Estate Planning Overview
In the years ahead, people will transfer an unprecedented amount of wealth to their heirs. Many of these people will pay more than their fair share of estate tax. How can you be sure that your estate passes on to the next generation in the most tax-efficient manner possible?
An essential part of the Estate Planning process is a review of all the types of insurance. Generally, this review focuses on life and disability insurance as it is important to plan for death as well as for the possibility that you may become disabled and experience a reduction in income. This process may also include a review of additional types of insurance including personal liability and health insurance.
At ARS Private Wealth we specialize in helping our clients create Estate Plans that are designed to work toward the objectives they have for their loved ones and future generations.
Along with your Retirement Wealth Plan, we will also assist in designing your Estate Plan by working side-by-side with our Estate Planning Attorneys who specialize in preparing plans for our clients.
For clients needing Estate Planning services, ARS Private Wealth will include the Estate Plan design in your Retirement Wealth Plan. In addition, we have negotiated special rates with our Estate Planning Attorneys, which saves our clients a significant amount in the drafting of these documents.
The formal execution of all documents in your Estate Plan can be done at our office in Houston or if you are out of town, we can provide instruction on proper execution at your place of residence.
During the entire process, we will act as the liaison between you and the attorneys, making the process simple and effortless to you and your family, just as we have done with all of our crew members needing this service.
Your Estate Plan will actually become a part of your overall Retirement Wealth Plan.
The following is a summary of the Estate Planning and financial process and a discussion of some tax planning techniques used at ARS Private Wealth. Although somewhat lengthy, it is intended only as a reference and is for informational purposes only Obviously, the process will vary from client to client according to his or her particular needs.
A Will is the most basic, albeit a vital, part of an Estate Plan. Generally, a Will covers the disposition of your property at death and may include the following provisions:
▪ Specific gifts of cash or property
▪ Direction regarding the division and distribution of the remainder of your estate
▪ Designating an Executor to carry out your wishes
▪ Setting forth trust provisions if a trust is established to hold property for a child or grandchild OR to protect property from a beneficiary's creditors, divorce, incompetency, and other similar events.
▪ Guardian designation for minor children
Statutory Durable Power of Attorney
This document allows you to name an individual or individuals who may make financial decisions upon your behalf should you become incapacitated or unconscious.
Power of Attorney for Healthcare
A Power of Attorney for Healthcare names one or more individuals who are authorized to make healthcare decisions if you become incapacitated or unconscious.
Many clients incorporate a Living Will into an Estate Plan. This document is also known as a “Directive to Physicians” and includes a statement with the wish of whether or not to be kept alive by artificial means.
There are many things to consider during the outlining process for a Will. Our Estate Planning worksheet is provided within this planning guide to help organize the process.
Together, we can design your Estate Plan for the distribution of property and decide if Trusts are to be established for certain individuals.
Types of Trusts
Several types of Trusts may be established to ensure that the distribution of your assets occurs in accordance with the intentions of your Will. Often, the majority of your Estate Plan will be contained in the Trust.
A Living Trust works in conjunction with your Will and can assist in the following ways:
▪ It provides protection against the establishment of a court-supervised guardianship to manage your assets should you or your spouse become incapacitated
▪ It establishes a Successor Trustee who will manage your assets
▪ The distribution of your Estate remains a private matter and does not become a matter of public record once probated
▪ Any assets you transfer to the Trust during your lifetime will not become part of your probate estate or a matter of public record
▪ LPL Financial Representatives offer access to Trust Services through The Private Trust Company N.A., an affiliate of LPL Financial
A Will and Living Trust are typically executed at the same time. Once the Living Trust is established, it allows you the ability to transfer assets to it during your lifetime and assists you in managing and investing your property. In particular, if you own or buy real property outside your state of residence, we typically suggest that your Trust take title to the property to avoid probate in the non-resident state.
Family Limited Partnership
A Family Limited Partnership may be used as a means of reducing the value of some of the assets of your Estate.
In particular, it allows you to transfer your property to a partnership as a separate entity and allows for gifts of partnership to be made several months later, so at your death you only own an interest in a partnership, rather than holding title to the assets. In some cases, this can generate significant discounts and works well for real estate, oil, and other business type assets.
For example: If the initial assets of the partnership have a fair market value of $3,000,000 at the time of your death and you have retained a 20% interest (1% general and 19% limited), your estate’s interest in the partnership may have a value not of $600,000, but rather of $350,000 or $400,000.
