How Do I Know If I Need Estate Planning or Asset Protection Planning And Whether Or Not An Irrevocable Or Revocable Trust Is Right For Me?

By
Todd E. Lutsky Esq. LLM

  1. Things to think about when considering estate planning as a married couple and related traps for the unwary.
  1. Do you own life insurance in your own name?
  2. Do you own assets jointly with your spouse?
  3. Is your spouse listed as the designated beneficiary on your IRA or 401k account?
  4. Are you a resident of Massachusetts?
  5. Does the value of your gross estate exceed $1,000,000?
  6. Do you currently have simple wills? i.e. which means that upon the death of the 1st spouse, all the assets go to the surviving spouse?
  • Let’s explore how the ownership of the assets listed above operate to cause unnecessary estate tax liability.
  1. Life Insurance: Upon the death of the owner of a life insurance policy, the death benefits are paid directly to the designated beneficiary and outside of the probate process. In addition, such death benefits are also income tax free to the recipient, i.e. surviving spouse. However, the trap for the unwary is that the surviving spouse now has cash and assuming it is not spent prior to his or her death, those assets are now subject to estate tax upon the surviving spouses death. If the death benefits of life insurance will cause the value of an estate to exceed the $1,000,000 Massachusetts or current $2,000,000 Federal exemption amounts, then such a policy should be owned by an irrevocable life insurance trust, which will prevent the death benefits from being subject to estate taxes.
  2. IRA and/or 401k Accounts: Upon the death of the participant spouse, the entire account may be rolled over to the name of the surviving spouse, who is listed as a designated beneficiary and would avoid the probate process. However, the trap for the unwary is that upon the death of the surviving spouse, the entire IRA or 401k account will be subject to estate taxes and ultimately income taxes. The challenge with qualified plan assets is to balance the income tax benefits of these plans by naming the spouse as designated beneficiaries with the loss of an estate tax exemption on the estate tax side. The solution might be to name the spouse as the primary beneficiary and a family revocable trust as the contingent beneficiary. This allows the surviving spouse the option of choosing to accept some or all of the money from the plan or disclaim it and allow the trust to receive the assets depending what the estate tax rules are in effect on the date of the decedents death. This technique will allow an individual to better utilize his or her estate tax exemption upon their demise.
  3. Jointly Owned Assets With A Spouse: With regard to any jointly owned real estate, investments accounts or bank accounts with a surviving spouse, upon the death of the 1st spouse to die, these assets would simply pass to the surviving spouse and avoid the probate process. However, the trap for the unwary is that all of these assets will now be subject to estate taxes upon the death of the surviving spouse. The real cause for this unnecessary tax is that the government allows the 1st spouse to die to leave an unlimited amount of assets to the surviving spouse without incurring any estate tax liability, thereby resulting in a potentially significantly higher estate tax liability upon the death of the surviving spouse.
  4. Planning note: The Tax Effects Of Owning These Assets Improperly
    Let’s assume that you answered yes to the questions listed above, that your estate is worth approximately $2,000,000 and suddenly one spouse dies. The 1st spouse’s death would result in little or no probate costs, no Massachusetts or Federal estate taxes, and all of the assets would automatically become owned by the surviving spouse. While this may sound like a good result, it is actually the largest trap for the unwary that the government provides in the estate planning world. The real result is that by passing all of the assets to the surviving spouse, under the unlimited marital deduction, the 1st spouse to die has effectively wasted his or her current $2,000,000 Federal and $1,000,000 Massachusetts exemption equivalent amounts. These exemption amounts represent the value of assets that the Federal and Massachusetts governments allow each person to pass to the next generation without paying any estate taxes. However the general estate planning rule is that if you do not use your exemption amount, either during life or upon your demise, that you effectively lose it, thereby leaving only a single exemption amount available at both the Federal and State level for use by the surviving spouse. Therefore, assuming the surviving spouse passes away in 2006 with an estate worth $2,000,000 there would be no Federal estate tax due, but there would be a Massachusetts estate tax liability in the amount of approximately $99,500. However, since there remains uncertainty with regard to the amount of the Federal estate tax exemption in the future, it would be wise to plan for the Federal exemption amount returning to $1,000,000 by 2011 and assuming no growth in the value of the estate, there would be a Federal estate tax due of approximately $435,000 in addition to the Massachusetts liability, mentioned above.
  • How utilizing your Federal and Massachusetts exemption equivalent amounts through basic estate planning with revocable trusts can reduce and maybe eliminate your estate tax liability.
  1. Facts: Joe and Jane own a home worth approximately $600,000, investment accounts worth approximately $400,000, a life insurance policy worth approximately $500,000, miscellaneous savings and checking accounts worth in total approximately $200,000 and a vacation home worth approximately $300,000. In addition, Joe and Jane own all of their assets jointly, and or have each other listed as the applicable designated beneficiaries. Finally, the only estate planning documents they have are simple wills.
