Estate Planning - General Information

What is Estate Planning?  If asked that question, many people would define estate planning as the determination of who receives property upon death.  Others might consider estate planning as a means of reducing taxes upon death.  Many would define estate planning as a combination of both.  In reality, everyone already has an estate plan.  The real issue is whether or not there was any “planning” by the individual.

For example, if an individual dies without a Will (called dying intestate), the probate laws of the state where the individual lives will determine who receives that individual’s property upon his or her death.  Similarly, whenever an individual creates a joint tenancy with the right of survivorship, such as a joint bank account, or names the beneficiary of a life insurance policy or retirement plan, the individual has created an estate plan, often without realizing it or coordinating with other planning decisions.

Estate planning is a process which provides the framework for an individual to determine his or her personal and financial objectives, both before and after death.  Those objectives might include providing for:

  • Financial security of a spouse and/or minor dependents
  • Long term care of elderly or disabled dependents
  • Orderly succession of a family business
  • Continuity of income and/or asset management in the event of disability
  • A structure to protect assets for intended beneficiaries
  • Minimization of estate taxes
  • Liquidity necessary to pay estate taxes and estate administration expenses

A well-drafted and implemented estate plan provides for the accumulation, conservation, and distribution of an individual’s estate in the manner which most effectively and efficiently accomplishes his or her personal tax and non-tax objectives.

This paper will provide a high-level overview of some of the typical “tools” that are used in creating an estate plan.  Not all will apply to each client, but are provided for general education and background information.

THE ESTATE PLAN

The Estate Plan is composed of various documents drafted to accomplish the individual’s tax and non-tax estate planning objectives.  At a minimum, crafted Estate Plans include the following documents:                      

  • Will
  • Power of Attorney for Property
  • Power of Attorney for Health Care
  • Declaration to Physician (Living Will)

Depending on the individual’s goals, the Estate Plan might also include one of the following types of trust:

  • Testamentary Trust
  • Self-Declaration of Trust
  1. Testamentary Trust is a trust that is created within the individual’s Will.  A Self-Declaration of Trust is created by an individual during his or her lifetime and is also called a living trust, a revocable trust, or a revocable living trust (they are all the same). 

There are other forms of trusts that are used for specific purposes.  For example, an Irrevocable Life Insurance Trust is sometimes implemented to receive life insurance proceeds free of federal estate tax after the individual’s death.  A Charitable Reminder Trust can be used to provide a charity with a benefit in the future, while securing an income tax benefit for the grantor in the present.  A Supplemental Needs Trust is a specific tool used to provide supplemental assistance for beneficiaries who are receiving public assistance, but in a way that does not diminish that public assistance.  These specialized trusts are beyond the scope of this paper.

Finally, again depending on the individual’s goals, the Estate Plan may also include a plan for lifetime gifts.

These customary components are described in a little more detail below.

1. WILL

A Will is a legal document which provides for the transfer of an individual’s assets or estate upon his or her death.  To be valid, a Will must be properly signed and witnessed and comply with the requirements of the applicable state law.

Although a Will is executed during an individual’s lifetime, a Will does not take effect until the death of the individual making the Will (called the testator).  As a result, a Will may be revoked or modified any time during the individual’s lifetime.

Upon the death of the testator, a Will must be probated if there are assets titled solely in the decedent’s name.  Probate is a process by which a court determines that a Will is valid, supervises the collection of the decedent’s assets, the payment of the decedent’s debts, and the distribution of the decedent’s remaining assets.

As a general rule, the testator may transfer his or her property in whatever manner he or she desires (subject to certain rights of a surviving spouse and dependent children).  This is one of the most important advantages of making a Will.  If an individual passes away without making a Will (that it, dying intestate), the state, not the individual, decides who will receive his or her property and in what proportions.

In this way, a Will is basically a set of instructions for the disposition of an individual’s estate.  With a Will, an individual may distribute property outright or exercise control over the future use of the property by placing restrictions on the distribution.

A common form of control is imposed by creating a Testamentary Trust under the Will.  Instead of distributing the property outright to an individual, the Will may direct that property be distributed to a Trustee who is named in the Will.  The Trustee holds the property for the benefit of the individual named in the Will (the beneficiary) upon the terms and conditions listed in the Will.  For example, a common strategy employed by parents is to have children’s inheritances held in trust until the children reach specified ages (say, ½ at age 30, and ½ at age 35).

In addition to the instructions for the distribution of the estate, a Will should also name the individual responsible for carrying out those instructions.  This individual is known as the Executor.  Similarly, a Will is the best way to name a Guardian for minor children.

