Busting Estate Plans Myths & Misconceptions
Table of contents
- MYTH #1 – ESTATE PLANS ARE JUST BOILERPLATE…
- MYTH #2 – HIGH FEDERAL ESTATE TAX EXEMPTIONS RENDER PLANNING MEANINGLESS…
- MYTH #3 – ONLINE DOCUMENT PREPARATION WILL CREATE A PLAN THAT WORKS FOR ME…
- MYTH #4 – MY BANKER TOLD ME TO PUT ALL THE ACCOUNTS IN JOINT NAME, TRANSFER ON DEATH OR PAY ON DEATH…
- MYTH #5 – I MADE AN ESTATE PLAN YEARS AGO…
MYTH #1 – ESTATE PLANS ARE JUST BOILERPLATE…
More than Pushing a Button
We can accomplish so much these days simply by pushing a button. I just returned from a conference in Florida, where I pushed many buttons using apps on my iPhone. It was simply amazing when you think about it.
I pushed buttons to check into my flight and to display my boarding pass. Another button informed me if my flight was on time, while yet another button tracked my bags onto the plane. Upon arrival at the airport, I pushed a button to summon an Über to take us to our hotel.
Rather than wait in a long line to check into our room, I pushed a button to check in, reading the assigned room number on my screen. We ascended in the elevator, and, after finding our room, I proceeded to punch another button to unlock our door. Once in our room we used buttons to read restaurant reviews and make a reservation.
We even pushed buttons to enroll in the conference break-out sessions, find the location of those sessions around the conference center, and communicate with the conference organizers.
There was virtually no interaction with a human being to accomplish all of these tasks. It seems that we can do a lot pushing buttons.
Even construct an estate plan. But not a good one.
You see, unlike many transactions, a good estate plan is only developed through a meaningful interaction with a knowledgeable professional. Sure, you can access web-based estate planning programs, but those can only perform one minor function in an estate plan—that is preparing a legal document that would say who gets what in the event of your death. Even then it probably doesn’t do a thorough enough job.
Why is that? Because there is so much more thought that should go into constructing an estate plan. Consider, for example, that you have several different baskets of assets. Some carry taxable income with them (such as annuities, IRA and 401(k) accounts), while in others you might achieve a step up in tax-cost basis that eliminates capital gains to your beneficiaries. Without a thorough understanding of the complexities surrounding these issues, it’s likely that you don’t maximize your plan, and that Uncle Sam becomes a larger beneficiary than he should.
How about those in blended families? A computer program won’t provide any insight into the problems associated with economically tying your spouse who is not the parent of your children to those children through marital trust planning. Sure, the program will describe the benefits of providing income to your spouse for the rest of her life, and then how the trust will distribute principal to the children upon her death. Seems pretty straightforward.
Except it’s not.
Will that computer program reveal how to maximize family harmony when every dollar your spouse spends following your passing will result in one less dollar that the children inherit? There are strategies to consider beyond what the cold calculations that artificial intelligence can master.
How about protecting your children’s inheritance from divorce or other economic maladies? Will those computer buttons know how to give your children the greatest amount of freedom in choosing their investments, distributing the trust income and principal, and ultimately deciding who should benefit from the inheritance following their deaths? I usually have lengthy conversations with my clients about the hopes and wishes that they harbor for their loved ones. Can you do that with Siri?
No. You can’t.
Selecting your trustee in the event of your disability is usually another in-depth conversation that I engage in with my clients. There’s so much to it, in fact, that I’m writing a book exclusively on that subject.
There are so many variables to a good estate plan that every person’s plan will be unique to that individual. Sure, if you have less than $100,000 in assets and a house you probably don’t need the best estate planning attorney out there, and perhaps a computer program will suffice.
If you’ve taken the time to read this column, chances are you’ve accumulated somewhat more than that.
Yes, it’s great that we can do so much by pushing a button on our Smartphones. But do you really want to put that small amount of thought into constructing a plan to protect you and your loved ones with what took you a lifetime to accumulate?
MYTH #2 – HIGH FEDERAL ESTATE TAX EXEMPTIONS RENDER PLANNING MEANINGLESS…
Tax Cost Basis
With the large federal estate tax exemption, many believe that estate planning is no longer as important as it once was. Quite to the contrary, estate planning today is more important than ever. There are many non-tax reasons to ensure that your hard earned assets end up with your loved ones protected from the reaches of divorcing spouses, creditors, predators, as well as in a tax efficient manner.
