Everyone who lived through September 11, 2001, shares a common experience. Although colored by our individual circumstances, we remember looking at the horrific images of destruction and misery and wondering why this tragedy occurred. Since that fateful day, Americans have flocked to churches, synagogues, mosques, and other places of worship seeking answers to questions regarding the meaning of life and the existence of suffering.

This national tragedy continues to affect all of us to varying degrees. We face similar issues in environmental calamities such as hurricanes, tornadoes, wildfires, and in personal struggles such as the COVID-19 pandemic and unexpected illnesses. In each instance, we prepare the best that  we can. We can prepare ourselves for these unforeseen circumstances by planning what we should do should in the event a crisis strikes. 

A comprehensive estate plan relieves stress at the time of a crisis, both for us and for those people in our lives whom we love. The core estate plan includes six (6) legal documents when probate avoidance is desired. 

These estate planning documents are your: Last Will and Testament, Revocable Living Trust, Durable Financial Power of Attorney, Health-Care Power of Attorney, Advance Medical Directive, and HIPAA Waiver Authorization.

Durable Financial Power of Attorney

Your Durable Financial Power of Attorney allows you to designate an “Agent” who will make financial decisions for you if you are temporarily or permanently unable to do so for yourself. Your Agent is held to a fiduciary standard of care regarding the management of your financial assets and will be vested with the legal authority to act on your behalf. This person may be your spouse, a parent, or a trusted friend. Without this legal document in force, if you become ill, injured, or incapacitated, no one can act on your behalf. As a result, if you suffer an illness or become incapacitated, and your family needs to manage your assets, pay your bills, or refinance your house, a Guardianship proceeding would need to be initiated by going to court and having you declared incompetent. Incapacity proceedings are often an arduous, protracted, humiliating, and expensive alternative, compared to working with a competent estate planning attorney to prepare your Durable Financing Power of Attorney.

Health-Care Power of Attorney and Advance Medical Directive

A Health-Care Power of Attorney designates your “Agent” to make health care decisions for you if you are unable to make them for yourself, due to an illness, injury, or incapacity. With this legal document in place, you can rest assured the person you trust will have the legal authority to make medical decisions for you, which can save your life, if you are not able to communicate your wishes to any health care providers. You also may desire to prepare an Advance Medical Directive, commonly known as a Living Will, which expresses what your wishes in the event that you suffer a catastrophic illness and end-of-life decisions need to be made in your behalf.

HIPAA Authorization

A HIPAA Authorization allows people whom you designate, such as your Agents or other individuals, to receive information from your doctors, hospital personal, and other medical care providers about your health condition.

Last Will and Testament

Your Last Will and Testament has several functions. First, and most importantly, this legal document allows you to specifically designate one or more individuals you desire to serve as the Personal Guardian to raise your minor children. Without a Will the court will decide who will be appointed as Personal Guardian for your minor children, which may not have been consistent with your wishes. Unfortunately, no matter how competent the judge may be, that judge does not know and love your children as you do, nor know your wishes. Second, your Will appoints your Executor to oversee the settlement of your estate. This person is charged with the fiduciary responsibility of properly collecting your assets in the event of your passing, paying all final debts, taxes, and administrative expenses, and distributing assets that are held in your individual name at your death to your intended beneficiaries. Without a Will, the state determines how, to whom, and when your property will be distributed, which assets will be distributed to your heirs under the laws of “intestate succession.” Unfortunately, distribution of property under your state’s intestate laws ignores your specific desires and family circumstances. As a result, your assets often do not go to the desired person, in the desired manner and at the desired time. Certain types of Wills, called pour-over Wills, may “pour” your assets “over” upon passing into a Revocable Living Trust (“RLT”), to be distributed to your designated beneficiaries as you desire under the specific terms of your trust.

Even with a Will, any assets you own at death must go through “probate” to be distributed to your designated beneficiaries. Probate is the court sanctioned process of transferring title of property from the person who died to  one or more people who have the right to receive the property in the event of your passing. Depending upon the state where your financial assets and real estate are located, this process can be expensive, time-consuming, and emotionally draining for those family members left behind.

