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By Michael E. O'Connor, Esq.

 

PLANNING FOR THE FAMILY AND THE FUTURE

 

 

           Regardless of what financial circumstances you may find yourself in during life, some thought must be given to how things would change when you die. The loss of a loved one is always emotionally traumatic.  It can also create a financial disaster.  Estate planning is an activity meant to limit the financial disruption caused by death.  Planning also will assure that the needs of your young children are met, that estate tax and income tax is eliminated or kept to a minimum, that a disabled child or parent is cared for, and that your widow (or widower) has adequate resources to live comfortably after you are gone.  Here we will look at several important issues in planning for future life and death.

 

           In the estate planning process, you should be dealing with a lawyer experienced in that field.  Often on larger estates, an accountant, life insurance agent, financial planner and bank trust officer will participate in the planning process.  The legal cost of estate planning varies substantially depending upon the complexity of tax issues, the need for unusual drafting in a will, and the amount of the lawyer's time required.  It is safe to say, however, that the cost of good planning is modest.  This is particularly true when comparing the cost to the expense of tax and legal difficulties which can result from an unplanned or poorly planned estate.

 

           A.       The Will

 

           The cornerstone of the typical estate plan is the will.  A will is a written document, executed under formalities required by law.  Among many other objectives which the will can serve, it provides for the disposition of all property owned outright at death.  A will can be changed any number of times, and it is only the last will, existing at death, which controls the disposition of the property.  A person may leave property in any way he or she chooses. This could be outright or "in trust".  There are very few limitations placed by the law on how property can be left.  There is a right created in a surviving spouse, however, to benefit from the estate.  Even if totally disinherited by a will, a surviving spouse may have a right to take a share of the estate.  This is called the "right of election".  The right of election is the greater of $50,000 or 1/3 of the estate.  The amount of the "estate" for purposes of this right of election includes joint property, certain gifts made before death and property in some types of trusts.   This right can be waived by a written agreement, known commonly as a pre-marital agreement.  In the case of second marriages, this agreement is used to protect the inheritance of children of the prior marriages.

 

           One unfortunate aspect of wills is that the terms can turn family members against one another.  A disfavored child who receives nothing under the will may be in a position to contest its validity.  You must be competent and not under undo influence in order to execute a valid will. If a disgruntled family member can convince a court that you were not competent, or that someone psychologically forced you to execute the will, then it can be declared invalid.  In that event, the contestant could share in your estate as if there were no will.  These will contests take up much of the time of the Surrogate's Court which supervises the administration of estates.  They tend to be very costly in legal expense and emotional distress.  It is critical therefore, in planning an estate, that every effort be made to avoid such a contest, or to minimize the risk of it.

 

           B.       When There Is No Will.

 

           A person who dies without a will is called an "intestate".  When you forego the right to make a will, the law effectively makes one for you.  New York law provides that the property of an intestate passes to family members as the statute provides. 

 

           Contrary to popular opinion, the State of New York does not receive any of your property except where there are no descendants of any grandparent, and no will.  Since this would include descendants of all cousins, it is extremely rare for an estate to pass to the State of New York.

 

           A more relevant problem is found in the way the legislature has chosen to dispose of your property if you have no will.  For example, if you are survived by a spouse and children, the spouse will not necessarily receive the entire estate.  Following is an illustration of how property passes when there is no will. Very seldom does this represent the wishes of the decedent, but it becomes the will, by default, nonetheless.

 

THE LAW OF INTESTATE SUCCESSION

 

N.Y. Estates, Powers & Trusts Law

 

If you are survived by:

Then the following people share in your estate:

Spouse & any child or children of deceased child

Spouse:  $50,000 and ½ residue

Children: the remainder by representation*

Spouse, no children

Spouse:  All

Children and no spouse

Children:  All by representation

Parents, no spouse, no children

Parents:  All

Brothers & sisters or their children, no spouse, no children, no parents

Brothers or sisters or their descendants:  all by representation

Grandparents or their descendants

All to grandparents or to their descendants in the nearest degree of kinship (per capita)**

 

 

*BY REPRESENTATION:  Children of deceased persons who would otherwise share in an estate take their parents' shares, divided equally among those on the same generational level.

 

**PER CAPITA:                 All to those in the nearest degree of relationship who are living. Nothing goes to the descendants of a deceased person if anyone is living at the higher level of relationship.