While federal estate taxes don’t affect as many as it once did, income tax planning built into your estate plan can mean the difference between your spouse and other loved ones paying large amounts, or even nothing at all.
Let me explain by example. Suppose you purchased ABC Stock at $1/share. That is your “tax cost basis”. Suppose the years the value of the stock increased to $11/share. If you sold the stock at $11/share, you would report a capital gain of $10/share ($11 selling price less the $1 basis) and likely pay 20% capital gains tax.
If you were to gift that stock to your daughter during your lifetime, she takes the same tax cost basis in the stock that you would have. So if she sells the stock at $11/share, she would also report a $10/share capital gain and pay capital gains tax.
If instead of gifting the shares to your daughter during your lifetime, you left them to her in your will or revocable trust at your death, the tax cost basis of the stock increases to $11/share. If she sells the stock at that price, she reports no capital gain.
Seems pretty simple. But it’s not.
Many estate plans build in trusts for spouses, so that at the death of husband, for example, the trust continues on for wife for her lifetime. When wife dies then the trust may distribute to children. When the estate tax exemption was lower, it was important to exclude the husband’s trust benefiting wife from wife’s estate.
That strategy no longer works, largely because it does not result in a second increase in tax cost basis when wife dies, resulting in unnecessary capital gains taxes. Those taxes may be quite high depending upon the appreciation that occurs between husband’s death and wife’s death. The longer that time period, the greater likelihood that the couple’s financial and real estate portfolio increases significantly in value.
The trust for wife may be important, however, to protect the intended distribution to her and then to the children. Without it, if wife remarries, her new spouse may have rights to these assets. So it’s important to build the trust in such a way to protect the assets from this danger while achieving the intended tax planning. This isn’t always as easy as it sounds.
Consider, for example, that in order to achieve the increase in tax cost basis on the second spouse’s death, not only will the assets that increase in value be adjusted, but so will the assets that decrease in value. This is because the tax law is written to adjust the new basis to the date of death fair market value.
Let’s return to my example where husband left a trust for wife. Assume further that at wife’s death some of the stocks in the portfolio increased by $10/share while other’s decreased by $5/share at the time of wife’s death. Assume further that one of their homes increased in value by $150,000 between the time of their deaths and the other home decreased in value by $50,000.
Without sophisticated planning, not only will the increases adjust when the children inherit the assets, but the decreases will adjust as well, resulting in the potential larger capital gains taxes when those assets are sold. It is possible to draft a will or a trust instrument that would only adjust the basis to the value of the assets that increased, while leaving the decreased basis alone. How that’s done, and whether that strategy is right for a particular client is beyond the scope of this column.
This is but one tax saving strategy that can be considered when planning a client’s estate. There are dozens of others. And, as I wrote at the onset of this column, there remain many non-tax reasons to plan an estate.
MYTH #3 – ONLINE DOCUMENT PREPARATION WILL CREATE A PLAN THAT WORKS FOR ME…
Garbage In, Garbage Out
Anyone who has ever had a computer course has been taught the adage “garbage in – garbage out.” This refers to the fact that while computers do amazing things, if the programmer enters incorrect information then the result will be incorrect. Even with better and better logic based programming, a computer chip doesn’t replace the human mind.
Most clients suspect that attorneys use word processing and software programs to draft their wills, trusts and related legal documents. Certainly that’s true – at least it is in my office. We use a sophisticated document drafting platform designed specifically for estate and trust attorneys. Most other good estate planning attorneys that I know of use similar software.
So does this mean that all most attorneys do is “punch a button” when creating legal documents? While you might view my answer as self-serving, that couldn’t be further from the truth. Once the documents are drafted using the software protocol, we often have to refine the product with “post assembly changes” that are necessary to meet an individual client’s situation. Further, the programs require us to enter an enormous amount of information and answer various prompts which will be different for each individual client based upon their unique profile.
So as you might suspect, if one simply relies upon forms generated from computer programs to tackle a variety of different situations then you’ll fall into the “garbage in – garbage out” problem that belies computer programmers.
A person whose estate is comprised of valuable real estate assets should have documents that have very different provisions than someone whose estate value consists mostly of IRA and 401(k) accounts. A person who is raising minor children should have a will and trust that reads differently than another person who has adult children and grandchildren. A different type of estate plan is warranted for a married couple in their second marriage with children from prior marriages than that of a long-term first marriage with children only from that marriage.
