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Estate Planning Overview – Basic Estate Plan Procedures and Documents

by Douglas Lineberry on August 12, 2011

What is estate planning, and what documents and agreements should an estate plan include?

Estate planning is the process of planning for likely or inevitable events in our lives and presently determining how we should address those events. A proper estate plan considers not only obvious events like death, but should also encompass issues such as retirement, disability, mental incapacity, guardianship of minors and asset protection (both for ourselves and our beneficiaries).

This outline presents several basic concepts and strategies that should be considered during the estate planning process. It is not intended to be a comprehensive guide that will allow you to independently plan your estate absent input and assistance from an attorney. It will, however, give you sufficient background information so as to be able to intelligently discuss your personal situation and alternatives when you do meet with an attorney.

I strongly recommend that you seek the advice and assistance of a qualified attorney when you prepare and estate plan. There are many unscrupulous non-attorneys that sell purported estate plan documents to the unwitting consumer. Often they are alleged to be “reviewed” by an attorney. These documents are usually prepared in a trust mill by non-attorneys and their assistants without any oversight or input from an attorney. They are rarely customized to actually fit your personal situation. Estate plans in a box (software) and from online companies are no better.  As Justice Painter (of the Ohio Court of Appeals) said:

To me, this case exemplifies the problems inherent in having assets pass by sloppily drafted instruments. The public should realize the danger in attempting to have a substantial portion of their wealth pass to their heirs or beneficiaries by IRA accounts, brokerage accounts, insurance policies, bank-deposit accounts, and the like. Often, as here, these documents are not prepared by a lawyer, not subject to the legal formalities of a will, and not artfully completed. For someone with the substantial assets involved here, an estate plan would have been advisable, so an attorney could have reviewed all documents such as this, avoiding ambiguity and its attendant costs, and ensuring that the decedent’s wishes were followed.

Tip! While the initial cost may be more, you’re much more likely to get an estate plan that meets your specific situation and accomplishes your goals if you work with an experienced estate planning attorney. Trust mills, online services and software kits are likely to produce documents that don’t accomplish your goals, create ambiguity and confusion and end up costing you and your heirs more in the long run!

The Basic Estate Plan Documents

Most estate plans include a last will and testament (often just referred to as a “will”), general durable power of attorney, health care power of attorney and health care directive to physicians (also known as a living will). Trusts are extremely powerful and also flexible agreements that are also often used in estate planning.  Common estate planning trusts include testamentary trusts (created when you pass away under the terms of the will), living trusts (created by you while you are still alive) and special purpose trusts that carry out a particular function (such as irrevocable living insurance trusts, also known as “ILITs”, that are intended just to hold life insurance policies). In some states (including Washington) community property agreements are also commonly used.

Probate

Before discussing what most lay people regard as the foundational estate plan document (the will), it is worthwhile to discuss the probate process. Probate is the judicially supervised process of administering your affairs and assets after you pass away. It includes marshaling your assets, ascertaining and paying your debts and finally distributing your assets. The process is necessitated by the fact that after you have passed away we need some means of transferring title to the assets that you owned. Since you are no longer available to transfer assets yourself, the court will order that someone can act in your place (your “personal representative,” also called your “executor”).

Among perceived problems with the probate process are its cost, the time it takes and the fact that it is a public proceeding. For example, I recently reviewed a probate file at the Pierce County, Washington Superior Court Clerk’s Office. I randomly selected a probate file that had been opened in 2005, read the decedent’s will, discovered that from beginning to end the probate took nearly eleven months and cost almost $5,000 (in court costs as well as fees paid to attorneys and accountants). In my experience, this was a very typical probate.

Because of the time, expense and public nature of probate, many people will desire an estate plan that will avoid the probate process.