Revocable Living Trust

Establishing a Revocable Living Trust (RLT) to hold legal title to your assets during your lifetime avoids the probate process to settle your estate. Your RLT acts as a Will substitute upon your death and vests the successor Trustee with the legal authority to collect assets, pay your debts, expenses, and taxes, and distribute your assets in accordance with the terms and provisions forth in your RLT. As a result, all assets held in your RLT avoid the costs, delays, and publicity of a probate proceeding because your RLT, which owns your assets, is never exposed to the probate process. Even though an RLT holds legal title to your assets, you retain complete control of the assets during your lifetime and can make changes to the RLT. If you become incapacitated, the person you have chosen as your successor Trustee will manage the assets for you, much like the Agent under your Property Power of Attorney, which also avoids a Guardianship proceeding for all assets owned by your trust. RLTs provide great flexibility in allowing you to direct how and when the assets will be used by your designated beneficiaries after your death. For example, you can include specific provisions that ensure your children do not squander money but, rather, have access to the income and principal of the trust for their health, education, maintenance, and support.

Finally, as part of your estate plan, you need to seriously consider how other assets you own, which distribute by Beneficiary Designation, pass to your family members upon your passing. Therefore, we urge you to periodically and carefully review the beneficiary designations of your tax-deferred retirement plan accounts, including your 401k, IRA, or other qualified plan assets. Often, personal, family, tax laws, and financial circumstances change, and you may desire to update your beneficiary designations to take into account these multiple changes. This becomes increasingly important, especially since retirement assets comprise a larger and larger portion of the typical person’s total assets. Periodically, you should also review the beneficiary designations on file with  life insurance companies where you are the insured, including company provided and personally owned life insurance policies. You should also review any bank account or brokerage accounts you own which assets may transfer automatically at death to a beneficiary, resulting from including a joint owner, or as a result of a transfer on death or payable on death designation on such accounts.

While we cannot eliminate the possibility of tragedy in our lives, please don’t let a personal tragedy become a financial disaster for your family.  

You do have the power and ability to significantly reduce anxiety for yourself and your loved ones by establishing a comprehensive estate plan that provides instructions to your loved ones regarding what should happen if tragedy occurs. 

This edition of Estate Planning Matters reviewed the core comprehensive estate planning legal documents which individuals who own property should have in place in order to protect themselves and their loved ones. Other issues which need to be considered include beneficiaries with special needs, asset protection strategies, as well as the impact of state income taxes, inheritance taxes, and potential changes in federal estate tax laws. 

Many clients include a Revocable Living Trust as a core document in their estate plan in order to avoid the costs, delays, and publicity of a formal probate proceeding at their passing. 

While most clients designate themselves as the Trustee of their RLT, it is vitally important to also designate a Successor Trustee, in the event that the client becomes ill, injured, incapacitated, or passes away. Without a Successor Trustee, if one of the above events occur, a member of the client’s family would have to initiate a legal proceeding in order to have a judge appoint a Guardian or Successor Trustee to administer the Trust.

While any competent adult may serve as Trustee, this edition of Estate Planning Matters will examine the factors that a client should consider when naming another individual to serve as Trustee of their Trust.

Designating a Successor Trustee
When selecting an individual to serve as Trustee, the Trustee should be deemed a United States person for income tax purposes. If any of the following are true: a non-U.S. person serves as sole trustee, non-U.S. persons constitute at least half of the trustees, or if a non-U.S. person may make any “substantial decisions,” then according to Treas. Reg. 301.7701-7(d)(1)(ii), the trust will be considered a foreign trust for income tax purposes. 

Generally, foreign trusts have increased reporting requirements for contributions to or distributions from the trust. In addition, the U.S. grantor of the trust needs to file Form 3520, (Annual Return to Report Transactions with Foreign Trusts), and the Trustee needs to file Form 3520-A, (Annual Information Return of Foreign Trust with a U.S. Owner). In addition, Internal Revenue Code (“IRC”) Section 684 triggers gain recognition when no U.S. beneficiaries exist or when the client dies. 

For these reasons, we recommend that our clients designate a U.S. person as trustee, or find a suitable corporate fiduciary to serve as a Successor Trustee. Also note that under some circumstances, naming a trustee who resides in another state may subject the trust to state income taxation if the trustee resides in a state that determines the domicile of the trust based upon the residence of the trustee. Therefore, clients and their estate planning attorney need to consider and analyze state laws when determining who should be designated as a Successor Trustee.

