Thursday, February 26, 2015

Planning for Vacation

Today’s blog takes a break from the complex gifting and tax issues we addressed in the past few posts to talk about aspects of estate planning that arise while preparing for a vacation. We will return to our discussion of gift issues next week. 

     With the unrelentingly cold weather and impending “Spring Break” weeks for many school districts, our thoughts turn to vacation, many of which involve trips to warmer climates. However, upcoming trips should prompt people to think about their current estate plans and some of the possible changes they have been putting off.
Here are a few tips to think about before setting off on vacation:
  • Do you have a Grandparent/Caregiver Power Of Attorney? If you are vacationing but leaving your minor children home with a grandparent or caregiver, do you have a written document giving the caregiver authority to make medical or other decisions in your absence. This document can be crucial in the event of an accident, and can provide you comfort knowing that caregivers can handle emergencies even while you are relaxing and enjoying your trip.
  • Do you have a list of assets, passwords, and important contacts? Many people manage most or all of their financial assets online and it is important to have a record of your accounts and passwords so that those you have named to act on your behalf for the benefit of your family can easily locate this information. This information should be part of the list of assets and advisor contact information you keep with your important estate planning documents. While this may require some time on your part, it can save your family significant time and money if misfortune should befall you. 
  • Are your disability documents current and available to those you have named? In Michigan a Durable Power of Attorney, for financial decisions, and a Patient Advocate Designation, for medical decisions, are essential to allowing another to act on your behalf in the event you become incapacitated. Before vacationing, you should be sure the documents are up-to-date and that those designated know where to locate these documents. You may even want to discuss your wishes with your designated agents.
  • Are your beneficiary designations are up-to-date? With proper designations, assets such as retirement accounts brokerage accounts and life insurance can pass directly to designated beneficiaries and avoid probate. If you have a Trust, these assets can be designated the beneficiary and allowed distributions pursuant to the provisions you have set forth in your Trust.
  • Are there any changes you have been contemplating making in your Will and Trust? While we usually suggest you review and update your estate planning documents every 3 to 5 years, while planning for a big trip you also may want to review your documents to make sure that provisions for your family, and those you have designated to fulfill those provisions, are still as you want them.
     Time spent on these issues will allow you to relax and enjoy your vacation knowing that your estate planning is in good order.

Tuesday, February 24, 2015

The Grantor Retained Annuity Trust as a Tool for Wealth Transfer

     We often discuss the benefits of Living Trusts as part of an estate plan, but there are other types of trusts that may provide our clients with significant benefits as part of a larger estate plan, depending upon the client’s particular situation.
     A Grantor Retained Annuity Trust (GRAT) is one method for wealthy clients to maintain an income stream yet transfer property (often which is highly appreciating) to a child with minimal Gift or Estate Tax. A GRAT allows the client to transfer assets into an irrevocable trust and retain the right to annuity payments for a fixed term of years or their lifetime. When the set duration ends, the remainder of the trust, including any appreciation, can go to a named beneficiary. Alternatively, it is possible to structure the GRAT to return the principal and a certain amount of income to the grantor, and distribute the excess income to the remainder beneficiary. While it is possible that the trust will earn insufficient income to cover the required annual payment and thus the Trustee must make that payment from the principal, with proper planning the GRAT is a powerful tool for wealth transfer.
     When using a GRAT to transfer assets, the gift tax value of the assets is determined at the time of trust creation and funding by subtracting the value of the annuity interest from the fair market value of the assets transferred to the trust. The value of the annuity interest will depend on the interest rate used, the value received by the grantor, and the value of the remainder beneficiaries’ interest. The IRS Regulations set rules for determining what interest rates may be used in the calculation of valuations, especially when family members are involved.
     As an example, if a 60-year-old client sets up a GRAT to last two years and uses the following provisions:
  • Contributed Asset Value: $1,000,000, 
  • The asset earns 5% per year 
  • The asset appreciates at 5% per year 
Over the term of the Trust, the client will receive two annual payments of approximately $515,000 and the remainder beneficiary will receive approximately $130,000 at the termination of the GRAT. Since the value of the annuity interest exceeds the fair market value of the assets transferred into the GRAT there is no Gift Tax liability to the client, nor do they use any of their Lifetime Gift Tax Exemption. If the client funds their GRAT with assets anticipated to appreciate faster than 5% per year, the benefit to remainder beneficiaries is even greater
     Since the GRAT permits payment of both income and trust principal to satisfy the annuity payments, it is important to treat the GRAT as a grantor trust for income tax purposes. This means the client retains liability for taxes on income and realized gains on trust assets even if these amounts are greater than the trust's annuity payments. This further enhances this tool's effectiveness as a family wealth-shifting and estate tax saving device because the client pays the income tax, thus reducing the their estate.
     In the right circumstances, the GRAT can be a powerful tool to transfer assets with minimal gift or estate tax consequences, but clients should carefully review their financial situation with both an experienced attorney and financial advisor before entering into such a transaction.

