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I. INTRODUCTION TO ESTATE PLANNING
V. ESTATE PLANNING QUESTIONNAIRE
An estate plan provides for the conservation and transfer of one's wealth. The process by which an estate plan is created is called estate planning.
B. OBJECTIVES OF ESTATE PLANNING
An estate plan should provide for the best use of the owner's assets during his or her lifetime. The estate plan should anticipate and provide for such lifetime needs as a child's education, income for retirement, replacement of income in the event of disability and management of the estate in the event of incapacity. These and similar objectives may be accomplished by utilizing a funded revocable living trust, making gifts, setting up a short-term trust, life insurance, acquiring annuities, rearranging business interests during life, setting up a retirement account and making charitable gifts.
2. Asset Succession
An estate plan should provide for the transfer of assets on death in such a way that the value of the estate passing to the heirs is maximized and is distributed in accordance with the wishes of the decedent and the needs of his or her family. This goal cannot be accomplished unless the estate owner's objectives are carefully determined. Only then can a plan be tailored for the owner which helps to carry out these objectives. Examples are obtaining the marital deduction against estate tax, taking full advantage of the unified credit against estate tax, avoiding probate, handling a business interest, and making charitable gifts.
3. Role of Tax Planning
Tax saving methods are employed to achieve many planning objectives. By minimizing taxes the owner will have a larger estate to enjoy during their lifetime and to satisfy the needs of the family after death.
The fact that a good estate plan will frequently save taxes helps to show the need for planning. An estate owner may have a natural reluctance to plan his or her estate. Planning causes the owner to come to grips with matters that he or she dislikes thinking about. How to provide for oneself in the event of retirement or illness? Who will receive the estate after death? How will the children be cared for? Discussing methods of saving taxes often opens the way for a franker discussion of the other elements of planning. Tax savings are only one aspect of estate planning and should always remain secondary to carrying out of the underlying objectives of the estate owner.
II. THE KEY TO THE ESTATE PLAN: SELECTION OF THE EXECUTOR, TRUSTEE, GUARDIAN AND CONSERVATOR
When an individual prepares or updates an estate plan he or she is faced with selecting the people who will implement the plan on his or her behalf. These people are the executor, trustee, guardian, and conservator. This discussion describes the duties and characteristics of the different representatives and thus serves as a guideline for the selection of the individuals and institutions who will serve in these roles.
The executor's job is to act as the legal representative of a decedent's probate estate. The executor is nominated in the decedent's will and is appointed by the probate court upon admission of the will to probate. Once appointed, the executor's main functions are to gather information about estate assets and liabilities, act as caretaker of the assets during the probate administration, and to keep accurate records of all estate transactions. These responsibilities specifically include the preparation of the estate inventory, the filing of various petitions to the probate court, and the preparation of the federal estate tax return, estate income tax returns and the California estate tax report. During administration of the estate, the executor collects money on behalf of the estate and pays taxes and expenses on its behalf. The executor is responsible for approving and paying, or rejecting, creditors' claims against the estate. The executor also has the authority, subject at times to court approval, to execute legal documents and to sell estate assets. The final duty of the executor is to distribute the assets in accordance with the terms of the will. At that time, the executor is discharged.
The role of the executor is important, but by its nature, it is temporary, lasting from nine months to a year in the simplest of cases and up to four or five years, or even longer, in very complicated estates.
An executor must be able to deal with the decedent's family and other heirs and should also have some appreciation for the decedent's financial position. However, an executor has only limited investment responsibilities; as the caretaker of the estate assets, the executor works to preserve the property during administration. The most common investment decision of an executor is the selection of the assets which must be sold to raise the cash needed to pay taxes and the other costs of administration. For example, if the home must be sold to raise cash, the executor may hire the real estate broker, approve the terms of the sale, execute the escrow instructions, and petition the probate court for approval of the sale. The executor must also protect the estate by disposing of assets which may cause a loss to the estate (or by otherwise limiting the estate's exposure to loss). In short, the investment responsibilities of the executor are generally exercised to raise cash and to limit losses rather than to invest estate assets for positive returns.
As part of his duties, the executor must maintain meticulous records of all transactions. The records are the foundation of required court accountings and all tax returns.
