By: James J. Ruggiero, Jr. Esq., AEP

Estate planning can be like a poker game; one bad hand and you’re liable to lose the game. Indeed, losses in the game of estate planning are potentially huge losses, with adverse consequences for generations to come.  

Think about it this way
Husband and Wife work hard their whole lives. By successfully playing the hand they were dealt, Husband and Wife have accumulated over $5 million in assets. Believing he is protecting his assets, Husband executes a simple will with Wife as the beneficiary, leaving her all of the assets. However, unknown to both Husband and Wife, their winning streak may have run its course. The rules of the game have changed.

Remember Wife’s inheritance of over $5 million? In 2011, should she die, her heirs will be faced with paying an estate tax.

While you may consider $5 million a large estate, bear in mind that the $5 million mark is only in play for the next two years. During this period, Congress will reevaluate the estate tax threshold. Therefore, even if Husband and Wife have an estate smaller than $5 million, their heirs may be faced with an estate tax in two years’ time.

When you include the value of your home plus investments, do you reach $5 million?

Does your strategy involve trusts?
Indeed, the law that was enacted on December 17, 2010 for 2011-2012 is complex even for the most adept poker player, but you do have an option. During 2011, you may choose to have your estate taxed under the new 2011 rule or the 2010 rule (when there was no estate tax). The latter rule requires the executor to make an election. If the executor makes an election to designate assets for modified carryover, the executor can allocate a basis increase of $1.3 million for assets passing to any individual, and an additional basis increase of $3 million for assets passing to a surviving spouse.

Actually, Husband and Wife were not dealt a one-of-a-kind hand, and because of the return of the federal estate tax in 2011, they cannot just let the chips fall where they may. Rather, by establishing certain kinds of trusts, Husband and Wife will come to the table with an advantage and be able to avoid the high stakes often presented by having only a simple will.

The truth is, without the establishment of a trust, all bets are off that your assets will be truly protected for the next generation—even if you don’t have assets that reach $5 million. 

Suppose once Wife dies, all of the money is devised to Junior by means of a simple will. Aside from the fact that Junior could pay a hefty estate tax, other risks also exist. What if Junior is a spendthrift whose marriage recently ended?  Now that the money has passed to him outright by way of Wife’s simple will, it now becomes fair game to Junior’s creditors and his ex-wife. By contrast, had Husband or Wife established a certain kind of trust for Junior, he could receive enough income to maintain a reasonable standard of living while staving off the likes of creditors and his ex-wife.

Privacy is another benefit of utilizing trusts in your estate planning. As singer Willie Nelson says, “never count your money while you’re sitting at the table.”

Most of us desire privacy in estate planning. Unlike a simple will, which gets probated in Court and becomes public knowledge, the terms of a trust can be unknown even to its beneficiaries.

Types of trusts
To optimize the rules of the game, Husband and Wife must understand different types of trusts, such as a Revocable Living Trust, the most common form; an Irrevocable Living Trust; and an Irrevocable Life Insurance Trust.

A Living Trust is established during the settlor’s (also called the grantor) lifetime. The settlor is the person who creates the trust and is usually the only person who provides funding for the trust. The settlor transfers property to the trustee to be held for the benefit of a beneficiary.

The settlor may also be the initial trustee with a Revocable Living Trust, but a successor trustee is appointed in case the settlor dies. A trust is a revocable trust when the settlor has reserved the right to revoke (amend) the document during his lifetime. The “revoke” card is a critical card to hold as it enables the settlor to revise or terminate the trust, taking into account a change of mind or circumstance such as marriage, divorce, death or disability. The down side to a revocable trust is that assets funded into the trust will still be considered the assets of Husband and Wife for creditor and estate tax purposes.

Unlike the Revocable Living Trust, the Irrevocable Living Trust is an arrangement in which the grantor departs with ownership and control of the property. With this instrument, a Husband or Wife cannot incur a change of mind and retrieve the property.  However, since Husband or Wife no longer own the assets, the benefit to them is that the assets cannot be taxed when either dies, nor can they be seized by creditors. Just as each play is calculated and the risks are weighted in the game of poker, the grantor who chooses the Irrevocable Living Trust does so knowing that full protection from creditors and estate taxes is achieved in exchange for the lack of control over assets.

Another game-changing tool is the Irrevocable Life Insurance Trust. Irrevocable Life Insurance Trusts are planning tools used to keep life insurance proceeds outside of the taxable estate. For example, if Husband and Wife have an estate of $7 million, they can pass $5 million to the next generation with no tax under the current federal exemption. That still leaves $2 million subject to tax.

With an Irrevocable Life Insurance Trust, a Federal Tax ID number is obtained and applied for the life insurance policy. Since neither Husband nor Wife is owner of the policy, it will not be part of their taxable estate. Further, the policy can be used to pay taxes on the remaining taxable $2 million.

There are more advanced trusts as well. One example is the Grantor Retained Annuity Trust (GRAT), which is gaining in popularity. In a GRAT, the donor irrevocably gifts appreciated assets into a trust but retains the right to receive back from the trust a fixed annuity amount each year. With a successful GRAT, all appreciation in trust assets subsequent to the original gifting, completely escapes the donor’s estate tax and passes directly to the trust’s beneficiaries. For the GRAT to be successful, Husband and Wife must survive the life of the GRAT. A realistic assessment of whether Husband and Wife will survive the life of the GRAT must be made and if not, Husband and Wife should try another estate planning tool, which can be discussed with an estate planning attorney.

Gift tax exemptions
In 2011, the gift tax exemption is $5 million for individuals.  The gift tax exemption was increased from $1million in 2010 and permits a tremendous amount of wealth to be transferred. Husband and Wife should consult an estate planning attorney to determine if gifting assets is a good choice for them.

With the current $5 million exemption only on the table for the next two years, Husband and Wife can bet all their chips that establishing a trust will ensure saving tax dollars in the future.

Simple wills used to suffice, but times have changed. By establishing a trust that meets their needs, Husband and Wife can ensure they are playing with a full house for years to come.