Understanding Wills, Trusts and Estates:
An Outline Guide to the
Fundamentals of Estate Planning
Stephen P. Magowan, Esq.
Note: This outline is intended to give a broad outline of basic estate planning considerations. In places, I may only put a one or two word description of a longer conversation you can have about these issues. This outline is intended as a springboard to further discussion, not as final advice.
a. What is “estate planning”?
i. Estate planning means many things to different people. When I talk about estate planning I mean the following:
(1) Creating and signing the documents, typically a will or a will and trust, which will control how your assets move after your death.
(2) Creating and signing the documents, including wills, trusts, IRA and pension designations, family partnerships and myriad others, that will minimize or eliminate the estate taxes that would be imposed at your and/or your spouse’s death.
These documents necessarily involve drafting the documents in (i) above. However, I feel that it is useful to think of the functions separately.
(3) Taking steps, frequently through the procurement of life insurance, to ensure to the greatest extent possible that your loved ones will be taken care of after your death.
(4) Engaging in financial planning to ensure that you have assets with which to plan and to live on in retirement.
In this outline I will be focusing on steps (i) and (ii) with a short discussion of (iii).
b. What taxes are imposed at death?
i. I feel that the first step to understanding your own estate planning needs, is to gain a comprehension of the taxes that may be imposed against your assets when you die. By doing this you can determine whether the imposition of such taxes is a risk you face. If it is, then this will control, in part, the estate plan you choose.
ii. There are U.S. federal estate taxes and Vermont death taxes. The Vermont taxes are not important so we will not discuss them here.
iii. The federal taxes are important, and we will discuss them. First you need to know a few key points:
(1) You can leave any amount outright to your spouse without your estate being subject to estate tax, but the property has to be left outright or in a special kind of trust. Thus in the typical “I love you” will (one leaving everything to a spouse) there is no estate tax due.
(2) You can leave up to $675,000 to any person other than your spouse without that amount of assets being subject to tax. This is the so-called “applicable exemption amount” and it is scheduled to go up to $1 million by 2006 according to the following schedule:
2000 & 2001 $ 675,000
2002 & 2003 $ 700,000
2004 $ 850,000
2005 $ 950,000
2006 or after $1,000,000
(3) Once you get above the exemption amount, the estate taxes go up to 55% of your assets. A table of those taxes is attached to the end of this outline.
iv. So for couple in say their early 50’s with a $750,000 in total assets (lower dollar amounts for younger folks), tax sensitive estate planning becomes important. This is simply a function of the effect of compounding interest.
(1) To take advantage of the $675,000 exemption amount you must use it by leaving the property to someone other than your spouse. Typically this is done by providing in the estate planning documents for the creation of a trust to which the first $675,000 of the decedent’s assets is distributed. You will hear this trust called many names in the financial press including “bypass” trust, “credit shelter” trust, or “family” (as opposed to spousal) trust.
(a) The surviving spouse is a beneficiary of this trust, but the idea is that he or she will only tap into that trust as needed.
(b) Why that last point? Those assets in the bypass trust are not subject to tax again when the second spouse dies. Thus, to the extent these assets are allowed to grow, that growth is not subject to estate tax at the second spouse’s death.
v. What do I mean by a “unified” credit? The credit applies for gift and estate taxes. The gift tax operates on certain gifts you make each year. However a special category of gifts is excluded, the so-called “annual exclusion” gifts.
(1) Annual exclusion gifts -- a powerful tax savings tool.
(2) Payments of tuition, medical expenses.
(3) Vermont’s Higher Education Savings Plan.
c. Wills and an Introduction to the Probate Process.
i. What is a will? A will is the written document by which you express your wishes as to how your assets are to be disposed. Think of it as a binding letter from the dead to the living.
ii. Required aspects of a will.
(1) In Vermont, to be assured of its validity, the will must be signed by the “testator” (a fancy word for the dead person) and by three witnesses, who witness and sign in the presence of each other and of the testator.
(2) If a person is given something under that will and he or she is not an heir (i.e., a spouse or descendant) he or she should not witness the will. If he or she does and there are not three other “competent” witnesses, the devise to him or her is void.
iii. The basic structure of a will:
(1) Introductory clause, says who you are.
(2) Paragraph naming the executor.
(a) The executor is responsible for collecting the assets the decedent owned at her death, using those assets to pay the decedent’s debts and the debts and expenses of the estate, including taxes and the costs of administration, and taking the remaining assets, if there are any left, and distributing that remainder as the decedent desired in her will, or in accordance with the rules of “intestacy” (the state rules on how property passes without a will).
(b) Who should be the executor?
