go to the children on that spouse’s death. If those requirements and certain bells and whistles are complied with, the property in that trust can be considered property of the surviving spouse (and included in the surviving spouse’s estate) upon the death of the surviving spouse. The benefit of the QTIP trust, where the estate is not large enough to have estate tax issues, is that when the surviving spouse dies, the children get a fully stepped-up basis in the trust assets for federal income tax purposes because those assets are treated for tax purposes as having been owned by the surviving spouse. Unfortunately, there currently is some uncertainty as to whether this basis step-up from a QTIP trust is permissible if the first spouse to die didn’t have an estate at least as large as the individual estate tax exemption (currently $5.45 million). If the deceased spouse’s estate was smaller than that, then the deceased spouse didn’t need the spousal exemption (he or she could have given all his or her assets to anyone, even other than a spouse, without triggering any estate tax). Practitioners are hoping that the IRS will clarify this soon. With such clarification, hopefully spouses who are unlikely to have estate tax issues but who want the non-tax benefits of a trust will be able to utilize the QTIP trust while preserving portability and achieving a step-up in basis upon the second spouse’s death.
Conclusion
While the changes in the federal estate tax laws in the past few years have been helpful in potentially eliminating federal estate tax in many cases where it might have been due under previous law, it is not the case that couples can simply ignore estate tax implications if they have less than $10 million of assets. Even couples with moderate levels of wealth may need to take steps to preserve portability of the exemption from the first spouse to die, and there are numerous other estate tax considerations that may be applicable depending on the level of wealth and assumptions regarding survival of the last-to-die spouse. In any event, there may be non-tax considerations that may cause a couple to consider a trust as an estate planning tool. For couples with even moderate levels of wealth, consulting an estate planning specialist may be well worth the time and modest expense.
[Editor's Note: I had to laugh at the author's description of a $5-15M+ estate as “moderate” as I'm sure many readers will not view that level of wealth as moderate at all. It reminds me that pretty much all Americans consider themselves “middle class.” (1% considers themselves upper class, and 10% considers themselves lower class.) Nevertheless, the main points made are excellent and were new to me and perhaps may even save my heirs millions of dollars, so I'm grateful for the article. Also, bear in mind the article doesn't even mention state estate taxes, so if you live in a state where that applies, you have even more need for a visit with an estate planning attorney.]
Do you have an A/B trust or are you relying on portability? What's your take on the QTIP step-up in basis issue? Did you know about the requirement to file an estate tax return when the first spouse dies? What about the “lock-in” of the first spouse's exemption amount? What percentage of docs do you think will have to worry about any of this? Comment below!
Some good info
Still one should give while alive and avoid most of this. You will also get the opportunity to feel good about what you are doing. Hard to enjoy it after you are dead.
Very good article (though I admit I skimmed parts). I imagine a couple like B may not have $3.3 million in liquid assets upon death either. Now the kids are trying to selling the farm/house/rental properties before the tax bill is due and may lose even more money. Definitely something to think about down the road. Thanks for contributing.
I just re-did my will and trust. That process involved a lot of expensive self-education due to my reading books and then having expensive consultations with my attorney. Based on my experience, I can tell you that this post was an excellent summary of the issues. Many , if not most physicians will benefit from a trust either for estate tax purposes, or to protect children’s assets from a future spouse. Not mentioned in this article is the avoidance of probate, which in my state ( California ) is very expensive and ties up assets for a long time. The trust will avoid probate and save a lot of money.
My trust is set up as an A-B trust, with a qtip option to be implemented for the surviving spouse to protect the children from a subsequent spouse. Upon death of the first spouse, the survivor will need to meet with the attorney to set up the new trusts, and at that time can decide on whether to set up the qtip or not based on law and circumstances at that time. There are provisions for special treatment for the IRAs to allow them to go to remain in the trust and still be stretched if the children are still young at the time of inheritance.
