Recent surveys have shown that a majority of Americans are unaware of the necessity of an estate plan for their future and that of their heirs. An estate plan ensures your property will end up in the right hands after you have passed and can relieve your loved ones of the burden of having to make difficult financial and medical decisions for you, in the event you're physically or mentally incapable of doing so for yourself. So if you are one of those Americans without a Living Trust as part of your estate plan or without an estate plan altogether (or you are not sure what an estate plan entails), below are the answers to your basic estate planning questions.
What is Estate Planning? Estate planning involves maximizing a client's control of his/her assets during his/her lifetime, while also planning for the beneficiaries' acquirement of such assets after the client's death. It involves preparing certain legal documents, including a Living Trust, Will, Durable Power of Attorney for Assets, Advance Health Care Directive, among others, which are customized to represent each client's desires and unique situation. By analyzing factors such as the client's net worth, types of assets owned, and family situation, we can implement a plan to minimize federal estate taxes (which can be up to 55%), avoid probate, provide for the care of minor children and preserve large sums of money until beneficiaries mature and are financially capable of managing said sums.
Consequences of No Estate Plan. The law allows every person to make his/her own decisions regarding the management of his/her finances (who will run the business, access the bank accounts, pay the bills, etc.), health care decisions (whether to be placed on life support, burial/cremation instructions, etc.), who to appoint as guardian(s) for minor children, and the manner in which assets are transferred to the beneficiaries. Only when the individual fails to make these decisions does the state of California implement its own plan. For example, if an individual passes without a Will, then the individual's assets must pass through probate (discussed below) and will be distributed by the California "intestacy" laws.
Intestacy is a set of rules by which a court determines who will receive your assets in the event you do not leave a Will. Many married persons assume the deceased spouse's assets will automatically transfer to the surviving spouse if either spouse passes without a Will. In actuality, the intestacy laws provide the surviving spouse with as little as one-third of the assets. [See Case Study 1 for an example where the surviving spouse is only left with ½ of the deceased's spouse's assets.]
CASE STUDY 1: Spouse Only Gets Half
Assume that Henry, who is married to Wendy, recently died with a $1 million estate, but without a Will. Henry had no children and his parents and siblings are deceased. Henry's only living relative is his sister's adult daughter, Debbie. Pursuant to the California intestacy laws (the law that applies if there is no Will), Wendy would receive only ½ of the estate and Debbie would receive the other ½. Henry's relationship with Debbie is not even considered by the court. Henry may have never even met Debbie. Nevertheless, Debbie will receive $500,000 from Henry's estate and Wendy is only left with the remaining $500,000.
So all I need in order to avoid probate is a Will, right? Wrong! In actuality, a Will is your admission ticket into probate. An additional legal device is required to keep your estate out of probate court, the most effective and flexible of which is a Living Trust.
Pitfalls of Probate. Probate is the legal proceeding in which a probate judge and a probate attorney oversee the transfer of the deceased's assets to the beneficiaries. The next logical question is: Why do I want to avoid probate? First, the probate proceeding is a lengthy process, which can take anywhere from six months to several years for the final distribution of the assets to occur. Second, an administrator/executor is designated by the court and must take inventory of all the deceased's property and provide a detailed account to the court, which is public record for anyone to see. Lastly, the cost of probate is significant and may be the most compelling reason to avoid probate. For example, the probate fees for a $4 million estate in California will be $53,000, and the judge has the discretion to approve additional fees to the attorneys and the administrator/executor, which is routinely granted. Accordingly, we advise that you create a Living Trust in order to bypass these obstacles.
A Living Trust Avoids Probate. Transferring title of all assets to a Living Trust will ensure that one avoids probate and therefore is an absolute necessity in almost every estate plan. The law views a Living Trust as a reliable legal instrument that does not require the supervision of a judge in probate court. Instead, upon the individual's death, the assets owned by the trust are managed and distributed by one or more persons appointed by the client (called a "Trustee"). The law assumes that since the client consulted an attorney and prepared a Living Trust, then that client's choice for Trustee will be capable of handling the affairs of the estate. In addition to avoiding probate, a Living Trust can also help to avoid estate taxes.
Estate (Inheritance) Taxes. The federal estate tax is considerable and is a vital consideration in the preparation of any estate plan. In 2009, the "exemption amount" (a dollar figure representing the value of assets a person can transfer at death without incurring tax) is $3.5 million per person and the maximum tax rate for each dollar over the exemption amount is 45%. However, starting in 2011, the exemption amount will be reduced to only $1 million with a maximum tax rate of 55%, unless revised by the Obama administration. This means that if a person dies in 2011 or thereafter, the first $1 million of his/her estate will be exempt from estate taxes, but any amount over $1 million will be subject to federal estate taxes of up to 55%. A properly drafted Living Trust can significantly reduce or even eliminate the federal estate tax. [See Case Study 2.]
CASE STUDY 2: Unnecessary Estate Taxes
Harold and Wilma have a combined estate of $4 million, all of which they own together as community property. If Harold dies in 2006 and leaves his entire share to Wilma, then Wilma's estate will be $4 million. If Wilma dies in 2011 (when the exemption amount is $1 million), then $3 million of Wilma's estate will be subject to estate taxes at the rate of 55%, or $1,650,000 in taxes!
But, if Harold and Wilma had jointly created a Living Trust, then the estate tax savings would be substantial: Instead of leaving Henry's $2 million share directly to Wilma, this amount is put into an Exemption Trust. Wilma has access to the assets in the Exemption Trust during her lifetime. Then at Wilma's death in 2011, the value of her estate is only her $2 million share, because the amount in the Exemption Trust is not counted in her estate. So, if Wilma dies in 2011, the estate tax liability would be $550,000 ($1 million x 55%) instead of $1,650,000 without proper tax planning. That's a savings of $1.1 million in taxes!
Thus, having a proper estate plan in place can result in hundreds of thousands, or even millions, of dollars in estate tax savings.
How We Can Help. At our firm, we walk our clients through every step of the estate planning process, from discussing the client's goals and family situation at the initial meeting to overseeing the proper execution of the paperwork in accordance with California's rigid requirements. Due to the subject matter and difficult decisions involved, many people procrastinate when it comes to estate planning. But to ensure that your legacy and loved ones are protected, a proper estate plan is a necessity and should be implemented as soon as possible.