If implemented properly, use of a limited partnership may have significant benefits at the time of your death and may allow additional discounts to the value of the assets held in the partnership.
Qualified Personal Residence Trust
A Qualified Personal Residence Trust involves the transfer of your primary residence or a secondary residence, or both, to a trust that will continue for a term of years and then is distributed to your children.
While the trust is in existence, you and your spouse may continue to live on the property and use it as you wish. However, upon termination of the trust, the property itself will then be distributed to your children.
These types of trusts are established with the intention that you would rent the property from the trust after it terminates. While the trust holds the house, you should continue to be eligible for benefits such as:
▪ Property tax deduction
▪ Mortgage interest rate deductions
▪ Rollover of primary residence under Section 1034
▪ Special rules of capital gains on the sale of the primary residence
The amount of the gift for estate and gift tax purposes is based on IRS tables and will depend upon the length of the trust and your life expectancy.
You, your spouse, a child, friend or bank may be a Trustee of one of these trusts.
Short-Term Grantor Retained Annuity Trust
A Short-Term Grantor Retained Annuity Trust (GRAT) may be used to transfer income/appreciation in your investments to your children at a low gift tax cost and has the following characteristics:
▪ The trust has a stated term of two to four years
▪ While in existence, the trust's obligation is to pay you a specified annual amount (the retained annuity)
▪ At termination, any property remaining in the trust would be distributed to your children free of state or gift tax
▪ Should you die before termination of the trust, the trust would not result in any benefit to your estate as the remaining property in the trust is included for estate tax purposes
The purpose of this type of trust is to allow your children to receive, on a virtually tax-free basis, the investment returns on property in excess of the state’s IRS interest rate.
Charitable Lead Trust
A Charitable Lead Trust includes a charity as a beneficiary. Under a Charitable Lead Trust, you make a gift of property to the trust, which provides for payment of a specified amount each year to one or more institutions for a stated period of time.
At the end of the stated period, the trust would terminate and the property remaining in the trust would be distributed to your children or a trust for their benefit. You would not be entitled to any income tax deduction at the time the trust is established. For income tax purposes, the Charitable Lead Trust is not a grantor trust and is taxable on its income, including capital gains. However, the annual amounts paid to the charity(ies) are deductible by the trust, thereby resulting in an indirect benefit.
Charitable Remainder Trust
A Charitable Remainder Trust is exempt from income tax, including capital gains and gifts to the trust can generate charitable income tax deductions.
If you transfer appreciated securities to the trust, those securities could generally be sold without incurring capital gains tax. The trust provides for specified payments each year to the donor so long as he is alive. Payments received from the trust have the same income tax characteristics as the income generated by the trust.
Since a charity will ultimately receive some property from this trust, you will be entitled to a charitable income tax deduction at the time the trust is established. This type of trust provides for the following:
▪ Lifetime Beneficiaries: provides for payment of the remaining trust assets to a charity after all of the individual beneficiaries have died
▪ Annual Distributions: a remainder trust provides payment of a "uni-trust" amount equal to a specified percentage of the fair market value of the trust as determined each year
▪ Remainder Trusts: can also be designed as a charitable remainder annuity trust, which provides for a specified payment each year without regard to the annual fluctuations in the value of the trust
Defective Grantor Trust
If you make a gift to a trust for your children called a Defective Grantor Trust, the income earned by the trust may be taxed to you directly, so that you are paying the income tax out of your estate while the children receive the gross income. In effect, your children receive a tax-free gift of the amount of income taxes that would otherwise be payable on trust income.
Other Estate Planning Ideas
As with your Retirement Wealth Plan, a properly executed Estate Plan has many different options for consideration. Several different techniques may be used to distribute the assets of your estate in a more tax-efficient manner.
You may have heard about installment sales, self-canceling installment notes, and sales for private annuities. These techniques have one thing in common: they are used to transfer property from a parent to a child while the parent retains some right to future payments.
Their purpose is to avoid a present gift but allows future appreciation to move to the younger generation. They are not as effective as outright gifts and are much more complicated. These techniques are often used by people who have rapidly appreciating assets which they would like to move to the younger generation, but who need to receive payments from their children as they do not have other assets to support them.
The current minimum interest rate for short-term intra-family loans is approximately 2%-3% (but these short-term rates have been over 6% in recent years). clients may make short-term loans, up to 3 years, to their children at the current interest rate without any gift tax consequences. Assuming it is a business or investment interest, any interest received is taxable to you and your children may deduct the interest paid. If it is investment interest they must have sufficient offsetting investment income.
