distribution

The Foundation – Part 2: Probate Avoidance

Continuing with Part 2 of this three part series, I am going to briefly cover some of the most popular probate avoidance strategies. As a refresher, the purpose of this series is to cover the fundamentals and foundation of estate planning and some of what I typically go through with a client during an initial estate planning consultation, including the following topics:

Part 1 – Last Wills & Testaments and Powers of Attorney
Part 2 – Basic Probate Avoidance Strategies
Part 3 – Joint Revocable Living Trusts

For purposes of this post, it is extremely important to remember that if any of the following probate avoidance measures are used with respect to any of your assets, the distribution of those assets upon your death will NO LONGER be controlled by your Last Will & Testament. The designation or form you used to avoid probate will now control the distribution of that asset upon your death. This is one of many reasons why it is important to talk to an experienced professional when drafting your estate plan; the experienced professional can work with you to ensure that your entire estate plan (i.e., your Will, your beneficiary designations, etc.) works together to achieve your desired goals and results.

Example: The “Average” Estate

A significant portion of most individuals’ estates are made up of the following assets: a house, bank accounts, retirement/brokerage accounts, life insurance, an automobile and tangible personal property (e.g., your household furnishings, antiques, collectibles, etc.). By implementing a few of the probate avoidance strategies below, most individuals will have the peace of mind in knowing that a significant portion of their estate, if not all of it, will avoid probate.

And, even if not all of the assets avoid probate (e.g., like the car and the tangible personal property), if those remaining probate assets are below a certain threshold amount, your State may still provide a way to transfer those assets without the need for probate after your death (e.g., in Wisconsin, if you probate assets are under $50,000, they can be transferred by affidavit and probate can be avoided). This should be a goal for almost all estate plans – to at least have the value of your probate assets below the probate threshold amount in your State.

Joint Ownership

Generally, any assets held and titled as joint ownership property pass to the survivor of the joint owners outside of probate. Common assets that can be held jointly include bank accounts and real estate. However, keep in mind that the asset will pass fully to the survivor, even if you wish it to go to someone else.

Beneficiary Designations

Any assets where you can and do designate a beneficiary will pass to the beneficiary outside of probate. Common assets where beneficiary designations are used include retirement accounts (e.g., pension plans, 401(k)s, IRAs), life insurance policies and brokerage accounts. If you wish to designate a beneficiary to any of these types of accounts, you can do so by requesting a beneficiary change form from your account administrator.

Payable on Death Accounts

Similar to beneficiary designations, payable on death accounts allow you to designate a beneficiary of that particular account. If such a beneficiary is designated, that account will pass to the beneficiary outside of probate upon your death. Payable on death accounts are particularly useful when it comes to your bank accounts. Most banks (if not all) will allow you to name a beneficiary to your bank account, you just need to speak to your banker.

Transfer on Death Designations

Again, similar to beneficiary designations, transfer on death designations are used to pass interests in property upon your death to a named beneficiary without the need for probate. The most common use of transfer on death designations are for real estate and business interests. This type of probate avoidance strategy will usually involve seeing an attorney to draft the transfer on death designation.

Marital Property Agreements (with Washington Will provisions)

For married couples in some States, marital property agreements with Washington Will provisions can be used to pass all of the decedent spouse’s property to the surviving spouse upon the death of the first spouse without the need for probate. If otherwise consistent with your estate plan, this can make the time and expenses involved at the first spouse’s death much easier to cope with. However, only some States allow for this type of probate avoidance strategy. This will also require you to see an attorney to draft the agreement.

Trusts

Any assets held in trust will also pass to (or be held for) the beneficiary of the trust without the need for probate. Generally, almost any asset can be held in trust; thus, this can provide a lot of flexibility and the most overall probate avoidance. Additionally, this will also require an attorney to draft the trust agreement. In Part 3 of this series I will focus solely on trusts so be sure to check that out once I post it.

Recap: The “Average” Estate

Above I stated that a significant portion of most individuals’ estates are made up of the following assets: a house, bank accounts, retirement/brokerage accounts, life insurance, an automobile and tangible personal property. The following is a recap of the probate avoidance strategies that can be used to pass those assets to your heirs without the need for probate:

  • House – joint ownership, transfer on death designations, and trusts.
  • Bank accounts – joint ownership, payable on death accounts, and trusts.
  • Retirement/brokerage accounts – joint ownership, beneficiary designations, and trusts.
  • Life insurance – beneficiary designations and trusts.
  • Automobile and tangible personal property – joint ownership and trusts.

