Now that the hustle of the holiday season is over, everyone is looking forward to the new year. January tends to be the month where people look for a fresh start and catch up on the tasks that were pushed off during the holiday season. For many people, that involves making new year’s resolutions. While some resolutions are harder to keep than others, a very simple resolution to make and keep is to review and update your estate plan.
Here are factors to keep in mind when considering updating your estate plan:
1. Life changes in your family: An estate plan is not one-size-fits-all; it is customized to meet your family’s unique circumstances and needs. Perhaps you had an estate plan prepared when your children were very young, but now they are older and capable of managing their own financial resources. In contrast, perhaps you have concerns about a child’s ability to make prudent financial choices, and would like to know your options for protecting any inheritance they might receive. Maybe you have a child or other family member with disabilities, and you are concerned about how the receipt of an inheritance will affect their public benefits. Perhaps you now have grandchildren that you would like to provide for as part of your estate plan. An estate plan can take all of these areas into consideration and be drafted to best fit your needs.
2. Your personal financial profile: Everyone’s financial profile changes over time. You may have accumulated significant assets since the last time you reviewed your estate plan, or you may be retiring and drawing down on your hard-earned assets. An estate plan created when you had a very different financial profile may not provide the best treatment of your estate based on its current and projected status.
3. Fiduciary roles in your estate plan: Creating an estate plan involves selecting various individuals (or entities) as fiduciaries, such as the Executor of your estate, Trustee of any trusts created under your estate plan, Guardian of your minor children, Agent during your life under your Power of Attorney, and Surrogate to make end-of-life decisions in your Living Will. Each of these roles is very important, so you should consider if the individuals who are named in these roles in your current estate planning documents are still the people you would want to serve. Your documents may name individuals who have gotten older and may be unable to serve in these roles due to health concerns, or individuals who have moved away and may not be able to effectively serve due to geographical distance. You may have created documents when your children were younger, but may now feel that your children are mature enough to take on these responsibilities. While anyone named in an estate planning document may resign or renounce if they are unable to serve in a fiduciary role, updating your documents now will avoid the time and delay involved in appointing the appropriate individuals to these roles in the future.
4. Changes in the tax laws: There is a saying that the only two constants in life are death and taxes, and your estate involves both. Your estate may be subject to various estate, inheritance, and/or generation-skipping taxes, and the law in these areas is constantly evolving. Depending on the law and your personal financial profile, your estate plan can be crafted to reduce your estate’s exposure to these taxes. Documents designed to account for one set of tax laws may not be as effective once those laws change, so it is important to update your documents to ensure they stay current.
So you have finally wrapped your head around the fact that you need to create an estate plan in order to determine to whom and in what amounts your property will pass upon your death. Estate planning attorneys realize that it is difficult to think about one’s own mortality, and getting clients to this point is half the battle. What you will want to consider as you go through this process is that your estate planning documents may not control the distribution of your entire estate. The distributions of some types of assets, categorized as nonprobate assets, are controlled by operation of law instead of the estate planning documents. While the creation of wills, trusts, and other estate planning documents is a crucial part of the estate planning process, it is equally important to understand how your nonprobate property will be distributed upon your death and, if necessary, coordinate the passage of the nonprobate property with your estate plan.
For estate planning and estate administration purposes, there are two broad categories of property: probate and nonprobate. Probate property is the property a person owns in his or her individual name that does not include a beneficiary designation. Common examples of probate property include individual bank accounts, vehicles, individually-owned real estate, and tangible personal property. An interest in jointly-owned property that is owned as tenants-in-common is also considered probate property because the individual’s interest in this property is severable from the other joint interests.
