Wills and Estate Planning
Everyone should have an up-to-date will that reflects an estate plan adapted to individual needs and circumstances. The estate plan is a thoughtfully designed arrangement for the distribution of one's assets in such a way as to achieve maximum realization of the planner's objectives. These can include keeping taxes at a minimum; providing financial management for the benefit of a surviving widow and children; selection of a trusted relative, friend, or advisor as executor or guardian; and so on. An estate plan can be simple and inexpensive to draw up; for a larger estate or one with special problems the plan may be extremely complex.
Most persons or couples of reasonable means should have an estate plan—and a will or wills as integral parts of that plan. But whether it is part of an estate plan or not the will is ordinarily a written document that takes effect on the death of the testator, the legal term for the person making out a will. The will's purpose is to distribute one's worldly assets to those whom the testator desires or “wills” to have them.
The estate plan may deal with broader categories of assets than the will. The estate plan may, for example, have provisions covering gifts, insurance, and annuities, special types of contracts such as those providing for the purchase of a business by surviving associates, trusteeship arrangements, and other devices designed to accomplish the testator's purposes. The estate plan may also provide for changes in the estate to be made before the planner's death. The will generally takes effect only on the testator's death.
Estate Planning: Four Main Tools
You can make a beginning toward estate planning by considering the four main tools a planner can use. The four are trusts, lifetime gifts, joint ownership, and wills. Other tools are, of course, available, and each has a valid purpose. Under specific arrangements, for example, death benefits may be paid to named beneficiaries under pension plans, profit-sharing programs, IRAs, tax-sheltered annuities, and deferred compensation arrangements. Some estates use irrevocable living trusts or buy-sell agreements dealing with businesses.
Adding It Up. In general, property is anything you can own. Everything you own belongs in your estate. That includes both real property, or real estate, meaning both land and all the things that are permanently attached to the land, and personal property. The latter includes tangibles, those items that have bulk or substance, and intangibles, things without physical substance. Among common tangibles are furniture, an automobile, cameras, clothing, a boat, and so on. Intangibles are such items as stocks, bonds, life insurance policies, and bank deposits.
A first step in estate planning involves inventorying all your property of whatever kind. With each item you should note the value or estimated value. You should also indicate how the property is owned—outright, in joint tenancy, or otherwise.
Objectives. What do you want to accomplish when you plan your estate? Your objectives should be clear; they often determine what methods you will use to transfer your property, or specific parts of it, to your spouse, relatives, friends, charities, or other beneficiaries. At the least you will want to know who your heirs will be and what each heir will receive.
Some specific objectives help to shape estate plans. A property owner may want to provide financial support for dependents, including both money to live on and funds that would be available in emergencies. Nearly all estate planners hope to reduce such estate transfer costs as federal estate and state inheritance taxes, the expenses of administering the estate, and others. Very basically, a valid objective is to ensure that the estate will have sufficient assets to meet its obligations.
Other objectives may seem obvious. As noted, you will want to name the person or persons who will administer or settle your estate after your death—and under what terms. The disposition of closely held business interests should be provided for. Finally, property distribution should make up parts of the estate plan.
Tool 1: Trusts
As one of the key tools of estate planning, trusts play unique roles. Whatever the type of trust, and there are many kinds for persons in many economic categories, the typical trust instrument places legal title in one person, called the trustee, and equitable title in another person, the beneficiary. In each case the “person” may be an individual, a corporation, group, or organization. The grantor (or creator or settlor) who establishes the trust gives the trustee the right to hold and administer the trust corpus, or principle, for the benefit of the other person or entity.
Three main kinds of trusts are used by the estate planner: living, or inter vivos (“between the living”), trusts; testamentary trusts established by will; and insurance trusts. Living trusts are set up while the grantor is alive, and take effect at once. Testamentary trusts take effect on the grantor's death. The corpus of the insurance trust consists of funds from an insurance policy—or funds to be paid out under an insurance policy or policies—and, possibly, other property as well.
Why a trust? To some extent the reasons parallel those that justify estate planning itself. Among the reasons:
· To protect spendthrift heirs or other beneficiaries who may be mentally, physically, or emotionally unable to manage property. The trustee can have total management responsibility.