Frequently the executor is the surviving spouse, a child, or another close relative of the decedent. In some cases, the person best suited to discharge these duties in a responsible and knowledgeable manner is the decedent's accountant or other advisor. And, of course, the executor does not discharge his duties without experienced assistance. The attorneys for the estate, who are retained by the executor, will guide and assist the executor at each step of the way. The decedent's accountant is frequently a valuable advisor on the decedent's business, financial and tax affairs.
Alternatively, the initial executor (or co-executor) may be a bank or trust company. These corporate fiduciaries are experienced in the management of estates. A corporate fiduciary brings the added advantages of being impartial and of having the people and procedures in place for discharging these tasks. At the very least, the ultimate successor executor named in a will (that is, the executor named to serve after one or more individuals) should be a bank or trust company. Since a bank or trust company has unlimited life, the naming of an institution as the ultimate successor executor ensures that the estate will be administered in a capable fashion even if the individual executors are unable to act.
For tax planning and other family purposes, many wills establish trusts for the benefit of the heirs of the decedent. These trusts, as all trusts, must be administered by a trustee.
Living revocable trusts are also commonly used in estate planning. While the creators of a living trust often serve as the trustees while they are alive, the role of the successor trustees is similar to that of the initial trustee of a testamentary trust. It should be noted that it is not uncommon for a corporate fiduciary to act as the initial trustee of a living trust. For example, there are obvious advantages where the creator is inexperienced or incapable or where the record keeping or investment services of the institution are needed.
A living trust avoids probate of the decedent's estate, which is often a costly process which exposes the private, financial matters of the decedent to the public. In a living trust, the successor trustee immediately assumes control of the trust assets at the death of the creator. Unlike an executor, the trustee of a living trust has immediate investment duties and powers (as spelled out in the trust document and by law).
The trustees of both testamentary and living trusts should have many of the same attributes as the executor: sensitivity toward the heirs and an organized and efficient approach to discharging his duties, but a trustee must also have the financial, business and investment acumen to invest and manage the trust assets. Accurate record keeping is essential to the performance of the investment responsibilities.
As with executors, family members and personal advisors who have the qualities necessary for a good trustee often serves as the initial trustee. Individuals may act with an institutional co-trustee. Such co-trustee arrangements are designed to combine the best of the individual and institutional skills. The bank or trust company performs most of the daily tasks of the trustee (including the record keeping, preparation of tax returns, insuring and safeguarding of assets, and the management and investment of trust assets). On the other hand, the individual trustee (typically a family member) offers greater sensitivity and appreciation of the family situation. In other cases, an individual is nominated as trustee with the power to hire an institution to perform the investment, custodial and record keeping functions. Alternatively, the bank or trust company may be nominated as the trustee with the power in a beneficiary to veto investments, direct the investment of trust assets, or hire an investment advisor.
From time to time it is necessary to nominate a trustee to discharge a limited function, such as deciding on additional payments to minor children or controlling life insurance policies owned by the trust. These trustees are typically referred to as "special" trustees and they are appointed for specific tax or family purposes. These trustees should be selected based on their particular duties.
Since a trust is often drafted to last for long periods of time, the ultimate successor trustee should be a well established bank or trust company because of their unlimited life.
Also to be considered is a durable power of attorney for property management and an advance healthcare directive, formerly referred to as a power of attorney for healthcare. The durable power of attorney for property management allows one to name an agent to act on their behalf with respect to property. Typically the agent has the power to buy and sell property for the principal, make gifts, bring or defend against lawsuits, and make many other decisions regarding the property of the principal. The agent will often have the power to manage the principal's businesses. The durable power of attorney for property management can be designed to spring into effect in the event of incapacity, whereupon the agent can exercise any legal rights that have been granted under the document. Accordingly, the agent should possess sufficient business, financial and legal acumen to properly manage the principal's business and property affairs. Typically, a living trust, together with a durable power of attorney can eliminate any need for a court to appoint someone to manage the assets of an incapacitated person.