(i) Make no mistake, an executor’s job can be a miserable one. In the spousal situation, it often makes sense for the surviving spouse to be the executor.
(ii) However, if there is no surviving spouse, the inclination is usually to name the eldest son or daughter as the executor. This is not always a good idea and can lead to disputes in the family. If there is potential for squabbling, you might want to pick an outsider to do things. Frequently, that person’s fear of being sued will keep them on the ball.
(3) Paragraph authorizing payment of debts.
(4) Distribution provisions. This section may be something simple like I leave everything to my wife. Alternatively you may list a host of recipients; you can also create a trust under the will.
(5) Name guardians of minor children.
(a) Basic considerations in naming guardian. What if your chosen guardians get divorced? Who gets your children?
(b) How will the guardian be paid? Issues when the guardian has his or her own family.
iv. Where to keep your signed will. Deposit at Probate Court versus in box at home versus safety deposit box.
d. The Probate Process
i. Probate is the judicial process by which a court tests the validity of the will and determines whether it is the last will and testament. It is also the process by which the executor gathers assets, pays creditors, and distributes assets.
ii. The length and expense of probate are its chief disadvantages. The fact there is judicial supervision is its chief advantage.
iii. What happens in Probate.
(1) Initial petitions.
(3) Selling assets; necessity for permission.
iv. Must there be probate?
(1) A number of assets are not subject to probate:
(a) Property held jointly with rights of survivorship (assuming the survivor is alive).
(c) Retirement accounts or individual retirement accounts.
(d) Life insurance payable directly to a beneficiary.
v. Basic techniques to avoid probate. There may be very good reasons to avoid probate altogether. For instance, where a husband and wife own only a modest amount of assets, say below $600,000, there is practically no reason that they should not own their assets as joint tenants with rights of survivorship or tenants by the entirety.
(1) Joint tenancies are the easiest and simplest form of probate avoidance. No fancy documents are required, and in some jurisdictions it is the assumed mode of ownership.
(2) Living trusts. These are discussed below.
i. What is a trust? A trust is basically a contractual agreement by which a person, usually called the settlor or donor, gives property to another person, who can be an individual, a group of persons, a bank, etc., with directions to that person -- who is called a “trustee” -- to hold that property for the benefit of another person or persons or class of persons. Those directions are what form the heart of the “trust agreement”.
(1) For example, in your will you might state that you leave $5,000 to Uncle Joe for him to hold in trust for the benefit of your niece Shirley. Shirley is to receive such income from this $5,000 as Uncle Joe determines. When she turns 25, Uncle Joe is to give her what he is still holding of the $5,000.
ii. The trustee is a fiduciary. That means he, she or it has to take care not to mistakes and is held in a position of special trust.
iii. What is a living trust?
(1) Don’t confuse with a living will.
(2) Essentially it is a probate avoidance vehicle. A living trust is a trust you create in your lifetime to hold your assets. You are the donor, trustee and beneficiary. When you die your assets stay in trust. What changes is the trustee.
f. The first questions you and your adviser need to ask.
i. Put together a list of your assets. Are these assets going to grow? Decline (i.e., are you retired and drawing on your retirement accounts)? Can you do a projection of growth?
ii. Are you potentially subject to estate tax? If yes, your estate plan should include a credit shelter trust/spousal disposition arrangement.
(1) An issue not to miss!!!! Are either you or your spouse not a U.S. citizen? If you answer yes, the spousal disposition has to be in the form of a special kind of trust in order to qualify for the “marital deduction” described above.
iii. What do you want done with your assets? Some questions to further discussions:
(1) Are you and your spouse comfortable with the potential survivor’s ability to manage the inherited assets? If no, this will indicate the need to create a trust.
(2) Do you want your children immediately to inherit all of your assets when you both die? If not, this indicates that you need a trust.
(3) Do your children have children? How do you want to take care of your grandchildren?
(a) Trusts v. guardianships -- avoiding the trap of the 18 year old with $20,000 (or more) to burn!
(4) Do you have married children?
(a) Protecting your child’s inheritance from the claim of an ex-spouse.
g. The role of Life Insurance from the Perspective of an Estate Planning Lawyer with no vested interest in selling life insurance!
i. Life insurance can be used as an income replacement tool.
ii. Life insurance can be used as a wealth replacement tool (i.e., to pay estate taxes).
iii. Life insurance trusts can be used to keep insurance proceeds out of your taxable estate.
iv. Term vs. whole vs. variable life insurance.
h. Planning with IRA’s and other retirement assets.
i. Importance of bringing these assets into the picture.
ii. Income tax issues.
iii. Stretch-out IRA’s and charitable giving.