· To enable the trustee to use discretion and, often, expert knowledge in managing trust property for the benefit of heirs, the grantor, and family members or others.
· To have a device for giving or leaving property to minors with the assurance that the trustee will manage the property until the beneficiaries are old enough to handle the property themselves.
· To take all or part of your estate property out of probate and in that way to save your heirs the costs and delays of going through the probate process.
· To set up a useful tax-saving plan.
Depending on your financial status and the complexity of the trust you want to set up, you could pay from $100 to $10,000 or more to an attorney to prepare your trust agreement. On average, you would pay about $300 to $500.
Such an expense could definitely be worth it. Remember that the federal government has provided that estates of $500,000 or less were to escape estate taxes in 1986. That figure was to rise to $600,000 in 1987 and subsequent years. In one case a couple had property worth $800,000, all in the husband's name. Assuming that the husband dies first, in 1987 or later, the entire estate passes to the wife. The so-called marital deduction allows whole estates of whatever kind to pass to a surviving spouse tax-free. But when the wife dies a different rule applies.
On the wife's death in 1987 or later, the federal exemption would apply only to the first $600,000 of the $800,000 estate. At rates in effect in 1986 the couple's heirs would pay $52,000 in estate taxes on the remaining $200,000.
This couple could have saved all $52,000 in federal taxes by establishing a trust. The couple would have had several choices, including these:
· A bypass trust that would set aside $600,000 of the husband's estate as the trust principle, with income from the trust and part of its principle going to the wife during her lifetime. The other $200,000 in the husband's estate would go directly, on his death, to the wife for her unrestricted use. On the wife's death the trust would dissolve and the entire estate would be distributed to the beneficiaries free of federal taxes.
· A marital deduction trust, with either of two kinds available: a general power of appointment trust or a so-called QTIP (qualified terminable interest property) trust. Again the couple's beneficiaries would pay no federal estate taxes on the death of the second spouse.
Under the general power of appointment trust, your spouse can decide after you die who will receive the trust's assets after he or she dies. The QTIP, by contrast, makes it possible for you to select the ultimate trust beneficiaries. With the QTIP you can make sure, if desired, that your spouse will not cut off your children by an earlier marriage. Otherwise the general power of appointment and the QTIP trust are virtually identical. Both, for example, qualify for the marital deduction and are included in the surviving spouse's estate. Both also produce income that must go to the surviving spouse.
· A generation-skipping trust, under which trust income goes to a grantor's children rather than to the wife and the principle goes to the grantor's grandchildren.
In many cases a grantor can use an irrevocable life insurance trust under which the proceeds from insurance policies are removed from the grantor's estate, to be distributed after the second spouse's death to the named beneficiaries. The spouse receives income from the trust until he or she dies.
Selecting the Trustee
The problem of selecting a trustee usually resolves into a choice between an individual and a corporation. The individual, whether the creator of the trust or someone else, might be closer to the trust beneficiaries than a corporate trustee—and might therefore be more responsive to the beneficiaries' needs. The individual might not even charge a fee. Under any circumstances, the person or persons serving as trustees could, as needed, obtain legal, investment, accounting, and other advice from experts.
The corporate trustee could offer different advantages. Such trustees are professional money and property managers. Unlike the individual trustee, they do not, usually, die or become incapacitated; personnel changes do not interrupt their services. Beyond that, they remain unbiased, independent of family pressures, and able to answer to charges of mismanagement. By comparison with the individual trustee who is also a trust beneficiary, the corporate trustee cannot incur personal income tax liabilities in administering trust property. A corporate trustee can, of course, act as cotrustee with an individual or individuals.
Tool 2: Gifts
Lifetime gifts function much like trusts. Essentially, they reduce the value of your estate and thus help to avoid estate taxes. An important difference, however, is that your surviving spouse has no access to the money you have given away. Thus most persons make certain that the surviving spouse will have enough income to live on after the first spouse's death.