There are certain things a Will cannot accomplish. For example, the provisions of a Will have no effect on property which passes by operation of law outside the probate estate. The most common example is property held in joint tenancy with the right of survivorship.  Upon the death of a joint tenant, the property passes by operation of law to the surviving joint tenant.  The deceased joint tenant cannot provide for a different disposition in his or her Will.

Similarly, the named beneficiary of a life insurance policy, retirement plan, or bank account will receive those benefits upon the death of the insured, the plan participant, or the joint account owner.  A provision in the insured’s Will or the retirement plan participant’s Will that purports to dispose of those proceeds will have no legal effect.  Likewise, property held in a land trust which names a joint or contingent beneficiary will be distributed pursuant to the provisions of the land trust agreement, not the Will of the deceased land trust beneficiary.  Finally, property held in a trust will be distributed pursuant to the terms of the trust.

Consequently, to ensure a Will accomplishes an individual’s goals, the individual must first determine his or her goals and second ensure the title to property is held (or beneficiaries named) in a manner consistent with those goals.

2. SELF-DECLARATION OF TRUST

A Trust is a legal document (a Trust Agreement) which names an individual or corporation as the Trustee to receive and hold legal title to property, which the Trustee will manage according to instructions in the Trust Agreement.  The Trustee of a Trust is sometimes called a fiduciarybecause he or she holds legal title to the property in the Trust not for his or her own benefit, but for the benefit of the person or persons named in the Trust Agreement.

The Trust Agreement provides the instructions for managing and distributing the property held in the Trust.  The Trust Agreement also defines the powers and obligations of the Trustee and names Successor Trustees in the event the Trustee named originally can no longer serve as Trustee.

The individual creating a Trust is called the Grantor.  With a Self-Declaration of Trust, the Grantor is also the Trustee.  That is, the Grantor declares himself or herself to be the Trustee of his or her own assets pursuant to the terms of the Trust Agreement.

The persons who receive income and/or other distributions from a Trust are called the beneficiaries.  Initially, the Grantor is also the beneficiary of the Trust; that is, the Grantor declares himself or herself Trustee of the Trust property for the Grantor’s own benefit.

In addition to naming the beneficiaries, the Trust Agreement determines what benefits or distributions each beneficiary receives, and when they will be received. The Grantor also names the beneficiaries who receive the Trust upon the Grantor’s death and defines the manner in which those beneficiaries receive the benefits or distributions of the Trust. The distribution upon the death of the Grantor may be structured to minimize federal estate taxes by coordinating the use of various sub-trusts.

Finally, the Trust Agreement defines the rights retained by the Grantor.  Typically, the Grantor retains the right to amend or revoke the Trust at any time and/or to withdraw any or all of the property from the Trust at any time.

As a result, the Grantor of a Trust continues to have complete control his or her assets, and continues to use those assets for his or her benefit as the beneficiary, although legal title to those assets is no longer held individually by the Grantor.  Furthermore, the Grantor retains the right to revoke or alter the Trust at any time to provide for a change in his or her personal objectives.

Recognize that a Self-Declaration of Trust is similar to a Will in that the Trust provides for the distribution of an individual’s assets upon death.  Even though the Trust is the primary dispositive tool, a companion Will is still necessary with a Trust.  A simple Will -- sometimes called a Pour Over Will because it directs that any estate assets shall be “poured over” to the Trust -- is necessary to provide for the disposition of any assets not previously transferred to the Trust.

Under certain circumstances, a Trust is more advantageous than a Will as a means of disposing of an individual’s estate upon death.  Here are some of the advantages and disadvantages:

A. TRUST ADVANTAGES

A Self Declaration of Trust provides three advantages that a Will does not provide, namely, avoidance of probate, privacy, and disability planning, each described below:

Avoiding Probate

A Trust may result in reduced settlement costs upon death because Trust-owned assets do not have to be administered in a probate court proceeding since assets owned by a Trust are not probate assets.  As a result, the assets in the Trust will not incur any costs related to probate.

Trusts can be used to avoid probate in multiple states.  Real estate is typically subject to probate in the state where the property is located.  For example, if an Illinois resident owns a home in Illinois and a vacation home in Michigan, the Illinois home may be subject to probate in Illinois and the Michigan home may be subject to probate in Michigan.  If both properties are held in a Trust, neither property is subject to probate, and multi-state probate proceedings are avoided.

Finally, the probate process takes time.  Normally, probate assets cannot be distributed until the Will is admitted to probate and an Executor is appointed and accepts the appointment.  In addition, in Illinois potential creditors of the decedent must be given a 6-month period within which to file a claim against the estate.  Typically, Executors defer making distributions until the creditor claim period has expired.

With a Trust, upon the death of the Grantor, the named Successor Trustee may begin to act immediately.  Consequently, the income or other benefits from the Trust may be paid to the Grantor’s beneficiaries without interruption or delay.