 

 

           C.       Substitutes for a Will.

 

           The will is not the only way of passing property at death.  Forms of ownership and beneficiary designations can also take care of transfer at death.  These will be discussed in more detail later.  A planning tool whose use has become very popular in many parts of the country is the revocable living trust.  This is a trust you create by agreement during your life.  Like the will, it has a provision for disposition of the property after your death.  You retain the right to revoke the trust, change the trustee, or amend the trust, making it very flexible.  At your death, the property passes out of the trust to the beneficiaries you have chosen.  In a sense, it serves as a substitute for the will.  It has an important additional advantage in that it can serve to assist you with management of your financial affairs should you become incapacitated by a stroke or other illness or injury.  While the trust has no tax advantage, it can be a valuable tool, particularly for the older person who is beginning to need assistance with financial affairs.  The cost of creating such a trust and funding it is much greater than making a will generally, which may account for its lack of widespread use in New York.

 

           There were many tax and non-tax disadvantages to use of a revocable trust, but many of these disadvantages were eliminated by federal and New York legislation. Further discussion is found in the chapter on Trusts later in this booklet.

 

MINOR CHILDREN IN THE WILL

 

           If you are young enough to have children who have not left home, the most important consideration in making a will is likely your concern for the children.  This concern should apply both to how children are to be raised if they are orphaned, and how the combined property you may leave should be protected, invested and spent for their benefit. 

 

           A.       Raising the Children.

 

           As a parent, you have a legal right to custody of your children.  That is the natural law and state law which allows you to raise your children and to make decisions on their behalf.  If one spouse dies, the survivor has the same right.  If both you and your spouse die, however, there is no one who automatically receives a similar right.  As parents, you have the opportunity to designate someone to act as guardian of the person and property of your children.  In New York, a guardian is appointed by the Surrogate's Court, which is the same court which administers estates.  Unless it can be shown that the appointment of your designated guardian would be contrary to the welfare of the child, your choice will be followed by the court.

 

           All children in the family could have the same guardian, or different ones could be designated for each.  Usually, the same person is chosen, and is designated as the guardian of the person and of the property of the child.  The guardian of the person is the substitute parent who would take the child into his or her home.  The guardian of the property would be in charge of the administration of any funds owned outright by the child.  It is possible that one person could be designated as guardian of the person and another as guardian of the property.  A guardian's authority continues on only until the child reaches age 18.  At that point, the guardian's legal authority ends, but the child may of course continue living in the guardian's home if that is agreeable to both.  Any property held by the guardian for the child must be released to the child at age 18 which is a problem in the eyes of most parents.  It is for this reason, among others, that good estate planning calls for the use of trusts to handle funds for minor children, rather than depending upon guardianship.  If the plan is properly structured, there should be no funds coming into the hands of the guardian other than that amount needed for the actual expenses of raising the child.  Another problem of a guardian handling the child's property is that the court subjects the guardian to very strict controls.  In most instances, nothing can be paid from the child's funds without the court approving the expenditure.  Getting the permission can be a very cumbersome and expensive process. Worse, the decision on what to spend and when to spend it is placed with a stranger (the judge) rather than a family member or other trustee of your choosing.  As a result, our estate planning objective is usually to prevent any property from being placed into the hands of the guardian of the property of an infant child.

 

 

           B.       Trusts for Children.

 

           The most flexible solution to the problem of handling the children's funds is to create a trust under your will.  If the children were orphaned, the entire estate could be divided equally among the children and then held in a separate trust for each.  This would allow each child to receive his or her share upon reaching whatever age you designate (often 21).  Except in the very large estate, however, this may fail to address all of the parental concerns.  It is quite possible that at the parents' death one child will be an adult, finished with education, and living independently, while another is looking forward to the expenses of education and the need for continued support.  If you pay the educational expenses of the older child, would it be fair then to give that child a full share, while charging the younger child for his own education, to be paid out of his own share? What if the fund available to the younger child is not sufficient to provide for all his or her needs?  The solution is to use a single trust for the benefit of all children.  This is referred to as a "sprinkling" trust.  It gets that name from the fact that the trustee is allowed to use the income or principal of the trust for the needs of any of the children, without treating them equally.  Such a trust would terminate when the youngest child reaches age 21, or whatever other age you choose.  The older child is disadvantaged somewhat by having to wait for outright delivery of the property, but the younger child is protected.