No two estate plans are the same. Be careful when you get advice from friends and relatives, because if you don’t know everything about their own personal and financial situation, then you can’t reasonably compare your plan to theirs.
What about those computer programs such as Legalzoom that are easily found on the internet? Do they do a good job?
Again, the “garbage in and garbage out” rule applies, except here you would be the one making the decisions and answering the questions. I advise any person who asks about these web sites the same thing that I would tell someone who creates their own internet based tax return. That advice is this: In order for these programs to do an effective job, they ask a multitude of questions. Many of the questions are basic, such as those that ask your name, address and phone number. But other questions aren’t so easy to answer without some base legal or tax knowledge.
Unless you know how to properly answer all of the questions that are asked, the product of a self-created will or a self-created tax return using a software program can be dangerously inaccurate.
In order to make my point, assume that you are creating your own will and a question asks you if you want your daughter Sally to be a beneficiary of your estate. You answer “Yes”. It then asks you how much of your estate you want Sally to have.
You know that you have already made Sally a named party on your brokerage account that has $100,000 in it under a “Transfer on Death” (TOD) designation. But you want your son Allen to receive 50% of everything that you own at your death. So you tell the computer program that you want Sally to get 50% of your estate and Allen to get 50% of your estate. Consequently, the will that the program generates reads 50/50 to Sally and Allen.
Is that going to be the end result? Sadly, no.
Why? Because Sally is going to get the $100,000 brokerage account outside of the will since it has a TOD designation. Everything else would then be split 50/50. This isn’t what you wanted. You wanted the TOD account to count towards Sally’s share. You would need to add extra language inside of your will to account for that.
The computer program couldn’t pick this up since it doesn’t know how you own all of your assets. Even if the program asks you how you own your assets, unless you know the difference between a joint account and a TOD account, you will have put garbage into the system and therefore the will that comes out is garbage.
When this happens, the legal and tax costs of fixing the problems are often enormous, since it is much more difficult to undo a mistake than it is to do it right the first time.
I could go on with a multitude of other examples. There are different consequences – both estate and income tax wise – regarding the formulas that a program uses to consume your federal and state tax exemptions. One formula could result in no tax while another formula triggers a lot of tax. Legal differences exist as to how the same words in a will effect adopted children, as opposed to those that are step-children. Business owners who have Subchapter S corporations need yet other provisions to avert income tax problems at death. The list of caveats goes on and on.
While you might save money in the short run creating your own legal documents, unless you are confident that you have sufficient knowledge and expertise not to put garbage into the system, the money you save creating your own documents using internet programs might easily be outweighed by the legal and tax costs of undoing problems created later.
MYTH #4 – MY BANKER TOLD ME TO PUT ALL THE ACCOUNTS IN JOINT NAME, TRANSFER ON DEATH OR PAY ON DEATH…
I hear this question all too often. A client will come in, thinking they have a great solution, and propose, “Should I put my bank and brokerage accounts in joint name with one or all of my children?” In almost all cases the answer is an emphatic “No!”
First and foremost, when you title an account in joint name with someone else you are actually making a gift of half of its value. So if Ethel puts her brokerage account worth $1 million into joint name with her daughter Fran, she just made a gift of $500,000 to Fran (half of the value of the account). Because the most anyone can gift tax free is only $15,000, titling an account worth more than $30,000 would require the filing of a federal gift tax return. In my example, Ethel would have to file a return that would either reduce her gift and estate tax exemption, or if she’s already used up her exemption she may actually have to pay gift tax.
Second, if Ethel’s daughter Fran is experiencing any legal or financial problems, Ethel may have put her account at risk. If Fran is going through a divorce, for example, a forensic accountant may discover the asset and it might be at jeopardy depending upon circumstances. The same holds true if Francoise has creditor or bankruptcy problems.
Third, titling the account jointly will likely thwart Ethel’s estate plan. Assume that Ethel has a will that says that upon Ethel’s death all of her assets are to be divided equally between her three children. If the account is titled jointly with rights of survivorship with Fran, Fran would inherit the account outright despite Ethel’s contrary intention in her will. Even if the account is held jointly as tenants in common, Fran owns half of it and the other half would be distributed in thirds according to Ethel’s will.