As a result, using a Trust allows the Grantor to avoid probate, thereby saving the costs associated with probate, including possible multiple probate proceedings, and preventing a potential interruption in income to his or her beneficiaries.

Privacy

A Trust provides greater privacy because a Trust is not a public document.  A Will must be filed with the Probate Court (whether or not a probate proceeding is required). Consequently, the decedent’s assets and their subsequent distribution are matters of public record.  A Trust does not have to be filed with the Probate Court in Illinois.

Disability Planning

A Trust allows an individual to plan for the management of his or her estate in the event of disability.  Trust Agreements appoint Successor Trustees to manage and administer the Trust pursuant to the instructions of the Grantor in the event the Grantor/Trustee is disabled, either physically or mentally.  A Will cannot provide a plan for disability because a Will is not effective until the death of the testator.

In this way a Trust will avoid the necessity of a public, time-consuming and potentially expensive probate court proceeding to determine whether the Grantor is disabled, and to name a guardian for the Grantor if he or she is found to be disabled.  A Trust will also avoid the court’s subsequent supervision of the Grantor’s estate during the period of his or her disability.

B. TRUST DISADVANTAGES

An Estate Plan which employs a Trust has two potential disadvantages over an Estate Plan which uses only a Will. First, legal fees associated with preparing an Estate Plan which includes a Trust and Pour Over Will are typically higher than fees for preparing a simple Will.
Second, securing the benefits of using a Trust requires the Grantor to transfer his or her assets into the name of the Trust (called trust funding). Trust funding will require additional time devoted to asset transfer administrative matters (for example, completing new brokerage account application forms), and may include additional initial costs (such as recording fees for transfers of real estate to the).

3. POWER OF ATTORNEY FOR PROPERTY

A Power of Attorney for Property is a legal document which allows an individual (called the principal) to name an agent to manage the principal’s financial affairs.  It allows the principal to define the powers his or her agent will have and to define under what circumstances the agent may exercise those powers, such as upon the disability of the principal.  A Power of Attorney for Property survives the disability of the principal (and in this regard it is sometimes called a “durable” power of attorney).  Powers of attorney terminate upon the principal’s death.  Finally, a Power of Attorney for Property may also be used to name a guardian for the principal’s estate and/or person.

A Power of Attorney for Property generally authorizes the named agent to hold property, pay bills, and handle other financial matters during the principal’s disability.  If the principal has established a Trust, the Power of Attorney for Property should also authorize the agent to transfer assets to the Trust.  Similarly, if the principal has established a pattern of lifetime gifts, the Power of Attorney for Property could authorize the agent to continue making the same pattern of lifetime gifts.

The powers of an agent pursuant to a Power of Attorney may be exercised without the necessity of a court proceeding determining the principal’s disability, thereby avoiding certain costs and the stigma of a court adjudication of disability.

4. POWER OF ATTORNEY FOR HEALTH CARE

A Power of Attorney for Health Care is a legal document which allows an individual (again, the principal) to name an agent to make health care decisions in the event the principal becomes unable to communicate those decisions.  It also allows the principal to define his or her wishes as to life sustaining medical treatment and provides a means to insure those wishes are honored.

Illinois has a standard statutory power of attorney for health care form which allows the principal to indicate his or her preference regarding life sustaining medical treatment, and it also allows the principal to indicate his or her intent with respect to anatomical gifts or organ donations.

The agent named in the Power of Attorney for Health Care should have a complete understanding of the principal’s health care preferences and should be capable of respecting and implementing those preferences.

5. DECLARATION TO PHYSICIAN (LIVING WILL)

A Declaration to Physician, patterned after the Illinois form of Living Will, is a legal document which states an individual’s preference as to death delaying medical procedures.  It is not a comprehensive health care document, such as the Power of Attorney for Health Care, because a Declaration is effective under limited circumstances and for a limited purpose.

A Declaration only applies when the individual is terminally ill and his or her life is being prolonged by death delaying medical procedures.  Under those circumstances, the Declaration allows the individual to state whether death delaying medical procedures should be withdrawn.

The effect of a Declaration is suspended while an Agent is acting under a Power of Attorney for Health Care with respect to life-sustaining medical procedures.

ESTATE AND GIFT TAX ISSUES

The Federal Estate and Gift Tax is a tax assessed upon the transfer of property during an individual’s lifetime (and it is sometimes called the gift tax) and/or upon an individual’s death (and it is sometimes called the estate tax).  The following is a summary of the federal estate and gift tax laws effective as of January 1, 2018.

1. GENERAL OVERVIEW

The Federal Estate and Gift Tax levies a tax on the value of gifts made during the lifetime of an individual and on the value of a decedent’s estate at death, in excess of certain limits.  The current tax rate is 40%.  Critical exemptions and deductions are described below.