 

           When we consider the extent of our property, it is common to overlook very valuable assets.  For example, life insurance may be provided through employment, or you may own substantial individual coverage.  While you are living, the insurance represents more of a liability than an asset, since the premium must be paid. Planning for a trust for your children, however, should include consideration of the proceeds of the insurance. 

 

           Careful thought should be given to how and when you want your children to take their share outright. Apart from protecting the needs of the youngest, many people chose to structure the termination of the trust so that each of the beneficiaries receives the final share in stages.  We all hope that our children will gain in maturity as they age.  If they might make an irresponsible decision about how they would spend their money at age 21, perhaps they would have more wisdom at age 25.  By calling for distribution of one-half of their share at age 21 and the balance at age 25, you may "hedge" the bet on their maturity.

 

           C.       529 Plans.

 

           Internal Revenue Code §529 created a state sponsored college savings plan which has very generous tax benefits.  It is an excellent alternative to consider when saving for the education of your children or grandchildren.

 

           A 529 Plan is an investment account owned by one individual.  It must have a single beneficiary.  So long as the benefits are paid out for tuition, fees, room and board, books, supplies and required equipment of the beneficiary, then the earnings in the account are totally income tax free.  Such expenditures may be paid at public or private colleges or universities in or out of New York State.  They also may be paid for trade or vocational schools.

 

           Presently under the annual gift tax exclusion, a gift made to a minor beneficiary would be limited to $13,000 annually (from one donor) before there is an effect on the estate tax of the donor.  An exception is made for 529 Plans which allows 5 years of annual gift tax exclusions to be put into the plan at one time.  In other words, one individual could contribute $65,000 to the plan of one beneficiary without any adverse tax consequence.  So long as the donor lives through the 5 years following such a contribution, it would be totally gift tax free.  If death occurs prior to that, then some of the gifting would have an impact on the donor’s estate tax.

 

           The sponsors of such plans include most major mutual funds.  The official sponsor of the State of New York plan is Upromise, an investment organization.  The investment manager of the plan is Vanguard.  If the account is opened with Upromise, then the donor can deduct up to $5,000 per year from New York taxable income (or $10,000 on a joint return).  If it is opened with a different sponsor, then that New York deduction is lost, but all other benefits continue.  The website for the New York plan is nysaves.uii.upromise.com.   

           Apart from the tax benefits, there is a substantial amount of flexibility in such plans.  First, the beneficiary can be changed by the owner. If such an account was opened for a new born, and as the child reached his or her teens, decided that continued education was not likely, the owner could change the beneficiary of the account to another child who did have educational plans.  Only if the funds came out other than for education would there be income tax on the growth in the fund.  In such a case, there would also be a 10% penalty.  If the need arose however, the owner of the account could even take the funds back by paying the income tax on the growth and suffering the 10% penalty. 

 

           Overall, the attraction of the §529 Plan is:

 

·       More substantial gifts can be made for the education of each child.

·       The beneficiary of the account can be changed to a different child if necessary.

·       A New York income tax deduction for contributions may be available.

·       The earnings in the account will be income tax free if they come out for education.

·       The money may be taken back by the owner.

          

 

LEGAL SERVICES, EXECUTOR, TRUSTEE AND GUARDIAN

 

           The services of an attorney are critical for the estate plan to work properly.  Family and financial circumstances dictate how simple or complex the process of planning one's estate will be.  The client with modest assets and a few adult beneficiaries may need nothing more than a properly drawn will.  Levels of complexity are added by the need to deal with minor children, for estates with sufficient assets to cause federal estate tax to be due, for plans for the disposition of a closely held business, for problems of children with special needs, and concerns about preservation of assets from nursing home costs.  Each of these problems, and the many others which can arise, cause the cost of estate planning to become higher.  Without exception, the cost involved in proper planning is very small compared to the cost incurred if the estate is not planned.  For example, failing to provide for credit shelter trusts for the estates of a couple with a federally taxable estate could cause extra estate tax to be due of $300,000 or more.  The person who does not adequately plan for asset preservation when nursing home care becomes necessary could find all of his assets lost to the nursing home care. This is in spite of the fact that substantially all of the assets might have been protected with proper planning. Similar disasters may befall the younger couple when one spouse dies and it is learned that only part of the estate will pass to the surviving spouse, with the rest going to the children.