Thursday, February 19, 2015

Gifting Strategies for Medical and Education Expenses

     As we touched on in our last blog, many strategies exist for using gifting as part of an estate plan. Today’s blog addresses some of the simpler planning opportunities available through gifting. In future blogs we will focus on the more sophisticated strategies.
     Tuesday’s blog discussed the Annual Gift Tax Exclusion, but it is important to note is that there is another, unlimited Gift Tax exclusion permitted for amounts paid by one individual in two circumstances:
  1. On behalf of another individual directly to a qualifying educational organization as tuition for that other individual.
  2. On behalf of another individual directly to a provider of medical care as payment for that medical care.
     A "qualifying educational organization" is one that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where it regularly carries on educational activites. It can be a primary or secondary school, including a vocational high school, college, university, or a normal, technical, mechanical school and similar institutions. . The Internal Revenue Code (the "Code") permits an unlimited exclusion for tuition expenses of full-time or part-time students paid directly to the qualifying educational organization providing the education. The Code does not permit an unlimited exclusion for amounts paid for books, supplies, dormitory fees, board, or other similar expenses that do not constitute direct tuition costs.
     "Qualifying medical expenses" are limited to those expenses defined in Code §213(d), but include expenses incurred for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body or for transportation primarily for and essential to medical care. In addition, the unlimited exclusion from the Gift Tax includes amounts paid for medical insurance on behalf of any individual. The unlimited exclusion from the Gift Tax does not apply to reimbursement for amounts paid for medical care by an individual. 
     While contributions to a qualified tuition program, such as a §529 plan do not qualify for the tuition exclusion above, they do enjoy treatment as a "present gift" that can qualify for the gift tax annual exclusion (currently $14,000 per year). The rules also allow the taxpayer electively to spread the contributions made in a single year over a five-year period. This means that grandparents can make a gift of $70,000 each ($14,000 times 5 years) to a §529 plan for a grandchild, for a total of $140,000 in one year, essentially "frontloading" a grandchild's education and allowing for a greater appreciation of the account. These gifts remove funds from the grandparents' estates, saving estate taxes on their deaths.  
     By using these gifting strategies, individuals can help their loved ones currently and reduce possible future estate taxation. Next week we will start discussing some of the sophisticated strategies used to increase the benefits of lifetime gifting in estate tax planning. 