In the 1980s the federal government liberalized the laws regulating gifts of property or money. In 1986 individuals could give up to $10,000 each to as many persons as they chose. For couples, the law allowed joint gifts of as much as $20,000 each to any number of donees. You need not report gifts of less than $10,000 to the Internal Revenue Service, but must (whether individual or couple) report all gifts exceeding that sum. After your death, the IRS will add up all the taxable gifts—those exceeding $10,000 per year per person—that you made during your lifetime and (if applicable) subtract the total from your $600,000 (1987) estate tax exemption.
Kinds of Gifts
You can give gifts in many different ways. A charitable remainder trust is actually a way to give assets to a charity while ensuring that you or your beneficiaries will receive the income from the gift property for a specified period. At the end of the period the trust dissolves and the charity receives the principle. Very wealthy persons may use a GRIT (grantor retained income trust) that sets aside part of the grantor's estate as a gift to a family member or friend. The grantor receives the income from the gift property for a specified period, whereupon it passes out of his or her estate and into the ownership of the beneficiary.
A third method of giving away assets operates on a principle opposite to that of the remainder trust. This charitable lead trust provides that a charity will receive the income from the specified property—but not the principle. When the trust ends, your heirs receive the principle. You arrange for a charitable lead trust in your will. Often, your estate enjoys even larger tax deductions than it would under a remainder trust.
Tool 3: Joint Ownership
Joint ownership of property offers both advantages and disadvantages that should be considered in estate planning. Joint ownership (a legal device that exists when two or more persons have ownership rights in property) allows that property to pass automatically to the other joint owner or owners outside the probate estate of the first owner to die. The device thus saves the time and expenses often involved in the probate process.
Other advantages may be noted. Some states levy lower inheritance taxes, or no taxes, where property is held jointly. Usually, too, the survivor receives jointly held property free of the claims of the creditors of a deceased joint owner.
Joint, Outright, and Community Property Ownership
Joint ownership is one of four basic ways in which real or personal property may be owned. The other three are outright ownership, community property ownership or rights, and tenancy in common. The three types of joint ownership or tenancy include:
Joint Tenancy with Right of Survivorship. Under joint tenancy with right of survivorship (WROS), the property interest of a descedant passes with his or her death to the surviving joint owner or owners. A married couple typically own their home jointly. When one dies, the property interest of that deceased passes to the survivor, who then owns the property outright in his or her own name.
A joint tenant can destroy the survivorship aspect of a joint tenancy. For example, if one joint tenant sells his or her share in property to a third party, that person and the remaining joint tenant own the property as tenants in common (see below).
Tenancy by the Entirety. A second form of joint tenancy is tenancy by the entirety. Some states provide for this special kind of joint ownership when a wife and husband own property jointly and exclusively. Tenancy by the entirety differs from joint tenancy with right of survivorship in three key ways: the former can only exist between husband and wife; in many states the survivorship rights can be terminated only with the consent of both parties; and, again depending on the laws of the particular state, the husband may have control over the property (and the right to any income from it) during their lifetimes.
Other Joint Interests. Where joint bank accounts or jointly owned government savings bonds are concerned, the owners may again have rights of survivorship. Thus family members commonly hold both types of property under this joint ownership arrangement. With a bank account, either party can make deposits or withdraw funds. On the death of one, the survivor becomes sole owner of the account by operation of law.
With savings bonds, a similar rule applies. Both joint owners have survivorship rights even though the bonds may be registered in co-ownership form and held in the name of “A” or “B.” Either A or B could cash the bonds during the lifetime of the other.
Tenancy in Common
Under tenancy in common arrangements, no co-owner has survivorship rights: none acquires the interest of another in case of the other's death. Rather, the interest of a decedent goes to the decedent's heirs as if the interest had been owned outright. The survivor retains his or her share. Tenants in common can own proportionate interests in property—for example, 75 percent and 25 percent respectively.
In outright ownership, one person owns property exclusively in his or her name. Community property is discussed below.
Not a Will
Despite some advantages, joint ownership does not take the place of a will. In cases on record, couples owning property jointly, but having no wills, were involved in serious accidents. One spouse died instantly. The other survived by a few hours or days. The survivor could not make out a will. By law, the property passed to the surviving spouse on the death of the other. On the death of the second spouse, the property typically passed entirely to the second spouse's relatives.
