Estate planning instruments

1. Last will and testament: Having a will is crucial for everyone, unless you prefer your state's laws of intestacy to govern how your assets are distributed. If you don't mind going through the probate process, a will can serve as your primary instructions for transferring your estate. Even if you opt for a trust-based estate plan with the help of a lawyer, you'll likely still have a will. In a trust-based plan, the will is often integrated to ensure any assets not covered by the trust are directed into it.

2. Durable power of attorney: empowers someone else to make legal and financial decisions on your behalf if you become incapacitated.

3. Health care power of attorney: grants someone the authority to make health care decisions for you if you are unable to do so yourself. It is vital to ensure you have both legal and health care powers of attorney, as the standard legal power of attorney does not cover health care decisions.

4. Living will: a set of instructions regarding your preferences for medical care, particularly in situations where you have a terminal condition or are in a persistent vegetative state.

5. Life insurance: provides your family and dependents with a financial safety net in case something happens to you. The death benefit can help them cover everyday living expenses, mortgage payments, credit card balances, personal loans, educational costs, and other financial obligations. It’s used as a tool for estate planning, particularly in cases where there might be estate taxes to pay. The death benefit from life insurance is generally tax-free to the beneficiaries.

6. Personal liability umbrella insurance: an additional layer of liability protection beyond what is typically offered by your primary insurance policies, such as homeowners or auto insurance. It acts as a "umbrella" to cover you for excess liability in case you are found legally responsible for causing injury to someone or damaging their property.

It's essential to consult with your attorney and insurance agents to understand your specific needs.

The Lifetime Exemption

When it comes to estate planning in the United States, an essential aspect is determining how to transfer your assets outside of your estate both during your lifetime and after you pass away. The federal gift and estate taxes are structured in a way that allows each individual to transfer a certain amount of assets tax-free, known as the "lifetime exemption."

As of 2023, the lifetime exemption stands at $12.92 million. This means that you only need to pay gift or estate taxes when transferring more than $12.92 million. For any gifts or estates above the exemption amount, a tax rate of 40% applies.

An advantage for married couples is that they can share their lifetime exemption. Through "portability," a surviving spouse can use the remaining estate tax exemption of their deceased spouse, effectively doubling the lifetime exemption for couples to $25.84 million under current rules.

It's important to note that lifetime exemption amounts are currently at an all-time high.

However, it's crucial to be aware that the larger exemption amount currently applies only to tax years through 2025. Unless Congress makes these changes permanent, after 2025, the exemption will revert back to the previous amount of $5.49 million (originally $5 million adjusted for inflation from 2010). Nevertheless, the IRS has clarified that if you make gifts under a larger exemption amount that is later reduced, there will be no "clawback" of the exemption or taxes.

Trusts

Trusts are an important tool in the US legal system that can offer protection for your assets both during your lifetime and after your passing. They provide control over how your belongings are distributed, and they can even help you save on taxes.

There are two main types of trusts: revocable and irrevocable.

1. Revocable Trusts: These trusts are flexible and can be changed whenever you want. While you're alive, the assets in a revocable trust are still considered part of your estate. However, they offer the benefit of avoiding the probate process, making it easier for your beneficiaries to receive their inheritance without public disclosure. You can move assets in-and-out at any time. No tax incentives.

2. Irrevocable Trusts: Once you place assets into an irrevocable trust, you can't change or take them back. You'll need to appoint someone else to manage the trust (trustee company), and while you can still manage the assets during your lifetime, you must assign beneficiaries who will receive distributions after you're gone. The main advantage of this type of trust is the potential to save on taxes.

Benefits of Irrevocable Trusts:

• Estate Tax Advantage: Assets placed in an irrevocable trust are not subject to estate taxes when you pass away. This can be a significant advantage, especially if your estate is valued above a certain threshold, currently around $12.92 million (lifetime exemption)

• Income Tax Advantage: Any tax obligations from assets (e.g. capital gains) in an irrevocable trust are the responsibility of the trust itself, not you. This means the trust has its own taxpayer identification number and may even be set up in a state with no state-income tax, potentially reducing your overall tax burden.

By using trusts, you can optimize your estate planning, taking advantage of both estate and income tax benefits.

Let’s sum up:

1. Revocable Trusts for Simplicity: If you want to organize your finances and ensure a smooth transfer of assets to your beneficiaries, a revocable trust is a great option. Think of it as an "insurance" for your assets while you're alive.

2. Consider Irrevocable Trusts for Tax Savings: If you anticipate your estate will exceed the lifetime exemption threshold of around $12.92 million, setting up an irrevocable trust earlier can help you avoid estate taxes on those assets. Additionally, assets in an irrevocable trust can grow without being subject to estate tax, though they may still be subject to capital gains tax upon distribution.

Growth company executives may want to contribute stock when it is worth a low amount, using a small portion of their exemption, and the subsequent growth will not be subject to estate tax (the growth will still be subject to capital gains tax).