Klitzman Law Group, PLLC

The Importance of a Will

“There’s much to plan for in life—college, your wedding, your first child, life insurance—and with more than enough to keep you busy, it’s easy to forget about your will.”

Even during a pandemic, few people want to spend time thinking about death. However, having an estate plan means having some of the most important documents you’ll ever create. Having a will is a gift that alleviates the burden placed on loved ones after we are gone, says this recent article “Why it’s important for every adult to get a will” from Bankrate. In a time of sorrow, the family and friends will be spared the stress that makes grieving more complicated when there is no will, no guidance and no path forward.

What is a will?

In its most simple form, a will is a legal document that serves to transfer property at your death to the people you choose. It is revocable, which means you have the legal ability to make changes to it, as long as you are alive and have the mental capacity to do so. However, wills do more than distribute property. The will is your chance to state your wishes for who will care for your children, what happens to your physical remains and who will take care of your pets.

Are Wills Pretty Much the Same?

There’s a good reason why the best wills are those created with an estate planning attorney: they are created to suit your specific needs. Just as every person is different, everyone’s will must reflect their life. Some people want to name a recipient for every single asset they have, while others prefer simply to give their entire estate to a spouse, their children, a trust, or a charity. However, there are also different kinds of wills.

A Testamentary Will is a will signed in the presence of witnesses. It is the best choice to protect your family.

A Holographic Will is a handwritten will, which is not acceptable in many states and could lead your family into all kinds of expensive and stressful battles, in and out of court.

An Oral Will is a verbal will that is declared in front of witnesses, but don’t count on anything you say being considered a legally valid will.

A Mutual Will is also known as a “I love you Will,” when partners create a joint will leaving everything to each other. There can be some tricky things about these wills, since when one person dies, the other is still legally bound to the terms of this will. If the surviving spouse remarries, it can become complicated.

A Pour Over Will is the ideal choice, when your plan is to pour assets into an established trust at your death.

What does a will do and not do?

Wills are used to determine guardianship for minor children and distribute assets and real property. Wills don’t control jointly owned assets, or contracts, like life insurance policies and retirement accounts. These are controlled by beneficiary designation forms. It won’t matter if your will says that your current spouse should inherit your retirement account and you never changed the beneficiary from your first spouse. This is why estate planning attorneys always tell clients to check on beneficiary designations when large life events, like divorce and remarriage, occur.

What happens if there is no will?

Without a will, the state’s laws will determine what happens and your wishes don’t count. That includes who inherits your property, and even who raises your minor children. The court will make all of these decisions. The stress that this creates cannot be underestimated. When there is no will, the chances of litigation between family members and trouble from distant relatives seeking a claim against your estate rises.

Reference: Bankrate (Nov. 6, 2020) “Why it’s important for every adult to get a will”

What Is Purpose of an Irrevocable Life Insurance Trust?

“Death and taxes may be certainties of life, but how much tax your family pays upon your death is still within your control to a certain degree.”

Irrevocable Life Insurance Trusts, or “ILITs” are life insurance policies owned by irrevocable trusts used to manage taxes on estates. There are complexities to using an ILIT, but the benefits for some people could be big, according to the article “What Advisors Should Know About Irrevocable Life Insurance Trusts” from U.S. News & World Report.

What is the goal of an ILIT? The goal of an Irrevocable Life Insurance Trust is to own a life insurance policy, so the proceeds of the policy are left to heirs, who avoid estate tax. It’s a type of living trust but one that cannot be dissolved or revoked, unless the trust does not pay premiums and the insurance policy owned by the trust lapses.

The federal estate tax exemption is currently $11.58 million for individuals, and $23.16 for married couples. Most people don’t need to worry about paying federal estate taxes now, but this historically high level will not be around forever. The current law ends in 2025, cutting the exemption by half. If Congress needs to raise revenue before then, change could come sooner.

Who needs an ILIT?

The main advantage of an ILIT is providing immediate cash, tax free, to beneficiaries. The value of the ILIT is out of the estate and not subject to taxable estate calculations. The life insurance policy ownership is transferred from the insured to the trust. The insured does not own or control the insurance policy, but this is a small price to pay for the benefits enjoyed by heirs.

The grantor is the insured person, and the policy is purchased with the ILIT as the owner and the beneficiary. The insured cannot be the trustee of the trust. In most cases, the trustee is a family member, and the insurance premiums are paid through annual gifting from the insured to the trust. These are the details that should be explained by an estate planning attorney to maintain the trust’s legitimacy.

If all goes as planned, when the insured dies, the ILIT distributes the life insurance proceeds tax-free to beneficiaries.

How does an ILIT work?

Let’s say that you have assets worth $15 million. You buy a life insurance policy that will pay $5 million to your children. When you die, your taxable estate would be $20 million, which in 2020 would incur about $3.3 million in federal estate taxes. However, if you used an ILIT and the ILIT owned the $5 million policy instead of you, your taxable estate would be $15 million. Your federal estate tax in 2020 would be about $1.3 million. The estate would save $2 million simply by having the ILIT own the $5 million life insurance policy.