Joint ownership may also produce results contrary to those intended, may save few or no taxes and other expenses, and may even increase taxes dramatically. The effects depend on state laws. But in many states lawyers cannot say for certain what the effects of joint tenancy may be. It may nonetheless be advisable to hold checking accounts and small savings accounts in joint ownership to provide the survivor with ready cash on the death of one joint owner; even if the account is frozen for a time it will normally become available well before the assets of the deceased's estate.
For sentimental or other reasons, a husband and wife usually own the family home jointly. Ownership of other assets should be based on sound legal advice—which also applies to the overall estate plan, including the will.
Joint Ownership—How Much?
No simple rules are available to indicate how much property should be held in joint tenancy. If the federal estate tax is not an important factor, a couple may hold all property jointly. But even if the couple's estate is large enough to be federally taxable, some joint ownership may be appropriate for the reasons noted.
The Economic Recovery Tax Act (ERTA) of 1981 produced some new rules on joint tenancies held by married couples. In particular, the act provided that only one-half of the value of the property held in a taxable joint tenancy is includable in the gross estate of the first spouse to die. This “fractional interest” applies regardless of whether the surviving spouse contributed to the purchase of the property.
As a caveat, joint ownership may actually result in a gift. This occurs where one joint owner has contributed all or a disproportionate share of the cost of purchasing property. If Mrs. Jones, for example, uses her own funds to buy corporate stock in her own and Daughter Joanne's name, and if the ownership is irrevocable, Mrs. Jones has made a gift, for federal tax purposes, to her daughter of one-half the value of the stocks. Her daughter has also gained some control over the stocks.
Different from Community Property
Property owned jointly should not be confused with community property. The latter exists in some western and southwestern states that follow Roman law rather than the English common law where property relationships between husbands and wives are concerned. In common-law states marriage gives husbands and wives certain rights in each other's property that often cannot be changed by a will. This is also true in community property states, but the rights are somewhat different.
In these states one-half the income earned during the marriage by either spouse belongs to the other. All property owned by the couple is presumably community property, of which each owns half. But property owned by either spouse before marriage and kept separate, with the income from such property also kept separate, and property acquired by one spouse individually, without contributions from the other spouse—for example, by gift or inheritance—are the separate properties of each spouse owning it.
In community property states married couples' wills cannot touch the separate property of either spouse or either spouse's share of the community property. But a couple can by contract agree on what is community property and what is the separate property of either. Such contracts take effect when written and signed. They are an essential tool of estate planning in community property states. But they do not obviate the need for a will any more than joint tenancy does.
The nine community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In these states estate planners should be wary of making a person other than the spouse a joint owner of community property. As a rule, half the wife's or husband's share of the community property passes to the surviving spouse and the other half goes to the heirs named in the descedant's will. The surviving spouse may or may not be named as an heir.
Tool 4: Wills
As the fourth and most important tool used in estate planning, wills need always to be individualized to the creator's (or testator's) situation, estate, and desires. The written will is signed by the testator in the presence of witnesses; it operates at his or her death to distribute property according to specifications in the document itself. The law imposes certain obligations, including the primary duty to pay tax liabilities, debts, funeral expenses, and the costs of administration. The law also provides for a surviving spouse's legal rights in a decedent's estate and refuses to recognize, on public policy grounds, provisions discouraging marriage, wasting assets, or tying up wealth for unreasonable periods of time.
Wills may be short and simple or long and complex. But in all cases certain essential requirements must be met. The will must, for example, be signed and witnessed to be valid. For his or her own peace of mind, a testator should have a lawyer prepare the “last will and testament.” “Do-it-yourself” wills, and wills written on standard forms, are generally inadvisable, largely because so many of them lead to legal problems later.
A will allows you to dispose of your property to the persons you select, at the time you choose, in the amounts and proportions you specify. You can also indicate how your property will be protected and who will be responsible for its protection. Anyone who is 21 years of age and mentally capable of understanding the nature of a will can have one drawn up. In some states or under some conditions the age requirement is reduced or waived.
