Figuring out what you want to do with your stuff when you die is… well, complicated. Most of the time we sign a stack of papers at our attorney’s office and think we’re done. But it’s not that simple. Here are 7 estate planning mistakes and how to fix them.
1. Not updating the executor of your estate.
The executor is the person that takes control over the assets when you pass away. He collects the assets, pays the final debts and expenses, and files the federal and state estate tax returns if needed.
A common estate planning mistake is we often choose an executor because they’re good with money. This means they’re usually older than we are. If this is the case, when your estate is finally settled, they may be deceased or no longer suited for the position because they are too elderly. If a bank is named, they often take a long time to handle the estate because they really don’t have an incentive to take care of the affairs. Or if it’s an attorney or CPA, are they still in business?
The fix: Review your estate executor every 5 years or so to make sure they are still the best fit. Children, nieces/nephews may be better suited to be your executor at some point.
2. Not changing documents to when your kids are adults.
When kids are young we name guardians to take care of them if something happens to us. Money is usually funneled into a trust and the trustee, who is usually not the guardian, gives income to the guardian for taking care of the kids. But what if the kids are adults? A common estate planning mistake is not updating documents when guardians and trust may no longer be necessary. It may make sense to distribute funds directly to adult children. It may also make sense to direct certain assets to certain children.
For example, A client that inherited $500,000 cash. They added it to their nest egg and continued on their way. The client’s sister inherited $500,000 as well. Within a couple of years, the sister, who never had any substantial money in their life, had spent her inheritance in less than 2 years. It might’ve been better to give her a stream of income or a house free and clear to offset her spending or mishandling of money.
The fix: Make sure the provisions in your will or trusts related to children are updated to reflect current circumstances.
3) Unsuitable health care directives.
HIPPA makes medical records and personal health information confidential. These records cannot be shared with family or anyone unless there is written authorization. Unless your documents include this information with specific directives, decision-making by others when youâ€™re incapacitated or approaching the end of your life could be impeded.
The fix: Review your familyâ€™s health care powers of attorney, living wills and advanced health care directives to make sure they comply with HIPPA.
4) Outdated estate tax provisions.
The 2020 estate exclusion is $11.58 million for individuals and $23.18 million for couples. This allows individuals and couples to transfer estates valued at these sizes free of estate and gift taxes. If a trust document was established before 2002, you may have provisions set at $675,000 for individuals and $1.35 million for couples, forcing a trust for the heirs to be funded at a much lower amount.
The fix: Review formulas in the estate documents with your attorney and/or tax professional.
5) Not using portability.
The surviving spouse can use any unused portion of their spouseâ€™s exclusion amount if the estate files a federal estate tax return within 9 months of the deceasedâ€™s passing. To take advantage of this portability, you have to have an estate of more than $11.4 million in 2019, and you have to file the estate tax return, even if it shows zero dollars owed. This can be costly in some larger estates, where the second spouse dies with more than $11.4 million in wealth.
The fix: There are a few options to talk to your attorney about including:
- Set up a credit shelter, bypass, family or exemption trust funded with assets from the first spouseâ€™s estate. That preserves not only the portability of those assets, but any growth in those assets would not be counted in the estate tax calculation.
- Disclaim part of the deceasedâ€™s assets, allowing them to pass to the children.
- File the federal estate tax return, preserving the portability of $11.4 million of additional estate tax exemption.
6) Not considering step-up in basis for tax planning.
Most estates do not have $11 million dollars. Therefore they will never pay a federal estate tax. Tax planning should be concentrated on income tax planning. One important consideration is the step-up in basis for appreciated assets, which means that, for the heirs, the capital gains tax obligation on the amount of appreciation during the deceasedâ€™s time of ownership will vanish. This is the closest thing to a free lunch, in the tax world, that you can get.
For example, I have a client that owns a cottage up near Traverse City that they bought in the 1950s for $40,000. It’s now worth close to $1 million dollars. In order to avoid the $960,000 capital gain, they plan on leaving it to their heirs, at which point, it can be sold almost tax-free.
The fix: Legacy stocks and highly appreciated assets can be held and passed on to heirs to get a step-up in basis.
7) Estate documents from a prior state of residency.
Estate and income taxes are determined by individual state law. Some state uses common law property laws while others use community property laws. This makes a difference when you transfer assets. 17 states impose a form of estate or inheritance tax, with different exemption amounts. Some estates that would not be subject to a federal estate tax might be subject to state estate taxes. If your documents were drafted in a different state from where you currently reside, they might be outdated and misapplied.
The fix: Review your estate plan to reflect your current state of residency.
Estate planning is not a one and done transaction. This is evident with the 7 estate planning mistakes listed above. It’s important to review your documents every 5 years or so to make sure they are still accomplishing your wishes, and reflect current laws.
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