Intestacy

Intestacy simply means dying without a will or other legal estate plan document that directs distribution of your assets. A person dying without a will is “intestate”. Each state has laws that direct the distribution of an intestate estate. For example, in Washington if you are married and all of your property is community property your surviving spouse will receive all of the property. However, if you are single your parents would receive the property and if your parents do not survive you then your brothers and sisters would receive it, unless you are single and have children, in which case your children would receive the property.

As you can imagine there are many alternatives as to where your property will go in the event you are intestate. Applicable statutes are simply the legislative best-guess at what most people would want in any given situation.

When someone dies intestate probate is not avoided. As mentioned above, the crux of probate is transferring title to assets. The same issue exists without respect to someone that is intestate.  The only difference is that the law, instead of your will, determines where your property is going to go. A court must still specify a personal representative (technically an “administrator” in an intestate probate) who will then have the court’s authority to transfer assets according to the statutory scheme.

Last Will and Testament

A will is a legal document that usually includes the following: (a) a description of your family members; (b) direction as to who will benefit from your estate; (c) limitations on how the beneficiaries will receive distributions (such as trusts for minor children, etc.) (d) nomination of your personal representative; and (e) nomination of your guardian if you have minor children. One significant advantage to a will over intestacy is the opportunity to make these determinations rather than accept decisions made by the legislature and courts.

The formalities that must be adhered to in preparing and executing a will are dictated by the laws of the state you reside in when you prepare the will. For example, in some states you might need two people witness the will, while in others you must have three witnesses.

Contrary to common belief, a will does not avoid probate. As stated above, probate is largely about transferring title to assets. While a will does give you the opportunity to state who will receive assets, under what circumstances and who will make the transfers for you, a court must still enter an order in a probate proceeding affirming that the person you nominated as your personal representative has legal authority to transfer assets.

Alternatives to Probate

As discussed, probate is often necessitated by the fact that we need a mechanism for transferring title to assets upon a person’s death. There are several other mechanisms that serve as probate alternatives. Each of these provides for a transfer of assets upon death by some means outside of intestacy or a will. These mechanisms include community property agreements, titling assets as joint tenancy with right of survivorship and using a revocable living trust.

Community Property Agreement

NOTE: The discussion on community property agreements applies only applies to Washington.

Community property agreements are agreements that allow a husband and wife to (a) establish that all of the property owned between them is community property, and (b) agree that upon the death of the first spouse to die, all of that spouse’s interest in the community property will vest in the survivor.

The feature that allows property to pass is a specific provision of Washington law. While community property agreements might allow probate to be avoided when the first spouse passes, a probate will still be required when the second spouse passes (and for that reason a community property agreement can be a supplement to, but is never a substitute for, a will or revocable living trust). Additionally, “no probate” does not mean “no process”. It is usually preferable to clear the first deceased spouse’s name from title at the time the spouse passes, which usually requires filing the community property agreement with the county recorder and then preparation and filing of various affidavits to remove the deceased spouse’s name from real property and vehicle titles, bank accounts, etc. While some process is therefore required, it is usually much less burdensome than the probate process.

There are potentially significant drawbacks to community property agreements. First, one of the spouses might have a separate property asset that they want to continue to regard as separate property. Second, in situations where the spouses are in a second marriage and each has children from a prior relationship, a community property agreement can essentially disinherit one of the spouse’s children. And finally, transfers of property under a community property agreement will waste the first deceased spouse’s estate tax credit because the property will be deemed to be subject to the marital deduction (discussed more fully below).

Joint Tenancy with Right of Survivorship

Titling assets as joint tenants with right of survivorship (or “JTROS”) means presently transferring title to your proposed beneficiaries as your joint tenants. Upon the death of any joint tenant, ownership of the property transfers to the surviving joint tenants (that is the survivorship feature).

To be blunt, titling assets as JTROS and calling it estate planning is such a bad idea it borders on being a dumb idea. This is true for many reasons. First, the asset is now subject to the claims of the new joint tenant’s creditors. Second, if the joint tenant dies before you then your “estate plan” has also died. Third, significant income tax benefits the beneficiary would otherwise enjoy will be lost. Fourth, amending the estate plan means re-titling all of the JTROS assets (which the joint tenants may or may not agree to).

