Key Takeaways
- As net worth grows, so can estate planning complexity for high-net worth individuals and families.
- This complexity can lead to common myths and misconceptions, which can cause costly delays, higher taxes, and in some cases, family strife.
- Identifying misconceptions early and taking appropriate actions to adjust an estate plan can help provide peace of mind and a sustainable legacy.
Overview
Revocable, portability, grantor, trustee, per capita, non-designated eligible beneficiary, GST, GRAT, IDGT, ILIT, and more. These are just a sampling of the terminology used in estate planning for high-net worth individuals and families. And the list of estate planning terminology only expands as tax laws become more complex and one’s net worth continues to grow.
It is no wonder that many people are bewildered by their own estate plan. This bewilderment can lead to believing some of the more pervasive estate planning myths and misconceptions, which can lead to costly delays, higher taxes, and, in some cases, family strife.
Identifying these issues early and taking appropriate actions to adjust your estate and wealth transfer planning can help provide peace of mind that may have felt unattainable, and a legacy that can be sustainable. Here are five common high-net worth estate planning myths and misconceptions:
Trusts are automatically funded when they are created.
False. Many people mistakenly believe that establishing a trust is the final step in achieving their estate planning goals. To make a trust truly effective, it must be funded. Funding a trust consists of ensuring that all the non-qualified assets intended to be owned by the trust are transferred to the trust instead of remaining in the name of the individual or couple. Trusts are not automatically funded when they are created and/or signed.
For example, for a trust to own real property, a deed must be recorded by the county recorder showing the transfer from the individual/couple to the trust. Most financial accounts must also be retitled in the name of the trust to become an effective transfer.
Most estate planning firms do not handle the mechanics of funding trusts. Rather, in most cases, after the trust has been created and signed, the drafting attorney will give their client a document that explains the importance of funding the trust, what naming convention should be used when retitling assets, and insights on technicalities that must be followed when transferring certain assets, including notary, filing, and recording requirements. However, in these cases, the responsibility to fund the trust remains with the client (you).
Example: Mr. Anderson owns a $3 million vacation home that he wants his family to continue to enjoy after his passing. He is concerned about the time and cost of the probate process. To alleviate his concerns, and as part of his overall estate plan, his estate attorney drafts a revocable trust to own the assets that Mr. Anderson wants to avoid probate. Generally, assets held in trust are not subject to probate and will transfer according to the terms of the trust. Upon completion of the revocable trust, his attorney instructs Mr. Anderson to transfer title of the vacation home to the revocable trust as soon as possible by recording the title transfer at the county records office. Unfortunately, Mr. Anderson never transfers the title of the vacation home to the trust, and he dies suddenly a few months after the trust is created.
Upon his passing, the vacation home becomes part of his probate estate. Since he lived in a high-cost probate state (4%), it costs the family $120,000, plus other legal and administrative costs, and many months to settle the estate. The time delay and probate expenses could have been avoided had the vacation home been owned by the revocable trust at Mr. Anderson’s death.
My spouse will automatically inherit my unused lifetime estate tax exemption.
False. The federal gift and estate tax exclusion as of 2023 is $12.92 million per individual ($25.84 million for married couples). This means that a married couple should be able to collectively give $25.84 million, during life, at death, or a combination thereof, to their children or other intended non-spousal beneficiaries, without incurring estate or gift taxes. Gifts or bequests above the exemption limits are subject to a 40% tax rate.
Portability, which is only available to married couples, is a method of transferring to the surviving spouse the amount of estate and gift exemption that the deceased spouse did not use. Prior to portability, a married couple was forced to use as much of the deceased spouse’s estate and gift exemption upon death to ensure the exemption wasn’t wasted. This was primarily accomplished by the creation and funding of a credit shelter trust (also known as a Bypass Trust, Exemption Trust, or Family Trust). Now, with portability as an option, a married couple can use their exemption at death by creating a Bypass Trust, or by electing portability and transferring the deceased spouse unused exemption amount (DSUE) to the surviving spouse to be utilized upon their death.
The surviving spouse does not automatically inherit their spouse’s’ unused exemption amount. To claim the DSUE, Form 706 (estate tax return) must be filed within five years of the date of death of the deceased spouse, even if no estate tax is due. Failure to make a timely DSUE election could result in the loss of the DSUE amount to the surviving spouse, which could result in millions in additional estate tax liability.
My estate plan does not need regular updates.
False. Many people today have estate plans that no longer match their goals because of tax law changes or family and personal circumstances. Failure to regularly update an estate plan can cause an increase in probate expenses, legal costs, and potentially result in assets being distributed to a non-intended beneficiary. We believe that everyone should review their estate plan at regular intervals, not to exceed every three years. We also believe that an estate plan should be reviewed whenever a major life event occurs to ensure that the documents continue to properly reflect the goals once facts and circumstances change.
Estate planning is only about death and taxes.
False. Contrary to popular belief, the primary purpose of estate planning is not tax avoidance at death. Generally, estate planning is a process that results in the creation of documents that identify who has the authority to make decisions for an individual during incapacity, and who gets what and when upon their passing. While taxes are a consideration when formulating an estate plan, their importance is highly correlated to the net worth of the individual creating the plan.
Planning for incapacity has become more important for estate planners given what transpired during the COVID-19 pandemic and the growing “silver tsunami” (according to the U.S. Census Bureau, almost one-quarter of the population will be over age 65 by 2060.) And with the U.S. Dept. of Health and Human Services estimating that about 70% of the senior population will need some type of long-term care, estate planning practitioners are focusing more on planning for the likelihood that their clients will need to appoint someone to take care of their financial affairs (durable power of attorney), make medical decisions for them if they are unable (healthcare proxy), and who should be responsible for their children if they are incapacitated or pass away while they are a minor (guardianship provisions of a will).
So, while a will, trust, and myriad other entities may be employed in your estate plan for tax mitigation and/or controlling your legacy to future generations, do not forget about the documents that protect you in the realistic event that you become incapacitated.
My will dictates who gets what assets.
False. When reviewing your estate plan, pay close attention to the titling and beneficiary designations of certain classes of assets because those designations will be respected even when a will or trust may say otherwise.
One of the most frustrating aspects of estate administration is finding out that certain assets (real property, brokerage accounts, retirement accounts, life insurance policies) are going to pass to unintended beneficiaries because of a mismatch between the testamentary document (will or trust) and the account titling or beneficiary designations. When a conflict exists, the asset will pass to the person(s) named as beneficiary (life insurance, retirement accounts) or the person who held joint title with the decedent (real property, etc.).
Bottom line
Estate planning can be complex for high-net worth individuals and families. Know the facts and don’t be misled by common myths and misconceptions. Working with a qualified estate planning practitioner to keep your plan up to date can help avoid unnecessary costs, time delays, and family strife.