 

           Lawyers typically charge on an hourly basis for their services.  Evaluating the cost which will be incurred in a particular project is more difficult, however, than it would first appear.  A broad inquiry would find that one attorney might have an hourly rate of $100 and another an hourly rate of $200.  Does this suggest that the lower hourly rate attorney is a bargain?  Not necessarily.  If an attorney is an experienced specialist, the estate planning project is likely to be something he or she does on a very regular basis.  The result can be that far less time is expended in doing the work than would be the case with an attorney with less experience in the field.  What could be a routine project for one attorney may be a novel one for another, requiring research and a great amount of custom drafting of documents. The cost of the final project may not vary substantially from one to the other.

 

           Most attorneys concentrate their practice to a great extent.  Unlike the medical profession, however, the concentration of legal practices is not as widely known to the public.  Finding the practitioner with the appropriate skills, who will handle the matter promptly and at a reasonable cost can be difficult.  If a friend or relative has had a similar problem in the same field of law, it makes sense to consider their experiences.  Do not hesitate to discuss the proposed engagement in advance with a lawyer.  In addition to hourly rate, discuss the estimate of what the total cost of the project would be.  This type of estimate would be difficult to give, however, prior to full discussion of the circumstances of the case.  Until it is clear what has to be done, it is impossible for the attorney to guess what it might cost. 

 

           The same considerations that apply to legal services in estate planning also apply to such services in estate administration.  Handling the legal services in the administration of an estate is far more involved than estate planning usually.  They can, however, vary dramatically from estate to estate depending upon the circumstances.

 

           An attorney’s role in an estate administration begins with the probate of the will.  This is a process in Surrogate's Court which may be fairly simple or very complex, depending upon the age of children, possible mental incapacity of a necessary party or objections which may be filed to the will.  Its purpose is to have the court declare the will as valid.  Other tasks undertaken by the lawyer include obtaining release of assets, preparing the decedent's final income tax returns, filing of estate income tax returns, handling the sale of real estate, preparation of federal and state estate tax returns, preparing a final account of the executor for the beneficiaries, and settlement of the estate.  Because the amount and complexity of the work may vary so greatly from one case to another, it is not possible to apply a simple formula to determine what the fees will be.  Once all of the circumstances of the estate are determined, typically in a first meeting, it may be possible to fairly accurately estimate the costs and what disbursements will be needed (such as filing fees, etc.).  As with all legal services, it is good practice to have an understanding of how the fee will be set, even though it may not be possible at the outset to determine exactly how much it will be.

 

           A.       Executors.

 

           The duty of an executor is to obtain the probate of the will, marshall the assets, pay the decedent's bills, file all necessary tax returns and then carry out the distributional scheme contained in the will.  An administrator who is appointed when there is no will has the same duties, except that the distribution at the conclusion of the estate is provided by the law rather than by will.  It is most common for one of the primary beneficiaries to be designated as executor. The advantage of this is that a major beneficiary is less likely to claim the statutory commission he or she is entitled to.  This can represent a major savings.  For example, an executor of an estate of $250,000 is entitled to $11,000 in commission.

 

           An inexperienced executor would usually not be capable of carrying out all of the duties involved, but the function of the attorney includes guiding him through each step, to a prompt and proper conclusion of the estate.  Banks with trust powers may also be designated as executor under a will, as can other individuals or advisors.  This is most useful when there is no appropriate beneficiary to act, or when friction is expected among the beneficiaries.  Since the executor's duties are relatively short term, investment expertise is not as important.  An executor is typically liquidating investments or distributing them in kind to the beneficiaries.

 

           B.       Trustees.

 

           A trustee, unlike an executor, looks forward to long term duties.  A trustee might be appointed to handle the funds for minor beneficiaries, and the trust could go on for many years.  A trust might even run for the entire lifetime of a beneficiary. Investment expertise becomes more of a concern in such cases.  A will or trust agreement can provide that a trustee has authority to hire investment advisors or otherwise obtain outside expertise.  It is more common, however, to see a bank appointed as trustee than as executor.  

 

           In addition to investment decisions, a trustee may be called upon to decide when distributions of principal should be made to the beneficiaries.  Such a decision is better made by a family member, so the appropriate choice might be to name both a bank and a family member as co-trustees. The bank's investment expertise and the individual’s knowledge of the family could then be combined for the best result.

 

           C.       Guardians.

 

           When one has underage children, a major concern in making a will is the designation of guardian. A surviving parent who is able would almost always act as the child's guardian.  If both parents are deceased the court will appoint someone to act in that capacity.  It is very important, therefore, that the parent's preference be contained in the will.

