The conundrum regarding estate planning reaches many different levels. Should I have a trust? What about an irrevocable trust? Who should own or be beneficiaries of my assets? Should it be the trust or an individual? I could go on and on regarding these scenarios. One by one, we will cover all of them, but not in this article. Here we will discuss basic estate planning in Q and A form.

1. What is a will? A will is a legal document which, allows you to set forth who is to receive your property upon your demise.

2. Should everyone have a will? In general, the answer would be, yes. This would not include recent graduates with little or no assets, or anyone, for that matter, whose assets are considered nominal.

3. How does a will differ from a beneficiary designation? A beneficiary is listed on retirement plans, life insurance and annuities. Beneficiaries can differ from what is in a will. An important distinction is that all beneficiaries receive their property without having to go through probate (more on that in a moment). Any property left through the will MUST go through the probate process

4. Describe the difference between the probate process and being named as a beneficiary. Two major differences are time and expense. When named as a beneficiary, money passes without delay to whoever is named.  Appropriate paperwork (such as company forms and a copy of the death certificate) is sent to the insurance company or trustee of the retirement plan, and the assets are transferred timely. When property initially goes through the probate process someone needs to be approved as Executor or Executrix of the estate, and all fees and taxes (if any) need to be paid before property can be transferred. This can be cumbersome, as well as time consuming.

5. What is the biggest mistake someone can make when listing a beneficiary? By listing the estate, and not an individual or trust, as the entity to receive the proceeds.  Listing the estate as beneficiary defeats the purpose of having a beneficiary, because a non probate item has now been made rotatable. Ugh.

6. What are other estate planning items, which should be considered? A power of attorney and a health care proxy.

7. What is a power of attorney? A power of attorney is a legal document which allows the named individual to speak for someone who is infirmed or otherwise unable to conduct his or her own financial affairs. For example, a spouse (or child) would be named power of attorney for the other spouse (or parent) in case of dementia, etc. Duties of the power of attorney would include payment of bills, taxes, and making investment decisions. This is just an example and does not represent the entire list.  A power of attorney’s duties end upon the death of the individual, at which point the will and its Executor are in charge.

8. What is a health care proxy? It is a document signed by an individual and on file with the person’s hospital and primary care physician, which states that no extraordinary means should be used to keep him or her alive. One of the reasons it exists is to end family disagreements in regard to “end of life” care. By signing a health care proxy, the individual has taken this incredibly emotional topic and put it on his or her own shoulders.

9. What is a trust? A trust is a legal document that says how and when assets will be distributed, as well as putting on necessary controls. For example, a trust may state that a child receives part of his inheritance at age 30, and the balance at age 40. A trust may also give discretion to the trustee to state that the child receives interest as earned and “trustee discretion” to receive principle, presumably something the trustee would deem appropriate. Placing assets in a trust removes them from the expense and publicity of probate.

10. What is the difference between a revocable and irrevocable trust? If property is placed in an irrevocable trust, the donor loses complete control. It is a decision, which should be long thought out, as most trusts are not irrevocable. Irrevocable trusts should be considered for estate tax purposes, but unless the estate is greater than $7 million for a married couple and $3.5 million for an individual, it is not something we would deem appropriate. A revocable trust, on the other hand, allows the grantor to change any language at any time. It is included in the estate of the individual, but would achieve probate and administrative savings because the trust does not go through probate.

11. When should a person consider having a revocable trust? This is an interesting and tough question to answer. If an individual or a couple has a young child (or children), makes in excess of $100,000, owns a home, has adequate life insurance and has investable assets of $250,000 (strictly an arbitrary figure), it is a discussion that should be had with an estate planning attorney. Other reasons would be to place restrictions on the assets due to child conduct or other relationship issues.

Disclosure : It is important that one sees a specialist (such as an estate planning attorney) to discuss these issues. Estate planning attorneys are properly trained and know exactly how these documents should be executed. An attorney who does not specialize in estate planning should not be considered.  Representative is not an attorney.