Aside from selecting a U.S. person to serve as trustee, let’s examine some of the important characteristics that a trustee should possess. The word “trustee” contains the word “trust” which provides the first clue about who will make a good trustee: someone the client trusts. 

Serving as a Trustee
An individual serving as trustee will usually need to make numerous decisions throughout the administration of the trust and these decisions require a certain degree of judgment, experience, impartiality, investment sophistication, record-keeping ability, and the ability to avoid conflicts of interest. 

The trustee will need to follow the letter and spirit of both the trust agreement and governing state statutes. These decisions become more complex when tension exists between the beneficiaries. Many clients believe that naming siblings as co-trustees will force the siblings to work together. Often, it has the opposite effect and causes resentment and a situation ripe for fallouts among family members. 

Another common situation involves a trust created for the benefit of a spouse during the surviving spouse’s lifetime with the remainder distributing to children who are not the biological children of the surviving spouse. Giving the trustee power to make distributions of principal for the surviving spouse would reduce the amount passed to the children upon the death of the surviving spouse. 

Therefore, the individual serving as trustee needs to understand specific family dynamics and the potential for family conflict to occur. While some clients often believe their surviving family members will be immune to these behaviors, a well-counseled and wise client understands that these problems occur frequently and plans for them by selecting a suitable individual and/or bank trust department to serve as Successor Trustee.

Once the client has confidence that the proposed Successor Trustee possesses the ability to administer the trust and successfully navigate the process of working with beneficiaries, the trustee then needs to understand the powers that are granted under the terms and provisions of the trust agreement, along with the impact of those powers. 

This begins with the client, in consultation with their estate planning attorney, deciding what distribution standard will guide the Trustee. Giving a trustee absolute, unlimited, or sole discretion puts the trustee in complete control of distributions and makes it more difficult for a beneficiary to compel distributions if the trustee decides not to make specific distributions to the beneficiaries. While this distribution standard provides the highest level of asset protection, it comes at a price. One flexible estate planning option would be to include a power for the trustee to distribute principal and income from the trust for the health, education, maintenance, and support, (also known as the “HEMS” standard) of the beneficiaries.

At The Levin Law Firm, we help guide our clients to establish comprehensive estate plans designed to achieve their wealth transfer planning goals.

This month’s edition of Estate Planning Matters focuses on financial and tax planning issues that could arise when planning with life insurance. 

Remember that Internal Revenue Code (“Code”) Section 2042 causes inclusion of the proceeds of a policy on the life of an insured if an estate receives the proceeds or if the decedent retained significant control over the policy, for example, by retaining the right to change beneficiaries of the policy or to pledge the policy as collateral for a loan. The Code refers to these rights as “incidents of ownership” and includes the policy proceeds in the estate of the decedent if the decedent dies holding any of these rights on the policy.

Setting up an Irrevocable Life Insurance Trust (“ILIT”) provides an effective way to remove the value of the policy proceeds from the decedent’s estate. By owning the policy in the ILIT and naming the ILIT as the beneficiary of the policy, as well as including restrictions on the trust which do not permit the insured to serve as a trustee, the insured releases all incidents of ownership in the life insurance policy. Of course, removing the policy proceeds from the insured’s estate requires advance planning and the insured should consult with a competent estate planning attorney to properly draft and implement the Life Insurance Trust  

If the insured did not create an ILIT to own the policy prior to purchasing the policy, the insured has two options:  gift the policy to an ILIT or sell the policy to an ILIT. If the insured gifts the policy, then the insured has gifted the current value of the policy, likely far less than the death benefit of the policy. This may not matter to the insured; however, there’s another issue. Code Section 2035 will include the policy proceeds in the decedent’s taxable estate if the decedent dies within three (3) years of the transfer. For some clients the three-year rule poses a significant hurdle to estate planning with life insurance.

Selling the policy to an ILIT for fair market value allows the insured to remove the policy proceeds from their taxable estate immediately, without gift tax consequences, thereby avoiding the application of the three-year rule. However, the sale of a life insurance policy to an improperly structured ILIT could cause income tax consequences because of the “Transfer for Value” Rule. 