Conclusion

As you can see, there are multiple ways to avoid probate in regards to a particular asset and among your entire estate. The strategy and combination of strategies chosen will be different for every individual; some strategies may provide more advantages than other strategies depending on your individual circumstances. Additionally, many of the above probate avoidance strategies can be achieved for relatively little cost and time while saving your estate and your heirs A LOT of time and expense after you pass.

However, like I stated in Part 1, any plan starts with a good and solid foundation, and that includes your estate plan. That means that even if you engage in the above probate avoidance strategies, you still need to have a Last Will & Testament to “catch” those assets that you may have missed or that could have fallen outside the probate avoidance measures you took. Probate avoidance strategies must be integrated into an already existing solid estate plan; otherwise, the benefits and advantages such strategies provide will be diminished.

Make sure to check out Part 3 (Trusts) of this series when I post it. And, lastly, like with any topic I blog about, I am only scratching the surface of these topics, you must contact a professional in order to fully consider how these estate planning strategies will play out in your individual circumstances.

I hope this helps!

-Matt

 

© 2015 Matthew D. Brehmer and Crummey Estate Plan.

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Beneficiary Designations: An Overlooked Estate Planning Tool

While a vast majority of the population has not prepared the “staple” estate planning documents that every person over the age of 18 should have, almost everyone has prepared a beneficiary designation form of some sort. When I say “staple” estate planning documents, I am talking about a Last Will & Testament, Health Care Power of Attorney (with a Living Will and HIPAA Authorization), and Durable (Financial) Power of Attorney. It is essential that every person have at least all of these documents to effectuate their estate plan; and, most importantly, they must all work together!

In honor of Halloween, in the following scenario, I am going to use Frankenstein, Frank for short, age 40. Frank is very proactive about preparing his estate plan – he does have a pretty dangerous job creating monsters so probably a good thing he’s proactive, right? Frank discusses his final wishes with his attorney and his attorney prepares him a perfect set of “staple” estate planning documents. Per his wishes, his Last Will & Testament states that everything is to go to his wife, if she survives him, and if she does not, then to be split equally among his children (age 15 and 13). Further, if his children are under the age of 25 at the time of his death, their share of his estate shall be held in trust until they are age 25. Great, Frank thinks he is all set to go, like many people would.

However, here’s the kicker: any asset that Frank has prepared a beneficiary designation form for, will NOT pass through his Last Will & Testament at the time of his death (unless he has named his estate as the beneficiary, which in most cases is not advised). That means that whomever Frank named as beneficiary on that form will get that asset at his death (the form may have been filled out 20 years ago when he just started working, was not married and had no children). His wishes as outlined in his Last Will & Testament will not control how that asset is distributed.

Good thing Frank was advised of this. Frank takes heed of this advice and updates his beneficiary designation forms to carry out the same wishes as under his Last Will & Testament. However, typically this is not as simple as just updating the names on the form. Frank needs to ensure that the form is prepared properly, which includes drafting to make sure that any shares his children may receive will be held in trust until they are age 25, identical to his wishes under his Last Will & Testament.

It is important to remember that if he had not updated his beneficiary designations, his “real” final wishes would not have been carried out after his death; his $200,000 IRA may have gone to his ex-girlfriend that he named as beneficiary when he was 20 years old. On the other hand, if he had updated his beneficiary designation but done so improperly, again, his “real” final wishes may not have been carried out after his death; his $200,000 IRA may have gone outright to his two financially immature children, then age 18 and 20, instead of being held in trust until they were 25.

Now Frank was proactive, think about all the people who have not had the “staple” estate planning documents prepared or had their beneficiary designations reviewed to ensure that they are correctly filled out; is their estate going to be distributed as they really intended? Further, Frank’s estate plan was relatively simple; most people’s circumstances and wishes are much more complicated than his. This makes conjunctive planning even more so important – attorneys must advise clients as to both their Last Will & Testament (or Trust) and any beneficiary designations that they may have made to ensure that they are all consistent and carry out the client’s final wishes.

Types of Assets

If you have any of the following assets, you have most likely prepared a beneficiary designation form at some point:

  • Any retirement accounts, including 401(k)s, IRAs, pension plans, profit sharing plans, etc.;
  • Life insurance;
  • Brokerage accounts; and/or
  • Annuities.

In addition, most States now allow owners to name a beneficiary for any real estate property they own (i.e., transfer on death designation) and any bank accounts they have (i.e., payable on death designation). Now, think about all of the assets you have or may have at death. For most people, besides your tangible personal property (e.g., household goods, automobiles, etc.), the above list of assets covers a majority of your estate. That is why beneficiary designation planning is ESSENTIAL to estate planning today.

