The following is a glossary of terms used by estate planning attorneys.
Power of Attorney
The power of attorney is the legal document that authorizes someone to act on your financial matters during your lifetime. All powers of attorney lapse at death. There are several types:
Immediate: The authority granted in it can be used immediately.
Springing: The authority granted in it can only be used (ie. it “springs” to life) when some intervening event “triggers” its use (i.e. when the person’s physician signs a statement declaring the person incapacitated and unable to manage his/her business affairs).
Limited: The authority granted in it can only be used for certain tasks and/ or for a limited duration of time. For example, authority to sign agreements for the purchase of real property that lasts only 2 weeks during which time the person granting the authority is out of town and cannot personally sign.
General: The authority granted in it can be used until the power is revoked or the person granting the power dies.
The power of attorney is useful for all estates, even when revocable living trust is used. Not all assets can be placed into a trust. Examples include: annuities, tax-deferred assets such as IRAs, social security and other government benefit programs, actions as plaintiff/petitioner or defendant/respondent in a court action. The power of attorney has major drawbacks. Most publicly traded institutions and transfer agents for individual stocks bonds and mutual funds are reluctant to accept it. Institutions cannot be forced to accept the directions listed by the person named in the power of attorney.
In most states a power of attorney cannot be used to create a Last Will on behalf of another, but it can be used to establish and fund a revocable and irrevocable living trust for that same person.
Advance Directives for Health Care
Living Wills are the written declaration that the person wishes to die naturally and not have life sustaining measures instituted.
Advance Directives typically include similar declarations found in the living will. Some allow specific references to issues of removal of life support, tube feeding and other measures. More importantly, the advance directive identifies those the grantor designates as decision-maker having the authority to sign medical releases and treatment orders.
Not all medical decisions are so-called “end-of-life” decisions. A single visit to an emergence room demonstrates the need to have someone with the legal authority to sign all variety of health care papers. Unless an injury is life threatening, no care will be provided until someone authorizes treatment.
Advance Directives are state-specific. Therefore, signing one in your state of residence may not be recognized and given full faith and credit in another state: certain powers listed in an advance directive in one state may not be honored in another state if that other state determines that the power conflicts with its laws.
This legal document is written express of your desires of important matters at death:
Who is to raise minor children as guardian?
Who is to manage the inheritance for minor children and when (and in what amount) should your heirs receive their distribution? Most states provide for outright distributions once the beneficiary is considered an adult (age 18). A Will can include provisions for age-appropriate distributions to beneficiaries.
How you intend to provide for beneficiaries in a multi-family household?
How do you intend to provide for someone that is not a legal heir to your estate? Examples include a companion, stepchildren or step-grandchildren, friends and charities.
It can eliminate the need for the payment of insurance bond during the legal process of implementing your wishes (probate).
For married couples, at the death of the first spouse, it can establish a means recognized by the IRS that permits the doubling of the estate tax exemption amount.
This is the legal process that is followed at the death of an individual when that individual owned assets in his/her name at death.
The greatest benefit provided by the process of probate is the settlement of claims within a limited period of time. Claims in estates that rely exclusively on the use of revocable living trusts may expose the estate to claims well after the statute of limitations expired in a probated estate. The issue of whether or not to use probate depends on the individual circumstances and it is not an all-or-nothing situation. Often probate is used in conjunction with a living trust by limiting the assets subject to the initial probate thereby reducing the costs of that process.
Certain assets are not subject to probate:
Assets jointly owned with another person with right of survivorship. Assets jointly owned as tenants in common are subject to probate.
Assets held in the name of the trustees of a revocable living trust.
Assets can be distributed by beneficiary designation. These include: life insurance, annuities, tax-qualified accounts and payable-on-death or transfer-on-death accounts.
Assets can be held only with a “life-estate” interest. Examples include real estate specifically titled in this manner and property held in a charitable remainder trust.
There are two “types” of probate:
“Short-form” or those reserved for small estates. These are typically handled through the filing a certificate or affidavit in the county where the person died, where the person lived, or where the person owned real property. This abbreviated process can last up to 6 months and usually involves the mere expiration of time to permit assets to transfer to the surviving heirs. If objections are filed, this type is transferred into a “long form” for disposition.
“Long form” for all other estates that are larger than those designated as “small estates”. This form can last 6 months to several years depending on the complexity of assets, or the intensity of debate surrounding the decedent’s wishes.
Tax planning takes two general forms: measures to take during life, and those to take at death. Naturally, the legal documents to implement both must be in place well in advance of death.
Lifetime planning techniques:
Gifting of cash,investments, business interests and real property and life insurance. Gifts to individuals have annual limits on amounts that would otherwise be subject to gift taxes. Gifts to charities can be in any amount, but limits are imposed as to the amount that can be deducted from income taxes in the year of gift.
Spending or reducing growth.
One can try to spend their children’s inheritance, but this is neither always possible nor very practical.