What if the estate tax exemption goes down before you die?

If the estate tax exemption goes down and you have already funded the ILIT, it remains safe from estate taxes. Here is another reason to consider an ILIT—as long as the funds remain in the trust, they are safe from beneficiary’s creditors.

Are there any downsides to an ILIT?

ILITs are not do-it-yourself trusts. They are complex and need to be structured so that the annual contributions used to pay the insurance premiums qualify for the $15,000 gift tax exclusion. To do this, an estate planning attorney will often include a “Crummy” power, which allows the insured to pay the trust for the premium, without reducing their lifetime gift tax exemption amount. However, it also means that beneficiaries need to be well-educated about the ILIT, so they don’t make any errors that undo the trust.

When a contribution is made, Crummey letters are sent to the beneficiaries, letting them know that a gift was made to the trust and they have the right to withdraw the money. However, if they withdraw the money, the insurance policy could collapse.

You’ll need to be committed to keeping this policy for the long run. You’ll need to be able to fund it appropriately.

There is also a three year look back for existing insurance policies that are moved into the ILIT, so the grantor must be alive for three years after the policy is given to the ILIT for it to remain outside of the estate. This does not apply when a new policy is established in the ILIT and does not apply if the ILIT buys the policy from the grantor.

Reference: U.S. News & World Report (Oct. 29, 2020) “What Advisors Should Know About Irrevocable Life Insurance Trusts”

Homeownership and Medicaid Can Be Problem

“Many people work hard to acquire real estate and then later find that that real estate makes them ineligible for Medicaid to help pay for nursing home or in-home, long-term care.”

The challenges begin when homeowners don’t do any Medicaid planning and decide the best answer is simply to gift their home to their children. It doesn’t always work out well for the homeowners or their children, warns the article “Owning real estate without jeopardizing Medicaid paying for nursing home” from limaohio.com.

A key tax avoidance opportunity is usually missed, when real property is gifted outright. The IRS says that if someone owns real estate, when that person passes, the heirs may eliminate a large portion of the taxable gains, if the real estate ends up being sold by an heir for more than the original owner paid for the property.

Let’s walk through an example of how this works. Let’s say Terry buys a farm for $1,000. The cost to buy the farm is referred to as a “tax basis.”

If the family is planning for the possibility of nursing home costs, Terry might want to give that farm away to her children Ted and Zach. She needs to do it at least five years before she thinks she’ll need Medicaid to pay for long-term nursing care, because of a five-year lookback.

When Terry gifts the farm to Ted and Zach, the two children acquire Terry’s tax basis of $1,000. Ted gets $500 of the tax basic credit, and so does Zach.

The years go by and Ted wants to buy out Zach’s half of the farm. The farm is now worth $5,000. So, Ted pays Zach $2,500 for Zach’s half of the farm. Zach now has a tax basis of $500, which is not subject to tax. And Ted receives $2,000 more than his $500 tax basis, and Ted will need to pay capital gains on that $2,000 gain.

It could be handled smarter from a tax perspective. If Terry owns the farm when she dies, then Ted and Zach get the farm through her will, trust or whatever estate planning method is used. If the farm is worth $3,000 when Terry dies, then Ted and Zach will get a higher tax basis: $3,000 in total, or $1,500 each. By owning the farm when Terry dies, she gives them the opportunity to have their tax basis (and amount that won’t be taxed if they sell to each other or to anyone else) adjusted to the value of the property when Terry dies. In most cases, the value of real estate property is higher at the time of death than when it was purchased initially.

There’s another way to transfer ownership of the farm that works even better for everyone concerned. In this method, Terry continues to own the farm, helping Zach and Ted avoid taxes, and keeps the property out of her countable assets for Medicaid. The solution is for Terry to keep a specific type of life estate in the farm. This needs to be prepared by an experienced estate planning attorney, so that Terry won’t have to sell the farm if she eventually needs to apply for Medicaid for long term care.

Your estate planning attorney will be able to help you and your family navigate protecting your home and other assets, while benefiting from smart tax strategies.

Reference: limaohio.com (Nov. 7, 2020) “Owning real estate without jeopardizing Medicaid paying for nursing home”

When Should Succession Plan Be Used?

“We currently have the highest estate tax exemption and the lowest intra-family interest rates in history. That combination alone is significant, but when mixed with the potential for lower estate and gift tax exemptions and depressed business valuations, you have a potent catalyst for transitioning ownership.”

Anyone with a taxable estate that includes an operating business should be looking into the efficacy of making gifts in 2020 to take advantage of a unique set of circumstances, advises the article “Why Now is the Right Time to Execute Succession Plans” from Worth.

