Minding the estate
It's not only the rich who have to worry about what they've amassed
You may think estate planning is about taxes. Not entirely, says Kevin Flatley--it's also about control. Wealthy clients, says the director of estate planning at Citizens Bank in Boston, "may set up a plan to save tax, but what really makes their eyes sparkle is the way they can manage the assets after their death." What if a spouse remarries? How much should a son-in-law get? A "generation-skipping" tactic that provides income for a daughter, with the assets passing to the grandchildren, can save taxes--and also keeps money away from a daughter's ex or other unintended hands.
Besides, estate taxes simply aren't an issue for most people. Currently, roughly 2 percent of estates are taxed. That is due in part to canny maneuvers, but the bulk of estates are exempt anyway. For 2004, the first $1.5 million of an estate, after deductions for such items as charitable bequests, is excluded. And thanks to a new law, the exemption is scheduled to rise while the tax rate falls. By 2010, no one will pay a dime.
But planners are edgy. The estate-tax bite will gradually diminish until it vanishes in 2010--but at midnight on December 31 of that year, it will reappear as if the phase-out had not happened.
The expert consensus is that the full return of the tax will be rescinded before the witching hour. Some in Congress are pushing for permanent repeal, but budget deficits and political sensitivities make that a long shot--the tax did raise $23 billion in 2003. Stephen Pappaterra, director of wealth planning at the Philadelphia office of PNC Advisors, says he's simply assuming there will be a tax of some sort. As an alternative to outright repeal, many planners expect an exemption of perhaps $3 million and a top tax rate well below the 55 percent in force before the changes.
Adding to the muddiness, states whose estate tax has been linked to the shrinking federal levy are scrambling to cut the tie or otherwise make up the loss. And a new federal tax on gifts totaling more than $1 million during your lifetime means still more planning complexity.
A matter of trust. Whether or not your estate is large enough for all of this uncertainty to concern you, Flatley's point about control is relevant even for modest estates. One tool that can handle an estate and also help manage your assets before you die--regardless of tax consequences--is a living trust.
The details vary, but the idea is simple: You set up a trust that kicks in when you can no longer handle your own affairs or when you die. It has several big advantages. Funds and property can be distributed quickly, family affairs can be kept private, and costs can be trimmed because assets passing through a living trust after death do not have to go through probate.
A living trust isn't the only way to avoid probate and make transferring assets simpler. Bank accounts and other assets can be jointly owned, going to the survivor. And there is life insurance.
But putting your home in joint ownership with a potential heir may mean losing some control over upkeep and remodeling, and even a home's sale. It also could subject your heir to unnecessary capital-gains tax on an eventual sale, and, depending on the property's value, could confront you with a gift tax.
Estate tax liability or not, minor children are a strong incentive to get your estate affairs in order--by naming a guardian, for example. "Otherwise, there can be a free-for-all in the probate court," warns Don Weigandt, an estate and tax-planning adviser at the Los Angeles office of J. P. Morgan Private Bank. "You may be talking about competing people who are well meaning but have different ideas of parenting. The people who should be making this decision can only express their views through a will."
Even people of modest means can set up plans, with an attorney's help, for managing assets on behalf of a child. A modest annual fee to a bank or other trustee--even a trusted family member--can get things going. Future financial hand-holding may be desirable even for young adults or surviving spouses. Without guidance, planners caution, someone unused to a sudden windfall can easily blow it within a few years.
Step by step. Many advisers suggest doling out funds in stages, both to ease someone into greater money-handling responsibility and to cushion a hit because of a youthful bad marriage or business and investment mishaps. One money manager's client, for example, left his 25-year-old daughter $600,000 in trust, providing her with investment income for 15 years plus lump sums of one third of the assets after 5, 10, and 15 years. The father's brother was named co-trustee along with a bank's trust department.
Too much tinkering because of worries that inherited wealth will turn children lazy and indolent could go bad, however. One client's idea that J. P. Morgan's Weigandt successfully discouraged was to tie the trust assets that heirs receive to the income they generate from their own hard work. Unless the trustee is given broad discretion (and is uncommonly wise), the consequences could be unfair. What if one child becomes an investment banker and the other a schoolteacher or stay-at-home parent?
Don't forget Fido, says Gerry Beyer, a professor of law at St. Mary's University in San Antonio and one of a growing cadre of lawyers and legal experts focusing new attention on providing for pets. More states, he says, are enacting laws to get around past roadblocks to naming a pet as a beneficiary of a trust. His website (www.professorbeyer.com) offers guidance and lists veterinary schools and animal welfare groups that can help place pets for adoption or, for a donation, supervise continuing care of your surviving dog, cat, or even a parrot. Beyer also offers a simpler and very workable approach: to arrange a conditional gift that makes a person beneficiary of a trust--but stipulates that the beneficiary has to take care of Fido or Fluffy.
Death to the Estate Tax?
The estate tax will disappear in 2010--but could stage a comeback in 2011 unless Congress revises the law.
Tax year Top rate Exempted assets
2001 55 pct. $675,000
2002 50 pct. $1,000,000
2003 49 pct. $1,000,000
2004 48 pct. $1,500,000
2005 47 pct. $1,500,000
2006 46 pct. $2,000,000
2007 45 pct. $2,000,000
2008 45 pct. $2,000,000
2009 45 pct. $3,500,000
2010 0 unlimited
2011 55 pct. $1,000,000
Source: U.S. Tax Code
This story appears in the June 14, 2004 print edition of U.S. News & World Report.