Fran might be altruistic and wish to share the account equally with her siblings. But she might have a gift tax problem herself. If she tries to divide the account that she legally owns, she is making a gift in excess of the $15,000 annual gifts that she can give tax-free.
Fourth, accounts owned jointly do not enjoy the full “step-up” in tax cost basis that would otherwise occur. Assume that Ethel owns 1000 shares of ABC Company Stock that is worth $100 share but she paid $10/share many years ago. If Ethel sold all of her shares she would recognize a $90,000 capital gain. But if Ethel dies still owning the shares, her children inherit them at the date of death value for tax cost basis purposes. So if her beneficiaries sold the shares shortly after her death for the $100,000 there would not be any capital gain and therefore no capital gain tax to pay.
But if Ethel places the account in joint name with Fran during Ethel’s lifetime, on Ethel’s death Francoise only gets a one-half tax cost step up. In this case, Fran would recognize a $45,000 capital gain if she sold the shares for $100,000. ($100,000 sales price less $5,000 basis in half the shares and $50,000 basis in the other half of the shares).
Hopefully you are convinced that placing assets in joint name with children isn’t a good idea. So what should you do if you want your child to be able to transact business on your accounts – particularly if you become disabled and unable to manage your own affairs?
This is where revocable living trusts really shine. Ethel can create a revocable living trust and name herself as her initial trustee but also name Franc as her successor trustee in the event of a disability. Fran can then transact business on all of Ethel’s accounts that the trust owns. It is not a gift to Fran since she is acting as a fiduciary for her mother. On Ethel’s death the trust avoids probate and rightfully distributes the accounts to all of Ethel’s children (if that is her wish).
Another alternative is a durable power of attorney. Ethel can sign a durable power of attorney that would name Fran as her attorney-in-fact to transact business on all of Ethel’s accounts. If you have a durable power of attorney created before that date, you should consult with your estate-planning attorney to determine if yours needs updating.
The bottom line is that you shouldn’t put accounts and assets in joint name with your adult children. There are reasonable alternatives that don’t carry all of the disadvantages associated with joint accounts.
MYTH #5 – I MADE AN ESTATE PLAN YEARS AGO…
Your estate plan that was created years ago may no longer be considered valid or effective due to several reasons:
Changing Laws: Laws and regulations related to estate planning are subject to updates and revisions over time. These changes are made to reflect evolving societal needs, address legal loopholes, or adapt to new circumstances. If you created your estate plan years ago, it may not align with the current laws in your jurisdiction. Estate planning laws can vary from state to state and can also be influenced by federal legislation. To ensure your plan remains valid and compliant, it is crucial to review and update it periodically to reflect any legal changes.
State-Specific Requirements: Estate planning requirements can differ from state to state. If you created your estate plan in a different state and have since moved, the laws governing wills, trusts, powers of attorney, and other estate planning documents may have changed. It’s important to update your plan to adhere to the specific requirements of your current state of residence. Failing to do so might result in your plan being deemed invalid or facing complications during the probate process.
Life Circumstances and Intentions: Over the years, your personal and financial circumstances may have changed significantly. These changes can include acquiring new assets, getting married, divorcing, having children, or experiencing shifts in your financial situation. An estate plan that was created years ago might not adequately address these new developments or reflect your current wishes. Regularly reviewing and updating your estate plan ensures that it accurately reflects your intentions and provides for your loved ones according to your current circumstances.
Outdated or Incomplete Documents: Estate planning documents, such as wills, trusts, and powers of attorney, require specific language and provisions to be legally effective. If your estate plan was created years ago, the language used in the documents might be outdated or fail to include necessary provisions that address contemporary issues or changes in the law. Outdated or incomplete documents can lead to ambiguity, disputes, or challenges to the validity of your plan.
Beneficiary Designations: In addition to formal estate planning documents, beneficiary designations on accounts and policies play a crucial role in asset distribution. If you haven’t reviewed and updated beneficiary designations over time, they may not align with your current wishes or account for changes in your family structure. Outdated beneficiary designations can result in assets passing to unintended beneficiaries or not reflecting your current preferences.
To ensure the effectiveness and validity of your estate plan, it is recommended to consult with an experienced estate planning attorney. They can review your existing plan, consider any changes in your circumstances or the law, and guide you through the process of updating and revising your estate planning documents to meet current requirements.
Please note that this explanation is general in nature, and it is always advisable to consult with a qualified estate planning attorney who can provide personalized advice based on your specific situation and the laws of your jurisdiction.