The cases of husbands and wives who sustained fatal injuries in a common disaster point up the importance of wills. Usually, the husband and wife have left their estates to each other. The deaths of both in the same accident could create difficulty, especially where the order in which the two died cannot be determined. For that reason most wills contain a common diasaster clause providing for the distribution of family assets in the event of simultaneous deaths or deaths resulting from the same accident.
Selecting an Executor
Selecting the person who will oversee the distribution of your estate according to your will is as important as choosing a trustee. Many of the same principles apply. The loyalty and ability of the executor may be the single most critical factor in ensuring effective and fair administration of your assets after your death: particularly in preventing losses and protecting the property you have left under your will.
Subject to the supervision of an appropriate court, the executor takes possession of the assets specified in the will, manages the estate as the deceased would have, pays debts, taxes, and expenses, retains legal counsel as required, and through counsel handles all the legal obligations and procedures incident to the “execution” of the will. The executor also accounts to the court and heirs for his or her stewardship and distributes the estate's assets according to the provisions of the will and applicable legal strictures. Business skill and judgment, diligence, and the capacity to attend to details and maintain proper records are essential qualities of the good executor.
As a testator, you can nominate the executor of your choice, and can also name alternates if desired. Often a testator appoints a surviving widow or trusted friend or relative. Testators often name their legal counsel as executor or co-executor. At your discretion as testator, you can name a corporate executor or trustee—usually the trust department of a bank. Such a selection means that your executor will have complete institutional facilities available, will enjoy permanence and freedom from personal and business distractions, and will be able to call on the staff and professional skills necessary to do the work properly. The widow, a relative, or a lawyer may be named coexecutor as a means of combining the close personal relationship of a trusted individual with the skills and facilities of the corporate executor.
Obviously, where a will establishes a trust, the bank trust officer or some equally qualified person is a logical choice as executor/trustee. The executor or trustee must be compensated for his or her services—except in the case of a relative or friend who serves out of a sense of duty or because he or she is a principal heir. Executors' fees are based on the size of the estate, but typically range from 1 or 1.5 percent to about 2.5 percent of the gross estate.
Preparation and Execution
Some statutory formalities govern the preparation of all wills. For example, as noted, wills must be in writing, must demonstrate the testator's intent to pass property to heirs, and may as a rule incorporate another document or other documents if the other documents exist when the will is drawn and if the will adequately identifies the additions. The only exceptions to the rule that wills must be written are nuncupative, or oral, wills. All wills have also to be signed, or given some visible mark intended as a signature—at the end of the will in some states and in other places in other jurisdictions.
Most states require that two witnesses attest to, or witness, the will's signature; some others require three witnesses. Where statutes require it, wills have to be published, with the testator stating that the will is his or her own. Witnesses generally sign in the presence of the testator and each other. No witness should be a beneficiary under the will. An attestation clause appearing before the witnesses' signatures states that all formalities have been complied with, but is not mandatory; the clause merely serves as evidence of proper execution.
A will can be either changed or revoked. But alteration or revocation has to take place before the death of the testator. The latter must sign any amendment, or codicil, in the presence of witnesses—exactly as when the original was executed.
Revocation may take place in a number of ways. Marking with intent to revoke, tearing up, or burning, or otherwise destroying a will effects revocation; so may the operation of law in given cases, or the testator's preparation and execution of a new will containing a specific clause of revocation or provisions that nullify or clash with provisions in an earlier document. Legal invalidation of a will may take place when a testator remarries, obtains a divorce along with agreement to a property settlement, or becomes a parent. State laws generally govern such invalidations.
Depending on the jurisdiction, destruction or revocation of a later will may revive an earlier one. But some states recognize revival only through republication—unless the intent appears otherwise.
Instructions and Disposition
A letter of instructions may provide a lawyer or executor with essential information and simplify the task of carrying out a testator's desires. Such a letter is not part of the will, and need not comply with any formal requirements. Its purpose is to furnish a detailed inventory of the estate's assets, give instructions regarding the locations of all needed documents—including birth, marriage, and military discharge records; social security card; insurance policies; a list of bank accounts and safe deposit boxes; title deeds; pension papers; and so on—and summarize instructions regarding liquidation of business affairs.
