With the markets> in constant turmoil, planning for the here and now seems daunting enough; planning for the after-I-die is even less appealing. Nobody likes talking about death, telling relatives what they re going to inherit or wading into jargon like terminable interest property. But if you haven t figured out where you ultimately want your investments and property to go, you won t control what happens to your savings when you die and your family will be forced to make hard decisions without your guidance. The stretch between Thanksgiving and New Year s is a great time for reflection and resolution. Here s how to get on the ball.
First, take stock of everything you own: Your estate includes not just your personal belongings and investments but also your home, life insurance and retirement savings plan assets, as well as your share of any jointly owned property. You must not only decide where you want each piece to go after you die but also inform your loved ones. If this sounds difficult, start by literally cataloging how you have piled up your most important possessions; connect the work you ve done with the things in your life that hold the most meaning. Using your life story as a narrative, write down what you ve accumulated and develop a list of your most significant purchases and investments. Then when you divide up your estate, you will be working from a sense of pride in your accomplishments, not anxiety about death and your heirs may be fascinated by the details that emerge.
Next, absorb three basic facts. First, you can give assets to your heirs tax free as long as the value of your estate is less than $3.5 million in 2009. (The estate tax will disappear in 2010, then come back for estates of more than $1 million in 2011 unless Congress rewrites the law. It probably will, so stay tuned.)
Second, one exception to the first rule is that you can bequeath an unlimited amount to your spouse without getting hit by estate taxes. Unfortunately, this is not a very effective planning tool, since it merely postpones the tax bite until your spouse dies. Accountants sarcastically refer to this kind of transfer as an I-love-you will.
Third, while your stock investments will be included in your estate, your heirs will get a tax break when they sell the shares. They ll receive what s called a stepped-up basis. Say you ve bought shares of Apple at $80, the stock rises to $150 by the time you die, and you leave the shares to your daughter. If the stock rises to $170 before she sells, she will owe capital gains tax on just $20 per share: the difference between $150 and $170.
Once you understand these principles, it s on to the nuts and bolts. Everybody needs a will (cost: about $500). No matter how old you are or what you re worth, your will is the device that tells the world how and to whom to direct your assets. Die without one and your property will be dispersed according to state laws, not your wishes. If your estate is complicated, you should consider consulting an estate-planning lawyer for advice on the complicated world of trusts. First, though, you ll need to know the difference between a living trust and an irrevocable trust.
Living trusts can be used as an addition or alternative to a will. With a living trust, you transfer (and retitle) property to a trust while you are alive but maintain control of your assets by naming yourself the trustee. You can amend this trust easily throughout your lifetime; when you die, the trust will be distributed according to the specifications you lay out in the trust agreement. A living trust typically costs $750 to $2,000 and allows your loved ones to steer clear of the costs and hassles of probate, which is the process of administering a will. (Probate proceedings become a matter of public record and can cost up to $5,000.)
For more-stringent controls on how your assets are deployed after you die, irrevocable trusts are useful. Property won t be placed in the trust until after your death; you can stipulate exactly how you want your money managed and name a trustee typically a relative, close friend or lawyer to execute your instructions. Trusts are extremely flexible, and various standard types can help you meet particular family and tax needs. Here are some to keep in mind:
Credit-shelter trust. Also called an AB or bypass trust. You ll write a will bequeathing an amount equal to the estate-tax exemption to the trust, specify how you want the trust to use those assets and pass the rest of your estate to your spouse. This effectively doubles the amount of your estate that is shielded from taxes since when your spouse dies, his or her estate will also be able to use the exemption.
Generation-skipping trust. Also called a dynasty trust, these allow you to transfer up to $3.5 million in 2009 ($7 million with your spouse) to beneficiaries who are at least two generations your junior. (Like the estate tax, the generation-skipping tax will disappear entirely for one year in 2010.) That typically means the money in the trust will end up with your grandchildren. But you can specify in the trust document that your children (or anyone else) may receive income the trust generates. You also can use its principal for almost anything that will benefit your grandkids, including health care, housing and tuition bills.
Qualified personal residence trust (QPRT). To shield a house or vacation home from estate taxes, you can put it in a QPRT, which allows you to give away your home, generally to your children, while you keep control of it over a period that you stipulate, typically five to 15 years. Because you will manage your home through the trust for that time, the IRS assumes the value of the dwelling to your children is only a small part of its fair market value, which means the property will gobble up a smaller part of your estate. One caveat: If you set up a QPRT but die before the trust runs out, your home will be included in your estate at its fair market value.
Irrevocable life insurance trust. These allow you to shield the proceeds of your life insurance from estate taxes. When you place your policy in this type of trust, you surrender your ownership rights, meaning you can no longer borrow against the policy or change your beneficiaries. But you remove the policy from your estate.
Qualified terminable interest property trust. Often used in blended families, the QTIP enables you to direct your assets to certain relatives. Essentially, when you put assets into a QTIP trust, your spouse will receive income from it after you die and then the beneficiaries you specify will get its principal after she dies. People who have divorced and remarried often use QTIP trusts to ensure that the bulk of the wealth they leave behind ultimately goes to their own children.
That s a lot of lingo, but just remember: Trusts are simply legal mechanisms to hold assets for beneficiaries. Within the boundaries of tax law, they are limited pretty much only by your imagination. Also remember there is more to estate planning than giving money to your heirs. For financial, emotional and ethical reasons, you also need to consider charitable bequests, a subject I covered last December and will revisit in the future. For now pick up a copy of the AARP Crash Course in Estate Planning, by Michael Palermo (Sterling, $14.95). And make sure you ve got a lawyer you can call for advice. Now go enjoy the holidays.