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Chapter 17

Chapter 17. Estate Planning: Saving Your Heirs Money and Headaches. Learning Objectives. Understand the importance and the process of estate planning Draft a will and understand its purpose in estate planning Avoid probate . Introduction .

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Chapter 17

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  1. Chapter 17 Estate Planning: Saving Your Heirs Money and Headaches

  2. Learning Objectives • Understand the importance and the process of estate planning • Draft a will and understand its purpose in estate planning • Avoid probate

  3. Introduction • Estate planning is planning for what happens to your wealth and your dependents after you die • You want to pass on as much of your estate as possible in order to avoid taxes and transfer costs • Also determine who has decision-making authority if you are incapacitated

  4. The Estate Planning Process • Step 1: Determine the Value of Your Estate • Estate’s net worth = value of your estate – level of estate’s liabilities • Value of your wealth determines tax planning needs • In 2012, the first $5 million of your estate could be passed on tax-free

  5. The Estate Planning Process • Step 2: Choose Your Heirs and Decide What They Receive • Once you know what you have, you can decide who’s going to get it • In addition to a spouse, consider the special needs of your dependents

  6. The Estate Planning Process • Step 3: Determine the Cash Needs of the Estate • Before distributing property to heirs, the estate must pay medical costs, funeral expenses, legal fees, outstanding debt, and estate and inheritance taxes • Funeral and settlement costs are generally around $15,000 or 4% of the estate value

  7. The Estate Planning Process • Step 4: Select and Implement Your Estate Planning Techniques • Decide which estate planning tools are most appropriate to achieve your goals • Most common are a will, a durable power of attorney, joint ownership, trusts, life insurance, and gifts

  8. Understanding and Avoiding Estate Taxes • The IRS charges estate taxes, then issues an estate tax credit • Unified tax credit - estate and gift tax credit that in 2011 allows $5 million of an estate to be passed on tax free • Above that credit, estate tax rate is 35%

  9. Gift Taxes • Gifts will transfer wealth prior to death, reducing the taxable value of the estate • You could give $13,000 per year per person tax free in 2011 • The recipient doesn’t have to pay taxes on the gift • The gift tax and the estate tax work together with a total lifetime tax-exempt limit ($5 million in 2011) on gifts over $13,000 per recipient

  10. Unlimited Marital Deductions • Unlike the $5 million threshold to other beneficiaries, there is no limit to the size of estate transfers between spouses on a tax-free basis • Spouse must be a U.S. citizen

  11. The Generation-Skipping Transfer Tax • A tax on wealth and property transfers to a person two or more generations younger than the donor • Assets are taxed as if they moved from the grandparents to their own children, then from children to the grandchildren

  12. Calculating Estate Taxes • Calculate the value of your gross estate (the value of all your assets and property) • Calculate your taxable estate by subtracting funeral and estate expenses, debts, taxes, and allowable deductions from the gross estate • Calculate the gift-adjusted taxable estate • Estimate estate taxes using federal rate

  13. Figure 17.1 Calculation of Estate Taxes

  14. Figure 17.2 Calculation of Estate Taxes for the 2012 Tax Year

  15. Wills • A will is a legal document that describes how you want your property to be to others. • Beneficiary - an individual who receives property • Executor - personal representative who will carry out the will’s provisions • Guardian – the person who will care for children under the age of 18.

  16. Wills and Probate • Probate is the legal procedure that validates a will and then distributes the estate’s assets • Probate allows for challenges to the will to be settled • Probate allows for orderly distribution of assets of someone who dies intestate -without a valid will

  17. Wills and Estate Planning • If there is no will, a guardian for your children will be chosen by the court • Will is an appropriate way to provide for the special needs of children • Property is transferred according to your wishes • Make special gifts or bequests through will • Without a will, court administrator distributes assets—costly, may conflict with your desires

  18. Writing a Will • Introductory statement • Payment of debt and taxes clause • Disposition of property clause • Appointment clause • Common disaster clause • Attestation and witness clause

  19. Updating or Changing a Will—The Codicil • A codicil is an attachment to a will that alters or amends a portion of the will • A codicil should be drawn up by a lawyer, witnessed, and attached to the will

  20. Letter of Last Instructions • A letter of last instructions is generally written to the surviving spouse • Not a legally binding document • Tells of location of the will, legal documents, financial assets, those to notify of the death, listing of personal property, funeral and burial instructions, and organ donation wishes

  21. Selecting an Executor • The executor: • Makes sure your wishes are carried out • Manages your property until the estate is passed on to your heirs. • Could be a family member, lawyer, or bank trust officer. • Deals with personal matters, pays taxes and debts, distributes remaining assets after bequests have been honored, reports final accounting to the court

  22. Other Estate Planning Documents • Durable power of attorney - provides for someone to act in your place should you become mentally incapacitated • Living will - allows you to state your wishes regarding medical treatment in the event of illness or injury making you incapable of making decisions • Durable health care power of attorney -designates someone to make health care decisions for you

  23. Avoiding Probate • Probate is the process of certifying your will in court. It is essential to validate your will and ensure your provisions are carried out • You should try to avoid probate if possible because of time and extra expenses involved • You can avoid probate through: • Joint ownership • Gifts • Trusts

  24. Joint Ownership • Tenancy by the Entirety • Joint tenancy with rights of survivorship • Tenancy in common • Community property

  25. Gifts • Gifts avoid probate and reduce taxable value of estate • They are a good way to transfer property that grows in value (stocks & real estate) • There is an unlimited gifts tax exclusion to charity or on gift payments for medical or educational expenses • Disadvantage: you may need the assets later, or they may be squandered

  26. Trusts • A trust is a legal entity that holds and manages an asset for another person • Is created when an individual (grantor), transfers property to a trustee for the benefit of one or more beneficiaries • The trustee can be an individual, an investment firm, or a bank • Any asset can be placed in a trust

  27. Trusts • Avoid probate • More difficult to challenge in court • Reduce estate taxes. • Allow for professional management

  28. Trusts • Provide for confidentiality • Provide for a child with special needs • Hold money till a child reaches maturity • Ensures children from previous marriage receive inheritance

  29. Living Trusts • A living trust places assets in trust while alive, allowing you to withdraw them later if you wish • Revocable Living Trusts - you control the assets in the trust and can receive income from the trust without removing assets from the estate

  30. Table 17.1 Advantages and Disadvantages of Revocable Living Trusts

  31. Living Trusts • Irrevocable Living Trusts - a trust in which you relinquish title and control of the assets when they are placed in the trust

  32. Table 17.2 Advantages and Disadvantages of Irrevocable Living Trusts

  33. Testamentary Trusts • A testamentary trust is created by a will, becomes active after you die • Standard Family Trusts – also known as A-B Trusts, Credit-Shelter Trusts and Unified Credit Trusts • Transfers assets to your children while still allowing surviving spouse access to funds

  34. Testamentary Trusts • Qualified Terminable Interest Property Trust (Q-TIP) • Gives individual ability to direct income to the surviving spouse, and then choose where the assets will go after spouse’s death • Sprinkling Trusts • Distributes income according to need rather than a preset formula

  35. A Last Word on Estate Planning • Many put off estate planning because it is complex and deals with death—don’t • Approach a professional for your estate planning • Make sure your family knows where your estate planning documents are

  36. Checklist 17.1

  37. Summary • Estate planning is a 4-step process that involves planning what happens to your accumulated wealth and dependents when you die • Designate beneficiaries, executor, and guardian in your will and review periodically • Use trusts to avoid probate

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