Estate Planning – Is it Necessary?

The exemption from federal estate and gift taxes will be $11,580,00 in 2020 (increasing from $11,400,000 in 2019). As a result, many people think that they no longer need estate planning use their estate does not exceed the amount at which estate tax will be incurred.

This is a classic case of the tax tail wagging the business dog. After all, in any type of planning (whether business planning or estate planning), the non-tax, business objectives should always come first. Once the non-tax, business objectives have been determined, tax planning (whether income tax planning or estate and gift tax planning) should be used to accomplish those non-tax, business objectives in the manner that is the most beneficial from a tax perspective.

The primary non-tax or business purpose of estate planning is dividing and distributing your assets according your wishes upon your death, and the proper estate planning documents need to be executed to accomplish this non-tax objective, regardless of the size of your estate. Therefore, it is always important to have the necessary estate planning documents in place to divide and distribute your estate according your wishes.

Why You Need a Will?

A will is the most important estate planning document. Settling your estate is much simpler when you have will. Texas law provides for a streamlined probate process known as independent administration when you have a will. On the other hand, if no will exists, court supervised dependent administration will probably be required, which is much more time-consuming and expensive.

By executing a will, you can select the person who will handle the affairs and assets of your estate. Without a will, the court will appoint the person who will handle the affairs and assets of the estate.

Do You Need a New Will?

You need a new will (or at least prepare a codicil or amendment to your existing will) if:

  1. You want to divide your estate differently than what is set forth in your current will.
  2. You want to change the executor (or successor executor) or the trustee(s) (or successor trustee(s)) named in your will. This may be a matter of choice. Alternatively, the persons named in your will may have predeceased you or may be unable to serve as your executor or as trustee, and you need to name someone else.
  3. You left specific property (usually real estate) to someone and subsequently sold that property. This may require a change to your will. For example, your will provides that a gift of real estate tract 1 is made to child A. Real estate tract 1 is then sold. If you want child A to receive something of equivalent value to real estate tract 1, your will needs to be changed.
  4. You left specific property to someone who predeceased you. Wills usually cover these types of situations, and these provisions should be discussed with you before you sign the will. Nevertheless, if this type of event occurs, you need to review your will and make sure that the division of property in the will is consistent with your current wishes.
  5. Changes in the tax laws may have altered the division and distribution of property under the will. This is most likely to occur when the will provides for the creation of a bypass trust and a marital deduction trust. Most wills provide that the bypass trust will be funded with assets equal to the amount of the estate tax exemption, and the remainder of the assets will be placed in the marital deduction trust. Assume, for example, that your will was drafted in 2017 and that your assets in 2017 were worth $9,000,000. Further assume that your assets are currently worth $11,000,000. In 2017, $5,490,000 would have been placed in the bypass trust, and the remaining $3,510,000 would have been placed in the marital deduction trust. Today, all of the assets would be placed in the bypass trust. Depending upon the terms of the bypass trust, this may not leave the surviving spouse with sufficient income.
  6. Use of the bypass and marital deduction trusts is no longer necessary to prevent stacking of assets in the estate of the surviving spouse. Now, the surviving spouse is entitled to use the unused portion of the estate tax exemption of first spouse to die even if a bypass or credit shelter trust is not formed. This is known as portability. However, to take advantage of portability, an estate tax return for the first spouse to die must be filed even if no estate taxes are due.

Do You Need Other Documents Dividing Your Assets?

While the will is the most important estate planning document, it is important to understand that the will often does not control the division and distribution of all assets. In fact, it is not unusual for the will to control the division and distribution of less than half of the assets of the person who passed away. Due to these circumstances, it is extremely important to pay close attention to the assets that do not pass according to the terms of the will (non-probate assets).

Some of the most common non-probate assets include:Bank accounts or brokerage accounts held as joint tenants with rights of survivorship;

  1. Defined pension plan benefits (whether from defined contribution plans or defined benefit plans);
  2. 401(k) plan benefits;
  3. IRA’s;
  4. Annuities; and
  5. Life insurance benefits.

