Introduction
Estate planning is important for everyone, but it’s unquestionably crucial for large estates. In addition to the standard preparations for end-of-life care and asset distribution, wealthy individuals need to make advance preparations to avoid estate taxes and unnecessary probate.
Large estates often include complex business interests that need to be addressed. Wealthy families also need to consider how their substantial assets will transfer to a spouse, children, extended family, and charities. To help you navigate the complex estate planning process for large estates, here are 10 topics that you should discuss with your attorney and financial advisor:
- Designate an agent with a power of attorney
- Draft an advance directive
- Nominate an executor
- Implement a gifting strategy to minimize future estate taxes
- Use beneficiary designations to avoid probate
- Use a revocable living trust to provide for your spouse and children
- Use an irrevocable trust to avoid estate taxes
- Leave a charitable legacy
- Use a life insurance trust to pay for anticipated estate taxes
- Plan for business succession
Designate an Agent With a Power of Attorney
Nobody likes to discuss the potential for mental incapacitation, but it’s one of the first things you’ll want to address with your estate plan. A good plan should prepare for contingencies by appointing an agent who can manage your financial affairs and a health proxy who is authorized to speak with your doctors and make important medical decisions on your behalf. Both of these can be accomplished with a durable power of attorney.
Draft an Advance Directive
An advance directive (sometimes referred to as a living will) is a legally binding document that outlines your healthcare and treatment preferences. Should you become incapacitated and unable to communicate important medical decisions, your doctors will be able to reference your advance directive to understand what treatments you would or would not approve. Your advance directive can broadly authorize any and all measures to save and sustain your life, or it can address topics individually. Some topics that are commonly addressed in an advance directive include palliative care (treatments to alleviate pain and suffering), resuscitation, and artificial life support.
Nominate an Executor
An executor or personal representative is the individual you choose to manage your estate’s affairs when you die. Executors have full legal authority to gather your assets, settle your liabilities, and distribute your possessions, so it’s important to nominate someone who is trustworthy, responsible, and well-qualified. While most people nominate a family member to serve as their executor, wealthy individuals with a large estate may want to consider using a professional like an attorney or trusted advisor.
Implement a Gifting Strategy to Minimize Future Estate Taxes
As of 2018, individual estates worth more than $11.2 million and joint estates worth more than $22.4 million (both indexed for inflation) will be subject to estate taxes ranging from 18% – 40%. Considering how this can take a major bite out of a large estate, it’s essential for your estate plan to include strategies that will minimize or eliminate your exposure to estate taxes.
One of the easiest ways to minimize future estate taxes is to implement a gifting strategy long before you pass away. The idea is to gradually move assets out of your estate over time rather than making lump-sum gifts upon your death that may trigger gift/estate taxes. As of 2018, individuals can gift up to $15,000 per person per year, and married households can gift up to $30,000 per person per year, without triggering a gift tax return. Anything above those limits would count towards your lifetime gift/estate tax exemption ($11.2 million or $22.4 million). If you contribute to an irrevocable trust, these limits apply to those transfers as well.
Use Beneficiary Designations to Avoid Probate
Probate court can be a long and costly process for large estates, so it’s usually best to avoid it as much as possible. Assets that have a contractual beneficiary listed on the account will transfer automatically upon your death, meaning they have the potential to skip probate when properly used. When you pass away, your executor will simply need to submit a death certificate to the financial institutions holding your assets, and the institutions will transfer the assets to the beneficiary listed on the account.
The following assets offer contractual beneficiary designations, and can be used to bypass probate:
- Bank and brokerage accounts with a payable-on-death or transfer-on-death beneficiary
- Real estate owned in joint tenancy or as tenants in the entirety
- Retirement accounts (401k, IRA, etc.)
- Life insurance policies
- Trusts
Use a Revocable Living Trust to Provide For Your Spouse and Children
As the name implies, revocable living trusts are established during your lifetime and can be amended or dissolved by the grantor (that’s you). With this type of trust, the grantor usually serves as the trustee and the primary beneficiary to retain full control over the assets transferred to the trust. When the grantor dies, a successor trustee will take over their reins and a successor beneficiary would either receive full or partial distributions from the trust. The most common living revocable trusts are marital trusts (where the spouse is the successor beneficiary) and family trusts (where children and extended family are the beneficiaries). Note that when the grantor dies, a revocable trust becomes irrevocable, and the terms of the trust can no longer be amended.
Use an Irrevocable Trust to Avoid Estate Taxes
Because the grantor loses control over assets transferred to an irrevocable trust, all assets transferred to the trust are removed from the grantor’s estate. In this case, transfers are treated like gifts—transfers of less than $15,000 per year (or $30,000 for married couples) are exempt, while transfers above that level will count towards your lifetime gift/estate tax exemption.
Where this differs from standard gifts is with the trust agreement. While someone can do whatever they please with a personal gift, trusts offer the ability for the grantor to decide when the beneficiary receives the assets and how the assets can be used. For example, a parent who is concerned that their child will blow through their inheritance can set up a trust that distributes a specified income each year rather than giving access to the principle value. Similarly, a grandparent can establish a trust for their grandchildren that can only be used for higher education costs. Either way, an irrevocable trust offers tax benefits and additional control over the grantor’s legacy.
Leave a Charitable Legacy
It’s fairly common for wealthy individuals to leave a portion of their assets to charity when they pass away. Other than the obvious altruistic intentions, gifting assets to a charity comes with a few tax benefits that are helpful for large estates. Annual donations can be deducted from your income tax returns, and gifts to charity successfully remove assets from your estate that would normally be subject to estate taxes.
If you’d like to leave a substantial amount of assets to charity, you may want to consider forming a private charitable foundation that can gift assets for years to come. If you’d like to set up a tax-free income stream during your lifetime, you can also consider using a charitable remainder trust that provides income during your lifetime with a tax-advantaged gift to charity when you die.
Use a Life Insurance Trust to Pay for Anticipated Estate Taxes
When estate taxes are unavoidable, you may want to consider using life insurance to cover some of the tax burden. Establishing an irrevocable life insurance trust allows you to pay the annual premiums within the annual gift tax exemption and use the trust’s death benefit to pay for your estate taxes when you pass away.
Plan for Business Succession
Many large estates include complicated business interests that need to be addressed in the estate plan. It’s important to create a succession strategy that ensures a smooth management transition and ownership transfer. For the latter, you’ll need to consider how the value of your business interest(s) will affect your estate taxes.
If the ownership interest(s) you plan to transfer are substantial, the recipient(s) may be left with a crushing tax burden that often leads to businesses taking on additional debt or selling shares to cover the tax. While every succession plan is unique and requires professional assistance, you may want to consider using an irrevocable life insurance trust to cover part or all of the expected estate taxes for your heirs.
Call our Arizona Estate Planning team at (480)467-4325 to discuss your case today.