Tuesday, February 17, 2015

Understanding the Estate and Gift Taxes

     One of the most misunderstood areas of estate planning involves the impact of Federal Estate and Gift Taxes. While most people understand they pay Federal Estate Tax on inherited assets and Federal Gift Tax on gifts made, few people truly understand what creates liability for these taxes and who is responsible for paying them.
     The first point to understand is that Federal Gift and Estate taxes are integrated into a single transfer tax under a unified rate schedule and with a unified credit that imposes a single tax on transfers during life and at death. The Internal Revenue Service group gifts and inherited assets together for purposes of determining total tax owed and the amount of assets excludable before payment of either Federal Gift or Estate taxes
     Let us begin with the Estate Tax. The estate of a deceased individual pays Estate Tax on the assets transferred to non-spouses at the individual's death. The estate tax rate is a sliding scale that tops out at 40%.  The Tax Code includes an Exclusion, which currently allows an estate to transfer $5,430,000.00 before incurring any Estate Tax liability. In addition to this large Exclusion, the Tax Code provides that any assets transferred to a surviving spouse are exempt from tax liability. In addition, any portion of the Exclusion that the estate of the first to die of a married couple does not use can be used by the surviving spouse's estate at his or her death. This ability, commonly known as Portability, means that a married couple will need to transfer nearly $11,000,000.00 at death before paying any Estate Tax. The Tax Code ties the Exclusion amount to the cost of living and therefore each year the Exclusion grows allowing ever-greater tax-free transfers.
     A person can choose to make gifts during lifetime instead of making bequests at death, making Gift Tax an important consideration. The person making the gift is liable for paying the Gift tax, if any is due. As indicated above, Gift and Estate taxes are integrated into a single transfer tax, so that the exclusion from tax becomes a "lifetime exclusion" rather than an exclusion at death. Any exclusion used during lifetime against Gift taxes will reduce the exclusion available against Estate taxes. 
     As noted above, we offset any Gift Tax against the Lifetime Exclusion before any tax becomes due. There is also another exclusion against Gift Tax--the "Annual Exclusion. A The Annual Exclusion on Gift Taxes allows any person to give up to $14,000 to any number of people, each year without creating any Gift tax liability. This means that a husband and wife together can give the each of their three children and their spouses $28,000 each year, reducing the parents' taxable estate by $168,000 each year without paying any tax on those transfers, and without using the Lifetime Exclusion. If our couple wanted to give their children additional amounts in a year, every dollar over $14,000 per beneficiary then reduces the parent’s Lifetime Exclusion.
     As an example, if the parents want to make a $200,000 gift to each of their three children so that the children can purchase a home, the parents can give a total of $28,000 to each child and $28,000 to each child’s spouse tax-free using the Annual Exclusion. The remaining $432,000 in gifts to the children and their spouses will reduce each of the parent's Lifetime Exclusion by $216,000 and reduce their remaining Estate Tax Exclusion by the same amount.
     In estate planning, we employ strategies that can increase the benefit of each of these Exclusions for people able to make substantial gifts. We will discuss some of these in our next blogs. 

Wednesday, February 11, 2015

Adding Additional Protections for Inherited IRAs

     Last year the Supreme Court of the United States unanimously held that Inherited IRAs do not qualify for protection during a bankruptcy. Stating that the term "retirement funds" refers to money set aside for time when a person is no longer working, the Court stated that three characteristics disqualify the funds held in an Inherited IRA from the status of "retirement funds.” 
  1. The owner of an inherited IRA cannot add additional funds to the account. 
  2. Holders of Inherited IRAs must take distributions from those accounts without regard to the number of years until the account owner reaches retirement. 
  3. The owner of an Inherited IRA may make penalty-free withdrawals from the account, up to the entire balance of the account, at any time without triggering the 10% withdrawal penalty found in the Internal Revenue Code.
     This important for any client who expects their retirement accounts to make up a large part of their estate, because this decision means that those inherited retirement assets do not enjoy the usual protection from creditors and will be at risk if one of their beneficiaries files for bankruptcy after receiving their inheritance. Presumably, those assets will also be at risk if a beneficiary divorces a spouse.  Thankfully, we already have a tool that addresses this concern and provides protection for beneficiaries. A standalone IRA Trust named as the beneficiary of a client's IRA can make distributions to the beneficiaries of the IRA Trust without exposing the inherited IRA to creditors. I
     Normally only an individual can be a "designated beneficiary" under an IRA, but if a Living Trust meets certain requirements it is considered a "see-through" trust and the Internal Revenue Code and Regulations treat the beneficiaries of the trust as the "designated beneficiaries" of the IRA. This allows those beneficiaries to stretch their distributions to receive the minimum required distributions over the life expectancy of the oldest beneficiary. In the event that it would be more advantageous for each beneficiary to take distributions over their own life span, it is possible to create specific sub trusts for each beneficiary under the IRA Trust to stretch distributions over the individual beneficiaries' lifespans. 
     For years, we have been using standalone IRA Trusts to assist clients who wished to place different restrictions on the distribution of their retirement and nonretirement assets or to protect beneficiaries from misusing the benefits of an inherited IRA by taking large lump sum distributions, or as protection against possible creditors or loss of assets in a divorce action. With this recent decision from the Supreme Court, a standalone IRA trust provides clients with the peace of mind that in the event one of their loved ones becomes one of the nearly 1,000,000 people who file for bankruptcy in the United States each year, their inherited IRA assets will remain protected.
     The law and regulations governing "inherited IRAs" and the use of IRA Trusts is expansive and complex. Before a client begins designating a trust as the beneficiary of a retirement account they should consult with a legal expert in that area. Additionally at the death of the account owner, it is important to seek additional advice as to the best way to retitle accounts or distribute the assets. If you or your clients have specific questions regarding this or any other planning matter please do not hesitate to contact us and we will be happy to provide you with an understanding of the consequences of any actions.

