"29
MISTAKES THAT CAN MESS UP YOUR ESTATE PLAN"
(PART 1 OF 5)
By Robert P. Bergman, Attorney at Law
There are many common mistaken beliefs about how estate planning and inheritance actually work. If relied upon by people, these mistaken beliefs can turn into serious mistakes that can cause your estate plan to misfire, malfunction, or be "messed up."
This is the first of five articles that deal with the common mistakes that people make every day that cause serious problems with their estate plans, and, in some cases, may cause results that are exactly the opposite of what was intended.
Mistake #1 - Failure to Understand How Your Assets Will Pass on Your Death
Many people think that their Last Will and Testament (i.e. their Will) controls how their real estate and other assets will pass upon their death, yet today most peoples' assets pass outside of their Wills. For example, assets owned in joint tenancy with someone else will to the surviving joint tenant. If there is a surviving named beneficiary on an asset such as life insurance, annuities, IRAs or other retirement plans such as 401(k), 403(b) and 457, the asset will pass to the named beneficiary no matter what your Will may say. Even bank accounts or brokerage accounts that name a "Pay on Death" or "Transfer on Death" beneficiary will pass those accounts to the named beneficiary. It is only your other assets (sometimes called your "Probate estate") that will pass pursuant to your Will.
Example: Bill named his oldest son as the beneficiary on his life insurance. His Will left his estate equally to his three children. The oldest son gets all of the life insurance and 1/3 of his Probate estate. His other two children each get 1/3 of his Probate estate, but none of his life insurance.
Another example: While still single, Don named his brother as the beneficiary on his 401(k) plan at work, and his life insurance. Don purchased his first home in joint tenancy with his brother, who shared the house with Don. Don later had a falling out with his brother and still later got married. Don changed his Will to leave everything to his wife.
Unfortunately, because Don never changed his beneficiary designations on his 401(k) plan and his life insurance, and the joint tenancy on the house, the bulk of his estate passed to his brother on Don's death and not to Don's wife. An additional complication came in when Don’s wife sued Don’s brother to assert a spousal community property interest in some of Don’s 401(k), the life insurance, and the house, because community property money (i.e. Don’s paycheck from work) had been used to contribute to the 401(k), pay premiums on the life insurance, and pay for the taxes, insurance and house payments on the house.
This mistake can be avoided by using a properly-drafted and funded Revocable Living Trust as the basis of your estate plan.
Mistake #2 - Trying to Plan an Estate around Specific Assets
Unless there are compelling reasons why a specific asset should go to a specific person, you should not try to plan around specific assets.
Example: Bill had three children and wanted to treat them equally. His Will even confirmed this. Several years before he died, he put his home in joint tenancy with his older son, added his daughter as the “Pay on Death” beneficiary of his savings account, and named his younger son as the beneficiary on his life insurance policy.
When he did this, all three assets were about equal in value. But then later he sold the home, put the sales proceeds in the savings account, and let the life insurance policy lapse. At Bill’s death, the saving account passed to his daughter, and his two sons received nothing. By planning around specific assets, he actually disinherited two of his children!
By the way, this problem often surfaces in a Will as well. If an asset is no longer owned, the bequest lapses. Let's say your Will leaves one of your rental properties to your son, and your other rental property to your daughter., with everything else divided equally between your two children. If you sell the second rental home (i.e. the one for your daughter) before your death, the first rental home will go to your son, plus he will get 50% of everything else. Your daughter only gets the 50% of everything else.
rental home 1 to your son and rental home 2 to your daughter, and the balance equally to both children. If you sell rental home 2, and then die, your son still gets rental home 1 plus he gets a full 50% of your other assets and your daughter gets the other 50%.
Again, his mistake can be avoided by using a properly-drafted and funded Revocable Living Trust as the basis of your estate plan.
Mistake #3 - Failure to Minimize Estate Taxes if You are Married in California
The federal government taxes the estate of everyone who dies who is a U.S. tax resident. This can include both U.S. citizens and non-citizen permanent residents who pay U.S. taxes. in 2009, the highest tax rate for estates is 45%!
This tax is not imposed on a surviving spouse who receives the property of a deceased spouse, as long as the surviving spouse is a United States citizen. If the surviving spouse is not a United States citizen, then property left to the non-citizen spouse may be subject to the federal estate tax (see below) unless it is less than the exemption amount, or unless it is left to the non-citizen spouse in a special form of trust called a Qualified Domestic Trust.
Federal estate tax law grants an exemption from the federal estate tax. The federal estate tax exemption, which was $600,000 for many years, started increasing dramatically starting in 2002, and as of 2009 increased to $3.5 million per person dying. In 2010, the estate tax is scheduled to be repealed for one year, and there will be there is no estate tax at all unless Congress changes the rules, which they could do at any time during 2010. Then, in 2011, the exemption is scheduled to drop to $1,000,000!
You may thinking things like, "My estate is only about $800,000 - I don't think I will even have a taxable estate when I die." However, this kind of thinking do not take in account that housing prices may rise over time, the uncertainty of the stock market, and the possibility that you are ignoring the value of life insurance policies on your life. It also ignores the possibility that Congress will change the rules again.
If you plan to be alive in 2011, you need to consider estate tax planning. Real estate prices alone can more than double in any ten-year period in the Silicon Valley (south San Francisco Bay Area) where my law practice is located, and even the downturn in the real estate market that started in 2008 will likely reverse over time. This would mean that an estate that is not taxable today could easily grow to a taxable estate in a matter of years.