 

           There are two aspects to guardianship.  One is guardianship of the property of an infant.  This would involve the management of funds which the child owns in his or her own name.  A child under the age of 18 may own property in New York, but has no capacity to take charge of it.  A guardianship of the property is a very cumbersome and expensive way of handling a child's funds.  A large part of the estate planning process involves avoiding any funds being left in the control of the guardian of the property.  The creation of a trust under the will for minor children substitutes a method of handling such funds which is far superior.

 

           The other aspect of guardianship is called the guardianship of the person.  The guardian of the person is charged with taking the child into his or her home and acting as substitute parent.  In choosing a guardian to designate in the will, it is very important that the person have child rearing skills and attitude compatible with the parent's philosophy.  The responsibility of a guardian is substantial, so it advisable that the designation be discussed with the person in advance.  While the same person may hold the position of executor, trustee or guardian, one may also chose a different person for each.  This allows the greatest skills to be applied to each of the jobs.

 

TAXES IN THE ESTATE

 

 

           There are taxes which affect the transfer of property at death, and require consideration when making gifts even during life.  With larger estates (those over $1,000,000), a great deal of the time spent in estate planning has to do with minimizing or avoiding the impact of estate taxes.  Smaller estates, while not requiring extraordinary planning for tax, should still considered it.

 

           Both the federal and state governments have estate taxes which can impact the estate. New York completely exempts an estate under $1,000,000.  New York has repealed its gift tax completely.

 

           As of the preparation of this chapter (March 25, 2010) there is no federal estate tax in effect.  It has been repealed pursuant to 2001 legislation.  Under the current law, the federal estate tax is scheduled to be “born again” for those who die January 1, 2011 and after.  The exemption under that new tax will be $1,000,000.  The maximum marginal estate tax rate will rise up to 55%. It is possible that the federal estate tax will be amended to provide for some other exemption and some other rate.  It is even possible that the tax will be retroactively changed so that 2010 will stop being a year without any federal estate tax.  Those issues will have to await government action.

 

           For those who die in 2010, there is a degree of substitution of taxes involved. While there is no federal estate tax, capital gain tax on accumulated appreciation will apply. Under previous law (and future law if legislation is not passed) the capital gain basis of assets owned at death were “stepped up” to the date of death value.  In this way all of the capital gains disappeared and the inheritors incurred no capital gain tax when selling the property, except to the extent it appreciated from the date of death.  Under the present carryover basis rules the executor or other estate representative would have $1,300,000 of basis adjustments which could be applied to assets in the estate.  If the capital gain exceeds that, then there would not be total “stepped up” basis.  There is also potential basis step up for property passing to a spouse, and that step up could equal a further $3,000,000.  These rules are complex and temporary.  No action or planning should occur without carefully considering them.

 

           The property subject to the tax system is all encompassing.  Real estate, stocks and bonds, bank accounts, life insurance proceeds, pension and profit sharing plans, IRA's, and almost everything else that might have any value is counted as part of the gross estate if you own it when you die.  The fact that an investment may be income tax exempt does not exempt it from the estate tax.

 

           While the gross estate contains everything owned at death, there are a number of deductions and credits which can reduce or eliminate the actual tax liability.  In addition to debts and estate expenses, the estate is entitled to deduct everything which passes to a surviving spouse.  This is called a marital deduction, and it has no limitation.  It becomes relatively simple therefore to eliminate all of the estate tax in the estate of the first spouse to die.  When the combined assets of both spouses could exceed the amount of the exemption allowed, the full use of the marital deduction in the first estate can cause a substantial extra tax to be due in the second estate however.  It is this second estate tax which can be reduced or eliminated by careful planning.

 

           The gift tax uses the same marital deduction rules, the lifetime exemption is limited to $1,000,000, even though a much larger estate could avoid estate taxation.  One extra benefit is allowed with the gift tax, called the gift tax annual exclusion.  This allows you to give up to $13,000 to each individual, each year, with no gift tax, and without using the unified credit.  A married couple could give $26,000 to each child each year, for example.

 

           Generally, if you expect your combined assets to amount to less than $1,000,000, no planning may be necessary to deal with it.  Unless there is some non-tax reason to do otherwise, you can simply leave what you have to your spouse, and then to children at the second death.  If there is any chance of an estate tax being imposed, however, the problem should be addressed by proper planning.

