Smart estate planning involves more than having a will, even a fairly complex one.  We are faced with continuing uncertainty in dealing with federal estate taxes, restrictive privacy rules in health care matters, mandated rules on how IRA and retirement accounts must be paid to beneficiaries, concerns over nursing home costs, and other financial privacy issues. With all of these factors in play, estate planning is a bit more complex than in years past. You must take into account a realistic assessment of your net worth, retirement plans, and consider the possible impact of future estate taxes (although with $5,000,000 exemptions from federal estate taxes, which apply for persons dying during 2013 and thereafter, and with no Oklahoma estate taxes, estate taxes are not a factor for most people). 

This article deals with several topics, the first of which deals with estate and income taxes. Trusts and other topics are discussed later on.

The Estate Tax Component.  The starting point begins with an assessment of your actual net worth.  This assessment will also give you a fair indication of how much your estate might have to pay in death (or estate) taxes (this will not be a problem for most of us; estate taxes may be a problem if an estate value exceeds $5,000,000).  If you are married, through the use of the portability rules, both you and your spouse can combine exemptions, so as to pass $10MM in assets to heirs, without any federal estate taxes.

As things now stand, there are no federal estate taxes for persons dying in 2010 (there is actually a “choice” to be made by the decedent’s heirs, which deals with the concept of something called “stepped up basis”; this topic will not be discussed in this article, since it basically deals with estates over $5,000,000). Beginning in 2011, and continuing thereafter, estates with less than $5,000,000 are not taxed. If an estate exceeds $5,000,000, the estate tax rate is a flat 40%.

Income Taxes. In addition, income taxes must be paid by your heirs, if they are the beneficiaries of your retirement plans (such as IRAs, 401k’s, 403B’s, etc.; but this tax does not apply to Roth IRAs). You cannot control how retirement benefits are paid to your heirs because the federal government has preempted your choices (there is one exception, which deals with naming a trust, or non-human being, as the beneficiary, and if that is the case, and in most cases, the trust will pay income taxes on benefits it receives at the 35% income tax bracket). Once you name a human being as your IRA beneficiary, the beneficiary will receive an annual benefit from the plan administrator, which is be based on the life expectancy of the beneficiary. 
So What Are We to Conclude on Estate Taxes?  Estate tax problems generally will not arise until your spouse dies.  Anything you and your spouse collectively own which is worth over $5,000,000 will be subject to 40% estate taxes. If you have no surviving spouse (i.e., you are single, or your spouse died before 2011), your estate will not be taxed if your assets are less than $5,000,000.

Trusts. Most people like to control their own affairs, which is to say, they do not like the concept of probate. Probate is a court procedure, in effect in all 50 states, which deals with administration of your property after you die. Sometimes, the costs of probate are very expensive, and sometimes, there are many delays before your estate is distributed to your heirs.

As a means of avoiding probate, many people place property in a trust. A trust is simply a written agreement as to how property will be held while you are alive, and what happens to the property when you die. You will be in charge of all property placed in a trust until you die (or are mentally incapacitated), and you can change the provisions of a trust with less formality than amending a will. Here is a list of some of the benefits of owning property in trust:

  • Because you can change a trust whenever you wish during your lifetime, it can adapt to changes in your needs and those of your family. The provisions of a trust do not become irrevocable until death.
  • In addition, such trusts can also save on fees and administrative expenses after your death, and save time and trouble for the beneficiaries. Assets can be paid out quickly after death, because trusts sidestep the sometimes costly and time-consuming probate process.
  • Furthermore, in most instances, a displeased relative cannot contest the trust’s provisions (as they can if you use a will – a will contest could hold up distribution of your estate for months or even years in probate court). To contest a trust, a disgruntled relative would have to file civil suits against each of the beneficiaries and/or the trustee. In many trusts, a contesting beneficiary will lose his or her potential inheritance, because the trust contains a no contest clause (which directs the trustee to pay the disgruntled beneficiary the sum of $10).
  • To set up the trusts you pay a one-time fee. Unless you later decide to change them, there are no further costs.
  • Trusts also are strictly private affairs, unlike probate proceedings, which are matters of public record.
  • If you later become incapacitated and unable to handle your affairs, a correctly drawn trust can take care of your needs and those of your family without having to go through the court system to establish a guardianship. This means that many of your financial affairs can be handled far more expeditiously. For example, if a stock you own is failing, it can be sold quickly, rather than waiting for days or weeks until a court gives its approval. This, of course, can mean the difference between profits and losses.

            The Trustees. You’ll undoubtedly name yourself as trustee of your trust, but you’ll also have to choose one or more successor trustees to handle affairs if you can’t.

            You may want to name your spouse, if he or she has a good head for business, but you’ll still need someone else to take over if you both die in a common accident. The first consideration, obviously, is that the person must be trustworthy, whether the person is a family member, close friend, or professional, such as your accountant, perhaps your lawyer, or a member of your bank’s trust department.