In contrast, nonprobate property is made up of two main types. The first type of nonprobate property is the property that a person owns as an individual but for which the person named beneficiaries by completing a beneficiary designation form provided by the financial institution holding the funds. This type of nonprobate property typically includes retirement accounts (401(k)s, 403(b)s, IRAs, etc.), life insurance, and financial accounts with a “payable on death” (POD) or “in trust for” (ITF) designation. The second type of nonprobate property is property that a person owns jointly with other individuals that is designated as being owned as tenants by the entireties (if the co-owners are a married couple) or jointly with the right of survivorship. Jointly-owned property may include real estate or financial accounts; in fact, Pennsylvania law provides that a jointly owned financial account is automatically considered to be owned jointly with the right of survivorship unless there is clear and convincing evidence that the co-owners intended for the account to be owned as tenants-in-common.
Most estates are a combination of probate and nonprobate property; however, recent trends show that nonprobate assets comprise a larger portion of an individual’s estate than in the past. This trend is important to note in an estate planning and estate administration context because nonprobate assets will be distributed by operation of law to the named beneficiaries under the beneficiary designations or the surviving joint owner, not to the beneficiaries named under the decedent’s estate planning documents. For this reason, it is important not only to know which assets are nonprobate at the time the estate plan is created, but also to update beneficiary designations (or even reconsider the titling of joint assets) after the estate planning documents are executed. Updating beneficiary designations is particularly important for older nonprobate assets, such as a 401(k) from a first job, that have beneficiary designations that were completed many years ago and may no longer reflect your life circumstances, let alone your estate plan.
A few examples illustrate these points. As a first example, suppose that a husband and wife execute Wills that leave all assets to the surviving spouse upon the first spouse’s passing. However, the husband has a large 401(k) through his employer, and he completed the beneficiary designation many years ago naming his mother as the beneficiary, as he was not married at the time. If the husband dies without updating his 401(k) beneficiary designation, that asset will pass to his mother instead of his wife. In a second example, suppose that a parent has three college-age children, and has created trusts under his Will to hold assets for his children until they reach age 40; however, the parent named his children outright as the beneficiaries of his life insurance. Without changing the beneficiary designation to name the trusts for his children, the life insurance will be payable directly to the children upon the parent’s death. Finally, consider the example of a mother who has an adult daughter and an adult son and executes a Will leaving her estate equally to the children. The mother also owns a house, but she retitles the house from her individual name to joint with right of survivorship ownership with her daughter. Upon the mother’s death, the daughter will be the sole owner of the house, while the son will not have any beneficial interest in the house.
While updating beneficiary designations after executing estate planning documents may seem like just another step, it is a crucial part of the estate planning process to ensure the you have coordinated the distribution of nonprobate assets with the distribution of the probate assets controlled by the estate planning documents, and that your overall strategy reflects your intentions. Working with an experienced estate planning attorney is real benefit as you go through this important process.
Shortly after Aretha Franklin died at the age of 76 after a battle with pancreatic cancer, documents filed in the Probate Court of Oakland County, Michigan by her family revealed that the legendary singer, who was estimated to be worth $80 million, did not execute a Last Will and Testament. Aretha Franklin now joins a growing list of celebrities, including Prince, Amy Winehouse, Kurt Cobain, Bob Marley, Jimi Hendrix, and Tupac Shakur, who all died without executing a Will or other estate planning documents. For many of these celebrities, their estates were, or are currently, subject to lengthy and protracted probate proceedings that played out for the media.
There are significant benefits to developing an estate plan, which can include a Will, Revocable Trust, and/or Irrevocable Trusts, even if you are not a celebrity.
First, and perhaps most importantly, developing an estate plan allows you to choose the beneficiaries of your estate, the amounts they receive, and how they receive those amounts. Individuals, like Aretha Franklin, who die without an estate plan will have their assets distributed according to their state’s intestacy laws or, for assets that contain beneficiary designations (such as IRAs, 401ks, and life insurance), according to the terms of the account provider. It is extremely difficult, if not impossible, for the personal representative of an estate to argue after an individual passes away that the intestacy rules should not apply when there is no Will or estate plan.
Second, creating an estate plan gives you flexibility to decide how your beneficiaries will receive assets. An estate plan could involve the creation of trusts, which allow the beneficiary to have the use of funds without having direct access to them. Trusts can be a useful tool for minor or young beneficiaries who may need time to develop prudent money management skills; for beneficiaries with special needs who cannot own significant assets outright without jeopardizing necessary public benefits; or for beneficiaries with significant wealth on their own or liability concerns who want to keep assets out of their own estates.
