As a native of Lexington, it’s easy to see the first-hand benefits of proper estate planning — money being preserved from one generation to another is a staple of many legacy Lexington families.
The financial security of your family depends not only on how you manage your wealth today, but also on how it will be managed and maximized in the future. Let’s take a look at a few of the essential core elements of any estate plan:
• Your last will and testament directs the distribution of much of the property you own upon your death. (Some assets pass outside of a will based on their titling, such as a joint account with rights of survivorship or an IRA through a beneficiary designation; for this reason, correct titling of assets is essential.) It also names an executor for your estate and guardians for any minor children.
• Advance medical directives (AMD) speak for you should you become incapacitated. A health care proxy appoints an individual to make medical decisions for you if you are unable to communicate. And a living will states your wishes in regard to end-of-life medical treatment.
• Power of attorney (POA) authorizes someone to make business of legal decisions on your behalf. There are different kinds of POAs. Some go into effect under certain circumstances (i.e., incapacity) and others stop going into effect under certain circumstances (i.e., when a person reaches the age of majority), while others are durable, or last despite circumstances.
For high-net-worth individuals, a central function of an estate plan is to minimize taxes and preserve as much of your estate as possible. “Gifting” assets to your beneficiaries during your lifetime is a popular estate planning tool.
The federal government (as well as certain states and municipalities) assess taxes on estates over a certain threshold. Until the end of 2012, $5.12 million is exempt from federal estate gift tax, with the excess to be taxed at a 35 percent estate tax rate. Effective January 2013, however, only the first $1 million will be exempt, and the highest estate tax rate will rise to 55 percent. Simply put, gifting this year means you can transfer more of your estate during your lifetime without it being subject to a gift tax. Some popular gifting strategies to reduce estates are:
Funding college costs for children and grandchildren. You can make a contribution to a 529 college savings plan, which will be treated as a gift to the beneficiary. This year, the gift tax annual exclusion amount is $13,000, so you can gift up to $13,000 to any individual tax-free, and to all individuals over your lifetime up to the maximum exemption amount (currently $5.12 million). You are permitted to accelerate up to five years’ worth of such contributions, putting in as much as $65,000 at once ($130,000 with your spouse), but that contribution will be treated as if it were being made in $13,000 installments over five years.
Making payments directly to educational or health care institutions. You can pay an unlimited amount annually on behalf of another person, a long as you send the money directly to the institutions where the expenses were incurred. Qualifying medical and educational expenses are generally not considered gifts and can be made in addition to the annual exclusion amount.
Donating to charitable organizations. By investing in charitable gift funds and community foundations, donations can stretch beyond your lifetime. Charitable gift funds permit you to make a tax-deductible donation, grow your donation and then direct a contribution — in your name — to nonprofits of your choice whenever you like.
As part of a comprehensive estate plan, a trust can help you preserve your wealth during your lifetime and facilitate the transfer of assets to your descendants or to a charity that you value and support. There are many different types of trusts and varying goals they seek to accomplish, including: minimizing estate and inheritance taxes; protecting assets from the consequences of disability, family conflict, spendthrift beneficiaries, bad business decisions or other legal issues; providing for special-needs children through their lifetimes, as well as minor children or grandchildren; and enhancing privacy, since trust assets avoid probate’s public proceedings. Briefly, three trusts often included in estate plans are:
Bypass or credit shelter trusts. This enables both spouses to take advantage of the estate tax exclusion amount, which would not be available if each spouse simply left everything to the other. Assets equal to the estate tax exclusion amount are placed in trusts after the first spouse’s death (currently $5.12 million). At the second spouse’s death, the heirs receive both exclusion amounts tax-free.
Irrevocable life insurance trust (ILIT) can remove life insurance proceeds from your taxable estate. The proceeds may be used to pay estate costs and provide beneficiaries with tax-free insurance proceeds. Since the trust becomes the policy owner, you forfeit the right to borrow against it or change beneficiaries. ILIT proceeds can be very useful and, for example, provide financial support to heirs until they can sell an illiquid asset like a business.
Qualified terminable interest property trust (QTIP): In a QTIP — often used in the case of second marriages — the surviving spouse receives income for life, but the balance is left to someone else, typically the decedent’s children. It tables advantage of the marital deduction, provides an income for the surviving spouse, but controls who the ultimate beneficiaries will be.
True wealth management means having a holistic view of all aspects of your financial life. It involves understanding what’s important to you and the causes and goals you find meaningful.
Andrew Hart is a financial advisor in The Bluegrass Wealth Management Group, UBS Financial Services, Inc. in Lexington.
Disclaimer: UBS Financial Services Inc. does not provide legal or tax advice. Any discussion of tax matters contained herein is not intended to be used, and cannot be used or relied upon, by any taxpayer for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter(s).