I mention JTROS not as a legitimate alternative estate planning strategy but rather as a warning. While there may be non-estate planning reasons for titling assets as JTROS, from an estate planning perspective it is typically a terrible idea.

Revocable Living Trust

A revocable living trust is in many respects a will substitute. Like a will, it specifies who your family members are, who will receive property from your estate, under what circumstances, and who will manage the property and distributions for you. One significant difference between the will and revocable living trust is that the revocable living trust requires that you presently transfer your assets to the trust.

A revocable living trust is a three-party document. It is created by you (and often your spouse, if married) as the grantors or trustors of the trust. As grantor, you are the person specifying the trust terms and signing the trust agreement. You will also be the beneficiary of the trust for the remainder of your life. The trust also requires a trustee to manage the trust property pursuant to the terms of the trust agreement. During your lifetime (and as long as you have the capacity and desire to do so), you will usually also be the trustee of the trust.

Once the trust agreement has been signed you can formally transfer title to your assets to it (by way of deed, vehicle title transfer, etc.). Thereafter, you can manage the assets as you previously had; now you are legally doing it as the trustee of the trust.

Upon your death the revocable living trust avoids probate because it does not die. Recall above that I mentioned probate is necessitated by the fact that you had your name on title to assets at the time you die.  With a revocable living trust in pace you will ideally pass away owning nothing, in which case there is no reason to undergo the probate process. Your successor trustee (who you named when you executed the trust agreement) steps forward to manage and distribute the trust property according to the terms of the trust agreement. While the successor trustee acts much as a personal representative would, the fact that the property is owned by the trust and is subject to distribution under the trust rather than a will means that the successor trustee does not need to perform his or her duties in the context of a probate proceeding.

The following chart summarizes the differences between using a last will and testament or a revocable living trust as the central document regarding asset management and distribution in the estate plan.

Comparison of Will and Revocable Living Trust

Will Revocable Living Trust
 Pre-Death Asset Management None. The will is operative only upon death. In the event of incapacity, you will have to rely on powers of attorney (which can be very problematic) or a judicial guardianship proceeding. In the event of incapacity, the successor trustee steps forward to manage all assets in the trust according to the trust agreement (thereby avoiding using powers of attorney or a guardianship).
 Privacy Upon Death None. A will must be filed with the court and becomes a public document.  The trust is a private agreement that is not filed with the court.
 Property Dispositions Upon Death The will and the trust are the same in this respect. The same distributions of your property when either or both of you pass away can be made in wills or in a trust. We can also include a provision requiring a pre-nuptial agreement in either wills or a trust in the event the surviving spouse marries.  Same as Will.
 Time to Administer Estate  It typically takes 8 to 12 months to fully complete a probate proceeding. Administration and distribution of assets under a trust can be done in several weeks (but the time can be longer depending on the type of assets; for example, in a slow real estate market selling a house to obtain cash to distribute can take longer).
 Creditor / Asset Protection The will and the trust are the same in this respect. Neither of them offers any real creditor or asset protection while both of you are alive. If you use a will, you still own all of your assets in your own name. If you use a trust, there are particular laws that allow creditors to reach assets in your own revocable trust.  Same as Will.
Costs (estimates of costs in Pierce County, Washington) Initial: $500 – $600Upon Death: $2500 – $3500 each spouseTotal: $5500 to $7600 Initial: $1800 – $2400Upon Death: $400 – $600 each spouseTotal: $2600 to $3600

 

 

As the above comparison indicates, the primary advantages of the revocable living trust over the will are the following:

  • Lower total planning and administration costs
  • A mechanism to manage assets upon incapacity
  • Privacy / confidentiality
  • Avoiding probate proceedings
  • Faster administration upon death

Estate Tax Issues

Both Washington and the federal government have an estate tax. While the following is an oversimplification, you can see that the estate tax is calculated much like the individual income tax.