Other portions of the letter may indicate where the will is kept, detail funeral instructions, and state the testator's wishes concerning investment of the proceeds of the estate, the education of children or grandchildren, future plans for the widow or widower, and similar subjects. The will becomes a public record; the letter remains private, and can thus express hopes or suggestions on very private, personal matters.
Where to keep the will? The safe deposit box is the most appropriate place if it can be opened without undue delay after the testator's death. Alternatively, the will may be delivered to the executor or to the testator's lawyer, or kept in a safe place with personal papers at home. In no event should it be accessible to a “disappointed heir.”
The person who dies intestate—without having made out a will—already has a kind of will: state laws governing intestacy. These laws comprise a “standard” will reflecting the legislature's conception of the deceased's probable objectives. Under intestacy laws, property left by a decedent passes to survivors according to rules fixed by the deceased's state of residence.
Such rules never operate as would an individual will made out according to a person's wishes. The rules frequently lead to serious shrinkage of the estate—and often to a distribution of assets quite different from what the deceased probably wanted. If the estate is large, long and costly litigation may follow the person's death. If the estate is small, it may be divided among various survivors in portions too small to help anyone. If the deceased leaves minor children, they will inherit part of the estate along with his widow.
The laws of intestacy provide in other ways for minor children. A guardian is usually appointed for the children, a process that involves expensive and time-consuming court proceedings. The guardian has to post a bond, renewable annually at a substantial premium. The guardian is supervised by the court and must account to it annually, resulting in more expense and loss of time. All of these procedures are designed to protect the children—and none takes into consideration the fact that the guardian may be the children's mother and the deceased's widow.
Intestacy laws have other effects. They make it impossible for all assets to go to the widow if there are children too. Nor do the laws consider the needs of the deceased's parents if a widow or child survives. Children are treated equally even though their needs may be quite unequal. Under the laws, faithful, loving spouses and mere legal mates are treated exactly alike; so are helpless widows and surviving spouses who are capable in business affairs.
In brief, the time and expense involved in making out a will is infinitesimal in comparison with the problems that may come with intestacy. The “will you already have” is always inferior to the will you ought to have—even though the laws represent the state's best efforts to protect and provide for survivors.
Intestacy laws work in parallel ways in specific situations. For example, where a husband leaves a widow but no children or parents, the widow inherits the entire estate—after deductions for various expenses that a proper will could have avoided. Where only the decedent's parents survive, the parents usually receive the whole estate—though in some states brothers and sisters also receive shares. As indicated, where a deceased leaves as survivors both wife and parents, the wife usually receives everything even if she is financially independent and the parents are aged and destitute. In a few states, however, the parents receive up to half of their son's estate regardless of the widow's needs.
If the wife and one child survive, each, usually, takes half the estate—but in some jurisdictions the child may take two-thirds or even virtually the entire estate under certain circumstances. Where the wife and two or more children survive, one-third of the estate generally goes to the wife and the remaining two-thirds are divided equally among the children.
The various state laws may, obviously, work great hardship or injustice. Further, the laws are subject to change without notification. A will, by contrast, can be changed only by the person making it out or under the circumstances already noted. A will should be reviewed from time to time, for example when a testator moves to another state; but the will remains the best available means of disposing of property after death.
What Law Governs?
The laws of the testator's state of legal residence determine the validity (or nonvalidity) of a will where personal property is involved. But because each state reserves the right to fix title to land situated within its boundaries, the law of the state where real property is located governs the validity and effect of the will respect to real estate.
All of this may affect the estate plan. A sound plan may call for avoidance of unnecessary ownership of real estate in states where the testator is a nonresident, particularly if there is any possibility that two or more states may claim a descedant as a resident and try to tax the entire estate rather than just the local real property. Most states, and indeed most countries of the world, cooperate with one another by recognizing as valid a will that is valid in the jurisdiction in which the will was made, the jurisdiction in which the testator was a resident, or—as regards real estate—the jurisdiction in which the property is located.
The extent of this cooperation may vary in given situations. The protocols governing such cooperation may, also, change. Thus it is desirable that the will be consistent with the requirements of the state of residence. Some unusual types of wills are recognized in only a few states; but a proper will drawn by legal counsel will be prepared in such a way as to meet the requirements of most if not all states.