Estate Planning Mistakes:
5 Not So Easy Pieces



The estate planning process can be a mine field for the uninformed. The process of estate planning involves the coordination of the various assets of an individual into a cohesive, comprehensive plan to provide for family members. The real trick here is to analyze all assets whether held individually, jointly, and those that pass by beneficiary designations to come up with an effective overall and integrated strategy to deal with these assets. In many cases assets are incorrectly titled and need to be realigned. Often times beneficiary designations for life insurance and retirement plans need to be changed to obtain better tax and estate plan results.

The following are some of the common mistakes or misconceptions in this area, along with related estate and tax planning strategies to address these issues and to improve a client’s tax posture.

Failure To Draft A Will

The failure to draft a will results in the following problems or disadvantages:

  • Intestacy Rules of Succession Control: The rules of intestate succession of the state of residence of the decedent determine who will receive the estate assets. These state rules of intestate succession are a poor substitute for a person’s actual wishes. The benefit of a will allows you to determine and control who gets what and when they are allowed to receive assets of your estate. Oftentimes a trust is drafted as part of a will or as a stand alone document to provide for management and preservation of assets for those in need of a trust due to youth, lack of financial skills or special needs.
  • Naming Fiduciary: Without a will, you have given up the right to name a person to administer your estate. Leaving this to state law or a judge is really not a good idea.
  • Bond Required: Without a will some states require a bond for anyone who serves as administrator. If an out of state relative needs to be named or wants to serve as administrator, a posting of bond is almost always required. The cost of such bond would far exceed the cost of drafting of will in most cases.
  • Guardianship: A will allows the naming of a guardian for young children. Most people do not want a judge to decide this matter if at all possible.
  • Avoidance of Estate Litigation: Having a well drafted will can help avoid costly, time consuming and often bitter litigation between family members. This is especially the case in second marriages.

Leaving All Your Assets To Your Spouse

Although it may seem like a good idea, leaving everything to your spouse may not be wise from an estate tax perspective. For 2012, there is a $5,120,000 exemption for any decedent. In 2013, the exemption will be $1,000,000. There is talk in Congress of increasing this amount but with the federal deficit and congressional gridlock it may end up this exemption remains at $1 million.

Where a decedent has a will that simply gives everything to the surviving spouse, they have failed to utilize their exemption. When the second spouse dies they include in their estate the assets received from the first spouse to die. If they have a taxable estate that exceeds the then applicable federal exemption, a federal estate tax will result. This excess will be taxed at 35 or 45 percent or more depending on what the law may be at their date of death.

Example: Husband has an estate of $1.5 and wife owns $1 million in her name alone. Husband dies in 2012 with a will that gives everything to his spouse. He pays no federal estate taxes because his bequest to his wife reduces his taxable estate to zero as a result of the marital deduction rules. She dies in 2013 when the exemption is $1 million. Her taxable estate is now $2.5 million via her own assets and those received from her husband. As she only has a $1 million dollar exemption, the excess $1.5 million is taxable at least at 35% perhaps more. Her estate taxes would be at least $525,000. If her husband had instead set up a unified credit trust (when his exemption was $5 million in the year of his death, 2012), there would be no federal tax at her death, saving the family $525,000.

To correct this problem, new federal laws were enacted that allow for the “portability” of the first spouse’s exemption. These new portability rules allow for the second spouse to use the first spouse’s unused exemption. So in our example, the new portability rules would seem to eliminate this problem. But do they really?

This all sounds good in theory but here are some limitations and special rules that may limit the value of portability:

  • If the surviving spouse remarries, then children may not get these assets. A unified credit trust would allow for the tax saving discussed above and the assets will end up in the hands of the children of the first marriage.
  • If the surviving spouse enters into a second marriage, the portability amount from the first marriage may be lost if the second spouse dies.
  • With the estate tax laws so uncertain, no one knows whether portability will remain part of the law in the future.
  • When there are assets that may appreciate over time, portability may not be the answer. Putting assets into a unified credit trust at the first to die instead of relying on portability will remove all appreciation from these assets from the second to die spouse and could result in huge tax savings to the family.
  • Unified credit trusts also offer other benefits such as creditor protection and problems associated with second marriages. They also can protect young children from loss of assets due to bad marriages, legal problems, creditor claims, bad business decisions, bankruptcies.
  • If a spouse wants to take advantage of the generation skipping transfer tax (GST) exemption, then the first spouse needs to establish a so-called GST trust or dynasty trust. Portability will not facilitate this result.

So where does this leave most taxpayers? Taxpayers can preserve their unified credit exemption and eliminate estate taxes by placing their assets in a credit shelter trust. If correctly structured, the trust provides the surviving spouse and/or descendants with income for life and access to the principal as needed, but the assets are not taxed in either spouses estate. The savings here could be quite significant and the planning is much more certain. Finally, using this mechanism combined with GST exempt provisions can accommodate a client who wishes to create a dynasty or generation skipping trust.

Owning Assets Jointly or Holding Too Many Assets Jointly

The problem here is the same as the one just discussed, namely, that owning too many assets jointly will not allow the married couple to utilize each of their unified credits, since property is transferred automatically to the surviving joint tenant.

