Building the Essential Estate Plan

Many people have put estate planning on hold. The estate tax law has been in flux the last few years. It is likely this year a permanent law will be enacted that exempts at least estates of $3.5 million and more, and it is possible more valuable estates will be exempt.

But estate planning is about much more than avoiding taxes. Even those who will avoid all or most estate taxes need to plan. The plan determines who receives your wealth, in what form, and when.

It is time to start planning your estate or updating your estate plan. We won’t know the tax details until later this year, but there are many other aspects of the plan to work on. In this post, let’s take a look at some of the big picture concepts of your plan. Every estate plan, regardless of the value of the estate, uses these principles. Consider them estate planning principles for everyone.

Flexibility versus certainty. Because of the uncertainty of the tax law, flexibility has been a keystone of estate planning since 2001. The shifting economic and investment picture is a new reason to be flexible. This is a trade off for every estate owner. By making a firm irrevocable plan, you know who will receive the wealth and what the taxes will be. But you also are unable to adapt the plan to new circumstances.

Changing asset values are a good reason to be flexible, even if it costs more in taxes.

There are several ways to keep a plan flexible. Of course, limiting irrevocable lifetime gifts, whether made directly or through trusts, is a good way to stay flexible. Another strategy is to refrain from leaving people specific amounts or assets. Instead, make gifts relative to the size of the estate or what others receive.

For example, instead of naming a specific amount to be left in a credit shelter trust, a will should use a formula or a range of values so the amount in the trust will change based upon the law in effect at the time. A credit shelter trust takes advantage of the estate tax exemption by leaving the exemption amount in the trust. The trust pays income and needed principal to the surviving spouse for life, and then the remainder goes to the children. You might not want to leave too much in the credit shelter trust, because that might leave your spouse with little or no money in his or her own name.

Similar results could occur with other bequests as asset values fluctuate. You do not know what the final value of your estate will be or what the relative values of the different assets in the estate will be. That is why it is a good reason to use formulas or other flexible methods to determine how the assets are divided or how wealth is distributed among trusts and other vehicles.

Organize and simplify. Many people procrastinate because estate planning an be a long, expensive process. The more assets a person has and the more complicated the estate is, the greater the complexity and cost of the plan. The estate owner can reduce the cost and the time it takes to put a plan together.

First, prepare a personal balance sheet listing the assets and liabilities in which you have any interest. Most estate planners can help with this by providing a questionnaire or workbook as a guide. The more work you do, the less work the estate planner does.

Next, consider simplifying the estate. You probably own various assets that were purchased for reasons that no longer are valid or you don’t remember. These can be disposed of. Even assets you like might be better in other hands if they would complicate the estate plan and would be difficult for your heirs to know how to handle. Assets without a strategic purpose probably should be disposed now. Also, some estates have a lot of low value assets. Consider selling these, especially if they are difficult to value or sell.

Continue the organization and simplification process after the estate plan is in place. This makes periodic reviews of the plan easier. It also makes things easier on your executor and heirs. Keep the personal balance sheet up to date and be sure your executor and key heirs know where it is kept. This simple process saves heirs a great deal of time, aggravation, and money.

A final step is to decide how any complicated or unique assets should be handled by your estate or heirs. Many people have collections, personal mementos, and similar items. Heirs often don't have as much interest in such items as the owner and might have no idea of their true value or how to handle or sell them. If you want to retain the items for life, be clear about what happens to them later. It is best to make a specific plan. Find out who would really like the items, even if it is someone outside the family. Either determine a value for them or leave instructions to the executor about how a fair value should be determined.

Make the key decisions. Too often, estate owners say, "Leave it to the kids and let them decide." Non-decisions often lead to family strife, wasted assets, and a general estate planning disaster. Estate lawyers always are amazed at the things adult children and other heirs fight over. Long suppressed issues and conflicts come to the surface. Seemingly meaningless items can have great symbolic value to someone, or at least the person claims they do.

Personal property and iconic items such as the family residence or vacation home are the most likely to cause such problems. There are many ways to handle these items, and we will discuss them in a future post.

A family business or significant real estate holdings also should have a detailed plan. With a business the owner should decide who will run it, who will have voting rights, and who will receive income. Voting rights and the right to receive income and distributions can be separated. Failure to decide these and other issues in advance almost guarantees that the business or the family or both won't survive many years.

Be on conflict alert. As I said, it is amazing what causes conflicts among heirs. The estate owner should know his heirs well enough to have an idea which property and issues might trigger disputes. Develop a plan that will reduce or eliminate those conflicts. Also consider providing an alternative disposition for property that causes disputes. Some wills, for example, provide that if the heirs cannot come up with a satisfactory way of dividing personal property, then all the property will be sold and the cash proceeds distributed equally. Some plans don’t even give heirs the option; they mandate that most property be sold and the cash distributed.

Don't wait for the perfect plan. It is likely that very bad things will happen if no estate plan is in place. Every estate plan is a product of compromise and trade offs. The trade offs are among tax reduction, cash flow, protecting wealth from heirs' mistakes, fair distribution, and other factors. An imperfect, compromise plan is better than no plan. Most parts of an estate plan always can be changed when a better idea is developed.

Go easy on control and favor flexibility. This is a corollary to the change and flexibility principle. Some estate owners want to control many aspects of their estates, even for decades after they are gone. A trend in recent years is to establish trusts dictating that distributions of income and principal be made only under certain conditions. Unfortunately, many things change. A plan that seemed ideal when created could become inappropriate over time. An estate owner cannot foresee all possible changes. This problem is likely to become worse in the future as life spans increase. Don't make estate planning decisions solely on the basis of today's circumstances. Leave room for growth, change, and unanticipated events.

Choose executors and trustees with care. Too many good estate plans were ruined because the wrong people were chosen as executors or trustees. These decisions often are made without much thought, with the estate owner often making the easy choice for each position. It might not be the best idea to automatically name the estate planner or oldest child as executor and the owner's bank as trustee.

Minimize surprises. Most estate planners agree that the greatest cause of will contests and estate disputes is surprise. One or more of the heirs was not expecting what the will or trust provided. They no longer can complain to the deceased, so they believe their only alternative for showing displeasure is to disrupt the estate plan and get mad at the other family members.

It is a not a good idea to circulate copies of estate planning documents. The owner should, however, let everyone know what in general is in the estate plan. If heirs are left unequal shares or a significant amount is left to charity, the affected heirs should know. The owner should give a brief explanation for the actions and be prepared to discuss the issues. Sometimes estate owners change their minds after discussing the plan with affected family members. The owner, for example, might not be aware how a family member feels about certain assets.

Every estate plan is different. Yet, every plan must follow certain principles for it to be successful.

Bob Carlson is editor of the monthly newsletter Retirement Watch and the web site He also is author of the books The New Rules of Retirement and Invest Like a Fox…Not Like a Hedgehog.

Posted 05-12-2009 2:19 PM by Bob Carlson