Gross estate

- Allowed deductions

= Adjusted gross estate

X Tax rates

= Tax payable

- Estate tax credits

= Estate tax due

For most people, three points are particularly relevant. One, the gross estate includes all property that you own or have an interest in at the time of your death. “Have an interest in” is an incredibly broad concept. It includes, for example, the proceeds of life insurance if you hold the “incidents of ownership” over the policy (the right to change beneficiaries, cancel the policy, etc.), even if the proceeds are not payable to your estate.

Two, every individual is allowed a dollar for dollar deduction for any property that transfers to a surviving spouse. This is often called the “unlimited marital deduction”.

Three, currently the federal estate tax exemption is on an adjusted gross estate of $3,500,000.  The Washington state estate tax laws, however, provides a credit that gives an individual exemption on an adjusted gross estate of $2,000,000. This is not an exceptionally high amount. Many people have life insurance policies that total $1,000,000, putting them halfway to the point of a taxable estate before any other assets are considered.

Note that as of the date of this article there is a further complicating factor in the federal estate tax.  Under current law the $3,500,000 exemption will automatically expire on December 31, 2012.  At that time, we will return to the estate tax as it existed in 2001, which is a mere $1,000,000 exemption.  The uncertainty surrounding whether Congress will actually fix the broken federal estate tax means that people who don’t have taxable estates today but would under the 2001 version of the law should provide flexibility in their estate plan to address a return to the $1,000,000 exemption.

While the effects of the estate tax and uncertainty surrounding it is a significant problem, another significant issue exists with a common planning tool and it’s effect on estate tax planning.  The issue is the unwitting use of community property agreements or a will or trust that leaves everything to the surviving spouse. For example, assume Husband and Wife have a joint $4,000,000 estate, all of which is community property, and a community property agreement, will or trust that specifies everything will go to the surviving spouse when the first spouse passes. If Husband dies in 2012, his $2,000,000 share of the estate would have been completely shielded by his state and federal estate tax credit. However, the estate tax calculation must be done in the order set forth above. His estate will receive a dollar for dollar deduction for everything that passes to his surviving spouse, leaving a $0 estate subject to estate taxes (and therefore no use whatsoever of his estate tax credit). When Wife dies with what is now her $4,000,000 estate, the combined state and federal estate taxes will be imposed on her now $4,000,000 estate.

The effect of this may be somewhat mitigated by a newer provision of the federal estate tax that does allow for some portability of an unused estate tax credit from one spouse to another, but portability is not automatic and does not apply with respect to the Washington state estate tax (and may not apply in other states).

This problem can be avoided by using what is commonly known as an AB Trust (also called a Credit Shelter Trust). An estate plan that includes an AB Trust will specify that upon the death of the first spouse, a trust is established for the benefit of the surviving spouse. The trust will receive assets from the deceased spouse’s estate up to the maximum amount that can pass free of tax and use all of the deceased spouse’s credit. The surviving spouse will continue to have access to the assets as the beneficiary of the trust. However, because the surviving spouse will not receive the assets outright, they will not be included in his or her estate upon death. In our example above, had an AB Trust been used as a receptacle for the Husband’s share of the community estate, the entire $4,000,000 estate could have passed free of estate taxes as the spouses successively passed away.

AB Trust provisions can be included in a will or revocable living trust. While the provisions are not terribly difficult to draft, if you are in a position where they should be included (that is, you have a taxable estate), you should consult with an attorney that is well versed in federal and state estate tax law. The two tax regimes are not always consistent and an AB Trust must be carefully structured to ensure that the maximum benefit of the estate tax credits is achieved.  This is not an area that you should leave to an inexperienced attorney, and it is definitely not an area that you should attempt to “go it alone” in by using an online document preparation service, software or estate planning kit.