  2. Consequences Of Joe Dying In 2006: Upon Joe’s death there would be no Federal estate tax, as their gross estate equals the $2,000,000 Federal exemption amount, and there would be no Massachusetts estate tax even though the estate would exceed the Massachusetts $1,000,000 exemption amount as the assets would simply pass to the surviving spouse under the unlimited marital deduction, as explained above. However, if Jane died later in 2006, and assuming no growth on the assets, there would be a Massachusetts estate tax due of approximately $99,500. However, in the event Jane died in the year 2011, and assuming that the Federal exemption amount is $1,000,000, as it is currently scheduled to be, and that there was no growth on the assets, there would be a Federal estate tax liability of approximately $435,000, in addition to the Massachusetts liability mentioned above.
  3. Solution Revocable Trust: These trusts are vehicles that would allow Joe and Jane to remain in complete control of their assets during their lives, provide the proper disposition and control of their assets following their demise as well as enable them to avoid the cost associated with the probate process and reduce, and in their case, eliminate both their Federal and Massachusetts estate tax liabilities. This is accomplished by drafting the trusts in such a way that ensure they allow both Joe and Jane to better utilize both their Federal and Massachusetts exemption amounts. Finally, it is important to note that even if Joe and Jane had their revocable trusts in place, but instead of funding them, they owned all assets jointly, the estate tax liability would be the same.
  4. Conclusion: If you are married, under the age of 60, and have assets that exceed $1,000,000, it may be appropriate to explore the use of revocable trusts in order to prevent the payment of unnecessary estate taxes and/or probate costs. In the event you meet these criteria, but are single, it may be appropriate to pursue not only revocable trusts, but also perhaps more sophisticated estate planning techniques in order to accomplish the same results.
  • Things to think about when considering asset protection planning and the use of Medicaid Irrevocable Income only trusts.
  1. Are you 60 years of age or older?
  2. Do you own a home, vacation home, or rental properties that you wish to protect?
  3. Is the value of your gross estate worth less than $1,800,000?
  4. Solution: Irrevocable income only trust(s): If you answered yes to these questions, then you should explore the implementation of either one or possibly two irrevocable income only trusts. These irrevocable income only trusts, like the revocable trusts mentioned above, will help you to reduce the costs associated with the probate process, ensure the proper disposition and control of your assets following your demise, enable you to retain a significant degree of control over your assets during your lives, reduce and in some cases eliminate your estate tax liability while at the same time serving to protect your assets from the cost associated with long term care. With regard to control, you may serve as trustee during your life. As trustee, you can manage and invest the assets as well as sell your home and replace it all without the need to obtain any permission from children. In addition, you would retain the capital gains tax exclusion associated with the sale of your primary residence. However, with regard to long term care planning, the newly enacted Federal legislation requires a 5-year waiting period following the transfer of your assets to the irrevocable trust before you would be eligible for Medicaid benefits. Therefore, the earlier you get started, the more likely you are to protect your assets from these costs.
  5. When to use one irrevocable income only trust: In the event you are fairly certain that the value of your gross estate will not exceed the current $1,000,000 Massachusetts exemption amount, and maybe the Federal exemption amount in 2011, following your demise, then you may consider implementing only 1 irrevocable income only trust as there would be no need for estate tax planning since your estate would be less than these exemption amounts.
  6. When to use two irrevocable income only trusts: In the event your estate may exceed the $1,000,000 Massachusetts exemption amount and you are married, you may wish to consider the implementation of 2 irrevocable income only trusts. By establishing 2 such trusts and dividing your assets between them, will enable each of you to better utilize both your Federal and Massachusetts exemption equivalent amounts, as explained above, thereby allowing you to reduce and possibly eliminate your Federal and/or Massachusetts estate tax exposure.
  7. Income tax concerns with irrevocable income only trusts: Since these trusts are drafted as grantor trusts, there is no adverse income tax consequences associated with them. The term grantor trust means that the donor, or creator of the trust, is considered the owner for income tax purposes. Although there would be a need to file a form 1041, which is the trust income tax return, there would be no taxes due at the trust level as the income would flow though the grantor trust and be reported on the donor’s individual tax return. In other words, the donor would continue to pay income taxes on any such trust income at his lower individual rates, just like he used to prior to establishing the irrevocable trust. Finally, in the event the trust has no income, then there would be no need to file a trust income tax return.
  8. Conclusion: If you are married, your estate is worth less than $2,000,000 but more than $1,000,000, and are concerned about protecting your assets from long term care, it may be advisable to explore the implementation of 2 irrevocable income only trusts. Again, the importance of 2 trusts for estates this large is to ensure that both the asset protection and estate tax planning concerns are being addressed. In the event you are either single or married, have an estate that is unlikely to exceed $1,000,000 following your demise and are concerned about protecting your assets from the cost of long term care, then a single irrevocable income only trust may be worth exploring.