There are often times when professionals should just adhere to their individual disciplines. When they choose to go outside of their known realm of expertise, they can give incorrect advice that can cost a client thousands of dollars. Consider the following hypothetical situation: A person, on the suggestion of his attorney, wants to change the beneficiary on his IRA from his wife to his estate. His wife was placed into a nursing home because of Alzheimer’s, so the change in beneficiary was prudent. The mistake may be making the estate the beneficiary for the following reasons:

1. Any property with a named beneficiary is property which passes outside of the probate estate directly to the beneficiary.
2. If the children are named as beneficiaries, they are eligible for the “stretch” IRA strategy,  which allows them to take withdrawals over their life expectancy.
3. By using a “stretch” IRA provision, taxes are paid on amounts withdrawn during the year of withdrawal.
4. If the estate were named the beneficiary, the amount of the IRA may have to be probated and would not pass expeditiously to the beneficiaries.
5. With the estate as beneficiary, the IRA, by law, would be liquidated forcing ALL of the taxes to be paid at the time of the liquidation. Stretch IRA provisions would not be allowed.

Conclusion…You should consider naming an individual as beneficiary of an IRA if you are interested in utilizing the stretch IRA provisions. This means that all monies can continue to accumulate tax deferred, and the only current taxation will be on the amount required to be distributed each year.  Make sure to check with a CPA or investment professional before any property is sold or liquidated to confirm any adverse tax consequences. Once liquidation is done…it’s too late. Try placing toothpaste back in the tube or un-ringing a bell.

As parents die and pass their assets onto their children, I am constantly asked how proceeds should be allocated. Whereas there is no “hard and fast” rule(s) on how these monies should be positioned, there are many general guidelines, which can be used. First and foremost, please ponder the following statement…”What do you throw away, the cow or the milk?” After you answer, huh(?) when reading that statement, just think for a moment…while it may be proper to use an inheritance to pay down a mortgage, in the long run, especially if finances are in order, we believe you should consider the possibility of investing the money, giving it the potential to grow, and amortize the mortgage naturally. Whereas if you used the inheritance to pay down the mortgage, yes, you would receive a guaranteed return on your investment as the interest rate used to borrow from the bank is an obligation, which would be satisfied, it is highly unlikely that most consumers would take their mortgage payment and allocate it toward saving. Here are some guidelines to think about when allocating an inheritance. As a disclaimer, the amount of inheritance I am talking about would be of a modest nature…say $500,000 or less. Obviously, individual situations may dictate may take precedence over these guidelines we offer.

1. Balance is the key. Investors “win” more often than not when (in using a baseball analogy) they hit singles rather than going for home runs. Your net worth is increased in two ways…either by increasing an asset or decreasing a liability. Think about doing both when allocating these proceeds.
2. Don’t be in a rush. The money isn’t going anywhere. Speak with your advisor as to the best course of action. Be sure NOT to use emotion when making a decision. Typically, emotional or impulse decisions are not the smartest ones.
3. Pay off “bad” debt. Not all debt is bad, but some is…primarily credit cards. If you have more than a “nominal” amount of credit card debt (fully realizing that nominal means different things to different people) pay it off. The next step, and this is another subject for another day, is to determine how NOT to get into credit card “hell” moving forward.
4. Do NOT pay off your mortgage, but…For example, if you and your spouse are in you mid 50’s and still have 20 years left on your mortgage, you may want to take a piece of the inheritance to determine what it would take to have your ENTIRE mortgage paid for by the time you retire. Another suggestion is to take the dividends from any investments and use that as an extra principle payment. Remember, one extra payment per year on a thirty year mortgage reduces your payment period by eight years.
5. Cash is STILL king. Retaining cash for opportunity costs is a worthwhile strategy… Having too much cash is like a widow saying that she received too much life insurance. Never gonna happen.
6. Understanding the “step up in basis” rule. When consumers inherit money, there is, often times, confusion about the taxable nature of the asset. The “step up in basis” rule works as follows:  Father dies leaving estate consisting of stocks, bonds, cash and real estate totaling $1,000,000 to his two children. Children are to share equally in the distribution. The children assume ownership of the asset retroactive to the date of death or an alternate valuation date within nine months of the decedents passing. The price they assume ownership is the value of the asset on the day they received control. If they sell the asset, there is NO federal tax due on the sale. Simple example, child inherits real estate with a fair market value of $400,000. Father paid $75,000 for the home. Child sells property for $400,000 after fathers demise…child pays no tax on the sale, as he assumed ownership at fair market value.  Child has received “stepped up” value of property upon fathers passing.
7. Make a plan. If you do not know how to make a plan, hire someone who does. I have had plenty of people say to me over the years, I am conservative and do not wish to take any risk. My retort is always…Are you conservative because you are…or are you conservative because you do not understand the investment business , and need someone to teach you so you comfort level will rise. It’s amazing how many people acquiesce to the latter, rather than the former.

