Let’s face it. Many of us shy away from thinking about growing old and facing death. Although it can seem difficult, there are simple steps that can be taken to alleviate common problems that occur after the death of a loved one. And you may be surprised to learn that many people derive great satisfaction and peace of mind from facing and addressing these issues. Here are some common mistakes and their solutions:
1. Putting It Off. A significant percentage of people in the United State die without having a valid Will in place. That means that state law will determine who receives your assets. The government’s plan may differ from what you would have chosen for yourself.
2. Not Naming a Guardian for Minor Children. Young people who have not accumulated substantial assets often think a Will is unnecessary. However, one of the most important provisions of the Will names the guardian of minor children. In the absence of a Will, the court will appoint a guardian without knowing who you would have chosen.
3. Using Simple “I Love You” Wills. An “I Love You” Will simply leaves all assets to the surviving spouse. It is true that the estate tax marital deduction results in no estate tax at the death of the first spouse to die, but this arrangement can result in estate tax after the death of the second spouse to die, if his or her assets exceed the exempt amount (currently $5,740,000 per person for New York estate tax purposes, and $11,400,000 per person for federal estate tax purposes). While there is “portability” for the unused federal estate tax exemption of the first spouse to die, this concept does not apply for New York estate tax purposes (or generation-skipping transfer tax purposes), and the unused federal exemption can be lost in the event the surviving spouse remarries (depending upon the order of death of the spouses in the second marriage). The solution is to have the exempt amount of assets pass to a “bypass trust” under each spouse’s will. The Bypass Trust is so named because the assets “bypass” the taxable estate of the surviving spouse after the surviving spouse’s death, even though the trustee can make distributions from the trust to the surviving spouse during his or her lifetime.
4. Improper Form of Asset Ownership. Assets must be titled correctly in order to take advantage of the Bypass Trust described above. The most common error of this type is when spouses jointly own major assets such as the residence. Since joint property passes automatically to the surviving joint owner, it cannot be passed to the Bypass trust. This can be corrected by changing the form of ownership to a tenancy-in-common. Similarly, joint bank and brokerage accounts can be separated into individually owned accounts so that each spouse has enough assets to fund the Bypass Trust in the event of that spouse’s death.
5. Assuming Your Will Covers All Your Assets. Many significant assets are not controlled by your Will. For example, beneficiaries under life insurance policies, retirement plans and IRAs are not named by Will. Instead, the beneficiary designation under the policy, plan or IRA trumps the Will, so it is important to periodically review these designations to make sure they reflect your current wishes.
6. Owning Life Insurance Yourself. Life insurance proceeds are included in your taxable estate for estate tax purposes if you had any “incident of ownership” over the policy. Inclusion of life insurance proceeds could easily turn a non-taxable estate into a taxable estate. Life insurance is by definition designed primarily to benefit your beneficiaries after your death, not you during your lifetime. You can avoid holding any incident of ownership by establishing an irrevocable life insurance trust (“ILIT”) to own the policy. This can ensure that your beneficiaries receive the full amount of life insurance benefits unreduced by estate tax.
7. Not Taking Advantage of $15,000 Gift Tax Annual Exclusion. The federal gift tax law allows each individual to make a gift of up to $15,000 per year to any individual without gift tax consequences. A married couple together can gift up to $30,000 per year to any individual making use of their gift tax annual exclusions. These gifts can reduce your estate subject to estate tax, or perhaps even eliminate the potential estate tax. Furthermore, the appreciation on the gifted assets is also excluded from your taxable estate. Gifts in excess of the annual exclusion amount can also be beneficial under the appropriate circumstances; such gifts reduce the unified federal lifetime gift and estate tax exemption (or are subject to gift tax if you have already exceeded the lifetime exemption amount).
8. Not Making Direct Gifts for Tuition and Medical Expenses. Federal gift tax law also allows you to make unlimited gifts that do not reduce the exempt amount if the gifts are in the form of direct payment of tuition or medical expenses. This is in addition to the $15,000 annual exclusion described above. Thus, you can directly pay the tuition bill of a child or grandchild (or anyone else) without gift tax consequences, even if the bill exceeds $15,000 in a year. The same rule applies to the direct payment of medical expenses.
9. No Business Succession Plan. Family-owned businesses have only a 40% chance of surviving when passed from the first to the second generation, and that survival rate drops precipitously when we look at family businesses passed to the third or fourth generation. The failure of these businesses to survive as they are passed to lower generations can be explained by both tax and non-tax considerations, but the odds can be dramatically improved by careful planning, taking into account, where necessary, the needs of children who work in the business and children who do not.
10. Not Planning for Incapacity. Estate planning usually includes preparation for the possibility of becoming incapable of making medical and financial decisions for yourself during your lifetime. You should execute documents that authorize someone else to act on your behalf in the event of your incapacity. Without these documents in place, court proceedings to name a guardian may be required, no matter how costly and unpleasant for all concerned.
Lisa S. Hunter is a Partner in the Estate and Tax Planning/Probate Law and Estate Administration Group.