In his book The Tax & Legal Playbook, CPA and attorney Mark J. Kohler targets the leading tax and legal questions facing small-business owners, and delivers clear-cut truths, thought-provoking advice, and underutilized solutions to save you time, money, and heartache. In this edited excerpt, the author discuss the strategies you can use to make things easier for your heirs after you pass on.
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Millions of Americans die each year without any type of estate plan in place, and this forces their families into the court system, where they experience the high cost and time delay characteristic of probate proceedings. In fact, more than 50 percent of Americans don’t even have a will or any type of estate plan. So does everybody need to be scared into a revocable living trust (RLT)? Certainly not!
There are three main reasons to implement an RLT:
1. You have provisions you may want to implement for minor children or children that act like minors and have special needs for managing their finances;
2. You wish for your family to avoid probate because you own a personal residence, business, or rental properties; or
3. You wish to minimize estate tax with a marital bypass trust.
A quality estate plan typically includes an RLT, as well as a number of ancillary documents such as a will, powers of attorney for finances and health care, an advance medical directive or living will, burial instructions, a directive for organ donation, final instructions, etc.
One of the key reasons for using an RLT is to avoid probate, which means avoiding attorneys, judges, courts, and the state sticking their noses into the family affairs. Probate is essentially the court’s process of determining if the will is valid, then executing its provisions. If there isn’t a will, then the court distributes the assets according to state law.
In addition to helping your family avoid probate, the RLT becomes the instruction manual for how the estate is to be distributed among the beneficiaries. The process is administered by the trustee you appoint and avoids a tremendous amount of wasted time and money spent going through court.
In order to make sure the trust does its job, it needs to be funded by holding title to four main assets:
1. Real estate (typically your personal residence),
2. Entities (such as corporations and LLCs for rentals),
3. Investment accounts (including retirement accounts with see-through provisions), and
4. Life insurance (so that minor children receive it constructively).
Estate Tax and the A-B Trust Strategy
In the late hours of December 31, 2012, lawmakers in Washington, DC, passed the American Taxpayer Relief Act of 2012. Under the “fiscal cliff legislation,” as it came to be known, the estate and gift tax exemption was set at $5 million. This means that the first $5 million of an individual’s estate may be inherited (at death) or gifted (during life) before any estate or gift tax is due. This exemption amount is adjusted each year for inflation, and Bloomberg BNA projects it will edge up to $5.43 million each in 2015, making the total exemption for a married couple a whopping $10.86 million.
With a marital bypass trust, often referred to as an A-B Trust, a married couple can take advantage of both personal exemptions, thus doubling how much they can leave to their family without estate tax. This is a special trust that creates two subsequent trusts upon the death of the first spouse, thereby doubling the estate tax exemption of approximately $5.5 million. This is typically only undertaken when a family’s net worth is more than $5 million.
Creative Provisions for Children
Many parents and grandparents don’t realize how creative they can be in distributing their assets upon their passing. Here are a few options to consider:
- Require your trustee to hold children’s inheritance in trust until they reach the age of 25, 30, or 35. Give it to them in stages, e.g., a third at age 25, a third at age 30, and the final third at age 35.
- Use a joint trust for minor children until the oldest reaches age 18, then split up the trust into individual trusts for each child. This makes it easier for the trustee to manage the trust while the children are minors. Then when different children pursue business, education, marriage, or even world travel, their trust is accounted for separately from the others.
- Consider having the trustee give the guardian of your children a specific amount each month to take care of the living costs of your minor children (room, board, clothing, school supplies, etc.). It could be something like $1,000 a month, adjusted for inflation as of the date of your trust.
- Place restrictions on inheritance if there's drug or alcohol abuse. An attorney can insert a provision that prevents a distribution to any child with an abuse problem and allow for the trustee to hold their funds in the trust until they have their life under control.
- Give the inheritance in matching funds, distributing $1 for every $1 the child earns.
- Give them a bonus for graduating from certain levels of college or don't allow full distribution until they obtain a certain level of higher education. However, still distribute funds for school or any secondary education program, skills training course, etc.
- Distribute funds for education. Or use their GPA as a “carrot”: Distribute funds only if children maintain a minimum GPA that you set. You could also tie funds for tuition or books to GPA to help keep the children focused on finishing school, rather than becoming career students.
- Distribute a certain amount of funds for a wedding.
- Distribute funds to start a business upon the presentation of an acceptable business plan to the trustee. Name a board of advisors to approve any small business or investments by the children.
If you have a child whom you’d like to disinherit from your estate, don’t just leave their name out of the will and think this will accomplish your goals, as the laws in most states will presume you intended to have them inherit unless you specifically state otherwise. Following your spouse, your children are the presumed heirs to your estate by law in the absence of an estate plan. As a result, it's important to include a complete list of your children in the estate plan and to specifically mention any child who will not be an heir by stating something like, “It is the intention of the settlor [you] to disinherit the following child from the estate.” It’s that simple; just clearly indicate in writing that you specifically intend them not to inherit your estate, and they’re out.