           There are numerous sophisticated techniques available to dramatically reduce or even eliminate a federal estate tax.  The effectiveness of each depends upon planning taking place as early as possible. The details of such planning are beyond the scope of this booklet.  Many are discussed in "Beyond the Basics".

 

 

PLANNING FOR THE NURSING HOME

 

           As the cost of skilled nursing home care skyrockets, more and more people want to investigate methods available to protect their assets from future possible nursing home expense.  We try here to briefly describe the rules of eligibility for Medicaid and to review some of the latest changes in the law and techniques for dealing with them.

 

           A.       Medicaid. 

 

           Medicaid is a joint federal and state program which provides medical benefits to the indigent.  It is not an entitlement program like Social Security, and you must be impoverished to one degree or another in order to qualify.  It should also be distinguished from "Medicare" which is an entitlement program under Social Security.  Apart from very limited hospital recovery periods and therapy, Medicare does not cover nursing home care.  Neither does the usual private or group medical insurance policy cover it.

 

            You must "spend down" your assets before Medicaid will begin to pay.   A single person is allowed to keep $1,500 in a burial account and $13,800 in other savings or other non-exempt assets.   You may also prepay the expense of a funeral, but the payment must go into an irrevocable burial trust maintained by the funeral director, so you have no right to its return.  Your home may be retained, but only so long as there is a prospect of intent of your returning to it.  The value of an exempt home is limited to $750,000.  When that prospect no longer exists, the house must be sold and the proceeds applied to the nursing home expense.   You are allowed to keep furniture, personal effects and other tangible property actually used, and an allowance out of income of $50 per month for personal needs. Any amount not expended for such personal needs each year must go to the nursing home, and cannot be accumulated.

 

           If the Medicaid applicant is married and the spouse is still living in the community, that community spouse is entitled to protect a greater level of property.  The spouse may retain the home, furniture, automobile and most other tangible personal property used in conjunction with it.  The spouse may also retain cash, securities and other assets with a minimum value of $74,820 and a maximum value of $109,560 (indexed for future inflation). Out of income, the community spouse may keep up to $32,868 per year or $2,739 per month (also inflation indexed). Amounts paid through Medicaid for a patient over age 55 are recoverable from the patient's estate (typically through sale of an exempt homestead).

 

           B.       Long Term Care Insurance. 

 

           Long term care insurance which pays nursing home expenses has been available for many years.  There were a number of pitfalls involved in such policies, and the high premium caused them not to be widely used.  Under a program developed through the auspices of Robert Wood Johnson Foundation, a product is available which may better serve the needs of senior citizens. A policy under this plan must provide a minimum benefit of $189 per day for skilled nursing home care or $95 per day for home care.  The benefit amount must also be adjusted upward for inflation at 5% compounded annually.  The coverage must be for three years in the case of skilled care or six years of home care, or any combination.

 

           The advantage of purchasing such a policy is that when the coverage term runs out (after three years of nursing home or six years of home care) the State of New York will qualify you for Medicaid without requiring any of your assets to be applied to the care.  Only income would have to be considered, after which Medicaid would cover the balance. The policy, therefore, eliminates the need to gift assets in anticipation of Medicaid or to create a trust to hold such property.

 

           There are a number of circumstances which could make this insurance alternative very unattractive.  For example, an applicant for a policy must show medical insurability.  A pre-existing condition or other health problem could eliminate the opportunity to purchase the insurance, or the premium could be increased to cover the increased risk.  The premium on the coverage would also increase dramatically with age.  An older applicant might find it prohibitively expensive, or even unavailable.  If the assets owned consist primarily of pension or profit sharing plans, the mandatory payments after retirement may be considered income rather than principal. Since income must be applied to care, this would prevent protection of those amounts.  In the right circumstances, however, and as part of a carefully constructed plan, the long term care insurance can be very beneficial.

 

           C.       Gifts and Medicaid. 

 

           The Deficit Reduction Act of 2005 made sweeping changes to Medicaid eligibility. In the process of applying for Medicaid, the "available resources" of the patient are verified and calculated.  Such available resources must be spent down before Medicaid begins paying for the nursing home care.  The principal recipient of the spend down would normally be the nursing home.  In measuring the available resources, the value of gifts made within 60 months preceding the Medicaid application (or preceding the institutionalization if later) are presumed to have been made in order to qualify for Medicaid. This applies regardless of whether the gift was made by the patient or spouse.  The length of ineligibility depends upon the size of the gift and the "average" cost of care for a private patient in a nursing home as established for Medicaid. For example, assume the average nursing home rate in the area of the state where the patient lives was set at $7,500 per month.  If the patient transferred $30,000, the amount of the transfer ($30,000) would be divided by the average monthly cost ($7,500) to determine the length of the disqualification, and the result would be 4 months.  The penalty period begins to run on the date the patient would be otherwise eligible for Medicaid, other than for the gifting.  Gifting within 5 years of nursing home need has become very unlikely to work to the families’ advantage.

