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What Does the Fiscal Cliff Deal Mean for My Estate Plan?

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Posted on Jan 09, 2013 | Share this post: Like Us on Facebook Join Us on Google Follow Us on Twitter

What’s most important to us as planners is how the “fiscal cliff” deal changes will affect our clients’ existing estate plans and whether any changes are necessary.

Most estate planning documents deal with non-tax issues.  A Will, of course, ensures the client’s chosen beneficiaries receive the estate upon death in the amounts and proportions written into that document.  The Will also names the Personal Representative (a.k.a. an Executor), who will administer the estate.  Financial Powers of Attorney and Medical Powers of Attorney are intended to ensure that the client’s specific wishes are carried out and to appoint the person they want to make those decisions in the event of incapacity.  These documents are critical to avoid unnecessary court oversight and the attendant expense, delay, and intrusion.  Even Revocable Trusts primarily deal with non-tax issues, including the very valuable benefit of structuring assets to avoid the probate process at death and to provide creditor protection for beneficiaries.

The goal of avoiding court involvement is more important than ever because over the last few years, additional layers of laws, rules, and oversight have made court conservatorships, guardianships, and probates even more intrusive and expensive.

One of the most important benefits of a Revocable Trust comes from establishing a beneficiary’s share in a continuing trust, which we call a Lifetime Protection Trust.  These can include trusts for children, where someone else will manage and protect the money until the child is a certain age.  The need for someone to do this is obvious, and in this form of a trust you, rather than the court, decide who will manage the assets and make the decisions.  A Lifetime Protection Trust also can extend past age 18, while a court conservatorship for a minor must terminate and distribute out to the child at that age.  Even custodial accounts established at banks and brokerage firms expire no later than age 21, but most clients want to postpone distributions until children are more mature.

Trusts also have advantages for adult beneficiaries.  Some may have special needs, and a properly drafted trust will protect the public benefits they rely upon, while allowing funds to be used for needs that are not covered by such benefits.  Clients frequently want to benefit an individual, but know that for various reasons the beneficiary would not make good decisions if he or she received a lump sum.  A Lifetime Protection Trust with someone else in charge may solve those concerns.  None of these benefits have anything to do with the estate tax.

Even a beneficiary who is mature and responsible can benefit from a Lifetime Protection Trust.  A capable beneficiary may serve as his or her own trustee and use the money as he or she sees fit.  Even that type of arrangement protects Trust assets from creditors, including those of divorcing spouses, lawsuits, and bankruptcy.  The Trust does have an estate tax savings aspect as well; it may not be subject to estate tax upon the beneficiary’s death.  That will be meaningful to fewer people if the exemption stays high, but the other asset protection benefits of these types of trusts are invaluable for families with estates well under the tax limits.

There are, of course, some aspects of estate planning that have been geared toward minimizing estate tax.  The most common of all is the “A-B” trust, where a husband and wife create a joint trust, and upon the death of the first spouse, the trust divides into a revocable Survivor’s Trust (A) and an irrevocable Family/Decedent’s/Bypass Trust (B).  The irrevocable Family Trust uses the deceased spouse’s estate tax exemption so that it will not be subject to estate tax when the survivor dies.  For a husband and wife who have this arrangement, the most important thing to consider is whether the survivor has an appropriate amount of flexibility to change the beneficiaries of the irrevocable trust.  The survivor can have that flexibility through a power of appointment, and most families want the survivor to have at least some ability to make adjustments.  It is critical that clients understand how much power the survivor has, and that it is neither too much nor too little.

There are more benefits to an A-B trust, even if estate taxes are no longer an issue.  One is that the spouses may like the idea that the survivor will benefit from the irrevocable trust, but that the survivor will not be able to give all the money away or leave it to a new spouse.  They know that what’s left when the survivor dies will go to the originally named beneficiaries.  This is of course especially important with second marriages when the spouses do not have mutual children.  Additionally, the irrevocable trust will be protected from creditors, as discussed above, so the survivor has that additional benefit.

Finally, the A-B arrangement still may help reduce estate taxes.  For clients with enough money to exceed the exemption amount, the A-B Trust is a more tax-effective strategy than relying upon the portability provision.  One concern is that the portability law could be discontinued.  Even if it remains, having separate trusts allows the surviving spouse more flexibility and control.  With separate trusts, the survivor can spend the money from Trust A and let Trust B grow and appreciate, gradually ensuring that more and more money is not subject to estate tax.  Additionally, the generation-skipping tax (GST) exemption of the first spouse is not preserved through portability.  It is, however, preserved in an irrevocable Family Trust, and that results in more estate tax savings for the next generation.  Even those clients who do not currently have enough assets to warrant estate tax concerns may be concerned that Congress may lower the exemption at some point.

Balanced against all the potential benefits is the downside of an A-B arrangement.  It does add a layer of complexity to the administration of an estate, and it requires that the B Trust be kept separate, with its own taxpayer identification number.  However, especially if it gives the survivor the appropriate level of flexibility through a power of appointment, there isn’t a substantial downside to the creation of this trust arrangement, and the administrative work may entail no more than a few extra hours of work each year.

Of course, each individual has to decide what is best in light of the circumstances.  However, it’s important to know that this “change” in the estate tax law doesn’t make it advisable to rip up the estate plan that you worked so hard to finally put in place a few years or even months ago, and start anew.  This is one item you don’t need to add back to your New Year’s resolution list.