When most people think about estate planning, their mind conjures up images of someone either really old or really rich. While an estate plan is necessary to have before you die, it may be even more useful for while you are alive.
Let’s get some basic terminology out of the way first. An estate plan is the name given to the overall plan put into place by your lawyer and is composed of several different kinds of legal documents, one of which is a trust and another which might be a will (which are discussed below). Put another way, a trust or a will is just one part of your estate plan; they are not the same.
But why does that matter for you? Well, here are 5 reasons why everyone – including you – will need an estate plan sooner rather than later, and not for the reasons you think.
TO AVOID PROBATE
After we die, a court proceeding known as probate is initiated in our home state, and in the state where any property was located. The purpose of probate is to ensure that all your creditors (including the IRS) are paid off, before your assets are transferred to your loved ones. In California, a probate proceeding takes at least a year to complete, and during most of this time, the asset cannot be sold, refinanced, accessed, or changed in any manner by your family without court approval. Worst of all, the probate is expensive. For an estate valued at $1 million, the cost of the probate is $52,000. When calculating the value of your estate, they look at the fair market value of your real estate, retirement accounts, and life insurance death payouts. Because probate is entirely public, your family is at mercy to the claims of not just known creditors, but unknown creditors as well.
A fully-funded living trust avoids a probate. A living trust is a document that spells out how your assets are to be owned and managed while you are alive and after you pass away. A will, by contrast, is a document that only states what happens to your assets when you die. Unlike a trust though, a will does not avoid a probate. This means if you die with only a will, there is still a probate. This fact alone makes a trust and a will two very different documents, which unfortunately gets missed by most people. Simply put, a will is not sufficient by itself in California if you are a home owner or have probatable assets valued beyond $166,000.
The key part to know about a trust is that it must be fully funded. This means that after you create and sign your trust document, your assets still need to be retitled appropriately. If you don’t change the title of your assets, there will still be a probate. In some situations, retitling means that your trust will now be the new owner of your home or bank account. In other situations, you will still be the owner of the asset, but your trust may be named as a beneficiary. In other situations, like businesses, you may assign rights to your trust. Each case is unique and depends on many factors. To find out more, you can check out our related article, “Should I Name My Trust as the Owner or Beneficiary?”.
TO REDUCE TAXES
A comprehensive estate plan can do many things to reduce your tax exposure.
One example of this is the double-step up in basis. If you are a married couple in California and holding title to your property as joint tenants, you are not taking full advantage of the double step-up in basis afforded to California married couples, which is a travesty in my opinion. The idea behind the double step-up is simple. If my spouse dies and I want to sell an appreciated asset, the adjusted basis of the asset steps up to fair market value at the time of my spouse’s death, assuming it was titled in community property. But if the asset was held as joint tenants, only half of the basis is adjusted to fair market value. You can learn more about this here: How Step-Up in Basis Works – Estate Planning.
Another example of tax savings is ownership of commercial properties. After the passage of Proposition 19 on February 16, 2021, your children will pay more in property taxes when you die, guaranteed, unless you are taking advantage of LLC ownership rules. Another example is avoiding federal estate taxes at death. If you have not taken advantage of the current federal estate tax exemption and have not created a trust to avoid the estate taxes, your loved ones will lose more than 40% unnecessarily in death taxes after you pass away.
People are amazed once they learn about all the things their accountant or financial advisor never told them. I see this with life insurance. While most people know that life insurance is “tax-free,” this only refers to income taxes. Death payouts of life insurance are subject to estate taxes. This can be avoided with the implementation of an irrevocable life insurance trust (ILIT), but that is not how most people own their life insurance policies.
Recently, I advised a Bay Area client who was an early investor in a startup. He was facing millions of dollars in capital gains taxes at the time of liquidating his shares in a company that was about to go public. This gentleman was entirely unaware that his business qualified under Section 1202 of the Internal Revenue Code, which is known as QSBS (Qualified Small Business Stock). Using certain types of trusts, we were able to avoid millions in unnecessary taxes.
TO PROTECT YOUR FAMILY
A good estate plan should build asset protection for you and your loved ones.
In designing a trust, many people make the mistake of leaving their assets outright to their children. Many of the plans I review are built to leave the home and bank accounts to the kids at a certain age like 25 or 30. But what happens if the child inherits your assets and then gets divorced later? What happens when your future son-in-law claims that he is entitled to 50% of your inheritance? Or what happens if your child gets into a car accident and then gets sued?
A trust can be set up with these life events in mind. Through proper planning, we can name an independent trustee who can manage the assets for your children, which protects them in situations like a divorce or lawsuit. This is a more responsible way of leaving assets to the children, especially with divorce rates through the roof.
Moreover, trusts and entity structures can also be established during your lifetime to protect against your own future creditors. This planning needs to happen well before any claim is brought upon otherwise the transfer can be undone by your creditor. Most people wait until after a car accident has occurred to begin this planning. Rather, the best time to create these structures is now, when you don’t think you’ll need it. The law protects you at this stage, but once the event giving rise to the lawsuit occurs, it’s generally too late.
TO PLAN FOR INCAPACITY
Whether it’s sudden, like a car accident, or gradual, like dementia or Alzheimer’s, more and more people will become incapacitated at some point in their lives. Once incapacitated, life becomes hard for your loved ones. They need to make financial and medical decisions for you, but will not be able to do so legally.
I once represented a man who was fully incapacitated from a terrible car accident. His wife needed to refinance and then sell their house to pay his medical bills, but she could not do so without his signature. She tried to speak to his doctors but they refused to speak with her, citing HIPAA compliance. The man’s wife was forced to petition the court for a conservatorship, which cost her tens of thousands of dollars and was a nightmare to deal with, because she kept having to go to court each and every month.
This all could have been avoided had the couple created an estate plan that included basic incapacity documents, like durable powers of attorney and healthcare directives, outlining who could make decisions in those situations. Simply put, every human being needs a basic estate plan, if for no other reason than to outline who can help you in the event that you cannot help yourself.
TO AVOID CUSTODY DISPUTES
If you are the parent of a minor child, your estate plan will also need to include guardianship documents. Without such documents, if something happens to the parents of a minor child, the minor is placed in temporary custody with the Department of Children and Family Services and then a judge will determine who the future parent will be for your child.
An estate plan will include your preferences on who the guardians should be for your children, should something happen to you. It is advisable not only to name permanent guardians, but also temporary (local) guardians who can also assist your children in the case of a medical emergency if you are not there.
Recap
The vast majority of people fail to recognize the importance of an estate plan until it is too late. It is my hope that this article has convinced you of the importance of safeguarding not only your assets, but also your family and their future. Whether it be to avoid unnecessary taxes or choosing guardians for your children, a fully-funded estate plan will take care of you both in life and death. Estate plans are like any other investment; with a little time and effort at the outset, the rewards you see later on are immeasurable.
NOTE: This article is for informational purposes only and should not be construed as legal advice. For legal advice please contact an experienced attorney about your specific matter. For more information visit Bridge Law, LLP. at www.bridgelawllp.com or email info@bridgelawllp.com
