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Estate Planning

Without careful planning, potentially over 50% of an individual’s assets could end up in the pockets of tax authorities instead of those whom he or she has selected to receive them.

Alternatively, estate assets could be lost to a creditor. In order to avoid such undesirable results, one must give careful consideration to the myriad opportunities available to ensure that wealth is preserved.

Estate planning is the process of formulating a strategy that will manage and preserve assets during an individual’s lifetime and for his or her beneficiaries upon death. Its goal is to maximize the amount of assets passing to an individual’s estate beneficiaries.

Healthcare decision-making

In addition to wealth preservation, one must give careful consideration to whom should be appointed to make health care decisions in the event one becomes unable to do so. A living will and a healthcare proxy are documents that every person should have. These documents take effect when an individual is unable to make healthcare decisions for herself, or to communicate her wishes. The living will defines the circumstances in which life sustaining treatment should be withheld. New York State law requires clear and convincing evidence of an individual’s wishes for life sustaining treatment to be terminated or withheld, which a living will provides. The healthcare proxy designates a specific person to make healthcare decisions on behalf of an individual unable to do so.

Power of attorney

The power of attorney, an instrument that designates an agent to make financial decisions on behalf of the principal, is another fundamental estate planning document. A power of attorney is operative only while the principal is alive and may be drafted to take effect either immediately or upon the incapacity of the principal. This instrument provides the principal with the assurance that important financial affairs can be handled by their agent in the event of disability.

There are many wealth transfer vehicles available to allow individuals to meet their planning goals. However, the last will and testament remains the fundamental estate planning tool, which every individual should consider. A will is an extremely flexible instrument that governs the distribution of the creator’s (or “Testator’s”) estate upon death. Due to its significance, the numerous requirements for creating a will must be strictly followed in accordance with state law in order for it to be upheld after death.

A well-designed estate plan should minimize Federal and New York State estate and gift taxes, as well as meet the client’s individual goals and needs. Estate taxable assets are those assets in which a decedent has any incidents of ownership at the time of death. Estate taxes must be paid within nine months of the date of death. Under current federal law, an individual dying in 2008 can pass up to $2,000,000 worth of assets without incurring federal estate tax, with a $3,500,000 exemption for 2009 (the New York State estate tax exemption is currently $1,000,000).

The current federal gift tax credit has remained at $1,000,000 for gifts made during lifetime. In addition, $12,000.00 in gifts can be made annually, per donee, by an individual, tax-free. This $12,000.00 annual exclusion amount can be doubled to $24,000.00 per year, if the gifts are split with a spouse.

Asset-freezing techniques

For individuals who have used up a portion or all of their estate and gift tax exemption, asset freezing techniques can help reduce the amount of their taxable estate. Such techniques allow an individual to value an asset as of a specific date, which can reduce the amount of taxes on a highly appreciable asset. Grantor Retained Annuity Trusts (GRATS) have become an increasingly popular means of freezing the value of assets and transferring property out of an estate.

A GRAT is a trust where the Grantor gifts property to a trust for a specific number of years while retaining an annuity (an annual payment from the trust assets at a fixed percentage rate) during the trust term. The Qualified Personal Residence Trust (QPRT) is a similar vehicle, which freezes the value of a home at a specific time. The Grantor transfers their personal residence to the trust while retaining a right to live in the home for a specific period of time before the residence is transferred to the beneficiaries. Because the contribution of an asset to the GRAT or a QPRT is considered a gift, the asset is valued as of the date it is placed into the trust, rather than date the trust ends. If the Grantor survives the trust’s term, the asset transferred by the GRAT or QPRT will be out of his or her estate at a discount.

Marital deduction

Individuals who are married may benefit especially from the ability to transfer their assets to their spouse, tax-free, upon death (the “Marital Deduction”). The Marital Deduction is, in effect, a tax-deferral method, since any property transferred tax-free by the first-to-die spouse will be included in the surviving spouse’s estate upon his or her death. Use of the Marital Deduction can also offer other important tax benefits to the surviving spouse. For example, the government allows a step-up in the cost basis of any real property inherited to the fair market value at the date of death, which allows the beneficiary to incur less capital gains tax upon subsequent sale or disposition.

There are several means of making use of an individual’s marital deduction ranging from simple outright transfers to the surviving spouse, to more complicated arrangements that may provide only income to the surviving spouse. Qualified Terminable Interest Property (QTIP) trusts provide the surviving spouse with all of the annual income of the trust while allowing the grantor to decide who will receive the remaining trust assets. QTIP trusts are frequently integrated into wills and can be invaluable in second marriage situations where the grantor wishes to care for the surviving spouse during his or her lifetime, but ensure that the trust proceeds will ultimately be paid to his or her children.

An important consideration is not to over-utilize the Marital Deduction, thereby wasting any remaining estate tax exemption available upon the first spouse’s death. A Credit Shelter Trust is a popular vehicle often utilized in combination with the Marital Deduction, which can significantly reduce the total estate tax liability of the spouses’ combined estates.

Providing liquidity

Proper planning should also provide for sufficient liquidity to pay any estate taxes due. One method of providing liquidity is with life insurance proceeds. However, if the owner of a life insurance policy retains certain powers over a policy, the proceeds are includible in his or her estate for estate tax purposes. An irrevocable life insurance trust (ILIT) is a beneficial vehicle to remove an insurance policy from an individual’s estate.

Individual Retirement Accounts (“IRAs”)

Individual Retirement Accounts (“IRAs”) and the income tax savings that they provide have become an important and powerful means of saving for retirement as well as for future generations. At death, however, with improper handling, IRAs can be subject to both income and estate taxes, which can significantly reduce the accrued value by as much as 75%. Proper administration of these accounts is essential in order to preserve their value for the individual’s spouses and children.

Estate plans must be reviewed and regularly updated in order to maintain their effectiveness. Changes in the tax laws are frequent and may have significantly undesirable effects on even the best estate plans, if they are not periodically reviewed and updated in light of any applicable changes in the law.