 

           Since outright gifts made within 60 months of the Medicaid application are considered, the 60 month period is commonly referred to as a "look-back".  If there are no gifts within the look back period, then there will be no disqualification.  This would be so even if a very large gift was made just before the look back period.  If a gift is found to have been made within the 60 month period, the disqualification period has no limit.  For example, if a gift of $300,000 was made 61 months before the Medicaid application, it would be outside the look back period and would cause no disqualification. If that same gift was made two months later, so that it was 59 months prior to the Medicaid application, it would be considered. Needless to say, extreme care must be used when structuring any gift and timing of application when the donor's future eligibility for Medicaid is at issue.

 

           While $7,500 is assumed here as the average monthly nursing home rate to compute gift disqualification, the actual rate is set by the state.  In January, 2010, the rate for Central New York was $7,264.  Other areas of the state are different (all higher).  The rates are adjusted each year by the state.

 

           D.       Exempt Transfers.

 

           Transfers of assets to a spouse or to another for the sole benefit of the spouse will not affect eligibility for Medicaid. 

 

           Special exemptions apply to the transfer of the homestead to a minor, blind or disabled child or transfer to a sibling who has an equity ownership interest and one year or more of residence in the property immediately preceding the patient's institutionalization.  A son or daughter who lives in the home as a care giver for at least two years before institutionalization may also be the recipient of an exempt transfer.

 

           E.       Using Trusts. 

 

           People typically have a desire to protect assets from the costs of nursing home care.  At the same time, they will have a desire to retain the assets they own for their own needs (other than nursing home) or to maintain maximum control over those assets for as long as possible.

 

            The law has established a set of rules concerning self-settled trusts.  These are trusts which are established during life by an individual (or spouse) whose eligibility for Medicaid is being determined. "Self-Settled" in this context, refers to a trust into which assets of the patient or spouse were transferred.  The law still allows a third party (other than a spouse) to create a trust, either during life or by will, and to put any restrictions on the use of those funds he or she may wish. It is only with regard to assets of the patient which find their way into the trust that the limitations apply. Further, a spouse may restrict the use of principal and income of the trust so as not to make it available for nursing home care so long as the trust is testamentary (created under a will). Such flexibility would not apply to an inter vivos (living) trust which contains property of the patient or spouse.

 

           The principal and income of a revocable trust are treated as an available resource to the patient who is a beneficiary of it.  If property is transferred out of a revocable trust to someone other than the patient, the transfer is a gift, subject to a disqualification. 

 

            A safe harbor trust has been authorized which may be very beneficial in certain circumstances. The assets of a disabled individual who is under the age of 65 may be transferred into a trust which is established for the individual by a parent, grandparent, guardian or a court.  The trust can be designed to protect the assets in it from the expenses of Medicaid care of the individual, while at the same time qualifying him for Medicaid.  The remaining corpus of such a trust must be made available at the beneficiary's death to the State of New York to reimburse for medical assistance paid on his or her behalf during life.  The trust property could be used for the special needs of the beneficiary, beyond medical and custodial care needs.  Such a trust would provide protection for a patient whose condition is expected to improve.  It would allow for assets to be preserved so as to provide benefit upon leaving the institution.  A collateral benefit of this trust is that it allows for prompt qualification for Medicaid, and therefore eligibility for the lower Medicaid nursing home rates.  Since Medicaid pays substantially less than the private pay rate for nursing home care, a substantial cost advantage is enjoyed.

 

           F.        Alternatives for Gifting Property. 

 

           If you desire to transfer property in order to assure qualification for Medicaid in the future, there are a number of alternative ways of proceeding.  Each alternative has advantages and disadvantages to you.  Generally, as the level of retained control over the assets transferred increases, the risk of possible attack on the transfer increases.  On the other hand, the safest transfers leave you without any control of the transferred assets.  Let us assume the expected nursing home patient is the parent and the recipient of the gift is the child.  Here are some of the alternatives:

 

                      1.    OUTRIGHT GIFTS.

 

                     ADVANTAGES:

 

a.   Simple and inexpensive to accomplish.

b.   Safe if at least 60 months separate gifts from Medicaid need.

