| Smart people who've worked hard all of their lives to
achieve financial success often make dumb estate planning mistakes. Those
mistakes can result in their families losing over half of their assets when they
pass between generations. They can destroy much of a lifetime's work. And they
can inflict a great deal of pain and heartache to the people they love.
The irony is that most of the mistakes are easily avoided.
With a little forethought, people of average intellect can construct estate
plans which perpetuate their estates for generations. To do that, you and they
have to avoid these traps:
- Procrastination
- The "I love you" Will
- Unbalanced Property Ownership
- Property Transfers Based on Non-Will Provisions
- Improperly-Owned Life Insurance
- Trying to Take it with Them
- Lack of Liquidity
- Equal Distribution to Heirs
- Saddling Children with Debt
- "It's all been taken care of . . ."
1. Procrastination
Everybody has an estate plan. If you don't create one, on
purpose, through carefully drafted wills, trusts and other documents, then your
state legislature will step in with a plan of its own. This plan, called the
laws of intestacy, dictates who will get your assets, how they will get them and
guarantees that your estate will pay the highest possible estate taxes in the
process.
If you're happy with your state legislature deciding who
will receive your assets after you're gone . . . and especially if you want to
pay the federal government the maximum estate taxes, then no additional work on
your part is required. But if you're not, then you have to develop estate plans
of your own and they have to be developed now.
2. The "I love you" will
Most people have very simple wills. They say that when one
spouse dies, all of his/her property goes to the surviving spouse and, when
they're both gone, all of the property goes to their children. Very straight
forward. And, for people with modest estates, these wills work fine.
For people with estates which exceed $3,000,000, however,
these wills create thousands of dollars of unnecessary taxes. These simple wills
waste an opportunity to keep up to $1,500,000 of assets free of estate taxes. On
a modest $3,000,000 estate, this single error can cost $600,000.
The solution is to have provisions in your wills or living
trust agreements which create a bypass trust (also known as a credit-shelter
trust) at the death of the first spouse.
3. Unbalanced property ownership
If each spouse owns substantially equal property, then
bypass trusts can function neatly to avoid estate taxes on up to $1,500,000 of
assets. However, if one spouse owns millions and the other spouse has only a
small estate, the bypass trust's effect will be largely wasted if the less
affluent spouse dies first. To avoid that, spouses should consider the benefits
of balancing their property ownerships.
4. Property transfers based on non-will provisions
Most people think that their wills control who will get
what when they die. Surprisingly, many assets are transferred based on
provisions which can contradict but supersede those of a will.
Bank accounts, certificates of deposit, retirement plans,
IRAs, annuities, life insurance policies, real estate and countless other assets
are often not controlled by wills. In the case of jointly-owned assets - bank
accounts, stock accounts and real estate are often owned this way - the
surviving joint owner often becomes the sole owner of the assets. And retirement
plans, IRAs, annuities and life insurance proceeds transfer to named
beneficiaries, not necessarily to the people named in a will.
Property ownership forms and beneficiary designations need
to be coordinated with your will planning. If they aren't, your carefully drawn
will can become meaningless and the estate tax savings which it tried to create
will be defeated.
5. Improperly-owned life insurance
Life insurance is often a significant part of many
affluent estates. Many people own life insurance because of the immediate
liquidity it will provide and because they understand that life insurance death
benefits are tax free. They're only half right.
Life insurance death benefits are not subject to income
tax. However, they are subject to estate taxes if the policies are owned by the
insured at his/her death. This can destroy up to 60% of the policies' values.
A very wise way to avoid this is to have life insurance
owned by an irrevocable trust. While the needs of the surviving spouse need to
be addressed, life insurance which is intended to pass to future generations
should clearly not be owned by the insured's.
6. Trying to take it with them
There are only three ways to reduce estate taxes: spend
the money, have a bypass trust and give it away while alive.
Affluent people, especially the self-made variety, often
do a very poor job of either spending it or giving it away. They got where they
are, financially, by being "accumulators" and they have a hard time with not
continuing that lifetime habit.
While thrift is an admirable quality, too much of this
good thing plays right into the IRS' hands. They and Congress want you to have
the biggest estate possible when you die.
They want your ignorance, procrastination and paranoia to
stop you from taking advantage of a whole range of laws which can result in your
estate paying zero taxes while you maintain your financial independence forever.
The IRS collects millions and millions of estate taxes every year which could
have been legally avoided from the estates of people who never quit being
"accumulators".
7. Lack of liquidity
Many affluent people create estates of great value which,
at death, are very illiquid. Holdings of real estate and family businesses often
represent 90% or more of affluent estates. But, if those estates are subject to
taxes of over 50%, those assets often have to be sold at fire-sale prices to pay
them. Estate taxes are generally due within nine months of death.
Forcing your family to choose between sacrificing a
treasured asset or taking on an enormous burden of debt to pay estate taxes is
simply stupid. It is also totally avoidable.
8. Equal distribution to heirs
Most people have great love for all of their children and
they want them to share equally in their estates. An admirable intent, but
"equal" is not the same thing as "equitable".
While dozens of examples exist, a common problem, often
mishandled, is when a person owns a business in which some of the children
participate. Giving both participating and non-participating children equal
shares of the business is a near guarantee for disaster. This blunder has
destroyed more businesses and families than probably any other estate planning
mistake.
If you have a business, a farm or some other
income-producing asset and some of your children participate in its management,
don't carve it up equally between all of your children. Provide the business to
your participating children and give your non-participant children non-business
assets. If this creates an unbalanced distribution, consider creating additional
assets through life insurance.
9. Saddling children with debt
The same kind of people who would blanch at a $500
MasterCard bill often leave their children with a range of estate problems that
can only be solved by millions of dollars of new debt.
Illiquid but substantial estates often have to borrow
great amounts of money to pay estate taxes. Those borrowings can come from a
bank or, in some cases, from the Treasury, but they all require complete
repayment of principal plus substantial interest. Too often, the assets which
triggered the tax - and the loan - can't generate enough income to cover it.
Enormous debts are also created when children who
participate in a family business are compelled to buy-out their
non-participating siblings' interests. This not only creates great financial
pressures but the process of negotiating a buy-out can create much acrimony.
Many families have been destroyed by just such a challenge.
Life insurance is frequently the best solution to these
financial problems. Too often, however, affluent people and their advisors don't
adequately explore this option because of ignorance and misunderstanding.
10. "It's all been taken care of . . ."
Good estate planning is never truly "done". As your
circumstances change and evolve over the years, your plans need to be kept
current and apace with them.
Few attorneys call in their clients for an annual estate
plan review. Fewer clients sit down, annually, and take stock of their
situation. But if they did - if you do - millions of dollars can be saved and
much heart-ache can be avoided.
Conclusion
Most people spend more time arranging a single vacation
than they spend on estate planning in their lifetime. If you're affluent, that's
not smart. It's very smart, however, to meet annually with your financial
advisers and ensure that your plans are both current and complete.
Here's a test to see if they are: will your current plans
give what you have to whom you want, when you want, in the way you want and do
it all at the lowest possible cost? If you answer "yes", then congratulations
and we'll see you next year.
If not, then make an appointment now to fix this problem.
No one can do it but you and you may have a lot less time to solve it than you
think. And if you're not sure about that, go back and read item number one on
this Top 10 list of estate planning mistakes - the one about procrastination.
And then grab the phone.
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