An advance healthcare directive allows one to designate an agent to make medical decisions if the principal is incapacitated. The agent is authorized to make decisions about the type of treatment the agent should receive and whether or not extraordinary life saving measures should be taken. All medical decisions requiring the informed consent of the patient would be made by the agent if the principal were incapacitated. While the power of attorney for property management should be a person with some degree of business and financial acumen, the agent under an advanced healthcare directive is usually a person very close to the principal who is selected without regard to business or financial acumen to make health care decisions if you are incapacitated. It allows them to make decisions about the type of treatment you should receive, and whether or not extraordinary life saving methods should be used.
A will is generally where parents nominate a guardian for their minor children, should there be need for one. The selection of a guardian of minor children is perhaps the most difficult decision parents must make in preparing their wills. During early married life when the estate is not large enough to require tax planning, the nomination of the guardian may be the primary purpose of a will.
A guardian is nominated to serve in two capacities: He or she may act as the guardian of the minor's estate, in which case they will be charged with administering and overseeing property owned by the child; or as guardian of the person of the minor, which amounts to acting as a substitute for the child's natural parents. In many cases, the same individual is named as the guardian of both the person and the estate of a child.
The selection of the guardian of the person is critical since that person will act as a substitute for the natural parents and will be responsible for raising the child until he or she reaches the age of majority, which is 18 years of age in California. During that period, the guardian will be the legal representative of the child, and as such, can authorize medical treatment, make educational and religious decisions, and generally exercise the legal authority of a parent. It is important to select an individual who is both capable and willing to serve in this responsible role.
While the child's trust or the guardian of the child's estate may be legally empowered to reimburse the guardians of the person for costs of raising the children, there are indirect costs for raising children which may not be covered, such as the addition of a room to the home or the purchase of additional furniture. Thus, parents may want to make special financial arrangements in their wills and trusts so that the guardians will not suffer an economic burden in caring for the children.
The guardian of the estate safeguards and invests the child's assets until he or she reaches age 18. Generally, it is better to establish a trust for the property going to a minor child than to use a guardian of his estate. The trust can be drafted to provide broad investment and invasionary powers, while a guardianship is a creature of law and controlled by statutes. In addition, a guardian must release all assets to the child when he reaches age 18. Therefore, a trust can postpone distribution of assets until a later age when the child may be more capable of using the money wisely. Also, the trust is more flexible and may be structured to fit the particular needs of the child.
As with other representatives, it is important that successor guardians be named in the will. It is also important to consider whether one person or a married couple should be named as guardian and, if a married couple is named, to consider the effect a divorce of the guardians would have on that decision.
A person engaging in estate planning should also consider the nomination of a conservator. A conservator serves the same function as a guardian except that a conservator cares for an adult, where a guardian cares for a minor child. A conservator is appointed in a formal court proceeding and acts when a person is unable to care for himself, either personally or financially. The conservator steps in as the legal representative of the conservatee and collects money, pays bills, and otherwise cares for the finances and/or person of the conservatee. As with guardians, a conservator can be the conservator of the person or the conservator of a person's estate (property) or both.
This function can be either long-term or short-term and should be assigned to someone who is willing to undertake the responsibility. Most frequently, family members are selected as conservators; although bank or trust companies are frequently selected as conservators of the estate.
In some cases the court proceeding to appoint a conservator can be uncomfortable and embarrassing for everyone involved. An important advantage of a living trust is that if the creator of the trust becomes unable to care for his or her finances, the successor trustee of the trust can manage the trust without the necessity of a court proceeding to appoint a conservator of the estate. This simplified procedure may allow the family to avoid the conflict and embarrassment often found in such court proceedings.
Each individual or institution chosen to act on behalf of a person or his or her estate has a particular function to perform. Financial experience, responsibility, attention to detail, and sensitivity to individual needs are common to all of the representatives, but differ in degree depending on the particular capacity in which the representative is to serve.
The primary qualities necessary for an executor are the ability to gather information relating to the estate for probate and tax purposes, to act as caretaker of estate assets, and to maintain accurate records during the administration period. The executor discharges his duties over a relatively short period of time.
A trustee needs to have the record keeping abilities associated with a good executor, but must also have strong financial and investment knowledge in order to administer the trust successfully over long periods.
Guardians and conservators of the person are responsible for the personal care of the individual with whom they are charged. On the other hand, guardians and conservators of estates require many of the attributes associated with trustees.