Thursday, February 5, 2015

Avoiding Personal Property Fights

While we value our client's privacy and would hate to have any of their affairs end up as a news story, there are lessons that are better learned by observing others than by experiencing them ourselves. With that in mind today's blog addresses an all to common problem that arises even when an estate does not contain an Oscar statuette. 

A current news story about the actor and comedian Robin Williams's estate is a clear example of why complete estate planning is necessary. The comedian's wife, Susan, and children  Zachary, Zelda and Cody are fighting over his estate, specifically personal property. Susan, married to Williams for three years, is claiming personal items that the children argue were to be given to them.
The dispute centers around two houses owned by Robin Williams at the time of his death. Williams' Trust grants Susan one residence and its contents upon his death, but there is another clause that says that his children get all of his "clothing, jewelry, personal photos taken prior to his marriage to his current wife,... memorabilia and awards in the entertainment industry and the tangible personal property located in Napa."  The wife is asking the court to define "memorabilia" to exclude Williams' collections , including Japanese anime figurines, antique weapons, carved boxes, theater masked, rare books, lapel pins, fossils, graphic novels and skulls, which the children are claiming. 
While Robin Williams carefully thought out his estate planning to protect all of his loved ones, he, like many others, failed to specify in detail personal property bequests. This can lead at a minimum to hurt feelings and can escalate into significant family disharmony and tear families apart.
Rather than leaving personal property bequests to the interpretation of various beneficiaries or the courts, it makes more sense to specify personal property bequests in a "Personal Property Memorandum", coordinated with the client's Living Trust, detailing specific beneficiaries for various personal items including, artwork, collections, specific pieces of jewelry, and any other personal property. 
We all have the ability to prevent family squabbles over personal property, whether of great value or sentimental value. Why leave it to others, including the courts, to guess or argue about how we really wanted our personal property to be distributed.

Tuesday, February 3, 2015

How do Powers of Attorney and Patient Advocate Designations Fit into an Estate Plan?

While people generally understand that a Power of Attorney and Patient Advocate Designations protect them if they become incapacitated, many people are confused about how these documents work and what their designees are obligated to do.

     Often, after signing their estate plan documents, our clients will ask, "now that I have a Durable Power Of Attorney and Patient Advocate Designation, what does my designated person have to do?” The simplest answer is they do not need do anything, nor can they do anything unless and until the client is declared incapacitated under the definition normally set forth in the document. The definition we use in our documents requires that two doctors certify in writing that the client is unable to care for his or her "financial or physical well-being". Once the designated person obtains those certifications, only then are they authorized to act on behalf of the incapacitated client. Upon obtaining the authority to act, the designees gain the authority and responsibility to make decisions that are in the client’s best interest.
     Under the Durable Power of Attorney, the designee should determine the assets of the incapacitated person and take action to protect those assets. This may include such actions as meeting with an investment advisor to ensure the assets are properly invested, paying bills, maintaining the house or other real estate, and making sure the incapacitated person receives care. While performing these tasks, the designated person should also keep complete financial records to show what actions they took and how they spent funds. In the course of the designee’s actions, any party shown the Durable Power of Attorney can rely on the fact that the designated person has authority to act with respect to all of the legal decisions the incapacitated person might otherwise have been able to make. 
     The person designated under the Patient Advocate Designation has the authority to make any necessary medical decisions, including treatment, selection of doctors and facilities, rehabilitation, and decisions regarding end-of-life care. We recommend that clients discuss what care he or she wants or does not want with their designees so that those people are better able to make decisions should the time come. Often, a Living Will is executed in conjunction with the Patient Advocate Designation as a declaration of those desires, especially of the intent not to be kept alive by heroic measures if it would merely artificially prolong the dying process.
     The responsibility given to another person under a Power of Attorney or Patient Advocate Designation is significant and should not be taken lightly. However the designee does not need to handle matters alone, they are allowed to employ professional advisors to assist them in caring for the client’s interests. As we always tell our clients, if it ever comes time for your designees to act, we will be there for them just like we are here for you.