Other Common Estate Plan Documents

General Durable Power of Attorney

A general durable power of attorney is a simple, inexpensive and reliable way to arrange for someone to make your financial decisions should you become unable to do so yourself. When you create and sign a power of attorney, you give another person legal authority to act on your behalf. This person is called your “attorney-in-fact” or, sometimes, your “agent” (while the term is properly “attorney-in-fact”, the person you name obviously need not be an attorney).

Commonly, people give an attorney-in-fact broad power to handle all of their finances. But you can give your attorney-in-fact as much or as little power as you wish. You may want to give your attorney-in-fact authority to do some or all of the following:

  • Use your assets to pay your everyday expenses and those of your family;
  • Buy, sell, maintain, pay taxes on and mortgage real estate and other property;
  • Collect Social Security, Medicare or other government benefits;
  • Invest your money in stocks, bonds and mutual funds;
  • Handle transactions with banks and other financial institutions;
  • Buy and sell insurance policies and annuities for you;
  • File and pay your taxes;
  • Operate your small business;
  • Claim property you inherit or are otherwise entitled to;
  • Transfer property to a trust you’ve already created;
  • Hire someone to represent you in court; and
  • Manage your retirement accounts.

The attorney-in-fact must always act in your best interests, maintain accurate records, keep your property separate from his or hers and avoid conflicts of interest.

A durable power of attorney can be drafted so that it goes into effect as soon as you sign it. Alternatively, you can specify that the durable power of attorney does not go into effect unless a doctor certifies that you have become incapacitated, or until you sign a separate certificate announcing that powers are then effective. This is called a “springing” durable power of attorney. It allows you to keep control over your affairs unless and until you become incapacitated or sign a certification, when it then springs into effect.

Your durable power of attorney automatically ends at your death. That means that you can’t give your attorney-in-fact authority to handle things after your death, such as paying your debts, making funeral or burial arrangements or transferring your property to the people who inherit it (although your attorney-in-fact can also be your personal representative or successor trustee).

Your durable power of attorney also ends if:

  • You revoke it. As long as you are mentally competent, you can revoke a durable power of attorney at any time.
  • A court invalidates your document. It’s rare, but a court may declare your document invalid if it concludes that you were not mentally competent when you signed it, or that you were the victim of fraud or undue influence.
  • You get a divorce. In a handful of states, including Alabama, California, Colorado, Illinois, Indiana, Minnesota, Missouri, Pennsylvania, Texas, Washington and Wisconsin, if your spouse is your attorney-in-fact and you divorce, your ex-spouse’s authority is automatically terminated.
  • The attorney-in-fact resigns and another is not named. To avoid this problem, you can name an alternate attorney-in-fact in your document.

Power of Attorney for Health Care

A power of attorney for health care is much like a general durable power of attorney in that you are naming a person to act on your behalf because you are unable. As the name implies, however, this power of attorney grants only the power to make health care decisions.

Health Care Directive to Physicians

A health care directive to physicians (commonly just called a health care directive, but also known as a living will or advance medical directive) is a statement that you can make as to whether or not you want certain medical treatment in certain circumstances.

In Washington, the health care directive is not only allowed for by statute, but a sample form is set forth in the statute. Essentially, the Washington health care directive statute allows you to specify whether you would or would not want artificially provided nutrition and hydration if you are permanently unconscious and terminally ill.

The decision that you make is not nearly as significant to your loved ones as the fact that you made a decision at all. We need only look to the case of Terry Schiavo to understand how important it is that we sign a health care directive.

Other Estate Planning Issues

There are many other issues that should be considered during the estate planning process. Among others, they include planning for special needs beneficiaries, charitable planning and asset protection. While it is beyond the scope of this short article to fully address all of these areas, you should consider how each of them might fit into your estate plan and consult with legal counsel that can assist your exploration of these areas and how they fit into your estate plan.

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