Estate Settlement Planning Strengthens Client Bonds
by Herb White, CFP, MBA

More than 55% of adults in the United States don’t have a will, according to a 2007 study by Harris Interactive, which means that the state could decide how their property is distributed upon their deaths. Why do so many Americans ignore estate planning? The greatest number of adults surveyed, 24%, assumed that they didn’t have enough assets to justify planning and 10% said they just didn’t want to think about dying. Surprisingly, approximately 9% did not have an estate plan because they didn’t know whom to talk to, which is double the percentage from just three years ago. Financial advisors can help clients understand that estate plans are not just for the rich and famous.

Getting it All Together

People tend to forget that they have amassed wealth from a number of sources including homes, pensions, insurance policies, investments, and 401(k)s. With a little guidance, most see how these can add up to big dollars, easily causing their estates to be subject to estate taxes. Even some clients who understand the value of their assets still need encouragement to set up an estate plan.

Clients are often unaware of how estate planning can save their families thousands of dollars in taxes and make sure that their property is distributed according to their wishes. Even the most basic planning can help many married couples reduce taxes or even eliminate them altogether. This is news your clients need to hear.

Many people have no idea that dying without a will can cause the state to decide who gets their property. It is also surprising how many people have not updated beneficiary designations on life insurance policies, IRAs, and annuities. As a result, they could leave assets to ex-spouses or others who are no longer supposed to receive them.

Advisors should help clients understand the importance of estate planning and pull together must-have documents including wills, insurance policies, property and mortgage papers, brokerage account numbers, and pension plans. These documents should be easily accessible to heirs when it’s time to settle. Advisors can offer to retain duplicate copies, further securing the client relationship and planting the seeds for a relationship with the heirs.

When you review these documents with clients, you can address potential settlement issues and make sure that beneficiary selections are up-to-date. Since life policies are good tools to address liquidity issues, advisors should encourage their clients to explore the potential benefits of an irrevocable life insurance trust. These trusts are commonly used to avoid estate taxation of the death proceeds, shelter property from creditors upon death, and provide for the income needs of survivors. The most important information is sometimes not documented. Good fact-finding can prompt clients to remember accounts they have forgotten about.

You should discuss account balancing if one spouse has the majority of assets. Encourage clients to determine how children from previous marriages should be included in the plan. Otherwise, the assets could go to the current spouse automatically. There may be unintentional results or clients who have not reviewed documents every three to five years or when a significant life event occurs.

Planning With Uncertain Tax Laws

The 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA) repeals the federal estate tax for the year 2010. EGTRRA increases the estate tax exclusion from $2 million for people dying in 2008 to $3.5 million for people dying in 2009, and to infinity for people dying in 2010. Unless Congress takes action before January 1, 2011, the tax will revert to an exclusion of $1 million. The maximum rate would go from the current 45% back to 55%. There would be a significant change from the current step-up basis to a modified carryover basis when determining the cost basis of all capital assets transferred upon death. It would have a profound affect on many clients.

Congress is less likely to eliminate to federal estate taxes in 2011 and beyond as the demand for government services rises. The first Baby Boomers reach 65 in 2011 and a significant portion will be drawing Social Security and enrolling in Medicare, which puts greater financial demands on the government.

We can’t say for sure what Congress will do, what the monetary requirements of government programs will be, or whether there will be a budget surplus or deficit. But, advisors can still offer strong guidance. If both clients and advisors think the estate tax will probably be reinstated, advisors should create estate plans that provide enough liquidity for the clients’ estates to pay the anticipated federal estate taxes.

On the other hand, liquidity to pay federal estate taxes may not be a factor for those who expect Congress to finalize the repeal before January 1, 2011. What if you plan as though Congress will not repeal the federal estate tax and Congress ends up doing it after all? You simply leave additional liquidity to your loved ones or favorite charity.
Financial advisors can also educate their clients about tax legislation effective in 2010, which governs the conversion of traditional IRAs to Roth IRAs. By converting a traditional IRA to a Roth IRA, clients can avoid required minimum distributions and allow their savings to continue growing income tax free. Clients would have to pay income taxes on the accumulated earnings and tax-deductible contributions.

However, taxes on conversions made in 2010 don’t become fully due until 2012. By paying the conversion tax, clients prepay income taxes for their heirs without owing any gift tax and reduce their taxable estate.

Traditional IRAs can offer current tax deductions and tax-deferred growth, but withdrawals are subject to ordinary income taxes. A Roth IRA takes the opposite approach; contributions are not deductible. Qualified withdrawals of contributions are income tax free; best of all, earnings are income tax free. The Roth IRA is definitely superior for estate planning.

Irrevocable Life Insurance and Credit Shelter Trusts

Many clients can benefit by rearranging some assets since estate taxes are based on the value of all assets. One popular method is to use an irrevocable life insurance trust. These trusts are key components of many estate plans. They are created during a person’s lifetime with the life insurance policy designated as trust property. Since the irrevocable life insurance trust is excluded from the grantor’s estate, it reduces the client’s taxable estate, which reduces potential estate tax liability. To prevent the trust from being included in the grantor’s estate, the grantor should avoid any incidents of ownership including the ability to control the policy in any manner.
Advisors explain to their clients the difference between funded and unfunded irrevocable insurance trusts:
• Funded – Income producing assets are transferred into funded irrevocable insurance trusts. Income earned from these assets is used to pay the insurance premiums.
• Unfunded – Unfunded irrevocable life insurance trusts are usually not completely unfunded. The trust usually owns an insurance policy and the grantor makes annual gifts to the trust and the trustee uses these annual gifts to pay the premiums.
Trust contributions are classified as future interests instead of present interests. Future interests typically don’t qualify for the $12,000 (2008) annual gift tax exclusion. Advisors can overcome this concern with the Crummey provision, which allows beneficiaries to withdraw certain sums from the trust for a short period after the grantor makes a contribution. Crummey power holders should be actual trust beneficiaries. However, the tax court has allowed annual gift tax exclusions for contingent beneficiaries who had been given withdrawal rights.

If the insured gives an existing life policy to an irrevocable life insurance trust and dies within three years of the transfer, policy proceeds are included in the insured’s estate. It is better for the trustee to use cash in the trust to purchase a new policy on the insured’s life. That way, the death benefit is generally excluded from the client’s estate. Advisors should work with the client’s estate planning attorney when suggesting an irrevocable life insurance trust.

Second-to-die or survivor life policies don’t pay proceeds until both spouses die, which is when death taxes generally become due. Advisors need to explain that premiums on a single second-to-die policy are generally lower than combined premiums on two individual policies. This allows the couple to obtain a larger face amount of insurance.

However, this strategy is not recommended if a surviving spouse will need the policy proceeds to live on. The credit shelter trust is a good fit for some clients because it gives the surviving spouse access to assets of the deceased spouse by making use of each spouse’s applicable credit amount. When the first spouse dies, their applicable exclusion amount ($2 million in 2008) is placed in the credit shelter trust. This trust is not taxed at that time nor is it taxed upon the death of the surviving spouse even if it has appreciated considerably in value. The surviving spouse has access to the income from the trust for life. Estates that do not generally benefit tax-wise from this type of trust are married couples’ estates that are smaller than the applicable exclusion amount and are not likely to exceed this amount in the future.

Take time to educate existing and potential clients about how estate planning can help them avoid probate, pass on their estates quickly, reduce taxes, protect assets from creditors, and provide for their loved ones. Advisors have the chance to make all the difference to these clients and their heirs.
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Herb White, CFP, MBA is president of Life Certain Wealth Strategies (www.lifecertain.com) in Greenwood Village, Colorado.