Account Agreements

In the case of bank accounts and brokerage accounts, if those accounts are held as joint tenants with rights of survivorship, the agreement opening the account is, in essence, an estate planning document because upon the death of one of the account holders, the assets will pass to the surviving joint account holders.

When a husband and wife establish accounts as joint tenants with rights of survivorship, this normally does not create a problem because the surviving spouse (who is also the surviving joint tenant) becomes the sole owner of the assets in the account. Nevertheless, it is important to determine whether these accounts held by spouses as joint tenants with rights of survivorship create tax or trust funding problems.

On the other hand, accounts set up as joint tenants with rights of survivorship frequently create major problems and unintended consequences whenever a parent with more than one child establishes an account with only one of those children as joint tenants with rights of survivorships. Parents often do this so that one child has signature authority on the account and can assist the parent with paying the parent’s regular monthly expenses. However, the parent usually does not understand that in this instance, the will does not control the division or ownership of the account opened as joint tenants with rights of survivorship upon the parent’s death. The child who is the joint tenant on the account will own the assets in the account upon the parent’s death. If the parent had wanted his or her assets to be divided equally, the parent’s objective of splitting the assets equally will not be achieved.

Beneficiary designations

Defined pension plan benefits are paid in the form of a qualified joint and survivor annuity (QJSA), and properly naming the person who will receive the survivor annuity is a critical part of estate planning. In the case of a married plan participant, the person who will receive the survivor annuity must be the surviving spouse unless he or she has properly waived his or her right to the survivor annuity.

The division and distribution of 401(k) benefits, IRA benefits and life insurance benefits are not determined by the will, but, instead, are determined by the beneficiary designations.

Income Tax Issues

It is extremely important for the non-participant joint survivor of qualified pension plans and the beneficiary of 401(k) plans and IRA’s to do the necessary income tax planning. The assets are not entitled to a basis step-up upon the death of the participant, and the income is taxable (unless attributable to participant contributions) as income in respect of a decedent.

Income from a ROTH IRA is not income in respect of a decedent because no deduction was taken at the time of the contribution.

What if You become Incapacitated?

As people live longer, it becomes increasingly important to address issues relating to incapacity. For example:

  1. Who will handle your affairs if you are unable to do so? Without proper planning, it will be necessary for a guardian to be appointed to handle your affairs. Once again, this is a time-consuming and expensive process. It can also cause ill will between the various family members because children are often required to file suit against a parent to establish a guardianship. To avoid these problems, it is advisable to execute a durable power of attorney, whereby power is granted to one of the children (preferably the one who is either the closest or has the most experience with financial matters) to handle the financial affairs of the person granting the power (the principal).
  2. Who will make medical decisions for you if you are unable to do so? Again, without proper planning, it will be necessary for a guardian to be appointed, which, again, is a time-consuming and expensive process. If guardianship proceedings are initiated, the guardian appointed to care for your finances may or may not be the same person appointed to care for you, personally. If a guardian is appointed for you, will the person appointed be the person you wanted and will he or she make the medical decisions you would have wanted? To avoid these problems to the fullest extent possible, you should name someone as your agent to make medical decisions for you in the event you are unable to do so. The person appointed should be the person you believe will follow your wishes when making these decisions.
  3. If you do not want to be placed on life support if you are diagnosed as terminally ill, you should execute a directive to physicians (living will) wherein you so state. You should provide a copy of the living will (as well as your medical power of attorney) to doctors and hospitals that regularly provide services to you.

Does Your Estate Need to File an Estate Tax Return?

Your estate will need to file an estate return if the taxable estate exceeds the estate tax exemption amount (currently $11,400,000 per person and increasing to $11,580,000 per person in 2020). However, there are other situations in which an estate tax return either must be or should be filed.

First, your estate must file a return if your surviving spouse wants to take advantage of your unused estate tax exemption under the portability provisions.

Second, it is advisable for your estate to file an estate tax return, even if not required, to establish the fair market values as of the date of death if trusts are being funded under the terms of the will. This makes it much easier to establish basis whenever these trusts are terminated years later.