strategies

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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Lifetime Gifts: An Important Estate Planning Technique (Part 2)

In Part 1 of this post, I focused on the similarities and differences between making annual gifts and making lifetime exemption gifts. Here, in Part 2 of this post, I will focus on the following reasons why it may still be important to consider making lifetime gifts:  

  • To minimize estate taxes;
  • To engage in Medicaid planning;
  • To provide for your loved ones during your lifetime; and
  • To decrease the size of your estate for easier estate administration after your death.

Minimize Estate Tax

Currently, in 2015, the estate tax exemption amount is $5.43 million. That combined with your spouse’s lifetime exemption amount if you are married, comes to $10.86 million. Therefore, for a vast majority of the population, minimizing estate tax is not even going to be on the radar. However, even though this exemption is permanent and indexed for inflation currently (and has been since 2010), Congress could always repeal it and lower the exemption amount; for instance, just seven years ago the exemption was only $2 million and if you look back another ten years before that, it was only $625,000. If Congress chose to go back to the “good old days,” a lot more of us would be subject to the estate tax. Keep that in mind.

For those of you who are unlucky enough (or, maybe I should say lucky enough) to be above the estate tax exemption, lifetime gifting is a great strategy to minimize estate taxes. Basically, by gifting assets away during your lifetime, either through annual gifts or lifetime exemption gifts, you are in essence “freezing” part of your estate. Consider the two following examples:

Example 1: You and your spouse have a $20 million estate today. You both live another 20 years, during which time your estate earns 6% annual interest and is now valued at about $64 million. Assuming the estate tax exemption increases at 3% during that same time, your combined estate tax exemption amount is about $19.5 million. Therefore, about $44.5 million of your estate will be subject to estate tax, which comes to about $17.8 million in estate taxes (at a 40% estate tax rate).

Example 2: You and your spouse have a $20 million estate today. Using $10 million of your combined estate tax exemption amount, you make a lifetime gift of $10 million, bringing the value of your estate down to $10 million. Assuming the same 6% interest, after 20 years, your estate is now worth about $32 million. And, assuming the same estate tax exemption amount as in Example 1 (about $19.5 million twenty years from now), you would have about $9.5 million of combined estate tax exemption left to use ($19.5 million – $10 million previously used). Therefore, about $22.5 million of you estate will be subject to estate tax, which comes to about $9 million in estate taxes.

As you can see from the two examples above, by making a lifetime gift, you can save a substantial amount in estate taxes; $8.8 million in the examples above. Furthermore, the two examples above are stripped down for ease of illustration; if you took annual gifts into account each year and also used up the increase in the lifetime exemption amount each year, the savings would be even more substantial (plus there are many other strategies that can make lifetime gifting even more effective, e.g., by applying discounts to certain assets when gifting).

The main reason why this works so well is because your estate is typically going to grow at a faster rate than the estate tax exemption amount (and the greater the arbitrage, the greater the effect lifetime gifting can have on your eventual estate tax liability). Basically, meaning that, when you make a lifetime gift and rid your estate of that asset, you also rid your estate of the accumulation that the asset is going to make over your remaining lifetime. So you are in effect, freezing the value of that asset and the amount of your lifetime exemption that it is going to offset.

However, there is one major caveat to consider here and when considering any other reason to make lifetime gifts. When you die with an asset in your estate, the asset receives a step-up in basis. When you gift an asset during your lifetime, the asset has a carry-over basis. Below are two examples that illustrate the difference:

Example 1: Years ago you bought an asset for $10. It is now worth $100. The day before you die you gift it to your child. Your child then receives a carry-over basis of $10. If your child were to sell that asset when it is worth $110, your child would be subject to long-term capital gains tax on $100 ($110 – $10).

Example 2: Years ago you bought an asset for $10. It is now worth $100. You die with the asset and bequest it to your child. Your child then receives a step-up in basis of $100. If your child were to sell that asset when it is worth $110, your child would be subject to long-term capital gains tax on only $10 ($110 – $100).