Modifying an investment portfolio that moves from aggressive growth funds to ones that do not produce as much internal gain in value also serves as an estate plan. The risk of this type of plan involves a potential drop in lifestyle if expenses exceed the income produced by investments.
Converting investments into income can help reduce an estate. This can be done using several methods:
Annuitize an investment. This may trigger an income tax and frees up money to pay expenses and lifestyle needs.
Transferring assets into a charitable remainder trust (CRT).
Implementing a self-canceling note (SCIN).
Using a qualified personal residence trust (QPRT)
Using a grantor retained trust (GRAT).
At death, planning involves the creation during ones lifetime the legal means to reduce future exposure to estate taxes. They include:
Last Wills or revocable living trusts and the appropriate separation of assets to fund trusts known as a Credit Shelter or Bypass Trust. The IRS doesn’t care if an estate is administered through probate or through a trust that avoid probate. The IRS wants to know the size of the estate.
At death gifts to charities, including direct gifts and “deferred” gifts such as a charitable remainder trust (or private foundation) of any asset, including annuities and those assets held in tax-qualified accounts.
Life insurance can serve many purposes during ones lifetime. It provides cash in a time of need. Those needs evolve over time:
The need to provide for a surviving spouse who is dependent on the income of the insured.
The need to provide for the surviving children and pay for the costs of raising the children and, where possible, provide higher education.
The need to provide cash to pay off debts such as mortgage debt, credit card debt or debt associated with the ownership and operation of a business (and other costs incurred by a business when a principal of the business dies).
The need to protect valuable assets from being sold to pay estate taxes (and income taxes on all tax-deferred accounts). The IRS requires full payment 9 months from date of death.
How you own it matters: If you own the policy or have “incidents” of ownership over a policy, it is estate taxed at its death benefit. Incidents of ownership include the ability to name beneficiaries, the power to borrow against the policy, the power to cancel the policy.
Insured owner – spouse beneficiary: The full death benefit is paid to the spouse and adds to the size of the spouse’s estate that will ultimately be estate taxed.
Insured owner – estate beneficiary. This arrangement will pay the full death benefit to the insured’s estate. With proper planning in the appropriate size of estate, the life insurance can be used to more completely fund the insured’s exemption amount that is free of estate taxes.
Cross purchase arrangements. Cross purchase arrangements work in a different manner. At the first death, the proceeds of the one policy are paid in cash to the surviving spouse. The decedent’s ownership interest in the other policy (of which the surviving spouse is the insured) is then determined (known as its interpolated terminal reserve value) and that value is added to the decedent spouse’s estate to calculate whether or not estate taxes are owed at that first death. To make this plan work; however, there has to be a means to hold the policy that precludes the surviving spouse from having an incident of ownership. In practical terms that means that the surviving spouse cannot be the trustee of the trust fund that holds ownership and control over the policy.
Irrevocable Insurance Trust as owner and beneficiary. Using this technique the insurance is owned outside the estate of the insured making the death benefit completely free of estate taxes. Payment of premiums can be exposed to gift taxes, but methods exist that can either reduce or eliminate these taxes as well. Existing insurance policies as well as new insurance can be purchased through a properly prepared ILIT, with the exception that any existing life insurance transferred to an ILIT in which the insured dies within 3 years of the transfer remains subject to estate taxes. This is the method of ownership that guarantees that none of the death benefit is subjected to estate taxes.
Funding a revocable trust
Funding is the second stage of creating a living trust. Once the document is properly signed; the next step is to make sure that all assets are properly transferred to the trust.
Assets held in trust will avoid probate so if the primary purpose of the trust is to avoid probate it is critical that title to these assets is changed.
General investment accounts should be transferred to the ownership of the trustees of the trust.
Ownership of tax-qualified assets should remain in the individual’s name. If there is a spouse, that spouse should be named as the primary beneficiary. The owner’s other family members can be named as contingent beneficiary or the trustees of the trust can be named as the contingent beneficiary.
Real property should be transferred to the trust. If there are any liens or other debts secured by the property it is important to obtain consent from the lender prior to recording any transfer documents.
Ownership of business interests should be transferred to the trust. If the business entity is an S-election corporation, special provisions need to be added to the trust document to ensure that the corporation does not lose this status. Shareholder, member or partnership interests can all be transferred to the trust.
Certificates of Deposit, individual issues of stocks and bonds need to be individually transferred to the trust. If there are any dividend reinvestment programs, each needs to be transferred to the trust.
Savings, credit union and bank accounts can be left in the individual’s name but each needs to have the trust added as the payable (transfer) on death beneficiary. This is done so that any gifts made by the owner of the account will qualify for the annual gift tax-free exclusion amount. Gifts directly from a revocable trust do not automatically receive gift tax-free treatment.
Vehicles typically remain in the individual owner’s name. Issues relating to the risk of loss of property casualty insurance coverage make the transfer to the trust unwarranted. In most states, title to most vehicles can be transferred without probate court.