A flexibly-drafted living trust based estate plan with tax planning needs to be in place before death of the first spouse. Additional tax planning may also be needed for larger estates.
Mistake #4 - Failure to Avoid Probate
Probate is the court procedure for proving a Will, paying the bills, and distributing the estate. Probate can be expensive, time consuming, and frustrating. Probate fees and costs often runs up to 5% of the gross value, even on small estates, and can take 9 to 24 months.
Probate is a matter of public record. Once Probate is opened, anyone can examine your file, make a copy of your Will, and get a list of your family members and their addresses, their ages, and what they are receiving from your estate! Probate also gives upset or meddling heirs a low-cost opportunity to challenge your Will.
If you own real estate in other states, your family may have to open a Probate in each of those states. Probate can be totally avoided by creating a Living Trust during your lifetime and then transferring record title of your assets to that trust.
Mistake #5 - Loss of Community Property Income Tax Benefit for Married Couples.
In California, married couples have the option of owning their joint property as "community property." Community property is defined in the law as the husband and wife each owning an "undivided one-half interest" in the property. Married couples in California also commonly own their property as "joint tenants with right of survivorship" which is defined as a "divided one-half interest" owned by the husband and wife. The form of ownership of property will determine the income tax treatment of certain types of property owned by the couple when the first spouse dies.
Certain property that people may own is classified as "capital asset property" for purposes of the income tax laws. These include investments such as real estate, stocks, bonds, mutual funds, options, precious metals, and collectibles, as long as the investments are not owned as part of a retirement plan or IRA.
When a capital asset is purchased, it receives a "cost basis" that fixes its value for income tax purposes. If the investment is sold later for more than the cost basis, it is reported as a "capital gain," and receives a lower tax rate than ordinary income tax report on a tax return. If it is sold for less than the cost basis, then a "capital loss" is reported.
If capital assets are owned by a married couple in California as "joint tenants," the surviving spouse will receive an income tax benefit by having the cost basis increased, which has the effect of reducing the amount of capital gains tax that would be owed by the surviving spouse. [Example: A mutual fund owned as joint tenants and purchased for $50,000 that has grown in value to $120,000 when the first spouse dies would have a new cost basis for the surviving spouse as follows: $50,000 original cost basis plus $35,000 (one-half of the growth in value, or $70,000 divided by 2), for a new cost basis of $85,000. If the surviving spouses sells the mutual fund for $120,000, then the taxable gain would be $120,000 minus the new cost basis of $85,000, or $35,000. The tax on the other $35,000 of gain is eliminated for tax purposes).
With community property ownership, the surviving spouse can inherit the property with a new “cost basis” in the property for income tax purposes that is equal to the fair market value of the property at the time of death of the first spouse! This is because, for income tax purposes, the deceased spouse is assumed to have owned both halves of the community property. Using the mutual fund example above for joint tenancy, the surviving spouse would receive a new cost basis of the original $50,000, plus both halves of the gain of $70,000 over the original cost basis, for a new cost basis of $120,000! This means that if the surviving spouse sells the mutual fund for $120,000 with a new cost basis of $120,000, the taxable capital gain is zero, nada, zilch!
Clearly, community property ownership of jointly-held property by California married couples has a major income tax advantage for the surviving spouse. With proper living trust planning a married couple in California can combine the Probate-avoidance features of joint tenancy ownership with the tax benefits of community property ownership.
Mistake #6 - Loss of Control by Adding Someone Else's Name to Your Account.
Jane lost her checking account to her father's creditors. She had put her father on her checking account as a joint owner so he could pay her bills while she was traveling. He had several creditors, however, and one of them filed a lien on the account. The bank was forced to pay her father’s creditor $80,000 of Jane's money. When he was added as a co-owner of Jane's account, Jane's father had the legal right under California law to withdraw the entire account, and the creditor "steps into the debtor's shoes."
In addition, Jane was deemed to have made a taxable gift to her father at such time as the creditors withdrew money from the account! Don't you just love our tax laws!
Interestingly, if Jane had a Living Trust own her bank account, she could have had her father as a co-trustee with herself. As such, he still could have paid her bills from the account, but his creditors could not have attached the account. He would have been only a trustee and not an actual owner of the account.
When you simply add someone's name to your account, you are subjecting that account to his or her creditors. You don't have to be a bad person to be sued these days or to be subject to a tax lien.
A Living Trust can protect your assets while still allowing another person to pay your bills.
Robert
P. Bergman is a
Bob gives regular free living trust seminars at his office in San Jose. Visit his website at www.lawbob.com where you can learn more, get on his mailing list, register for an upcoming seminar, schedule a consultation, and read other articles on estate planning topics that Bob has written. You can also reach him by e-mail at rpb@lawbob.com or telephone at 408-247-0444. All inquiries are confidential.
This article is intended to provide general information about estate planning ideas, concepts, and laws, and is not to be relied upon as rendering legal advice about your particular situation. No attorney-client relationship is created by this article. The laws concerning estate planning, wills, trusts, and estate taxes are very complex, often state-specific, and change on a regular basis. Consult with an experienced attorney before taking any action that would affect your personal or business matters.
This web
site is provided as an educational service by the
Law Offices of Robert
P. Bergman.
If you have questions or comments, you're invited to contact
attorney Bob Bergman
at rpb@lawbob.com or 408-247-0444.
All contents on this web site are Copyright © 2010 and thereafter by
Robert P. Bergman, Attorney at Law. All rights reserved worldwide.