        If you’d like to name a relative but fear there may be too much pressure and quarreling within your family, it’s probably a good idea to name an institution or a professional to handle the job.

        As a safeguard, the trust should contain a provision that allows you to remove any successor trustee, for whatever reason, and name another at your discretion.

                                                                    Funding the Trust. 

        To avoid probate – which is a highly desirable objective – the Settlors (sometimes referred to as Grantors or Trustors – in other words, the persons establishing the trust) of a revocable living trust must transfer all right, title and interest to their property, to a Trustee. The probate court only has jurisdiction over your property if it is titled in one of three ways: (a) in an individual name; (b) as a tenant in common with another; or (c) whenever a life insurance policy, an interest in a pension or retirement plan, or an IRA, designates the death beneficiary as being “my estate”. All other types of property – life insurance which designates a beneficiary other than “my estate”, property owned as joint tenants with right of survivorship (or tenancy by the entireties), or property held in trust or property which has a pay on death beneficiary or a transfer on death beneficiary – escape the jurisdiction of the Probate Court.

       Thus, to avoid probate, title to your property must be transferred to a Trustee.
        In a properly drawn revocable living trust, there are certain assets which are listed, which are deemed to be property belonging to the trust estate – without any other specific document of conveyance to a Trustee. For instance, personal property owned by the Settlor at the time of his or her decease, unless specifically excluded, should be regarded as being a trust asset. Clothes owned by the Settlor would fall within the category of tangible personal property, and such property would belong to the trust estate (due to the conveyance made to the Trustee under the terms of the trust). Similarly, household goods would fall within the list.

        Real Estate. The problem of funding the trust becomes a bit more complicated with respect to real estate. In all instances where a trust is prepared, and the Settlor owns real property, a quit claim deed is usually furnished, in which title is conveyed from the Settlor to the Trustee. If the Trustee dies, then the Successor Trustee will sign an affidavit (also known as a Certificate of Incumbency, or Memorandum of Trust) and file it with the Registrar of Deeds. Such an affidavit should be sufficient evidence to satisfy a title examiner that the trust was not revoked prior to the Settlor’s death and that the duties of Trustee are now being carried on by a Successor Trustee. By analogy, the resignation by the president of a corporation, and the election of a successor president provides a means whereby the successor president assumes the duties of the office of president. Similarly, a Successor Trustee assumes the duties of the office of Trustee, when the original Trustee no longer serves in that capacity.

        In most instances, the Settlors will record the quit claim deed with the Registrar of Deeds (i.e., the County Clerk). Once the deed is recorded, the County Tax Assessor might argue that the homestead exemption of the Settlor is lost because title in the real estate is being held by a Trustee, not a homesteader – however, in Oklahoma, because the trust is a revocable living trust, and because the Settlor is the beneficiary of the trust during his or her lifetime, the homestead exemption is not lost. There is an Oklahoma statute on that point.

          In addition to real estate, Settlors should also convey title to any interest in mortgages (and the notes which are secured by the mortgage), and oil and gas interests.

            Stocks and Bonds. But what about title to other types of properties, such as stocks and bonds? Here’s what happens when a trust is “unfunded”. Several years ago, a client owned several millions of dollars in securities. The client (who was the Settlor of the trust) died without first transferring title to the securities to the Trustee (he was the trustee). He died, and the successor trustee then called me and asked what she must do to get the securities in her dad’s trust. This was in 1984, and things were a bit different then. I explained to her that her dad should have put his brokerage account in his name as trustee of the trust. I then learned that he did not have a stock broker, but only had stock certificates. I then explained that the stock transfer agents for all of these companies would have to be convinced that when her dad signed his trust, he conveyed his stock interest to himself as trustee of the trust. There was some language in the trust which suggests that a conveyance had been made. The problem we were facing was, the stock transfer agents didn’t know he had signed a trust, and had no independent record that a transfer had been made (fortunately, he had signed an allonge, which is, effect, a stock power, which is used to transfer certificates of stock).

So I began a long term telephone and letter campaign with lots of stock transfer agents. After banging some heads, and citing the rules of the stock transfer association (which were only 20 pages long at the time; now the rules are at least 100 pages long), I was able to cajole the stock transfer agents that the stock was transferred to the trust. In retrospect, we were lucky. We could have admitted his will to probate (the beneficiary of his will was his trust), but his daughter didn’t want to do that. She lived in a small town, and didn’t want the neighbors to know how much money her dad had (and how much she would inherit).

To avoid this sort of problem, the Settlor should at least sign a stock power or an allonge (which is an endorsement to the stock certificate, and works much the same way as a stock power) as part of the trust closing documents – and the signatures of the Settlor (as shown on the stock power or allonge) should be guaranteed by an officer of a national banking institution, using the Medallion Guaranty stamp (this is a nationally recognized signature guaranty program). An easier method would be to have the stock certificates kept by a stock broker. The brokerage account would be in the name of the trust (i.e., the trustees; technically speaking, only trustees can own property – the trustees hold the property in trust, for the benefit of the beneficiaries).