Third, an estate plan can, depending on the circumstances, allow you to reduce taxes that your estate may be subject to at your death. There are numerous estate planning techniques, many of which involve the use of trusts, that can be developed and implemented to reduce estate, inheritance, and/or generation-skipping taxes that may be assessed against an estate. These tax-planning options are extremely limited for intestate estates.
Fourth, the development of an estate plan may allow certain aspects of the estate administration to be completed in a more private manner than available for intestate estates. Probate records are public documents, so many of the details of an estate administration are available to the public. While a Will must be filed as part of a probate record, many trusts that could be created under an estate plan are not included in the probate record, and therefore do not become public. While public interest in the administration of your estate may be less than the interest in Aretha Franklin’s or Prince’s estates, the ability to shield some aspects of an estate from the public can be beneficial.
So, in the words of the late, great Queen of Soul...."You better think......"
Although parents may be paying tuition, covering children under their health insurance, and even claiming them as dependents on their tax return, without a Power of Attorney that parent may be helpless to aid their adult aged child (over 18 years of age) with medical or financial matters. Their doctors, hospitals, and even the college they attend, are limited in the information they are able to share with parents or other adults. A Power of Attorney for medical and financial matters allows a college student, or any adult, to appoint someone to handle these matters for them if they are unable or unavailable to handle it themselves.
While they are home between semesters, you might want to consider speaking to an estate planning attorney who can help plan and put the proper documents in place to allow your young adult to appoint the person or persons they trust to handle financial and medical matters for them. If they have a serious illness or accident, having these documents in place can save the family time and significant costs by avoiding the immediate need to seek a court appointed guardian. If they are traveling abroad and need assistance with matters at home, the Power of Attorney will allow their agent to handle banking transactions, sign tax returns and many other types of matters for them.
Taking the time to be sure these documents are in place before they become necessary can save the family, and the young adult, time if an emergency arises and it becomes necessary to use them.
Whenever you discuss your estate planning with your attorney, you should be sure to discuss the preparation of a Durable Power of Attorney as well. A Power of Attorney is a document that allows someone to act on your behalf when you are not present. Although incapacity is typically the reason a Durable Power of Attorney is used, it can also be helpful to have in other circumstances. If you are unavailable to act on your own behalf because of travel, deployment or temporarily living outside the area, your agent can handle many types of transactions for you. A Power of Attorney is commonly used in real estate transactions where the Seller has already moved out of the area and needs to appoint someone else to sign documents on their behalf.
A Durable Power of Attorney does not transfer assets to your agent or attorney-in-fact, but allows that person to act for you in most circumstances. Without a Durable Power of Attorney, when someone becomes unable to handle their own affairs, the appointment of a guardian will likely become necessary. A guardianship proceeding is conducted before the court in the County in which you reside and can be an expensive process that would take considerable time to accomplish. This can lead to bills going unpaid, the inability to handle every day banking transactions and cause a major disruption for you and your family. A Durable Power of Attorney, in most cases, can eliminate the need for a guardianship proceeding and allow your agent to handle financial transactions, real estate transactions and many other situations on your behalf.
Together with a Will and Advanced Healthcare Directive, a Durable Power of Attorney is an important part of planning for your future.
With less than 5 months remaining in 2012, we have had many clients take advantage of the current $5,120,000 exemption from federal estate taxes by engaging in some form of lifetime gifting. We have helped clients to establish Family Limited Partnerships (FLPs), Grantor Retained Annuity Trusts (GRATs), and Intentionally Defective Grantor Trusts (IDGTs). In many cases, multiple strategies have been combined to provide the client with additional planning benefits, including the potential for even greater estate tax savings.