After reading a lot more, I had the trust revised to change the successor trustees and executor from the spouse to a local bank with a substantial trust department (Boston Private). I did this because I have young children and realized that our children’s aunts and uncles, whom we had named as successor trustees, were financially illiterate. Managing the trust is a bit more complicated than most financial tasks, and I realized while it would not be a challenge for me, they would be sure to make a mess of things. The bank charges AUM fees of about 1% on the first million and decreases thereafter, so it’s expensive, but not out of line. They manage the investments in Fidelity index funds, which is where most of my money is, so there wouldn’t be any additional AUM fees. They would move my Vanguard funds into Fidelity after death. The trust officer I spoke with reviewed some cases that they managed (anonymously, of course) and I was impressed with the detail and hands-on approach they appear to take with minors whose assets they manage. My attorney strongly advised against Fidelity or Vanguard, who appear to only manage investments for an AUM fee, but don’t get involved in the details of real estate management or disbursement of funds to minors.
I spoke to about 8 friends who had trusts set up. No one would recommend their attorney, as all were unhappy with the attorney for various reasons, so be prepared. My first one made mistakes, some of which I caught at the time, others came to light 10 years later when I redid it. The most recent one was excellent, as far as I could tell, but very busy and so very slow and somewhat unresponsive. It took over a year to get the trust done, and another year for revisions that I asked for. The cost will vary based on hourly fees, but most seem to cost between $3,000 and $6,000 and mine fell on the higher end of that, as I live in an expensive area and went with a high-end recommendation this time.
VERY IMPORTANT: Houses and other real estate, as well as all non-retirement financial accounts ( investment and checking and savings accounts ) must be carefully re-titled into the trust or the whole exercise was pointless. Reportedly, most people who set up trusts don’t complete this task. Transfer on Death (TOD) accounts, and other beneficiary designations on accounts will trump your will and trust, so all of these need to be changed. It was very difficult and time consuming, as the banks kept making mistakes, and there were some issues around the language of the secondary beneficiaries on the IRA accounts. ( the spouse is the first beneficiary, but some negotiation was necessary between the attorney and Fidelity to have the IRAs go to a sub-trust to allow IRA stretching for the minors)
NOTE: If you will be subject to an estate tax, you should become familiar with the IRD tax deduction. Kitces has two articles on this, which are very informative, and are the only articles on this subject that I found. In essence, if you inherit an IRA, and are subject to estate tax, you will have to pay 40% estate tax, plus additional income tax on what you withdraw, and in some cases end up paying the entire IRA to those two taxes. To avoid this, there’s an IRD ( income in respect of the decedent) deduction, which credits back that part of the estate tax that applied to the IRA income taxes to the heirs on their income taxes , but the heirs have to tell their accountant to take this deduction when they withdraw IRA money, and apparently most CPAs won’t know about this or won’t know that the heir is entitled to it.
Thanks. I’m the author. I understand that living trusts are common in California due to the expensive probate process. I happen to live in a state that has a very simple/inexpensive probate process, so most people here put the trusts in place through their wills, rather than during their lifetimes.
Thanks again for the article. Yes, California is a great place to live, except for the high income taxes, high sales tax, probate, high real estate costs, earthquakes, and drought . However, there’s no estate tax, so it’s definitely a good place to die.
So, how long did it take for your attorney to get your documents done? I assume you were able to get them done in-house, and perhaps professional courtesy and some knowledge of the field helped (?)
Are you saying that the only reason to use a revocable (aka living) trust is to avoid probate? I thought that the money needed to be in the trust so that it could be redistributed at death into the irrevocable A & B trusts, and to smooth the path for the executors and guardians. I have young children, and I thought that the trust helped with that as well, but perhaps not.
And, congratulations on surviving a career in Big Law! 😉
ALEXXT, our attorney worked pretty quickly (he generally turned around each draft in a couple of weeks after each meeting). The process took a fair amount of time, but that was my fault, as I wanted to do quite a bit of digging to make sure I was comfortable with the approach we were taking. I didn’t have this done in-house. Many (maybe most) BIgLaw firms (at least the ones in the top 50 or so) don’t do estate planning anymore, or if they do it is very specialized planning for extremely wealthy people.
If avoiding probate is not a goal, then the trusts can be testamentary trusts in the will, itself. The assets go into trust as part of the probate process.
Thanks for the congrats on surviving a career in BigLaw. It is a tough way to make a living, and I am looking forward to leaving the long nights, uncertain schedule (completely at clients’ mercy) and heavy travel to the younger folks!