In addition, holding property jointly does not completely avoid probate in a husband and wife scenario. Although there may be no probate when the first spouse dies, the survivor will eventually own all the previously owned joint property that will then be probated and subject to estate administration on the second spouse’s death. So if avoiding probate and keeping one’s estate private is a goal joint tenancy ultimately will not work.

Joint tenancy type arrangements can be extremely problematic where there is a second marriage. If assets pass to the surviving joint tenant on the first joint tenant’s death, such assets become the sole property of the survivor. That survivor is free to draft a will that does not provide for the children of the deceased spouse. This can create real problems and expensive, time consuming and contentious litigation. This situation needs to be discussed and planned for with an experienced estate attorney.

Transferring of assets into joint tenancy with other family members (not a spouse) raise other problems. Gift tax, gift tax filing responsibilities and income tax issues are raised by such scenarios. For an article that details these problems please read IRS Checking Real Estate Transfers For Unreported Gifts.

Failure To Own Life Insurance Properly

Naming the beneficiary of a life insurance policy seems simple enough. However, where a second marriage is involved and the wife is named beneficiary, these proceeds may never end up benefitting the deceased spouse’s children. Where a husband and wife suffer a simultaneous death and small children are named as contingent beneficiaries of the life insurance proceeds, without estate planning a court will have to appoint someone to administer the policy proceeds. The person the court appoints as trustee may not be the person the deceased parties would have chosen. This could be a very expensive and problematic situation which can be solved by drafting an appropriate trust document.

From a federal estate tax perspective, people are surprised that life insurance owned by an individual is included in their taxable estate at death. This may result in federal estate taxes being paid on insurance proceeds at death. To avoid federal estate taxes, often times an irrevocable life insurance trust is utilized to own such policies to remove them from the taxable estate.

To pay premiums on such policy held in trust there can be gift tax implications. However, if the trust is drafted properly and certain documentation and notices are given each year, the insured can make annual gifts to the trusts that qualify for the annual donee exclusion to pay for the insurance premiums on such policies.

Finally, if a current policy is transferred to an irrevocable trust, care must be taken to account for the 3 year rule under federal law. This rule pulls back into the estate the insurance policy transferred to the irrevocable trust if the taxpayer dies within 3 years of the date of transfer. Special drafting considerations need to be employed in this context. It is often recommended that an irrevocable trust is first drafted and then the trustee purchases the life insurance policy to avoid this three year rule.

Failure To Have A Gift Giving Plan

Taxpayers sometime fail to recognize they can give $13,000 per year to as many donees as they desire. In addition, the spouse can join in such gift for an additional $13,000 annual donee exclusion. This will allow for gifts of $26,000 per year to as many donees as desired. Note that this gift must be a present interest gift as defined by the Internal Revenue Code, regulations and case law. Basically, a present interest gift is one where the recipient can enjoy the immediate benefits of such a gift in a significant way. For more on this topic, related and other gift strategies please review Gift Giving: Tax Advantages.

There are other gift giving strategies that may be available depending upon the situation. For example, the use of a family limited partnership can be a powerful transfer vehicle that can create estate and income tax savings for a family. Please see the article Family Limited Partnerships to explore these tax benefits.

Gifting of shares in a closely held business to those involved in a family business can be quite advantageous especially if the value of such shares are currently depressed due to the current financial conditions. For using tax strategies such as minority interest and lack of marketability discounts and how they create tax advantages in a bad economy please read my article Gifting Shares of Stock In A Bad Economy that was published in the Tax Corner section of the Journal of Accountancy in September 2009.

Depending on the situation other gift giving strategies such as the following may be utilized:

  • Intentionally defective grantor trusts
  • Qualified personal residence trusts
  • Charitable remainder and charitable lead trusts
  • Qualified tuition plans (see Section 529 Plans: Gift Tax Rules) and other qualified transfers
  • Qualified medical transfers

Warning

The above are just highlights of some mistakes that can occur without proper planning. The reality is that any estate plan must be tailored to the client’s family needs while taking gift, estate and income taxes into account. The special financial needs of family members also need to be considered. Blended families and second marriages raise special practical, legal and tax considerations.

Bringing together a person’s diverse assets to fit into an integrated and comprehensive estate plan that results in wills, trusts and other documents that actually work as intended is at the heart of sound estate planning. Do not hesitate to call me to explore the possibilities.

Steven has been providing outstanding legal advice to me for seventeen years. He is THE authority on estate planning and financial planning. Steven is a compassionate and thorough attorney who thinks of every possible contingency. He easily explains complicated issues, and it has been my pleasure to recommend him to my friends.
Gwen Bland

1420 Walnut Street Suite 300
Philadelphia, PA 19102

Telephone: 215-735-2336
Fax: 215-985-1666

Email: sjfpc@comcast.net
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From their offices in Philadelphia, PA, the law firm of Steven J. Fromm & Associates, P.C. provides a full range of estate planning, probate and estate administration, tax, business and corporate legal services to clients throughout eastern Pennsylvania and the Delaware Valley, the Lehigh Valley Area, the Five-County Area, Bucks County, Delaware County, Montgomery County, Chester County, Philadelphia County, Berks County, Lehigh County, Lancaster County, York County, Harrisburg, Norristown, Doylestown, Media, West Chester, Allentown, Lancaster, and Reading.