8 Common Estate Planning Errors

The federal estate tax is no longer a concern for most Massachusetts couples as the 2018 federal exemption amount, through portability, is $22.4 million.

Consequently, one carefully must consider the disadvantages of trusts with estate tax provisions (commonly referred to as “QTIP”, “credit shelter,” “bypass,” or “A-B” trusts) now that, for most Massachusetts couples, the only potential benefit is the minimizing of the Massachusetts estate tax.

The basic concept of trusts with estate tax provisions is to ensure that both spouses utilize their exemption amount by leaving assets to their respective trusts instead of to each other. For example, if Mary and John together have $1.5 million and Mary, as surviving spouse, dies with that amount, her estate will have a Massachusetts estate tax liability of $64,400. In contrast, if Mary and John split their assets and each leave half to their respective QTIP trusts, there is no Massachusetts estate tax liability upon the death of the surviving spouse.

Yet clients often complain about their trust with estate tax provisions. John and/or Mary may have one or more of the following complaints:

• They may complain about the initial, as well as the on-going, legal expenses as they will need periodic updates to their trusts due to changes in the law.
• They may complain that the trusts did not serve their purpose of minimizing state estate taxes as they ultimately moved to a state that does not have state estate taxes or eventually reduced their assets below $1 million by spending on in-home, assisted living and/or nursing home care or by gifting to family members each year up to the amount of the annual exclusion.
• Mary may be annoyed with having to file four tax returns each year as she, as the surviving spouse, must file a 1040 and Form 1 and she, as the trustee of John’s trust, must file a 1041 and Form 2. 
• Mary may complain about a capital gains tax liability upon selling her home if the value has increased since John’s death and his trust owns half of the home. For example, assume the home was purchase for $400,000, valued at $500,000 at John’s death and sold for $800,000. The tax basis of Mary’s half is $200,000 and John’s trust’s half is $250,000. Mary does not owe any capital gains tax as she has a $250,000 exclusion, which covers her gain of $200,000. In contrast, the trust has a gain of $150,000 and does not qualify for an exclusion, resulting in a capital gain tax liability.

In sum, trusts with estate tax provisions are not a one-size-fits-all plan. One carefully must consider the client’s individual situation and all of the available options for minimizing state estate taxes such as annual gifting and transfers to the next generation at the death of the first-to-die spouse.

Nothing in this article should be considered legal advice as this is a complicated area of the law.

A common estate planning error is failing to consider an annual gifting program to reduce the federal and Massachusetts estate tax liabilities and reduce the amount of assets potentially subject to one’s and one’s spouse’s long-term-care needs.

An annual gifting program basically is a plan to make annual gifts to family members up to the amount of the federal gift tax exclusion, which currently is $15,000 (2018).

Historically, the reason for not making larger gifts is that lifetime gifts that exceed the amount of the federal gift tax exclusion ($15,000 in 2018) reduce (dollar for dollar) one’s estate tax exemption available at death. One’s estate tax exemption is the total amount that one can leave at death to the next generation without incurring an estate tax liability.

For example, together John and Mary have $1.46 million. Assuming their assets neither appreciate nor depreciate in value, the surviving spouse’s estate will have a Massachusetts estate tax liability unless they fund the first-to-die’s trust with estate tax provisions with at least $460,001 or they reduce their assets by spending or gifting at least $460,001.

Each year John and Mary each can give $15,000 to their four children. The total is $120,000 ($15,000 times 2 times 4). Each year John and Mary also each can give $15,000 to their children’s spouses. Now the total is $240,000. If John and Mary continue their annual gifting program to their children and their children’s spouses for two consecutive years, they have reduced their assets by $480,000 and thereby reduced their combined assets to below $1 million, resulting in savings of $61,840 in Massachusetts estate taxes.

Everyone seems to know the rule about being able to gift away $10,000 ($15,000 in 2018) each year. However, few understand that gifting needs to be done at least five years prior to applying for MassHealth long-term-care benefits. If one is considering gifting primarily out of concern about needing nursing home care now or in the future, it is imperative that one consult an elder law attorney to provide guidance and supervise the gifting of assets.