Life Insurance is one of those subjects that conjure up the need to take a Zantac primarily because it reinforces the adage that the only thing certain is death and taxes. Nobody likes to talk about mortality, especially his own, but it is a subject that needs to be addressed by all people. Even though needs may change, the need for owning life insurance does not. In this article, I am going to discuss three scenarios regarding life insurance, single people with no dependents, married people with dependents, and an older couple (empty nesters) with a need for insurance due to having an estate tax liability.

Before I address the three scenarios,

there are a few items I would  like to discuss about insurance in general.  First, it is a rare instance that I would recommend anything other than term insurance. With term insurance, you are strictly paying for coverage. It is sold in “premium guarantee bands”, usually ten, fifteen or twenty years. Make sure the policy is not conditionally guaranteed for the entire period. A conditional guarantee means the company can increase the premium after a certain period of time. Make sure the policy you buy is fully guaranteed for the premium guarantee period. As you might expect, a shorter guarantee period costs less than a longer guarantee period. Term Insurance does not have a “savings element”, or cash value, associated with the policy…it is for protection only. Universal Life or Whole Life insurance does have a “savings element” affixed to it and would be decidedly more expensive than term. If you have invested the maximum amount in your 401(k), have adequately funded 529 plans definitionand have proper savings and little debt, then you may want to look into Universal or Whole Life insurance. Until then, purchase term insurance because it is with this that you can buy the largest amount of insurance for the least possible cost. Two other points to remember:  any life insurance proceeds received are received income tax FREE. In addition, by having a named beneficiary, proceeds are paid quickly and privately without having to go through a lengthy probate process.  Please note if an insurance policy has an incontestable clause (usually two years),  the company has the contractual right to investigate any claim. Once a policy is two years old that right disappears, unless they can prove fraud at the time the application and accompanying medical exam were secured.

If you are single,

have little debt and no dependents, there are few circumstances that would warrant having an abundance of life insurance coverage. For a single individual, I would dwell more on disability insurance to make sure your income is protected and long term care insurance to make sure you have proper funding in the event of illness and the infirmities of old age. Typically, any group life insurance you may receive from your employer would suffice. These amounts are normally a flat amount ($25,000-$50,000), or a multiple of your compensation.  For example, if you earn $75,000, your group life might be twice your salary, or $150,000. If your estate were in excess of $3,500,000, you may want to have life insurance to pay any estate taxes. For the majority of individuals, this is a moot point.

For married people,

especially if there are children involved, having the proper amount of protection is a cornerstone of any viable plan. There are many rules of thumb for calculating the proper amount of insurance. One method is to use a “five times income” calculation. Another would involve taking the present value of any education and housing needs, determining a viable amount of income which may be necessary, and through a more comprehensive needs analysis, arriving at a figure which is reasonable. If both husband and wife earn in excess of $100,000, along with a mortgage, income, and education liability, it is not uncommon for each spouse to have at least $1,000,000 of coverage through the income dependency period. The goal of any insurance is to make sure that you can remain in the world that has been provided for you…nothing more and nothing less. A life insurance professional with a CLU (Chartered Life Underwriter) designation is normally qualified to provide proper counsel.  Most, if not all, insurance professionals work on commission and are only compensated on the products they sell. There are very few, if any, fee only insurance people. Please ask your insurance professional for clarification.