In addition, it would be helpful if the Settlors maintained a list of all of the trust assets, including all stock certificates, bonds, life insurance policies, by date of issue and registration or policy number, etc., as well as a list of title certificates for automobiles, horses, airplanes, mobile homes, boats, bank accounts, or anything else that has a registration number. Such a list would be additional proof of what assets were included in the trust, and such a list would be of tremendous benefit to the successor trustee (who really ought to know what you own when you die).

Other options on stock. As an alternative means of avoiding probate, the owner might make a “transfer on death” designation (this requires contacting the stock transfer agent or stock broker and completing additional forms), and indicate that upon the death of the owner, the security or brokerage account will be “transferred on death” (TOD) to the acting trustee of the trust.

            Bank Accounts. All bank accounts and bank account numbers, regardless of the style of the account, should be included in the trust, as being part of the trust assets. It is advisable to change the style of the account at the bank, and this can be accomplished as follows: (a) the Settlors can re-title their account as being a trust account (this method is usually the only means available at a credit union – and some banks will not permit the account to be styled any other way) – new checks will not have to be printed, because the account will not be regarded as a “new” account; or (b) the Settlors can add a POD (pay on death) designation to the account, with “the acting trustee of the Smith Revocable Living Trust” as being the POD beneficiary (this method is permitted by most banks) – again, no new checks will be required. The taxpayer identification number for the account will be one of the Settlors’ social security numbers.

            IRA’s and Retirement Plans. Because there are income taxes to be paid on retirement plans (except Roth IRA’s), even in the event of death, there may be adverse income tax consequences to the beneficiaries if a death beneficiary has been improperly designated. Normally, the plan participant will name his or her surviving spouse as the primary death beneficiary, with the children named as contingent beneficiaries. These benefits will be paid independently of what the trust states, because the trust never owns the IRAs. The benefits are usually paid to the named beneficiary, over that beneficiary’s life expectancy.

            Insurance. The beneficiary of insurance policies will normally be the acting trustee of the trust (in some instances, the other spouse will be the primary beneficiary, with the acting trustee as a contingent beneficiary). There are no adverse income tax consequences in life insurance (the policy proceeds are not taxed for income tax purposes). If the proceeds are paid to the trust, the trustee can hold the proceeds for a named beneficiary, until the beneficiary attains a desired age (e.g., Little Billie will get his share of the trust, but not until he is 25 years old; until then, the trustee can make payments to him or for his benefit).

            Power of Attorney. Another estate planning instrument you’ll need is a durable power of attorney that names the same person you’ve selected as your successor trustee. A power of attorney, which creates an agency relationship between the principal and his or her attorney in fact, isn’t a magic document that will take the place of wills and trusts, because it’s automatically revoked at death. However, a “durable power of attorney,” if permissible where you live (it is permitted in Oklahoma) will allow the person you’ve chosen to act for you (i.e., as your agent), if you’re unable to do so yourself (which usually means, during periods of disability). This is especially helpful if you or your spouse must go into a nursing home or some other institution (and in this instance, a health care power of attorney is usually signed; the health care agent might be someone different from the financial agent, under the durable power of attorney).    

           Living Will. You may also want to have a “living will” that says you don’t want to be kept on a life support system if you’re terminally ill or there’s no hope of recovery. Most states allow this choice. These documents may also permit donation of body parts to science.

            Business Owners. If you own a business, you have still more planning to do, because control of the business must be carefully planned, and your family cared for in the manner you want them to be. You’ll probably have to answer some hard questions in designing a business succession program. For example, do you have:

  • A procedure, acceptable to IRS, to value the stock in your closely held business?
  • A buy-sell agreement with a potential purchaser of the company stock?
  • Life insurance that is earmarked specifically to fund the buy-sell agreement?
  • A “key man” insurance policy that will help your company procure new management?
  • An asset that will provide cash to pay estate taxes that will be due on your death?

Other means of dealing with an estate. A revocable trust can’t protect you from creditors, or give you any benefit if you need help on paying for nursing home costs. There are, however, other means of passing title to property without a will or trust (using a transfer on death deed, or POD bank account). These techniques in property ownership don’t help if you are disabled, and for that, you need a durable power of attorney.

Estate planning requires some thinking on your part, and learning as much as you can about how your property can be distributed when you die. If you die without a will or trust, your estate will be distributed to your heirs, based on a formula the legislature has established. To resolve this uncertainty, your should at least have a will. Keep in mind that the probate of an estate is not an evil undertaking, which should be avoided at all costs. However, it is time-consuming and in many instances, very expensive for the heirs. Hopefully some of the thoughts shared in this short article will be of assistance in the estate planning process.

©2013 James H. Beauchamp