Careful consideration of the individuals and institutions who will act in these positions should be made at the very outset of the estate planning process. The estate plan, no matter how well designed, will depend on these representatives for successful completion of its goals.
In recent years, living revocable trusts have become a popular alternative to wills and probate as the medium for the testamentary distribution of property to heirs. While the terms "living revocable trust" and "inter vivos revocable trust" are commonly used, the legal import and practical consequences of the use of revocable trusts are often not thoroughly understood. Thus, the purpose of this article is to compare living revocable trusts and wills, and to explore the advantages and disadvantages of each.
As a general proposition, both living revocable trusts and wills are prepared as estate planning documents and, for that purpose, the two vehicles are virtually identical in the variety of estate plans which they can implement. For example, both wills and revocable trusts can provide for distribution by outright gift or by trust, and both can take advantage of the various estate planning tools such as the marital deduction, generation skipping trusts and Internal Revenue Code §303 redemptions. Since the testamentary provisions of wills and revocable trusts can be identical, neither affords estate tax advantages over the other.
Wills and revocable trusts also share certain similarities during the creator's lifetime. For example, both documents can be amended or revoked by the creator and thus neither limits the creator's control of his property. Since the creator of a revocable trust is taxed on the trust income, the trust (like the will) does not afford any income tax advantages to its creator.
However, living revocable trusts also differ from wills in a number of very significant ways. The primary advantages of the trusts are management, flexibility and savings at death; the disadvantages are mainly the setup costs and some administrative inconvenience.
The most publicized advantage of revocable trusts is their ability to avoid probate and thus to reduce the difficulty, delay and expense of transferring one's estate.
At death, the administrative expenses of the trust are less than for a probate estate due primarily to the avoidance of statutory fees for the attorney and executor. Although that savings is negligible (or possibly nonexistent) for a small estate, the reduction can be substantial in a large estate. While some fees are inevitably incurred in administering a trust after the creator's death (e.g., the preparation and filing of death tax returns), the costs can often be as low as one-third to one-half of the normal probate fees (depending on the size and complexity of the estate).
As examples of probate costs, the combined attorney's and executor's statutory fees for a $500,000 estate are $26,000 and for a $1,000,000 estate are $46,000. In addition, there are extraordinary fees for work not covered by the statutory formula, such as the federal estate tax return, state and federal income tax returns, sales of property, and litigation. While the extraordinary fees are based on the work actually done, the statutory fees are purely the product of a formula. In addition, in a large estate the statutory formula will often result in excessive fees to the attorney and executor. For revocable trusts the attorney's and trustee's fees are based on the work actually performed.
The delay in probate proceedings is primarily the result of numerous procedural requirements not found in trust administration. For example, when an estate must be probated, the decedent's family can anticipate a delay of one to two months for the appointment of an executor and the collection of estate property. With a living trust, the trustee can immediately pay the last illness and funeral expenses, begin managing the decedent's property, and start income payments to the family. (The trustee is able to act quickly because part or all of the creator's property is placed in the trust during his or her lifetime and the trustee does not have to obtain court approval to begin dealing with the trust property.)
In recent years, the probate laws have been modified to provide for expedited procedures in an attempt to reduce the delay and expense of court proceedings for selling estate property, investing estate cash, and other administrative matters. While these changes have improved the system, living revocable trusts continue to be more responsive and flexible than probate estates in responding to family needs. In this regard, an additional and often overlooked advantage of the living revocable trust is that it immediately focuses on the family needs and future financial planning, while a probate estate is, in effect, a one to two year conduit between death and distribution. During that period, the probate estate often inadvertently serves as an unwanted and continuing reminder of the loss of a spouse or parent.
The living revocable trust can also avoid the expense of court supervision. Testamentary trusts may be required to periodically account to the court and obtain approval of the trustee's transactions, while living revocable trusts are usually not required to account to the courts. (However, where the beneficiaries or the trustee of a trust desire court supervision for their protection, they may obtain court review of the trust transactions.) Also, during the period of administration, trusts can generally buy, sell, lease and hold trust assets with the trustee's discretion. The executor of a probate estate can also buy, sell, lease and hold assets, but should generally obtain court approval for sales and purchases of property.