This is such a timely article. My parents have an A/B Trust, however when my father recently passed away, his side of the trust went to his adult children. Their assets exceeded the maximum allowed by 50%. What are the advantages and disadvantages of passing one’s assets to adult children vs. the surviving spouse? I know they filed income taxes the year he passed. Does passing assets to adult children affect portability?
Do all non-retirement accounts need to be changed in the name of the Trust or can it be left alone with the Trust as the beneficiary?
My kids are getting nothing other than a paid upfront education, and college funds for their kids. The rest is up to them.
No trust fund kids coming from me.
Everything else will be placed in a college fund trust to hopefully fund education for generations or until someone figures out a loop hole or a way to steal/spend it all.
Great article, thanks. I find it infuriating that the rules of the game can change, at any time, with a stroke of a pen.
Thank you anononymous lawyer and AlexxT for enlightening us and sharing some real-world examples. I hope to have an estate tax “problem” someday, and will most likely solve it by donating the excess to charity as time goes on.
A trust is something I’ve been wanting to look into “next year” for about the last five years. I know that avoiding probate can be a huge benefit, depending on what probate looks like in your state.
I knew about the importance of retitling assets, and it all seems rather complicated. I’m surprised to hear (from AlexxT) that most people who go to the trouble of setting up a trust don’t bother to properly re-title the assets.
Re: titling the accounts:
Well, it’s been 5 years and you still haven’t set up your trust. By the time you do, you might wait another 5 years before you start re-titling your accounts. Before that’s all done, you may run out of energy and start procrastinating and get distracted long before it’s finished.
Part of the problem is that you need to get many of these account documents notarized. These required both of our signatures, so we had to go down together. Some required a signature verification, which is a higher form of notary, and only one or two people at the bank could do that. So we both would go to the bank together ( we were able to do go together; I don’t know if we could have signed separately). I have a bunch of different checking accounts, and each account had to be done, and they didn’t want to do them all at once. Then someone did the accounts on the wrong forms, so we had to go back again. Then we had to get forms for the Vanguard accounts, get them notarized, and mail them in, and that took a few phone calls to Vanguard to get it right. That was actually easier than Fidelity. We had issues with the language on the stretch IRAs, because the lawyer wrote about inheriting “per laws of California” but Fidelity is based in Massachusetts, and wanted it per Massachusetts, which my lawyer wouldn’t do, so we settled on writing “per stirpes” ( don’t ask). Then I would periodically find another account that I had neglected. Getting the house re-titled was easy, as the first attorney did that, but he also re-titled a house my wife owns for her mother, which he wasn’t supposed to do, and to this day we’re not sure if that was properly changed back.
After that, I spent a lot of time writing letters of instruction to my wife ( she has an MBA, among other degrees, but doesn’t really get all the personal finance issues, so I wrote out detailed instructions and explanations) , kids, the trust bank. I documented all our accounts with statements which went into a binder that has a copy of the will and trust. ( don’t put the original in a safe deposit box, because you can’t get into the vault until the will is validated. Catch-22 ). You need lists of accounts, passwords, and other assets. Life insurance as well. I also documented valuable antiques and other items around the house that I didn’t want given away by mistake. I also have a list of bills, and phone contacts. I included an example of all my monthly bills in my binder as well so nothing will be missed, and a list of automatic payments, some of which should continue ( eg utilities, water) and some of which should be stopped ( gym membership, cable ) I also did a video tour of the house, both room by room as well as by type of asset ( eg where I keep my spare cash , documents, etc ). That’s also useful for insurance purposes. All of this was eventually organized, and put in the binder, and digitized onto a thumb drive. I included a list of passwords. ( Your will should also include a statement giving your heirs control of your digital accounts and assets. Your attorney will probably do this automatically, but check). I gave a thumb drive to a trustworthy sibling to guard, and that contains the will, trust, letters, asset lists, video tour etc. It’s in a sealed envelope, and the password is in a separate sealed envelope, both un-labeled.
I also have all my bills and statements sent to me by mail, rather than email, so that nothing will be overlooked after our deaths, especially new accounts that I might open between now and then.
All of that took a long time, and required lots of revisions. Most people get distracted and lose interest before it’s done. As it happens, I just finished this 3 year process this very morning and put a revised thumb drive to my sibling in the mail today.
