The Retirement Corporation of America

How To Make The Most Of The New Estate-Tax Rules

NO ONE LIKES to think about estate taxes. Not only are they highly complex, but they won't become due until you are dead. Finally, when estate taxes are due, they can really hurt since the current maximum rate on estate taxes is 50%—far higher than the highest rate on income taxes.

Maybe you won't have to think about estate taxes. You must have a hefty estate before the federal estate tax kicks in. The tax law that Congress passed in the summer of 2001 began raising the minimum amount at which taxes take effect. Note that Congress voted to eliminate the estate tax completely in 2010 but to bring it back in 2011. Obviously we'll be hearing more from Congress about estate taxes.



As things stand now, you could pile up some fairly substantial assets and not have to worry about the estate tax. On the other hand, once you fully master your financial future, you probably will pile up some fairly substantial assets. Furthermore, your estate will include such things as appreciation in the value of your home, gains from your investments, any life insurance and the value of your retirement plans.

You set out to build personal wealth—maybe even enough wealth to make you a millionaire. Well, if you learn your lessons well and apply them, the estate tax is going to apply to you. If you have created a business, then you certainly want a plan that spells out how ownership and control of that business will be passed along to your heirs.

If you prove to be anywhere near as successful as you hope and plan to be, you had better start doing some estate planning. That can range from making sure you have a will that accomplishes everything you want it to, to creating complicated trusts that minimize the estate tax your heirs will have to pay.

If estate planning is necessary, it also is highly complex—nothing that you should attempt to tackle on your own. Start your estate planning no later than age 40—meeting with an attorney, CPA or financial planner. Follow their advice about how to manage your estate plans and how often you should meet to update them.

Finally, we have been talking about the federal estate tax. Your state also has an estate tax, so your planning should include the full range of estate tax issues: federal and state.

Start With the Paperwork

Estate planning goes beyond just tax issues. It also should include all the documents that ensure your final wishes are carried out:

•  Will. This spells out how your assets will be divided up after your death. It also specifies who will be the executor of your estate—paying all necessary bills and making sure your heirs get all they are entitled to.

•  Durable Power of Attorney. You hope to be in total command until the very end, but that may not happen. A Durable Power of Attorney allows someone else—usually your spouse—to make necessary financial decisions if you are incapacitated and can't make them on your own. Without that Durable Power of Attorney, your family might have to go to court to get the most simple financial transactions taken care of.

•  Medical Power of Attorney. This allows loved ones to make medical decisions on your behalf if you are incapacitated and can't make them.

•  Living will. This is a statement concerning your wishes about life-sustaining medical treatment. It would list types of treatment you want to avoid.

Keep the Papers Where They Can be Found

It's not enough just to prepare all those documents. You want to make certain they can be readily found if, and when, they are needed. For example, you don't want the only copy of your will in the safe deposit box at the bank. Your bank box will be sealed at your death and it could be weeks or even months before your survivors have access to the will. Keep the original of the will in the bank box but keep a copy with your other important documents.

The same holds true for your life insurance policies. If they're in your bank box, it could be a long time before they become accessible and your heirs can file a claim on your policy.

The best advice is to draw up a list telling the location of all your important financial and legal documents. Let your spouse and at least one other person know where that list of important documents is kept. Also include the location of the key to your safe deposit box and any other important keys you might have.

Make sure whoever you designate as executor of your estate knows how to contact the important people in your financial life: attorney, accountant, insurance agent, stockbroker, etc. Emotions will be running high at your death and mistakes at this point can be costly. You want to make everything as easy for your survivors as you can.

Keep Everything Up-To-Date

Estate planning is such an unpleasant subject that many people do it just once and never again. But your financial life keeps changing. You want to keep your estate plan up-to-date to handle changing circumstances.

At the least, review your estate plan and will every five years—but every three years would be better. Does your will still do what you want it to? Do you have the best estate plan for your tax situation? Is the person you picked to be executor of your estate still the person you want to do it? Your wise old Uncle Fred may have been the first choice when you created the estate plan 10 years ago. But is Uncle Fred, now 10 years older, still able to carry out the work of executor? If not, pick someone else.

Finally, draw up a separate letter that isn't part of your will that states how you want items of sentimental value distributed among your heirs. You can change your mind and pass your old pocket watch to someone else simply by changing the letter without going through the time and expense of writing a new will.

The Husband and Wife Estate Tax Rules

There is no estate tax on assets passed to a surviving spouse. You might leave an estate of $10 million. If it all goes to your spouse, every penny will escape estate taxation.

You could take that to mean that you should leave everything to your spouse and forget about making any estate plans. That could be a very costly mistake. The $10 million would pass to your spouse tax-free. But what happens to the estate when he or she dies? Then the entire estate is subject to a tax rate that currently peaks at 50%. Furthermore, the tax must be paid quickly—even if the heirs must sell off the family home, the family business and a lot more to come up with the money needed.

A better way is for each spouse to create "bypass" trusts that take full advantage of that exemption from estate taxes (that estate tax floor has climbed to $1 million in 2002 and 2003). Here's how it works:

1. Ownership of jointly-owned assets is divided so each spouse owns assets up to the full amount of the exemption.
2. At death, all of your property passes to your spouse—free of estate taxes.
3. The exempt amount ($1 million or more) goes into a trust—free of estate taxes.
4. The surviving spouse draws on the income from the trust during his or her life. When he or she dies, the trust passes to the heirs. Because the surviving spouse also has that estate tax exemption, $1 million or more of the assets within the trust goes to the heirs—still free of estate taxes. Complex as this may sound, it is pretty straightforward compared with many estate planning techniques. Things get more complicated if there is a second marriage because of death or divorce. You want your children to inherit, but the second marriage could produce a second family—more children to divide the inheritance among or children who will inherit instead of your children.

The answer then is a Qualified Terminable Interest Property trust—always referred to as a Q-Tip trust. You leave your assets to a Q-Tip trust. The surviving spouse gets income from the trust while he or she is still alive. After the surviving spouse dies, assets in the Q-Tip trust go to the heirs you designated when you created the trust. None of those assets can be willed to the second husband or wife.

Estate planning has been made wildly complicated by the 2001 tax law which completely eliminates the estate tax in 2010—only to restore it in 2011. Since there is no telling how Congress will resolve this situation in the future, you have to plan as though estate taxes will be an issue upon your death.

You need to create wills and other documents, so plan to meet with a lawyer at some point in your life—the sooner the better. Raise questions about estate planning then and be guided by what the lawyer says.