Once children have grown and education costs have been amortized,

life insurance may have to be used to pay for estate taxes. As the law currently states, and this should change by the end of 2009, there is federal estate tax due if an estate is valued at more than $3,500,000. Before any property can be transferred, the tax must be paid. If there is insufficient liquidity to pay the tax, assets must be sold in order to pay the liability. Life insurance, as it is received income tax free, is the best way to pay any estate tax liability. The use of “second-to-die” insurance, as well as the use of an Irrevocable Life Insurance Trust, is the most cost effective way to satisfy this obligation.

There has always been confusion between the terms, trusts, probate and beneficiaries. How are they used? What are the advantages and pitfalls? In this posting, I want to discuss beneficiary designations and appropriate ways of caring for this subject.

1. What is probate? Probate is the legal process, which can be lengthy and expensive.  Before any property can be passed to an heir or heirs, there are documents which need to be filed and executors which need to be appointed.
2. One advantage of naming a beneficiary is that proceeds  are IMMEDIATELY paid to the recipient without having to go through the probate process. Any insurance policy, annuity, or tax sheltered retirement plan (IRA, SEP, 401(k), TSA, etc) has the opportunity to name a beneficiary, and this chance should not be overlooked.
3. Do not make the estate the beneficiary of your IRA, annuity or retirement plan. By making the estate the beneficiary you make a non-probate item, probate-able. It is a classic and common error and one which should never occur. To give you a hypothetical example: Jane is the beneficiary of her aunt’s estate. Included in the estate was an IRA worth over $2,000,000. The attorney named the estate as the beneficiary of the IRA and Jane. By doing this, he needed to liquidate the IRA before it was paid to her. It is possible, due to taxes and fees, over 60% of the IRA would shrink before it was transferred. Conversely, if Jane was named as beneficiary, the TOTAL amount would have been passed to her, tax free, and she would have to take distributions according to IRS tables. This error could cost Jane well over $1,000,000.
4. What is a Transfer on Death (TOD) designation? A TOD designation is available in most states, and is used on accounts which, typically, do not offer the opportunity to name a beneficiary. For example, a “non-qualified” (meaning a non retirement plan) brokerage account which is in an individual name. For example, Mary would add her child(ren) as TOD recipient(s) of her brokerage account. These assets would transfer automatically upon Mary’s demise without having to go through the probate process.
5. Consider using a TOD designation instead of joint ownership if you are a widow or widower. One mistake made by consumers is to name a child as a joint owner of an account (bank or brokerage) in order to avoid probate. Follow along with this example. Mary adds her daughter Susan as the joint owner of her bank account. Mary’s sole intention for doing this is to make sure the account does not have to go through probate  and to give Susan access to her funds in case of emergency. The purpose was not for Susan to use this account as her personal ATM.  Unbeknownst to Mary, Susan had gotten herself into financial difficulty, and the proceeds of this account were used to settle her debts. By making her daughter joint owner of the account, she now exposed this asset to her daughter’s creditors. The use of the TOD designation allows for the consumer to continue controlling the asset while making sure it  passes promptly upon their demise.
6. How does a trust avoid probate? By naming a trust as beneficiary, all proceeds are paid to the trust, and the trust document will determine in which manner the proceeds are paid. Trusts are an extension of the grantor’s wishes, and many powers may be given to the trustee to grant them additional discretion.  By their general nature, all trusts avoid probate.

Conclusion. Any estate planning questions should be directed to a competent estate planning attorney who will work in conjunction with your tax professional and investment advisor to formulate the proper and correct strategies for your estate.