Wow, that is awesome how organized you are.
We just did our AB trust and living trust last year and was starting to think it was a waste with the federal limits. This article made me glad I did it now. With ours, any high value item we put in the living trust to avoid probate, and just keep the personal checking account balances low so we didn’t have to re-title them. All my LLCs keep most of the other stuff just to avoid having a probate problem.
Yes, I could have skipped the small checking accounts, but I decided to re-title all the accounts because I wanted to be thorough. As long as I was doing it I did it all, and I might forget and put more money into one of my smaller accounts and die at the wrong time. I don’t have any LLCs as I’m an employee.
Great organization! I’m the same way and have done many of the same things. One resource that you might find helpful is called DocuBank. You keep a card in your wallet and then anyone (family, ER, etc) can access medical powers of attorney, wills, trust docs and so forth. It keeps them secure but at the same time available.
Great info Thanks
Thank you for the article – you made a complex topic very clear and as easy to understand as possible.
In the beginning of your article, you state, “After including life insurance proceeds and other assets, a significant number of doctors and other high-income professionals faced potential estate tax liability upon their deaths.” I just want to clarify that life insurance proceeds are not included as a part of a taxable estate UNLESS the deceased had any “incidents of ownership” in the policy OR named his/her estate as the beneficiary. This little rule is often overlooked but can easily be remedied by transferring the policy to a person you trust and/or changing the beneficiary. The new owner can be a spouse, but this could be problematic if you divorce. Another option is to transfer into a life insurance trust.
If you transfer ownership of your life insurance policy, be sure to obtain written confirmation from your insurance agent of the transfer. The new owner is responsible for maintaining the policy, including premium payments, which you can gift.
Transferring life insurance is similar to any gifting. Just changing the names on the forms doesn’t cut it.
Yes, you’ll have to file a gift tax return (unless transferring to spouse) if the present value is over the annual exclusion amount. You also have to relinquish any control over the policy, which means you cannot do such things as change the beneficiary, use policy as collateral, cancel policy, etc.
Nice post OP, thanks! We also redid our wills recently. I am an avid DIYer but this is one area that I strongly urge against trying to DIY. Even OP who is an attorney hired an estate planning attorney. We paid $3000 for both our wills, Healthcare POA’s, and General POA’s. We have redone wills at least four times in our marriage usually related to moves between states (couldn’t wait to get that Louisiana “usufruct” language out of our wills). An excellent resource prior to your appointment with an estate planning attorney is a book WCI reviewed by James Lange, Retire Secure. We are using a version of the cascading beneficiary plan described in the book and alluded to by AlexxT above. I would like to stress how important proper titling and beneficiary forms are in your plan as they will always win out over your will. Our attorney emailed us the exact language he wanted used for our contingent beneficiary trusts for our kids on our IRA’s and 401k. Establishing a relationship early with an estate planning attorney is a good idea. Ours did our last set of wills about 12 years ago and appropriately chastised us for waiting so long to update them. Our plan is to touch base with him every year or two to be sure nothing needs updating and then readdress the wills when our youngest is no longer a minor. Keeping guardians current is another important aspect of your wills. Thanks again OP!
Dr. Mom, your mention of having documents redone if you move between states is really important. Things can get especially messed up if people move to or from states with different property systems (community property v. common law). In some community property states, the assets you bring when you move into the state from a common law state are likely to be categorized as separate property, even though these same assets would have been community property if you had lived in the community property state all along. This can result in some pretty wacky results if not planned for appropriately. I agree that the titling of assets (retirement accounts, etc.) including primary and secondary beneficiaries is REALLY important. That’s a whole different topic and clearly the article was plenty long, already!
Long but really, really good. Estate planning often gets pushed aside in personal finance perhaps because it’s unpleasant to plan for our own demise. Thanks again. Best wishes.
Dr. Mom: I’m glad you mentioned the DIY issue. I knew there was something else I wanted to mention, and that was it. Based on all my experiences, there is no way that this should be done by anyone other than an experienced estate attorney. Apparently there are cut rate boiler plate paralegals and attorneys who churn these out for little cost but without much customization or explanation. Also the DIY websites ( legal zoom, nolo press) which I would avoid for this problem. It took a lot of back and forth with my attorney for me to get this right, and lots of discussions and revisions ( hence the high cost). My first estate attorney made several mistakes. No doubt it would have been a disaster with a generalist.