In addition to the savings which generally result from avoiding probate, living revocable trusts afford particular advantages to persons who own real property in other states. Under the American legal system each state controls the real property located within its boundaries and, as a result, real property located in a state can only be probated by the courts of that state. Consequently, if a California resident dies owning real property in another state, two probate estates will be needed--one in California, as the primary state, and another in the state in which the property is located. The administration of the second probate estate involves additional court costs and often requires a duplication of some work which, of course, increases the fees. Real property in a living revocable trust avoids out-of-state probate since the property was not, for legal title purposes, owned by the decedent at his death.
As a final advantage of avoiding probate, the terms of a living revocable trust are confidential. A will, on the other hand, becomes a public record when it is admitted to probate and consequently its terms are subject to public scrutiny. For this reason, celebrities, persons with complicated family or business relationships, and others who simply desire privacy frequently establish trusts.
2. Trust Management
The living revocable trust allows the creator to work with a trustee and to evaluate the terms of the trust during his lifetime. In this way, the creator can determine if the trustee is capable and sensitive to his or her needs and to the needs of his family. During this period, the creator retains the ability to remove the trustee and to appoint a successor and to amend or revoke the trust.
In addition to the testamentary benefits, a living revocable trust offers advantages in responding to the financial management problems of injury, illness, emergency or incompetency. Under these circumstances, the trustee can continue to manage the trust property for the benefit of the creator during the period of the creator's inability (or, if the creator was serving as trustee, the named successor trustee can manage the property). On the other hand, without a trust, the creator and his family would have to endure the awkward public process of having a conservator appointed by the court.
A person may also desire to have the benefit of professional management in situations other than incapacity. For example, a person may be living abroad or constantly traveling so that the day-to-day management responsibilities could not be properly attended to or, alternatively, a person who has inherited property may be unfamiliar or unskilled in investments. Institutional trustees have the resources and experience necessary to manage investment property for such individuals.
Another advantage of revocable trusts is that they are generally less susceptible to challenge than wills. While a trust is subject to attack on the same grounds as a will (such as undue influence or incompetence), the operation of the trust during the creator's lifetime affords evidence of the creator's continuing review and affirmation of the terms of the trust document.
The probate avoidance and management advantages offered by a living revocable trust are not available without some costs.
First, the preparation of a living revocable trust is more expensive than a will. The additional expense of the trust is primarily due to the work required by the increased need for documentation (e.g., provisions for the management of property during the creator's lifetime and by the work necessary to transfer the creator's assets into the trust).
In addition, if a corporate trustee is appointed to serve during the creator's lifetime, the trust will be charged a trustee's fee. A typical annual administration fee of a bank or trust company would range between .75% to 1.25% of the value of the property in the trust, with a minimum fee of at least one thousand dollars. The percentage could be slightly higher or lower depending on the size of the trust, the type of property, and the trustee's management responsibilities.
A living revocable trust also requires attention to certain formalities during the creator's lifetime. For example, sales and purchases of trust property must be transacted in the name of the trust (as the legal owner of the property). Consequently, persons dealing with the trust (such as banks, title insurance companies, and escrow companies) will frequently want to review the administrative provisions of the trust document. These formalities are only slightly more complicated than if the transactions were consummated on a personal level, but they do require additional attention to detail and may be inconvenient.
Under the original legislation that was enacted to interpret Proposition 13, a transfer of real property to a living revocable trust was considered a "change of ownership," and, as a result, caused reappraisal of the property. On July 10, 1979, Governor Brown signed AB 1488 into law. This bill made several major revisions to the original Proposition 13 enabling legislation, including a specific exemption from the change in ownership provisions for transfers to living revocable trusts. Therefore, it is now possible to transfer real property to a living revocable trust without losing any Proposition 13 real property tax savings.
In addition, both California and the Internal Revenue Service recognize a living revocable trust as an "alter ego" of the creator. As a result, in many instances no separate income tax return is required for the trust during the creator's lifetime so long as the creator is acting as the trustee or co-trustee of the trust.
Living revocable trusts offer the advantages of probate avoidance and management flexibility. However, those advantages are not without their costs. Revocable trusts are more expensive than wills to set up and maintain, and they require additional attention to their ongoing maintenance.