Nothing in this article should be considered legal advice as this is a complicated area of the law.

A common estate planning error is not realizing that you may spend a significant amount of your assets on your long-term care. Having been an elder law and estate planning attorney for over 20 years, I have seen many clients spend enormous sums on in-home, assisted living, and nursing home care. For example, let me tell you the story of Mrs. Smith. In 2010, when we first met, her net worth (including her condo) was approximately $900,000. As she was 92 and living in her home, Mrs. Smith was convinced that she would have a significant amount of assets at her death and thus put a lot of time and energy into deciding which relatives, friends, and charities would be the beneficiaries of her estate. Prior to 2010, she had executed a life estate deed whereby her son owned the remainder interest. In 2012, Mrs. Smith moved into an assisted living facility and, in 2016, she fell and fractured bones in her neck. As a result of the fractures, she required 24-hour care, the cost of which was $5,500 per week. She received 24-hour care for over a year. Her son became concerned about her running out of money and, fortunately, was able to find for her a private room in a nursing home. She moved to the nursing home, spent down her assets to $2,000 and became a recipient of MassHealth long-term-care benefits. Luckily, when Mrs. Smith’s condo was sold, her son kept his share of the proceeds from the sale of the condo in an account solely in his name. He is spending his share of the proceeds supplementing the care provided by the nursing home.

In sum, it is important to realize that you may spend a significant amount of your assets on your long-term care and plan accordingly. Long-term-care insurance is an important planning tool as it is a means of passing on some of the potential exposure to an insurance company. For those who decide against long-term-care insurance, there are other options such as outright gifting, testamentary trusts, and life estate deeds.

Nothing in this article should be considered legal advice as this is a complicated area of the law.

A common estate planning error is failing to consider testamentary trusts to reduce the amount of assets potentially subject to one’s spouse’s long-term-care needs.

A testamentary trust is a trust created by the terms of a person’s Last Will and Testament. The idea behind this strategy is to ensure that the surviving spouse does not inherit all of the couple’s assets and instead a portion of the couple’s assets is left to the first-to-die spouse’s testamentary trust. For example, assume that John dies first and leaves everything to Mary. Under these facts, all their assets are exposed to Mary’s long-term-care needs. In contrast, if they have testamentary trusts and split up and retitle their assets, upon John’s death, a portion of the assets would pass to his testamentary trust for the benefit of Mary. If she applies for MassHealth long-term-care benefits, the trust assets are not considered to be Mary’s as long as the language of the trust indicates that distributions are solely at the Trustee’s discretion.

The devil is in the details. In order for this strategy to work, Mary and John must (1) execute new Wills containing testamentary trusts for the benefit of the other and (2) split up jointly-owned assets and retitle real estate so that the real estate is owned as “tenants in common” or solely by John or Mary. If these two steps are taken properly, upon John’s death, a portion of his assets pass via his Will to his testamentary trust for the benefit of Mary and the trust assets are protected if Mary needs nursing home care now or in the future.

Some of the disadvantages of the testamentary trust strategy are as follows:

• This strategy requires a probate at John’s death.
• After John’s death, there will be ongoing administrative costs as the Trustee will have to file annual tax returns for the trust and accountants charge more for preparation of trust returns than individual returns.
• This strategy will not work if both Mary and John require nursing home care.
• It may be difficult to take out a mortgage or line of credit on real estate held in a testamentary trust.
• This strategy requires that Mary not be the Trustee and this is problematic if Mary and the Trustee disagree on how to spend (or not spend) the trust assets.

Arguably, testamentary trusts allow elders to have their cake and eat it too as this strategy enables elders to protect assets and yet have those assets available to them. However, this technique is not a one-size-fits-all as the surviving spouse must give up control of a portion of the assets. Nonetheless, testamentary trusts should be considered by couples who strongly desire that their children inherit a portion of the assets even if the surviving spouse needs nursing home care and are comfortable with the surviving spouse’s loss of control over a portion of the assets.

Nothing in this article should be considered legal advice as this is a complicated area of the law.

