The following are some commonly cited reasons, some meritorious while others not, as to why a person might engage in estate planning.
1. Concern about the Estate Tax and other transfer taxes
At an initial client meeting recently, the first words the client uttered were, “I don’t want the government to get any of my money if possible.”
For whatever reason, many clients believe that the Estate Tax or some other transfer tax will affect them when they pass away. This is largely untrue as the Estate Tax has been increased to $5 million. Hence, the portion of the population that will be affected in the future by it will be very small. Granted, there are some who are reading this that will point out the Estate Tax amount was only lifted to $5 million for 2011 and 2012 (inflation adjusted) and thereby the Estate Tax issue will arise again in the not so distant future. However, it is doubtful that the Estate Tax would be lowered to a very small exemption amount come 2013 because such would be characterized as a “tax increase” and voting for tax increases are politically unpopular.
Regardless, many people come into my office with the belief that the IRS will extract a large portion of their estate upon death. So one of the first questions I ask them is, how much do you think your estate is worth? When I hear that their estate is worth $400,000, $1.5 million, $800,000 or $3.2 million, I tell them to not get too concerned about a tax that will most likely not affect them.
2. Avoid probate
Probate is somewhat what of a dirty word to non-lawyers because the process is lengthy and expensive.
For instance, if Donny Decedent, an unmarried man without children, passed away in Yreka, CA and his entire estate consisted of a single home worth $400,000, probate would take anywhere between 9 – 18 months to complete and the attorney handling the case would be permitted to charge a fee $11,000. Of note, the executor’s fee is the exact same as the attorney’s.
However, the executor’s fee is often not taken because the executor is often a beneficiary and inheritance is not subject to income tax whereas payment rendered for being an executor is subject to income tax. In light of this, an executor-beneficiary often forgoes the fee because it will result in a larger inheritance for them. Thus, the focus on probate fees is primarily geared towards the attorney’s fee.
Although $11,000 does not seem like a large percentage of the estate, 2.75% percent, it should be noted that probate fees do not take into account any mortgages on the property. So in the above example, if the house had a mortgage of $30,000, then the estate’s value would in reality be $100,000, not $400,000. Yet, the attorney’s fee would still be $11,000 which would represent 10% of the estate. In other words, for every $10 of Donny Decedent’s estate, $9 would be paid to his beneficiaries and $1 to his attorney. Consequently, individuals often write revocable trusts because assets held in a revocable trust are exempt from probate. Prob C §13050(a)(1).
3. Ensure familial harmony/continuity
Parents often write estate plans primarily out of concern for their children, or a minor in legal speak.
Since minors are legally incompetent, they are protected by laws until they have reached the age of majority in California, 18. In particular, if a minor were to become parent-less prior to reaching the age of 18, a guardianship of both their estate and person would need to be established. In a guardianship of the minor’s estate, somebody would need to be appointed by a court to supervise the minor’s finances. Whereas in a guardianship of the minor’s person, somebody would need to be appointed by the court to supervise the minor’s schooling, medical needs and other child-rearing activities.
It should be noted that a revocable trust established by a child’s parents will not solve both guardianship problems in case it is needed. A revocable trust can only manage the minor’s estate because a revocable trust is merely a legal document that spells out how a child’s inheritance is to be distributed to them. Whereas a guardianship of the minor’s person requires a natural person to supervise since one could not ask a writing, which is basically what a revocable trust is, to make medical or school decisions for the minor. Thus if a minor loses both of their parents, a guardianship of their person will be needed.
4. Prevent mismanagement of inheritance
One of primary concerns in estate planning is that a designated family member will be unable, as either the trustee or executor, to distribute the estate’s assets.
People would like to see that their assets go to their beneficiaries in an expedient and affordable procedure. However, this is often not the case as once the individual has passed away, typically a surviving spouse parents, the designated child often times has no idea what to do and gets lax with their duties. A principal advantage in writing a trust is that it allows an estate to avoid probate, yet this attribute is a double-edged sword.
Since a trust is not subject to court supervision, a trustee may easily make numerous legal mistakes in the trust administration process. Compounding this is the fact that by the time a beneficiary realizes that the trustee has committed a breach of trust, the damage is often irreparable. For example, I received a call last spring and the person, a beneficiary of this trust, said that the trust estate had been depleted and the trustee was personally broke as she had spent the bulk of the trust money on vacations and beauty products. Since a vacation and beauty products would qualify as “perishables” there was little if anything she could recover from the trustee as damages. Naturally, she was not very pleased when I told her that court action would be largely ineffectual.
In short, the selection of who distributes your estate, whether it be a trustee or executor, is probably the second most important question facing clients in estate planning. Naming beneficiaries is the most important question in case you are wondering.
5. Asset protection
Some people have the misconceived notion that revocable trusts are asset protection devices. A revocable trust is not an asset protection device because assets in a revocable trust are subject to creditor claims. Prob C § 15304.
For instance, Larry Leadfoot, a California resident is up watching late-night television and sees an advertisement for an asset protection trust in California. Knowing that his driving is a serious liability, Leadfoot calls the number and speaks to a representative who mails him the advertised documents. Leadfoot receives the packet and follows the directions exactly. Following this, Leadfoot heads off to the local bar to celebrate the fact that he thinks that his assets are immune from creditors. Leadfoot then drinks to the point of inebriation and proceeds to drive home drunk wherein he crashes into a fellow motorist, Isue Freely. Freely naturally files and wins a massive judgment against Leadfoot for damaging his antique 1974 AMC Gremlin.
In order to recover this judgment, Freely compels Leadfoot to attend a debtor’s exam at the local courthouse so Freely can figure out if Leadfoot is a judgment-proof defendant. At the hearing, Leadfoot exclaims, under oath, that he has no assets to his name as he transferred his estate to an asset protection trust for his own benefit. The judge, upon hearing this, informs Leadfoot that he is sadly mistaken as California law does not allow a person to shield assets from creditors through a revocable trust. The judge then allows Freely to attach his judgment to Leadfoot’s “trust.”
6. Disabled family member
Since a person with a disability receives needs-based assistance from the federal and state government, an inheritance would seriously jeopardize their ability to receive future benefits. In light of this, parents often draft a “special needs trust” for their disabled child. This special needs trust will allow the disabled child to receive an inheritance, subject to certain restrictions, while at the same time retaining their eligibility for government benefits such as Supplemental Security Income (SSI) and Medi-Cal.