As a result, a person who is considering establishing a living revocable trust should be satisfied that the advantages of the trust outweigh the simplicity and lower cost of a will.
As general rules of thumb for evaluating the propriety of establishing living revocable trusts, the following should be considered: (1) larger estates will benefit more than smaller estates from the probate avoidance feature of trusts, (2) revocable trusts are generally inappropriate for persons who are not attentive to detail or who wish to avoid the inconvenience and attention required by a trust, and (3) trusts offer particular advantages to the inexperienced investor, the overseas business person, the person who owns out-of-state real property, and the person under disability.
While living revocable trusts are not the panacea for all estate planning ills, they do offer significant advantages under the proper circumstances.
IV. THE EIGHT BEST EXCUSES FOR NOT PREPARING AN ESTATE PLAN
Each of our five estate planning partners has over 20 years of experience in estate planning. One of the more frustrating parts of trying to help people with estate planning is the strong inertia of many people who know they need estate planning, but because of certain conflicts, uncertainties or concerns, cannot quite get the estate planning process started. Through our experience, we have found that talking about those problems (which we label as "best excuses") can help the client realize that doing something is almost always better than doing nothing, no matter what the excuse.
We thought it appropriate to share our experiences in this regard, and thus present what we have found to be the eight best excuses clients give for not doing their estate planning, and what we find to be very good answers to those best excuses.
Reply: Like most things, you have to make time for matters that are important. Letting yourself be too busy is simply a convenient excuse to put off something you think you will always be able to do later. Unfortunately, car accidents, strokes and other unexpected tragic events in our lives do not let us put off indefinitely this type of planning.
Reply: You already have an "estate plan." Even if you don't know what you want to do for your estate planning, the state you live in has decided where your property goes if you do nothing. Anyone who dies without a will or other estate planning document is governed by state statutes. Those statutes direct who is to receive your property and when. If the statutes pick the wrong person, or the wrong assets that a person should receive, or the age at which they should receive those assets, then your desire and the state's plan will not be the same.
Reply: Not doing anything can cost you even more. For example, you may be able to avoid or reduce estate taxes which can be as high as $.55 on the dollar. Basic tax planning can often save hundreds of thousands of dollars in estate taxes. Also, many times you can avoid probate administration fees and delays. Those fees are based on statutory schedules that can cause a $1,000,000 estate in California to be subject to $20,000 or more of attorney fees and another $20,000 of executor fees. The minimum time to probate an estate is usually six months.
Reply: One of the primary reasons for estate planning is to make appropriate provisions for your family in the event of your death. The focus is on planning to help protect their interests. Having completed your estate planning does not mean you are going to die any sooner than you would have otherwise, but it does give you the peace of mind to know you have taken care of providing for your family's needs if you do.
Reply: Your lawyer treats anything he or she learns about you as confidential and acts only for your best interest. It makes as little sense to avoid seeing a lawyer to keep your financial situation private as it does to avoid seeing a doctor to keep your health situation private. Ultimately, that strategy is going to backfire.
Reply: No matter how small an estate you may have, usually there are reasons why having a will or trust in place for the disposition of your property is better than having no will or trust at all. For example, if you have minor children, you need to think about nominating a guardian to take care of those children if there isn't a surviving parent. There are numerous other issues like these that should be addressed, even for someone with a small estate.
Reply: If you do not agree and do nothing because of that disagreement, then your spouse will be able to control everything if you die first. With a will or trust, you can at least make decisions to control your one-half of the community property and all of your separate property.
Reply: If you do not name them, then state law will name them for you, by establishing a priority for who may act in those roles, and they may be just the people you want to avoid receiving those powers.
V. ESTATE PLANNING QUESTIONNAIRE
The information requested in this questionnaire is necessary to enable us to develop a comprehensive estate plan that integrates your family goals with tax and other legal considerations. If you have any questions about the data requested, we can discuss them when we meet. However, our first meeting will be most productive if you bring this questionnaire, completed to the fullest possible extent.
Also, please bring a copy of your current will(s), trust agreement, deeds for real estate, most recent income tax returns (both individual and business), life insurance policies and premarital agreement (if any).
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