There are many reasons for gifting to the next generation. The two most common reasons are (1) to reduce estate tax liability and (2) to reduce the amount of assets potentially subject to one’s and one’s spouse’s long-term-care needs.

A common estate planning error is failing to consider the capital gains tax consequences when gifting an asset. If you give property to the next generation, the recipient of the gift has a “carryover basis” in the asset. In contrast, if the next generation inherits the asset, the recipient has a “step up” of the tax basis if the asset has increased in value (or “step down” if the asset has decreased in value).

For example, Mr. Smith buys a stock for $10,000. He gifts this stock to his daughter Mary. Because the stock was gifted (and not inherited), Mary has a “carryover basis” of $10,000. If she sells the stock for $20,000, the sale triggers a capital gain of $10,000.

In contrast, if Mary inherits the stock, she has a “step up” of the tax basis on account of the appreciation in value between when Mr. Smith purchased the asset and when he died. Her tax basis is the fair market value on the date of his death. If the date-of-death value is $19,000 and she sells the stock for $20,000, the sale triggers a capital gain of $1,000.

In sum, thought always should be given to the capital gains income tax consequences of gifting. One must analyze the benefit of holding onto the asset until death in order to achieve a “step up” in the tax basis versus gifting in order to achieve a reduction in both (1) potential estate tax liability and (2) the assets potentially subject to one’s and one’s spouse’s long-term-care needs. Because of the inherent tension between gifting of assets and the minimizing of capital gains taxes, one should avoid gifting assets having a low tax basis. Cash is preferable as the transfer of cash can never trigger a capital gain. Also, because of this inherent tension, many of my married clients choose to name their children as the primary beneficiary of a portion of their assets (rather than leaving all of their assets to each other) as this is a means of reducing the assets available to the surviving spouse while at the same time minimizing the overall capital gains tax liability.

Nothing in this article should be considered legal advice as this is a complicated area of the law.

A common estate planning error is not understanding that your beneficiary, POD and TOD designations, for the most part, supersede the provisions of your Last Will and Testament. Let’s say your Will says your annuity goes to your son, but you designated your daughter as the primary beneficiary of your annuity. If both survive you, who gets your annuity? The answer is your daughter and the reason is that your beneficiary designations, for the most part, supersede the provisions of your Will.

Why do I say “for the most part”? The reason is that sometimes the provisions of your Will would determine who gets your annuity. For example, let us assume you had named your spouse as the beneficiary of your annuity and your spouse dies before you. In that situation, if you had not named a contingent beneficiary, the “default” provisions of the annuity contract determine who gets the annuity. Sometimes default provisions indicate that the assets are to be distributed to the owner’s estate and whereas other times the default provisions indicate that the asset is to be distributed to specific family members, for example to the owner’s children if there is no surviving spouse.

From our first meeting to when my clients sign their estate planning documents, I emphasize the importance of naming both primary and contingent beneficiaries.

At the first meeting, I do a thorough review of my client’s assets and determine which ones are retirement accounts, annuities and insurance policies. Once I have determined those assets, I inquire as to primary and contingent beneficiaries. Next I ask my client if he or she has any savings bonds, bank accounts, or non-retirement brokerage accounts for which he or she has named a beneficiary or designated a POD (pay on death) or TOD (transfer on death) beneficiary.

If there is any inconsistency between the beneficiaries of their estate plan and their beneficiary, POD and/or TOD designations, we discuss the reason for the inconsistency. For example, sometimes individuals designate charities as the beneficiary of one or more of their retirement accounts for the reason that the charities will not have to pay income taxes notwithstanding the fact that the charities will be receiving pre-tax monies. Moreover, some individuals avoid naming charities in their estate planning documents because of certain requirements under Massachusetts law such as the requirement that the Public Charities Division of the Attorney General’s Office is notified of the Massachusetts probate proceeding when a charity is inheriting under the estate plan.

Finally, at the signing, I provide my clients their estate planning documents in a binder that has an index as well as tabs and sheet protectors for each of their estate planning documents. Most importantly, there is a tab and sheet protector specifically for the confirmations of their beneficiary, TOD and/or POD designations.

Nothing in this article should be considered legal advice as this is a complicated area of the law.