Although the above strategies are excellent ways to take advantage of the current planning opportunity, we have also been encouraging our clients to consider using Qualified Personal Residence Trusts (QPRTs). For those not familiar with a QPRT, it is simply the transfer of a personal residence to a trust, wherein the donor retains a right to reside and use the residence for a term of years. At the expiration of the term, the real estate passes to the trust beneficiaries or is held in further trust for them. The QPRT provides for an initial discount on the gift because of the donor’s retained right to live there and it also allows any appreciation in the value of the property to move out of the donor’s estate tax free. However, when discussing the QPRT strategy with fellow estate planners, CPAs, financial advisors, and in some cases, even the clients themselves, the strategy is often dismissed out of hand, on account of the low interest rate environment we are in. The stock response I usually get is… “QPRTs work better in high interest rate environments.” In many ways, the low interest rates have caused the QPRT to be forgotten. But it should not be.
While it is true that low interest rates decrease the value of the retained interest (right to live in the property for a term of years), which increases the value of the gift, there are a few factors currently in play which mitigate the higher gift value assigned to the transfer. The primary factor is the depressed real estate values. Most of our clients’ primary residences are located in Bucks and Montgomery counties, the Philadelphia suburbs, Princeton, New Jersey, and the Saucon and Center Valley areas to the north. Their vacation residences are often located in Florida or at the Jersey Shore. These locations are very desirable places to live and vacation, yet such properties are being appraised at 25%-50% below market values from just a few years ago. While we do not have a crystal ball, we feel such properties have the potential to increase in value, with such appreciation outside of the Donor’s estate. This would likely make up for the smaller discount attributable to the current low rates.
Another major factor in favor of using a QPRT, even in this low interest rate environment, is the current $5,120,000 lifetime exemption from federal estate tax. This unprecedented exemption makes the smaller discount on the gift less problematic than in prior years when the exemption was substantially lower. In my experience, the donor often does not feel as compelled to drive down the value of the gift given the larger exemption the donor currently has to work with.
Finally, gifts of fractional interests in real property allow for discounting of the gifts to the QPRT. Assuming clients don’t mind the added complication and cost associated with gifting fractional interests to two separate QPRTs, the transfer of fractional interests adds value to the trust.
Similar to a GRAT, a donor who transfers real property to a QPRT must survive the QPRT term for the strategy to work. However, like a GRAT, a QPRT is as close as you can get to a no lose proposition in that, if the donor does not survive the term, the donor is in no worse position than if the donor had done nothing, except of course for the legal fees incurred to implement the strategy.
One advantage the QPRT has over the GRAT or the FLP is that the strategy has not been under attack in recent years, and if done properly will be a safe harbor. Additionally, some clients feel more comfortable gifting an asset that is not generating income, which is the case with most personal residences. The retained right to live at and use the residence for a number of years also provides a measure of security not found with outright gifts. Finally, upon the end of the term, the QPRT will usually provide that the donor may lease the residence from the QPRT or the trust remainder beneficiaries. This provides another mechanism to move additional assets out of the donor’s estate (via rent) without using any gift tax exemption.
These are exciting times for estate planning, but the current opportunities may not be available on Jan 1, 2013. Some have even described the situation as the perfect storm, and in many respect it certainly is. So please carefully consider the use of GRATs, FLPs, and IDGTs, before year end, but don’t forget the QPRT.
Estate Planning and Elder Law practitioners in Pennsylvania routinely recommend to clients that they execute a Durable General Power of Attorney naming an agent to be empowered to act on their behalf as an essential estate planning instrument. At a recent seminar presented, in part, by Montgomery County Judge Ott, he outlined what he considered the standard to determine capacity for the principal who is executing a Pennsylvania Power of Attorney.
The Principal must:
1. Understand the nature of the authority delegated to the Agent(s); and
2. Understand the nature of his or her assets to be delegated to the Agent(s); and
3. Understand the meaning of the Power of Attorney Notice now required for all Power of Attorneys.
The attorney should establish and document that all three of these standards have been met in order to avoid the instrument being overturned (invalidated, revoked) on the basis of incapacity, which could expose the attorney and/or the Agent to complications and possible liablility.