Generally, Code section 101(a) excludes the life insurance death benefit from taxable income. However, if the policy was transferred for valuable consideration, (which would be the case if the policy were sold), then the Code includes the policy proceeds in the policy owner’s income, due to the “Transfer for Value Rule.”  Unless an exception to the Transfer for Value Rule applies, the proceeds are taxable, except to the extent of the amount paid by the purchaser.

The Transfer for Value Rule contains the following safe-harbor exceptions:  (1) a transfer in which the transferee derives their basis from the transferor (gift); (2) a transfer to the insured, (3) a transfer to a partner of the insured, (4) a transfer to a partnership in which the insured is a partner, or (5) a transfer to a corporation in which the insured holds office or is a shareholder. 

Creating a trust that qualifies as a grantor trust with respect to the insured removes the sale from the application of the Transfer for Value Rule because this type of transaction is treated as a transfer to the insured. 

For example, let’s assume that Grace owned a life insurance policy with a $5 million death benefit. On the advice of her attorney, she sold the policy for $100,000 (its fair market value) to an irrevocable trust that her attorney drafted for Grace. Unfortunately, Grace’s attorney made a critical mistake and failed to ensure that the trust was a grantor trust with respect to Grace. 

One month later, Grace died and the Trustee of Grace’s trust received the $5 million death benefit but was shocked to learn that receipt of the policy proceeds resulted in $4,900,000 of taxable income to the trust. Since trust tax rates are very compressed, an income tax liability resulted in excess $1.8 million, leaving only $3 million for distribution to the trust’s beneficiaries.

Now let’s roll back the clock and assume Grace engaged a competent trust and estate planning attorney who created a grantor trust as to Grace, to purchase the policy. Again, the Trustee sold the policy to the trust for its $100,000 fair market value; however, under this scenario, because Grace’s attorney structured the trust as a grantor trust as to Grace, the sale fell into one of the safe-harbor exceptions to the Transfer for Value Rule, which transfer was deemed a transfer to the insured. When Grace died a month later, the receipt of the death benefit was not treated as taxable income and the Trustee was delighted to distribute the entire $5 million death benefit to Grace’s beneficiaries.

This edition of Estate Planning Matters, and the above example, demonstrate the complexities that arise when clients own and transfer their life insurance policies to trusts. It is vitally important to understand the relevant tax rules and planning strategies in order to properly advise clients in the area of planning with life insurance, especially since there are numerous tax traps for the unwary. 

We have all heard someone say it:

“I’ve decided to keep working beyond retirement age to keep my mind sharp.” Today, that widely held notion has some science behind it.

Three (3) researchers at the Max Planck Institute for Demographic Research in Germany have released a study showing measurable differences in cognitive decline between those who bow out of the workforce earlier versus later in life. Some of the differences were stark.

The team utilized data from the Health and Retirement Study, an extensive ongoing database of information of 20,000 Americans maintained by the University of Michigan. 

The authors of this study did not try to pinpoint an optimal retirement age — that would depend heavily on individual circumstances — but their results do suggest that working until age 67 (vs. retiring between age 55 and 66) can ward off the type of cognitive decline suffered by people with Alzheimer’s disease.

Subjects in the study averaged a full one-third reduction in typical cognitive declines observed in people aged 61 to 67. The positive effects can be enduring, say the study authors, lasting from age 67 at least through age 74.

One surprising finding was that it did not appear to matter exactly what kind of work participants did — whether it was highly brain-intensive or nearly mindless. It all seemed to offer some protective effects against cognitive decline.

Therefore, for many personal and financial reasons, we should consider the benefits of deferring retirement to protect and preserve our mental health and well being 

Estate planning attorneys often tell clients that even if you do not have a large estate, you need an estate plan. 

Estate planning involves much more than planning to avoid the federal estate tax, although understanding the estate tax and its impact on a plan are certainly required. 

