The True Cost of Failing to Plan Ahead
In a world that has seen rising costs of housing, food, utilities, and other necessities, preserving money for the next generation has never been more important. Many people fail to understand the potential consequences of failing to plan ahead. Roughly 70% of generational wealth is lost in two generations, and roughly 90% of generational wealth is lost in three generations. This blog post will discuss how people can help save their estate money, allowing them to give the next generation a better life and preserve their legacy.
Where do Expenses Come From in Estate Planning?
Various added costs can be incurred by an estate in the course of its administration. This list will go over common costs that can diminish an estate and how to plan ahead to save on those costs.
1. Probate
Probate is the process of the court supervision of the division and payment of your assets. Through this process, the court will consider what assets you have that are considered “probate assets”. Essentially, this distinction is any property you may own that is not held in a trust or subject to a Pay on Death designation. The court will first require your executor to pay your creditors and then distribute your remaining property to your heirs. If you fail to create a will, the court will order the executor to make distributions in accordance with your state’s intestacy laws. This process can be lengthy, especially if there is a challenge by one of your beneficiaries. It is common for estates to incur thousands, if not tens of thousands, of dollars in attorney’s fees depending on the complexity and size of your estate, and whether a challenge arises. American estates lose roughly $2 billion annually in the probate process.
How to Avoid Costs Associated with Probate
POD
There are various ways to avoid the cost of probate. The first is to ensure that you have designated a Pay on Death designation on any accounts or assets that allow it. This can help keep some assets out of probate, allowing for expedited distributions to your designees.
Revocable Trust
The revocable trust has become the gold standard for many people seeking to avoid probate. A revocable trust is a document that allows you to serve as trustee of a trust in which you are also a beneficiary. This document gives you the power to add or remove property from the trust and use the property during your lifetime. Upon your passing, the trust will become irrevocable and a successor trustee will be appointed. Depending on your wishes, the trust can either pay out to the individual beneficiaries listed in the document, or the property can be held and managed by the trustee and distributions can be made as directed by the trust agreement.
The assets contained in this trust will avoid probate, helping to save on attorney’s fees and reducing the risk of a challenge. Additionally, the trust can be structured to provide creditor protection to the beneficiaries, preventing their creditors from accessing their inheritance. Although these trusts are typically more expensive than a will to create, they often pay for themselves by saving people significant costs in probate and by preventing the beneficiary’s creditors from accessing the assets contained in the estate
2. Improperly Drafted Documents
In an attempt to save money on the cost of creating a will, more and more people are seeking out DIY solutions. Although some of these DIY sources may be reliable, there are certain risks involved. Often individuals will seek out documents that may not be valid in their home jurisdiction or may not be properly executed or funded. This can lead to complex probate challenges when such errors occur and may cause your intended beneficiaries to lose out on their share of your estate.
How to Avoid Using Improperly Drafted Documents
Use a Knowledgeable Attorney
By using a local attorney who is knowledgeable about your jurisdiction’s estate planning laws you can ensure that your documents achieve your goals and will not cost your estate thousands of extra dollars in expensive litigation. Additionally, no two estates are identical, and local attorneys can help find solutions to your unique challenges, providing you with individualized solutions to ensure your estate accomplishes your goals.
3. Gift, Estate, and Generation-Skipping Tax
These taxes are imposed on lifetime gifts and large estates. Every taxpayer gets three “coupons” to use for these taxes. First, any individual can make a gift to another individual as long as the amount does not exceed the annual “coupon”. Currently that “coupon” is $18,000 for individuals and $36,000 for married couples. In addition to the annual coupon, each individual can make gifts, including through their estate or throughout their lifetime in the amount of $13.61 million or $27.22 million for a married couple. Anytime you make a gift to an individual in a calendar year, the amount in excess of your annual exclusion will require a gift tax filing, and the amount in excess of your annual “coupon” will come out of your lifetime exemption. Additionally, each individual can gift the same amount as the lifetime estate tax exemption to a skip-generation person ($13.61 million). The current tax rate for estate and generation-skipping tax ranges from 18% to 40% of the amount in excess of the lifetime exclusion. Therefore, if you have a large estate it is imperative to plan ahead to avoid a substantial tax on your assets when they pass to the next generation.
How to Minimize Negative Estate Tax Outcomes
Lifetime Gifts
The first and most straightforward way to plan ahead for potential estate tax implications is by taking advantage of your annual gift exclusion. Lifetime gifts can be made to any individual annually as long as they do not exceed the limits listed above. This allows individuals to make gifts outright during their lifetime, reducing their taxable estate size. Additionally, some gifts are exempt from gift tax regardless of size such as gifts to charitable organizations, gifts directly for the payment of tuition, and gifts directly for the payment of medical expenses. This option does have some downsides, however. Many individuals fear that their gift may be going to an irresponsible party that is not ready to manage money. These considerations can be solved through the use of certain trusts. It is also wise to speak to an attorney before using this strategy to prevent potential Medicaid implications that can be triggered by such gifts.
Crummey Trust
A Crummey Trust is a type of trust that is funded progressively over time. The IRS has ruled that gifts of future interests do not constitute a completed gift, and therefore are not eligible for the annual exclusion. Estate planners developed a simple solution to this issue, a limited power of withdrawal for beneficiaries. Each year the grantor of the Crummey Trust will gift each beneficiary the amount of the annual exclusion for that year. The beneficiary will have the power, for a limited amount of time, to withdraw that amount outright from the trust. Once the power has lapsed and the beneficiary has failed to exercise their withdrawal power, the amount will pass into the trust. The IRS has found that this lapse in withdrawal right makes the gift a present interest and it is therefore able to be exempt from the gift and estate tax. This allows an individual to gradually fund their trust without additional tax planning required.
Dynasty Trust
A Dynasty Trust is a trust that continues in perpetuity. Only select states, such as South Dakota, allow for such trust agreements. These trusts are an excellent planning strategy for those who wish to build generational wealth. Dynasty trusts allow an individual to make a gift to future generations. As long as this gift is less than the grantor’s lifetime exemption, there will be no subsequent generation-skipping tax as the beneficiaries change from generation to generation. This allows the money in the trust to grow over time. These trusts are typically funded with assets that produce capital gains to avoid additional income tax. Additionally, when such a trust is established in South Dakota, no state income tax is applied to the gains of the trust corpus. This allows for exponential growth without the problems incurred by the generation-skipping tax. Furthermore, it ensures that future generations' inheritance will not be subject to their creditors or poor financial management. Typically a dynasty trust will also be a directed trust, allowing various advisors who take on different roles in the management of trust assets. This gives the trust additional flexibility, allowing it to be adaptable to new challenges that may arise in the course of its administration.
Conclusion
Unfortunately, a lack of future planning can cause your life's hard work to be lost to avoidable costs. The good news is that there are many options for those seeking to preserve their estate and take care of future generations. By working with an attorney you can create a customized estate plan that will help save your estate money and preserve your legacy for generations to come. If you would like to learn more about what plan is right for your circumstances, feel free to schedule your free consultation today!