Non-Probate

A Last Will & Testament directs how and to whom your executor or personal representative should distribute your probate property. However, if you have prepared a beneficiary designation form for one of the types of assets listed above, that asset will not go through probate and therefore, the distribution of that asset will not be controlled by your Last Will & Testament. The distribution of that asset will be controlled by the beneficiary designation form that you filled out, possibly haphazardly and without much thought and advice.

While avoiding probate is great news and on the top of most people’s estate planning goals, the beneficiary designation form must be filled out correctly in order to properly effectuate your final wishes. This is something that should be discussed with an attorney so you can ensure that it is done correctly and that when fully considering the big picture, your final wishes are carried out. The big picture includes all of your assets and how and to whom they will be distributed to at your death, whether that distribution is controlled by beneficiary designations, your Last Will & Testament, and/or your Living Trust.

Naming Your Beneficiaries

Depending on your estate plan, you may choose to name an individual, trust, estate, charity and/or any combination of these as the beneficiary to one or more of the assets listed above. However, this decision is not as easy as just filling in a blank on a beneficiary designation form. There are numerous considerations to contemplate and discuss with an experienced attorney before making any final decisions. Some of the issues that may arise depending on your estate plan include (all of which will be discussed in future posts):

  •  How to effectively and efficiently leave the asset to multiple beneficiaries, whether the asset should be split up immediately among the multiple beneficiaries, held in trust for some or all of the multiple beneficiaries, spread out over future generations, etc.;
  • How to protect the asset from the beneficiary, whether the beneficiary is too young, financially immature, disabled, has creditor/divorce concerns, etc.;
  • How to minimize the tax consequences, whether it is the impact of estate tax, generation-skipping transfer tax, income tax, deferring tax, etc.;
  • How to comply with the complex IRA (or any asset listed above) rules, whether you are naming an individual, estate, trust and/or charity as a beneficiary and the different consequences of naming each; and/or
  • How to prepare and implement an estate plan that considers the big picture and ensures that your estate is distributed effectively and efficiently, according to your final wishes, with the least amount of time and cost involved.

Conclusion

With beneficiary designations possibly controlling the distribution of a majority of a person’s estate, estate planning must include beneficiary designations and how they affect the person’s final wishes as outlined in their Last Will & Testament and/or Living Trust. This is why both the long trusted “staple” estate planning documents and beneficiary designation forms are important and required for every person today. This will, in many cases, inevitably lead to attorneys and financial advisers being required to work together to ensure that the client’s estate plan is carried out correctly. The issues that may arise are complex and the consequences may be severe, therefore, you need to seek professional advice before finalizing your beneficiary designation forms.

– Attorney Matthew D. Brehmer

 

© 2014 Matthew D. Brehmer and Crummey Estate Plan.

The Monthly 5 and 5: The 5 or 5 Power

Each month I will be publishing a post discussing five advantages and five disadvantages of a particular estate planning technique – the post will be called The Monthly 5 and 5. In this first installment of The Monthly 5 and 5, I will be discussing the “5 or 5 power.” Notice the similarity? Yes, that’s right, the “5 or 5 power” was inspiration for The Monthly 5 and 5.

The “5 or 5 power” gives a beneficiary of a trust the power in any calendar year to withdraw the greater of $5,000 or 5% of the trust’s assets. This means that for any trust with assets of less than $100,000, the beneficiary will have the power to withdraw up to $5,000 each year; and, for any trust with assets of more than $100,000, the beneficiary will have the power to withdraw up to 5% of the value of the trust’s assets each year (i.e., because 5% of $100,000 is $5,000).

You may be asking yourself: Why $5,000 or 5%? What’s so magical about those numbers? Well, put most simplistically, because that is what the Internal Revenue Code (IRC) says. In order to avoid certain consequences, this annual withdrawal power is limited to $5,000 or 5% of the trust’s assets under the IRC. Why is it important to abide by the IRC? Well, for instance, if instead, you gave the beneficiary more than a $5,000 or 5% annual power to withdraw, the beneficiary’s withdrawal power could be deemed a general power of appointment over the trust and some or all the assets in the trust could be included in the beneficiary’s estate for estate tax purposes. This could create devastating tax consequences for the beneficiary.

Below are five reasons (each with an advantage and disadvantage) why the “5 or 5 power” can be a useful estate planning tool:

Reason 1: Minimum Distribution

Let’s say that the trust allows the trustee to only distribute the income of the trust (and not any of the trust principal) to the beneficiary each year for the beneficiary’s support. If in a particular year the trust generates very little income, the 5 or 5 power allows the beneficiary the power to withdraw up to $5,000 or 5% of the trust’s assets that year regardless of the amount of trust income.