BigLaw1636, thanks for the reply above. It sounds like your trust took a while too, with multiple revisions and several weeks of turn-around, although I’m sure mine was worse.
I read a few books by Jefferey Condon on trusts. These were on a very basic level, for lay people, and perhaps, like a lot of these finance books, designed to drum up business for the author, but they were helpful for me as a lay person. They helped clarify some of the issues that trusts are designed to solve. He also concurred with my attorney, who advised against trying to do too much protecting and management of children from beyond the grave. There was also a book that WCI reviewed, “can you trust your trust”, which was less readable and less applicable, but also helped me understand some issues. I think that book and a few of Condon’s are all worth reading.
If you are interested in learning more about this topic, the “insider’s” book that many financial planners keep in their libraries is “Estate Planning Smarts: A Practical, User-Friendly, Action-Oriented Guide” by Debra L. Jacobs. 4th edition came out 4/30/15 so very current. Considering the topic, it’s a bargain at $24.95 and written for the layman. Highly recommended.
Thanks for the recommendation. I’ll order it today.
I’m on this website, so of course I’m interested in learning more about all things financial, but it will probably end up costing me far more than the 24.95 if it makes me go back and talk to my attorney again. 🙁
My parents have an A/B Trust set up, however when my father passed away, his side of the trust went to their adult children. Their assets exceeded the maximum allowed by 50%. They filed income tax the year he passed away. What are the advantages and disadvantages of passing assets to adult children vs. the surviving spouse? Does it affect portability?
TEDC, I’m not sure I completely understand the facts in your situation, but it sounds like something different than a typical A/B trust, as an A/B trust is designed to benefit the surviving spouse during his or her life, with the remainder going to benefit (usually) the children. Your father’s trust sounds like it skipped the first step and just went directly to the children. To the extent that trust exceeded the exemption amount in the year of your father’s death ($5.45 million for a death in 2016), the excess would be subject to federal estate tax at the 40% rate. Portability would not apply, as your father would have used up his entire exemption amount. Your mother would still have her exemption amount (minus any gifts she’s already made above the annual reporting threshold).
Ordinarily, when people do A/B trusts, they cap the amount going into the trust at the exemption amount and leave everything else to the spouse in one form or another (as the exemption amount is unlimited for gifts to a spouse that is a US citizen). It sounds like your parents’ situation is more complex and presumably there are estate planning attorneys involved.
Thanks for your prompt response BigLaw36. Yes, there were estate attorney’s involved that ensured federal estate taxes were filed. Also, the A/B trusts was capped at the amount allowed. Any excess amount was carried over to my mom, in which case we’ll have to pay 40% federal taxes when the time comes as she will definitely exceed the maximum allowed.
Their A/B trust was constructed to benefit the children to prevent a scenario which happened in the Lucille Ball and Tony Curtis estate debacles. Lucille Ball remarried, upon her death her second husband remarried and upon his death his subsequent wife was left with all Lucille Ball’s and Desi Arnaz’s memorabilia. This left Desi junior and little Lucy completely shut out. A similar case played out when Tony Curtis’s children, including Jamie Lee Curtis, were inadvertently left out of his will after a subsequent remarriage. Forwarded is an article:
http://www.examiner.com/article/inheritances-send-tony-curtis-and-lucille-ball-s-children-into-tailspin
Our trust lawyer retitled our homes as part of his fees. Our financial advisor retitled our retirement and brokerage accounts. I, myself, completed the Vanguard forms to retitle our self-directed brokerage accounts.
The checking accounts, autos, home valuables, and historic gun collections were left titled as is. Not everything needs to be retitled. They can be dispersed via a simple will.
Actually, you don’t retitle retirement accounts as they pass according to the named beneficiary. That’s a picky point, I realize, but many people don’t realize how retirement accounts pass. This sometimes results in an ex-spouse getting the IRA because the beneficiary form was never updated. Even if the will states that the IRA/401k/etc. goes to the children, the beneficiary form rules.