As you can imagine, that difference plays a major role when considering lifetime gifting. In some instances, it may be a deal breaker, and in others, it may not affect the decision as much. For instance, if you will be subject to estate taxes, it may be more beneficial to reduce your estate before you die even if your child would be subject to more capital gains tax on that asset because the highest long-term capital gains tax rate is only 23.8% (which includes the net investment income tax) compared to a 40% estate tax rate. However, if you are not subject to the estate tax, it may be more beneficial to keep low basis and high growth assets in your estate so that when you pass away, those assets will receive a step-up in basis and save your heirs substantial amounts in long-term capital gains tax.

Medicaid Planning

Nursing home costs are a major concern for many (and, with good reason, the national average nursing home costs are around $6,500 a month).  Long-term nursing home care can wipe out your entire estate pretty quickly. Therefore, Medicaid planning has become a large part of estate planning today. And, one of the most used Medicaid planning strategies is lifetime gifting.

Each State has its own complex set of rules when it comes to Medicaid planning with lifetime gifting and the rules are forever changing so it is important to contact an expert when considering this strategy. However, the basic strategy is this – to gift away your assets prior to the Medicaid look back period (depending on your State that look back period could be 3 years, 5 years, or some other time period).

There are a number of risks associated with lifetime gifting that are especially pertinent here. Once you’ve made a gift it is irrevocable. Meaning that the person you gave the gift to now owns it. You cannot get it back. Furthermore, the person who you gave the gift to is now at risk of losing it; for example, to creditors, to a divorcing spouse, to different heirs if they pass away, etc. This means that the person you gave the gift to may not be able to support you later on should you need it.

All of these risks are heightened during Medicaid planning. This is because if you don’t make it past the look back period, you will be hit with a penalty period based on the gifts given during that look back period. During that penalty period you will not receive support from Medicaid for nursing home costs, which could really leave you in a tough spot if you have no other access to support. Furthermore, if you never end up needing Medicaid and living a long life outside of a nursing home (like we all hope), you may no longer have enough to support yourself because you gifted it all away. Therefore, lifetime gifting as a Medicaid planning technique must be discussed with an expert to ensure you are weighing all of the benefits and risks associated with it.

Providing for Loved Ones During Life

Lifetime gifting may be a great way to provide for your loved ones during your lifetime. If an annual gift is less than $14,000 to any one person, not only will there be no tax liability, there is no requirement to file a Gift Tax Return. Even if the gift is greater than $14,000, there will be no tax liability so long as you have not used up your entire current lifetime exemption amount of $5.43 million. However, you will be required to file a Gift Tax Return to report a gift greater than $14,000 to any one person within the same year.

Lifetime gifts can be a great way for people to support their loved ones during their lifetimes without the fear of tax consequences or added responsibilities (like filing another tax return). However, you do need to consider the carry-over basis versus step-up in basis discussion above if gifting securities and/or property as opposed to cash.

Ease of Estate Administration at Death

Lifetime gifting may also be a great way to ease the administration of your estate at the time of your death. Typically, the smaller the estate, the easier it is to administer it at death. Furthermore, the type of assets that are held in your estate at the time of your death can determine how easy or how cumbersome administering your estate will be. If your estate is made up of entirely nonprobate assets, then administering your estate will be relatively easy. However, if you estate is made up of many different probate assets, then administering your estate will become more cumbersome and expensive.

By making lifetime gifts that reduce the value of your estate and rid your estate of probate assets, you can really lift some of the burden and costs that fall on your loved ones when having to administer your estate after your death. Again, however, you do need to consider the carry-over basis versus step-up in basis discussion above. Furthermore, you do not want to diminish your estate to a level where it becomes difficult for you to live day-to-day.

Conclusion

As you can see from above, lifetime gift planning is still very much alive in estate planning today. And, this holds true even for those who are not concerned about estate taxes. However, there are many things that need to be considered before making a lifetime gift and they should be discussed with an expert. But, if after weighing all of the risks and benefits, the scales are tipped in your favor, lifetime gifting can provide an important estate planning technique that starts to take effect prior to much of your other estate planning.

Thanks for reading!

-Matt

© 2015 Matthew D. Brehmer and Crummey Estate Plan.