Advantage: At a minimum, the beneficiary will be able to receive at least $5,000 per year for support.

Disadvantage: The amount subject to the beneficiary’s 5 or 5 power may not be protected from the beneficiary and/or creditors of the beneficiary.

Reason 2: Strict Trustee

Let’s say that the trust allows the trustee to distribute income and/or principal only for the health, education and support of the beneficiary. If a trustee is particularly strict when following this standard and distributes very little to the beneficiary, the 5 or 5 power allows the beneficiary the power to withdraw up to $5,000 or 5% of the trust’s assets each year even if it is not for the health, education and support of the beneficiary.

Advantage: The beneficiary will be able to withdraw at least up to $5,000 per year without having to satisfy the trustee that it is being used for health, education and support.

Disadvantage: The beneficiary could exhaust the trust more rapidly than intended over time, whether the trust is small (i.e., $5,000 withdrawn each year) or large (5% of trust assets are withdrawn each year), when the main purpose of the trust may have been to transfer wealth to future generations.

Reason 3: Benefit Without Estate Inclusion

Let’s say that both the trust grantor and his wife are near their lifetime exemption amounts for estate taxes (i.e., if they go over their exemption amount, part of their estate will be subject to estate taxes). The trust grantor sets up a trust for the benefit of his spouse during her lifetime with the remainder going to his children at his wife’s death. Here, the 5 or 5 power allows the wife to use the trust as another source of support and income during her lifetime (limited to $5,000 or 5%) but does not substantially increase her estate for estate tax purposes at her death.

Advantage: The amount of trust assets not subject to the 5 or 5 power are not included in the wife’s estate at her death; and, thus, not subject to estate taxes at her death.

Disadvantage: The amount of trust assets subject to the 5 or 5 power (i.e., the greater of $5,000 or 5% of the trust’s assets) will be included in the wife’s estate at her death; and, thus, if including this amount in her estate causes her total estate to exceed her lifetime exemption amount, the amount that exceeds the lifetime exemption amount will be subject to estate taxes at her death.

Reason 4: Crummey Trusts

Let’s say that the trust grantor set up a Crummey Trust for his two children. Each year his two children allow their right to withdraw the amount of the annual gift to lapse. When a beneficiary allows their withdrawal right to lapse, it is considered a deemed gift to the other beneficiaries of the trust. However, by adding the 5 or 5 power to the Crummey Trust, the lapsing of the withdrawal right is only considered a deemed gift to the other beneficiaries so much as it exceeds $5,000 or 5% of the trust’s assets.

Advantage: If the amount of the annual gift to the Crummey Trust is less than or equal to $5,000 or 5% of the trust’s assets, there will be no deemed gifts to the other beneficiaries by allowing the withdrawal right to lapse.

Disadvantage: While the main purpose of a Crummey Trust is to protect the trust assets from the beneficiaries until you see fit (as spelled out in the trust document), the 5 or 5 power gives the beneficiaries unfettered rights to withdraw up to $5,000 or 5% of the trust’s assets each year, regardless of the amount of the current year’s gift.

Reason 5: Hanging Crummey Trusts

Let’s use the same scenario as in Reason 4 except that the amount of the annual gift exceeds $5,000 or 5% of the trust’s assets. If the amount of the gift exceeds $5,000 or 5% of the trust’s assets, it is considered a deemed gift to the other beneficiaries of the amount in excess of the 5 or 5 power; and, thus, possibly causing gift tax consequences for the beneficiaries in the future. However, by adding a “hanging Crummey” provision, the amount of this deemed gift can be eliminated over time (I will explain this further in another post).

Advantage: Over time, the amount of any deemed gift to the other beneficiaries caused by allowing the withdrawal right to lapse will be eliminated; thus, not creating gift tax consequences for the beneficiaries in the future.

Disadvantage: The “hanging Crummey” provision allows the beneficiary to have continued withdrawal rights over the accumulated amount of gifts that have not  yet been offset by the 5 or 5 power; thus, allowing such withdrawal rights to possibly substantially increase over time, contrary to what the trust grantor may have intended.

As you can see above, adding a “5 or 5 power” to a trust document may be done for a number of reasons and it does have some really important advantages. But, like most things in life, the advantages must be weighed against the disadvantages. As always, if a “5 or 5 power” is something you are considering, you should consult an experienced estate planning attorney. It will be each individual’s personal situation and wishes that will control whether or not the advantages outweigh the disadvantages of utilizing a “5 or 5 power” in their estate planning.

– Attorney Matthew D. Brehmer

 

© 2014 Matthew D. Brehmer and Crummey Estate Plan.