My estate planning and probate clients who come from Los Angeles County, Santa Barbara County, Ventura County and Orange County, (and occasionally from Northern California) will often speak with me about what they have heard regarding estate planning and avoiding probate. Retained by clients as their California estate planning attorney and California probate lawyer, they freely share their concerns about estate tax, gift tax planning and the other items listed here:
1. Failure to Make Gifts to Reduce Estate Taxes. Easy gifting options include the $12,000 annual exclusion, $1,000,000 lifetime gift exemption, and unlimited tuition/medical gifts. In a 45% estate tax bracket, each $12,000 gift saves $5,400 in estate tax.
2. Failing to Protect a Child’s Inheritance. A child’s inheritance that passes outright to the child is not protected from creditors, divorce, or estate tax at the child’s death. To protect the inheritance, it may be better to leave assets in trust for such child’s benefit. If desired, the child can be named as the co-trustee of the trust along with a third party.
3. Failure to Pursue Sophisticated Estate Planning Tools. Explore techniques to reduce estate taxes and/or protect assets. Consider the family limited partnership, charitable trusts, qualified personal residence trust, and sale of assets to children.
4. Wasting $2,000,000 Exemption When First Spouse Dies. The $2,000,000 exemption is wasted when assets are left outright to the surviving spouse. Instead, the Will should create a bypass trust to be funded with $2,000,000 of the decedent’s assets, saving up to $900,000 of estate taxes (assuming a 45% estate tax rate). WARNING: Naming the spouse as beneficiary of life insurance/retirement plans prevents such assets from going into the bypass trust. Also, if the house goes outright to the survivor, the decedent’s portion cannot be used if needed to fully fund the bypass trust. The impact on the overall plan should be considered before making such a bequest.
5. Wasting $2,000,000 GST Exemption. This results in needless estate taxes at the deaths of children. Instead, consider segregating $2,000,000 ($4,000,000 for husband and wife) of assets in trust for the benefit of children for life and then to grandchildren, free of estate tax at each child’s death.
6. Life Insurance Policies Owned by the Insured. The proceeds of life insurance are subject to estate tax when the insured owns the policy. For example, $1 million of coverage taxed at 45% leaves only $550,000 coverage after tax. Transferring ownership of life insurance to an irrevocable life insurance trust (or having the trust buy new coverage) removes the proceeds from the estate, provided the insured lives for three years after the transfer.
7. Poor Timing of Retirement Plan/IRA Distributions. Penalty taxes arise if retirement plan/IRA distributions are too small, too early, or too late. Devise a distribution strategy and beneficiary designations to maximize income tax deferral, but with due consideration of these penalty taxes. Consider designating a charity as beneficiary to avoid estate tax and income tax.
8. Failure to Plan for Lifetime Contingencies/Disability. This may result in a court-supervised guardianship. Plan ahead by executing a power of attorney for management of property and personal affairs, advance health care directive and living trust. Be wary of “standard form” documents.
9. Lack of Liquidity to Pay Estate Taxes. Illiquidity can result in forced “fire sale” of real estate or a family business within nine months of death in order to pay taxes. In this situation, it is advisable to explore life insurance and plan for the orderly sale of assets.
10. JTWROS (“Joint Tenants with Right of Survivorship”) Ownership Designation on Brokerage or Bank Accounts. This designation prevents such accounts from being funded into the bypass trust when the first spouse dies, potentially wasting the decedent’s $2,000,000 exemption (and costing up to $900.000 in extra estate taxes). This also applies to “P.O.D.” (pay on death) accounts and “Trust” accounts payable to a named beneficiary (example: “A, Trustee for B”). While these designations avoid probate, other problems arise instead. Multiple party accounts should be set up as tenants in common.
If you would like to speak with a licensed California attorney about these matters or estate planning in particular, call Mitchell A. Port at (310) 559-5259.