Your children would receive a larger benefit if the loan were made on an interest-free basis, as they would not pay any interest to you. In this circumstance, you are treated as having made a gift of the amount of interest foregone. This ultimately subjects you to a gift tax, further depleting your estate.
The net effect of the children receiving the full benefit of the investment returns on the borrowed funds, together with your payment of income tax and gift tax, ultimately results in your children receiving more from your estate than if you had continued with the traditional minimum interest debt.
Interest-free loans may also be made to a Defective Grantor Trust. If your children were not able to utilize the deductions from the interest payable on a loan (whether interest-free or interest-paying), the loan could be made to the trust, in which you would not receive any deduction and you would not be required to recognize any income. If the loan were made on an interest-free basis, you would still have gift tax payable on the amount of foregone interest.
Bequest of 401(k) Account to a Family Foundation
If a Family Foundation is designated as the beneficiary of your qualified plan after the death of both you and your spouse, the funds may remain available during your lifetimes.
Should you die first, your spouse would have the option to roll the account over to an IRA at ARS Private Wealth and avoid the estate and income tax. The remaining assets could then be transferred to the family foundation also free of estate and income tax. This enables you to ensure the funds will be managed and directed by your children rather than paid to the federal government.
The foundation could receive 100% of the funds in your account, or should the account be distributed to your children after you both die, the foundation would receive a net amount of as little as 30% of the funds.
Gift in Will to Foundation
You may also choose to make a substantial gift from your estate to a family foundation upon your death and replace some of those funds with a second-to-die insurance policy.
The purpose of this technique is to permit your children to control 100% of those assets through the foundation, while “replacing” those assets at a somewhat reduced cost through the purchase of the second-to-die policy.
The insurance would be held in an Irrevocable Life Insurance Trust. That trust could also be a generation-skipping trust, which could continue for several generations without ever being subject to estate tax.
You might suggest that your parents’ Wills be revised so that their estates would be held in a generation-skipping trust for your benefit and the benefit of your children, or their estates could completely skip you and go straight to your children in a trust.
Your Estate Plan will actually become a part of your overall Retirement Wealth Plan.
Under current law, in 2016 you are entitled to give away $5.45 million at death without any federal estate tax; every individual is entitled to give away $5 million during his or her life without any federal gift tax, and such lifetime gifts also reduce the estate tax exemption. Most states have inheritance taxes that are imposed only if there is a federal estate tax. For example, a married couple who reside in Texas and whose property is located in Texas will generally not be concerned about death taxes unless their combined estates exceed $10.9 million. However, in order to take full advantage of both $5.45 million exemptions, it is imperative that the Wills be prepared in proper form.
You may leave any amount of property to your surviving spouse without the imposition of taxes, whether the estate is valued at $100,000 or $10,000,000. However, when your surviving spouse dies, the surviving spouse’s entire estate, less his or her exemption, will be subject to tax. This permits a deferral of death taxes until both spouses die.
To take advantage of the tax deferral (known as the “Unlimited Marital Deduction”), it is necessary that the Wills be prepared in proper form.
Inherited property is not generally subject to income tax. Some exceptions exist for items that would have been taxable income to you if you had received them during your lifetime (such as pension benefits, deferred compensation, last paycheck, and certain installment obligations). Except for items that are subject to income tax, all of your property receives a new income tax basis upon death. Thus, if you own stock with a basis of $10 and a fair market value of $100 upon your death, your beneficiaries will receive the stock with a $100 basis.
Particular advantages apply to all that are community property states, and the tax laws provide a new income tax basis not only for your one-half community property but also for your surviving spouse’s one-half community property. However, if your surviving spouse has any separate property, that property does not receive a new basis until that spouse dies.
Life insurance is generally carried for one of two reasons — to build an estate in order to provide for a surviving spouse and/or children or to provide liquidity in the event the estate includes valuable assets that are illiquid, such as real estate or a closely held business.
Once a possible need for additional insurance has been identified, it is generally advisable to consult with a Wealth Planner at ARS Private Wealth to determine the best product to satisfy that need. If additional life insurance is obtained, it may be advisable to establish a separate life insurance trust to hold title to the policies to reduce estate taxes.
Insurance guarantees are based on the claims-paying ability of the issuing company.
Estate Planning Documents may be outsourced to an outside affiliate. LPL Financial and ARS representatives do not offer tax or legal advice or services.