The federal exemption from transfer taxes is at a historically high level. Individuals may transfer up to $11.58 million of assets during their lifetime without incurring federal gift, estate or generation skipping transfer tax (GST). The current maximum federal gift and estate tax rate and the current maximum federal GST tax rate is now 40 percent. As the law stands now, this amount is not scheduled to be reduced until the end of 2025, but whether that will remain is anyone’s guess.

The IRS has stated that it will not attempt a claw back of taxes if the exemption amount decreases soon, so taxpayers who put off taking action before December 31, 2020 will miss out.

Lower Value Another Incentive to Develop a Succession Plan

It is important not forget the impact of the global pandemic. Valuations in some parts of public markets continue to be high, but many private companies have lost a lot of value. The lower appraised values can be beneficial for succession planning. If a business owner is willing to transfer all or a portion of the private company to successive generations now, that lowered appraisal value means that more wealth can be shifted. There is the possibility of growth in the future, free of gift, estate, or GST tax.

How Do Interest Rates Impact Succession Plans?

Many strategies used to transfer assets between generations are based on interest rates which are near the lowest they have ever been. Every month, the IRS releases the updated Section 7520 and Applicable Federal Rates (AFR). These are the rates used for transfer techniques like GRATs and intra-family loans. In October, the 7520 rate was 40 basis points (“bps”), and the Mid-Term Annual AFR, used for loans with terms of three to nine years was 39 bps.

Succession Plans Take Time to Create

This unique combination of exemptions, low business valuations and low interest rates is likely to lead many business owners to their estate planning attorney’s offices to implement succession plans before the calendar years ends. The smart move is to contact your estate planning attorney, CPA, and financial advisor as soon as possible to discuss options, and get succession plans going. There will likely be a more-than-usual last minute rush to complete many financial and legal tasks this December, and getting started as early as possible will make it more likely that your succession plan can be completed before December 31, 2020.

Reference: Worth (Nov. 2, 2020) “Why Now is the Right Time to Execute Succession Plans”

What Does Legacy Planning Mean?

“To ensure a lasting legacy, you need to get your documents in order and have a clear plan for how your wealth will transfer, avoiding taxes and inheritor pitfalls along the way.”

Asset distribution is how many estate plans begin, but we can create legacies for generations to come through our estate planning, says Kiplinger in the article “Legacy Planning: Create a Lasting Legacy.” You may not realize it until you sit down to prepare an estate plan, or even until you prepare a second estate plan. Your life has been devoted to building wealth and now it’s time to plan for the next generation. This is when estate planning becomes legacy planning.

Why is Legacy Planning Important?

If the goal is to leave wealth to children, the plan may be simply to bequeath assets.

However, if children are not good at handling money or if there is a concern about a marriage’s longevity, then you’ll want to look past a simple transfer of assets on death. For some families, a concern is leaving too much wealth to children, undermining the parent’s life of work and respect for their accomplishments. Legacy planning addresses these and other serious issues.

Which Documents are Necessary for Estate Planning?

Most people need the following documents:

Revocable Living Trust, or RLT. The person who creates this trust maintains full control of assets that are titled to the trust while they are living, and then directs how assets are to be passed on when one spouse dies and then after both spouses die.

Pour-Over Wills. Used in conjunction with a RLT, these work to direct assets to the RLT.

Durable Power of Attorney. These documents are part of planning for incapacity. They designate a person who will make financial and/or legal decisions for you, if you cannot do so.

Health Care Directives. Note that these have different names and details, depending on the state. For most people, they consist of a Living Will and a Durable Power of Attorney for Health Care. Together, these two documents provide a platform for you to share wishes about medical care. The Living Will gives guidance about your wishes, if you become too sick to communicate, including your wishes on pain medication, artificial feeding and hydration and resuscitation. The Durable Power of Attorney (sometimes called a Health Care Proxy) names a person who can make health care decisions, if you can’t do so for yourself.

How Do I Leave a Lasting Legacy?

Many people believe that their children should be the only beneficiaries of their wealth. However, for others, even those with modest estates, supporting an organization that has meaning to them through a gift in their will is just as important as leaving money to children and grandchildren.

Here are a few questions to consider when thinking about a legacy:

• How much wealth is “enough” for heirs?
• At what age should money be transferred to heirs?
• Should incentive milestones be created, like completing college, attaining higher education goals, or staying sober?

If assets are left directly to children, there is always the risk that they may lose the wealth. Sometimes that is not the child’s fault, but this can be prevented with good planning. Inherited assets can be protected in trusts, which can be created to protect wealth and provide for professional management.

Do Trusts Avoid Estate Taxes?

Another important consideration when creating a legacy, is minimizing tax liabilities. Not every estate plan is designed with taxes in mind, so you’ll want to discuss this with your estate planning attorney.  The issue of taxes can become more complex, if the estate includes illiquid assets, including real estate or a family owned business.

Reference: Kiplinger (Oct. 30, 2020) “Legacy Planning: Create a Lasting Legacy”