……….and if 1) the retirement account is titled as a trust, and 2) the beneficiary is ??
A point to check on.
The trust is the beneficiary of the retirement account. The RA is not “retitled” to the trust. (btw, a trust as beneficiary of a retirement account can easily be fouled up at death of the account owner. Make sure your attorney and financial advisor understand all implications of doing so.)
So what are the downsides of these trusts? Is this money stuck in them forever so that there are ongoing costs associated with accessing the money? I’ve heard they are taxed differently than money that isn’t in a trust.
The downside? High tax rates. Currently 40+ %. Trusts are a wealth destroyer because of the admin fees (1% NAV) plus high tax rates. Our children are too young ( 20s ) to inherit our assets. The trust fits our current needs. If in 25 years their capacities change, or our assets dwindle , we could abolish the trust. Our retirement accounts could be inherited at the stepped up basis.
The high taxes don’t have to destroy the trust’s wealth. Trusts currently get a deduction for the income they distribute at which point the income is taxed at the beneficiary’s tax rate rather than trust rates (of course for minor/young children who may not be able to handle such a distribution one may need to balance this). Also, if your heirs are high income producers, they may be in the top tax bracket anyway, so it wouldn’t make a difference where the assets are held (trust or personally–but the trust adds asset protection). You can also allow your heirs to manage their own trusts when they reach a certain age where you feel they will be mature enough and financially educated enough to handle the task–no fee to a trust company at that point. Until my children reach that age, I have the comfort of knowing that our assets are protected from someone spending the funds unchecked “for the benefit of our children.” I trust the guardians that I have selected for my children to treat them fairly, but if something happened to the guardians I chose and the children somehow ended up with someone else, my kids’ inherited assets would be protected. The strange scenarios, however unlikely, are numerous, and the estate plan I have set up lets me sleep a bit better at night.
I like the asset protection that estate plan trusts will provide the inherited assets from creditors, etc.
Also, a good way to catch some of the newer assets or those you forget to put in your living trust’s name before you pass is a pour-over will. This type of will basically gathers up those assets of yours that were not already titled within the trust and pours them over into the trust after your passing (of course it’s better to title things correctly in the first place).
Anyway, to each his own, and these are just my opinions that work for my situation.
I wholeheartedly agree. Well stated.
I have set up my estate similarly with the same intentions.
I do have a question though. In the case that the trust does need to be managed by a successor trustee, I would prefer that be an institutional trustee until my kids are mature enough to handle it. Does anyone know of an institutional trustee that would administer the trust for a flat fee rather than AUM and let the funds continue to be invested with my current advisor (Evanson Asset Manager)?
If one spouse dies then their exemption on the split trust does not increase anymore with inflation (currently $5.45 million) so should and is the second person able to spend money in that portion before they spend money in the portion they will be leaving (which will go up with inflation)?
Thanks
I’m not exactly sure what you mean by “split trust”. I suppose if they had managed to split the estate so that assets were owned 50:50 (which is rare), then the surviving spouse could potentially empty the trust, keeping his/her separately-owned property intact and available for a higher inflation-adjusted exemption. Of course, by making this decision, you are forgoing the opportunity to take advantage of portability in the event the deceased spouse does not use all of his/her exemption.
Andrew, I’m not sure what type of trust you are referring to here. With an A/B trust, the assets of the first-to-die spouse that go into the trust are out of the deceased spouse’s estate and never go into the estate of the surviving spouse. So, even if the trust grows dramatically, upon the second spouse’s death the assets in the trust will go to the kids with no estate tax. Portability never comes into play if the trust received assets equal to the full exemption amount. If the second spouse spends the trust assets down, that diminishes the benefit of having those assets out of the estate. By spending only the trust assets, the second spouse is increasing the likelihood that he or she will have an estate tax problem upon death. Sure, his or her exemption amount will increase with inflation (under current law), but his or her separate assets are likely to increase MUCH more than inflation if nothing is being spent from those assets (and the only spending is coming out of the trust). I don’t see any benefit to this approach. By the way, JFOX, while I assume you are correct that assets being owned 50/50 is rare in most states, in community property states this is very typical if there has only been one marriage.
BIGLAW – Totally agree!