A common estate planning error is failing to provide a trust for minor beneficiaries. Absent a trust for the inheritance of a minor, the court will appoint a conservator to hold, manage, and use the money for the benefit of the child or grandchild. A conservatorship of a minor child or grandchild is less than optimal for several reasons. First of all, the conservatorship process can be time consuming and costly and the cost is paid from the child or grandchild’s assets. Secondly, there are times when unfortunately an unsuitable person is appointed the conservator. For example, if your estate plan provides that your deceased daughter’s share goes to her minor children, the minor’s father (potentially your daughter’s irresponsible ex-spouse) may be the person who the court appoints as conservator. By far, however, the biggest disadvantage of a conservatorship is that the minor is entitled to the balance of his or her inheritance at age 18. As we all know, eighteen-year-olds often do not make wise choices. Arguably, there is no worse time to receive an inheritance as an inheritance at age 18 serves both as a temptation to spend irresponsibly and a distraction from attaining a higher education.

A trust for minors is far more optimal than a conservatorship. To begin with, if the trust contains the proper language, the funds are available for the minor’s health, education, maintenance and support. Second, a trust for minors allows you to choose who will manage the money. Third, using a trust for minors enables you to avoid the expense and the time-consuming nature of the conservatorship process and court supervision. The primary reason for using a trust, however, is that it allows you to determine the age at which the minor will receive the balance of his or her inheritance. Some clients choose age 25 whereas others decide on ages 30 or 35. The reason for using these older ages is to minimize the potential for wasteful spending of the inheritance.

As a closing note, do not overlook the importance of coordinating your estate plan and beneficiary designations. Notwithstanding the perfect provisions of your trust for minors, if you name a minor directly as a beneficiary of an asset, a conservatorship will be necessary.

Nothing in this article should be considered legal advice as this is a complicated area of the law.

A common estate planning error is failing to update all beneficiary designations. From our first meeting until the time when my estate planning clients sign their estate planning documents, I emphasize the need to update all beneficiary designations as I find that clients tend to update approximately ninety percent of their beneficiary designations, but somehow fail to update one or two.

I emphasize the importance of updating all beneficiary designations by telling the story of Mr. Smith. When we first met in 2006, Mr. Smith had four minor sons. His goal was to prevent a situation where his sons would receive a significant inheritance at age 18 as he believed that a sizable inheritance at age 18 may bring about imprudent spending and distract his sons from attaining a higher education. Accordingly, his Last Will and Testament indicated that his assets were to fund a trust for his minor sons and his sons were to receive the remaining trust assets when the youngest attained age 25. After signing his 2006 Will and the Trust, Mr. Smith needed to update all of his beneficiary designations. In other words, he needed to go through the laborious task of naming the trust as the beneficiary of each of his life insurance policies, retirement accounts, and annuities.

In 2016, Mr. Smith returned to my office. At this point his youngest was 25 and Mr. Smith believed that his sons were mature enough to handle a sizable inheritance. Consequently, Mr. Smith asked me to draft a new Last Will and Testament. His new Will simply was to state that his sons each received a one-fourth share of his estate. After he signed his 2016 Will, Mr. Smith again needed to update all of his beneficiary designations. This time he needed to name his four sons as the beneficiaries of each of his life insurance policies, retirement accounts, and annuities.

Like many clients, Mr. Smith updated only about ninety percent of his beneficiary designations. Unfortunately, when Mr. Smith died, the beneficiary of his annuity still was the trust he signed in 2006 for his minor sons. This mishap complicated matters as now there was much more work to be done. Because Mr. Smith had overlooked or put off updating the beneficiary designation pertaining to his annuity, the proceeds of the annuity were paid to the trust and the trustee had the responsibility for the tax id number for the trust, tax returns for the trust, and an accounting to the trust beneficiaries. In contrast, if Mr. Smith had updated all of his beneficiaries when he updated his estate plan in 2016, the proceeds of the annuity would have gone directly to his sons, thereby avoiding the necessity of a tax id number for the trust, tax returns for the trust, and an accounting to the trust beneficiaries.

Nothing in this article should be considered legal advice as this is a complicated area of the law.