2. UNLIMITED MARITAL DEDUCTION

Any individual may transfer an unlimited amount of assets to his or her spouse, either during lifetime, and/or (with certain limited exceptions) upon death, without incurring an estate or gift tax. This is sometimes called the Marital Deduction.  As a result, virtually all transfers between spouses do not result in an estate or gift tax.

3. APPLICABLE EXCLUSION AMOUNT (EXEMPTION)

In addition to the unlimited Marital Deduction, each individual has a credit against estate or gift taxes which is referred to as the applicable exclusion amount, and popularly referred to simply as the exemption.  For 2018, the federal exemption is $11,200,000 per individual.  That is, an individual may transfer assets in the amount of $11,200,000 to an individual other than his or her spouse, either during lifetime or upon death, without incurring a federal estate or gift tax.  Transfers in excess of the applicable exclusion amount are subject to tax at a maximum rate of 40%. The federal estate tax exemption amount is scheduled to expire in 2025.

4. PORTABILITY

In 2013 Congress introduced portability into the tax code. Portability allows the estate of a decedent who is survived by a spouse to make an election which will allow that surviving spouse to use the deceased spouse’s unused applicable exclusion amount. 

For example, if husband dies in 2018 with a taxable estate of $8,000,000, then the husband’s unused applicable exclusion amount would be $3,200,000 ($11,200,000 less $8,000,000). Husband’s executor would make the election to transfer the unused portion of his applicable exclusion amount to the surviving wife on a Federal Estate Tax Return.  If wife also dies in 2018 with a taxable estate of $17,000,000, then the wife’s exclusion for estate tax purposes would be $14,400,000 (her deceased husband’s unused exemption of $3,200,000 plus wife’s $11,200,000 exemption).  Thus, only $2,600,000 ($17,000,000 - $14,400,000) would be subject to Federal estate tax. 

With the introduction of portability, a married couple can currently pass up to $22,400,000 to their family or other beneficiaries without Federal Estate Taxes

5. FEDERAL GIFT TAX ANNUAL EXCLUSIONS

As noted, lifetimes transfers are subject to gift tax.  In order to exempt small transfers from gift tax -- and from gift tax reporting requirements -- the law recognizes annual gift tax exclusions (or simply, annual exclusions).  That is, currently each individual may transfer, in 2018, $15,000 per year, per donee, without incurring a gift tax (or making a taxable gift).  The annual exclusion is periodically adjusted for inflation.

For example, a married couple with two children and four grandchildren may transfer $180,000 per year without incurring a gift tax by giving each child and each grandchild the maximum exclusion amount of $30,000 ($15,000 from each spouse).

In addition to the $15,000 gift tax annual exclusion, an individual may gift an unlimited amount, without incurring a gift tax (or making a taxable gift), to any individual for that individual’s tuition and medical expenses, provided that payments are made directly to the educational institution or to the person or medical institution providing the medical care.

6. ILLINOIS ESTATE TAX

The State of Illinois has a separate estate tax with tax rates generally starting at 8% and rising to 28%. For 2018, the Illinois estate tax exemption amount is $4,000,000.  Unlike the federal applicable exclusion amount, the Illinois estate tax exemption is not portable between spouses.  The State of Illinois does not have a gift tax.  However, lifetime gifts may have an impact on the Illinois estate tax.

LIFETIME GIFT PROGRAMS

Clients often embrace strategies to reduce the size of their estate, with the goal of reducing the amount of their assets that may be subject to estate tax.  The advantage of a lifetime gift program is the ability to remove the value of gifted assets, and any subsequent appreciation on the gifted assets, from the estate of the donor.  In addition, the gift removes the income from the gifted property from the donor’s estate and may result in current income tax savings if the donee is in a lower income tax bracket than the donor.

As a general rule, the property most suitable for a lifetime gift program is property with the potential for significant appreciation.  In addition, the availability of discounts for lack of marketability and lack of control make gifts of a minority interest in a closely held business desirable assets for a lifetime gift program.

In order to assure that the value of the gifted asset will be excluded from the donor’s estate for future tax purposes, the donor must truly give up control of the gifted asset.  Similarly, the donor must be able to give up the income from the asset.  However, there are vehicles, such as Family Limited Partnerships and Limited Liability Companies, which allow the donor to gift property and still exercise control over the gifted property. 

Depending on the individual, a lifetime gift program may play a significant role in an individual’s Estate Plan.

CONCLUSION

The preceding discussion of general estate planning topics is intended to provide accurate and current information.  However, the discussion is general in nature and should not be acted upon without obtaining competent, professional advice.  Also, this discussion is not exhaustive of all planning opportunities that are available.  Please feel free to contact us if you wish to discuss any topic relating to your estate plan.

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