Until 1916, the United States did not have an estate tax. The Revenue Act of 1916 assessed taxes on estates (“Estate Tax”) based upon the value of an individual’s assets as of the date of death when President Woodrow Wilson signed this legislation creating the transfer tax. The first iteration of the Estate Tax allowed an exemption of $50,000 with rates ranging from one percent (1%) to ten percent (10%) on estates over $5 million. Thereafter, the rate jumped to twenty-five percent (25%) for estates of $10 million.

Originally, the Estate Tax was imposed to fund the United States’ involvement in the first world war, however even after that war ended, the Estate Tax stuck. The Revenue Act of 1924 increased the top tax rate to 40% on estates over $10 million and for the first time, added a gift tax on transfers during life (“Gift Tax”) when it became clear that wealthy individuals found a way around the Estate Tax by transferring wealth during their lifetimes. The Gift Tax was short-lived because it was repealed in 1926 while the Estate Tax rate was lowered to 1% for estates below $50,000 and 20% for those over $10 million. In the decade between 1932 and 1942, the Gift Tax was reinstated, and the Estate Tax and Gift Tax were increased while the exemption amounts were lowered. Estate Tax rates climbed to their all-time high of 77% for estates over $50 million in 1941.

After the Gift Tax became permanent, individuals again found a work-around to avoid taxation on transfers by skipping over their children and making transfers to their grandchildren. In response to this, Congress passed the Tax Reform Act of 1976 (“1976 Act”) introducing the Generation-Skipping Transfer Tax and unifying the Estate Tax, the Gift Tax, and the Generation-Skipping Transfer Tax. This unified regime exists to this day. The 1976 Act also capped the Estate Tax and Gift Tax at 70% for estates over $5 million. The Economic Recovery Act of 1981 phased in an increase in the unified tax transfer credit from $47,000 to $192,000 and a decrease in the maximum tax rate from 70% to 50% and eliminated the limits on estate and gift tax marital deductions. The Taxpayer Protection Act of 1997 phased in an increase in the amount excluded from taxes from $600,000 in 1997 to $1,000,000 in 2006.

In 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 (“2001 Act”) reduced the maximum estate tax rates from 50% in 2002, to 45% where it remained until 2009 while increasing the exemption amount gradually until it reached $3.5 million. The 2001 Act repealed the Estate Tax and Gift Tax altogether in 2010 for this one year. In 2011, the exemption amount was raised to $5 million and adjusted for inflation, while the top tax rate was lowered to 35%. In 2013, the top tax rate was raised to 40% which is the current rate. 

The Tax Cuts and Jobs Act of 2017 temporarily doubled the exclusion amount from $5 million to $10 million, as adjusted for inflation, which is the current law and which is set to sunset on January 1, 2026, if not sooner.

In September of 2021, Congress released proposed legislation containing proposals eliminating the benefits of numerous tried and true estate planning techniques which would have had serious ramifications for many Americans. Those proposed changes included acceleration of the reduction in the estate tax exemption amount, taxation of formerly non-taxable transactions between grantors and grantor trusts, eradication of valuation discounts, elimination of stepped-up basis at death, and increased tax rates. Those changes were eliminated and now the Build Back Better Act seems to have become a distant memory with little chance of passage.

One of the many interesting things about the Estate Tax was that it was designed to prevent dynastic fortunes from transferring from one generation to the next. When one-third of the top 50 wealthiest Americans on Forbes’ annual list are heirs, it seems clear that the Estate Tax has failed in that respect. With the current exemption of $12.06 million, which is now at its highest amount in our nation’s history, individuals can transfer substantial assets by gift during life, or my testamentary transfer at death. Last year, only 1,275 estates in the entire country owed Estate Tax, despite the historic amassing of wealth by the very richest citizens.

For those individuals who desire to have a conversation with a qualified and competent estate planning attorney, for the purpose of discussing effective wealth transfer planning strategies for the disposition of their assets, it is certainly possible to create a plan where very modest or no gift or estate taxes would be due, essentially making the Estate Tax voluntary. 

If you have questions about whether your estate might be subject to Estate Tax at your passing, it is vitally important to talk to an estate planning attorney about your desires and concerns. Even if your total assets fall below the current exemption amount, you should plan for the transfer of your assets to your selected beneficiaries during life and upon your passing. The new year makes a great time to plan for the future and to ensure your legacy goals are achieved.