 

                             

                            DISADVANTAGES:

 

a.   Parent must part with absolute ownership of gifted assets. Very few individuals find this acceptable.

b.   Child receives capital assets at parent's income tax basis. When later sold, substantial capital gain tax might then be incurred.

c.   Child might die or lose the gifted property to his own creditors or in a matrimonial break up.  If child represents that he will keep the property and give it back as needed, this promise may become impossible to fulfill.

d.   Children who have been paid their inheritances in full tend not to be as attentive as those who have only a expectancy.

e.   If a child has college age children and is applying for financial aid, the assets gifted from the parent and the income produced may limit the financial aid.

f.   If residence is transferred without retained life use, a senior or veteran’s exemption from real estate tax would be lost.

 

 

                      2.   GIFT OF HOUSE WITH RETAINED LIFE USE.

 

                     ADVANTAGES:

                                

a.   Parent is assured continued occupancy of the house for life.

b.   Parent is not parting with an asset which would typically be used for other purposes than shelter.

c.   Because property given with a retained life use is includable in the parent's estate for estate tax purposes, the income tax basis on the property is stepped up at death, thus eliminating capital gain problem.

d.   If the property is sold prior to parent's death, at least part of the capital gain exclusion on personal residence may still be available.

 

                            DISADVANTAGES:

          

a.   If parent decides to move to another area of the country it may be difficult or impossible to sell the property and reinvest the proceeds in another residence because of the child's involvement.

b.   There is a completed gift at the time the deed is delivered.  This requires gift tax returns.  The value of the gift is complicated by the retained life use.  If a husband and wife own the house together, two sets of gift tax returns may be required (one for each spouse).

c.   This transaction can be more expensive to carry out than the outright gift of cash or securities.

d.   Disability, death, insolvency and marital problems of the child can affect the title.

e.   If the parent enters a nursing home and qualifies for Medicaid, the Department of Social Services may claim the right to income from the property rental.  If the property is sold, they will want a portion of the proceeds of sale which represents the value of the remaining life use.

 

                      3.   MEDICAID TRUST.  The Medicaid Trust is an irrevocable retained income trust.  It typically provides that income will be paid to the parent during life, and at death the remaining principal will be paid to the children.  There should be no right of invasion of the principal for the benefit of the parent.  Parent may retain a limited power of appointment to redirect the disposition of the property among the children if one has health or financial problems.  Such a retained power of appointment causes the gift to be incomplete for gift tax purposes, which eliminates the need for paying gift tax. 

 

                            ADVANTAGES:

 

a.   A protected income stream is preserved for the parent, not available from the other alternative methods.

b.   Such a trust is fashioned to be includable in the parent's taxable estate upon death.  In this way, the income tax basis of the assets in the trust are stepped up, eliminating capital gains tax.

c.   If the residence is contained in such a trust, it can be sold and the trustee could purchase a replacement residence in another locale if appropriate.  If parent moves into an apartment, the house proceeds would be available for generating additional income.

d.   Capital gain exclusion could be fully available.  Special drafting care must be taken however to preserve the exclusion.

e.   This method prevents the problem of the taxable income from the parent's property being taxed on the income tax returns of the children. Since the parent is entitled to all income, it is income taxable to the parent.

 

                            DISADVANTAGES:

 

a.   The trust assets will not be available for the needs of the parent. This could prevent use of privately paid home care which would be preferable to the patient, but which may not be available under Medicaid.

b.   The trust terms are irrevocable.  If there is any change in law or regulation which jeopardizes such a trust, there may not be flexibility to adjust.

c.   Debtor-creditor law may jeopardize the effectiveness of such a trust as a fraud on creditors.  The law on this subject is only now developing.

d.   Such a plan is more expensive to put in place and to maintain.

e.   It is best to have a trustee who is not a beneficiary under the trust.  This may be difficult for the parent and perhaps unacceptable.

 

           Planning for the problems of the nursing home and Medicaid have become an important element in the estate planning of every person who approaches old age, and even among some in middle age.  There are many "tools" to use on the problem, but all require that the problem be addressed well before actual nursing home admission.  Each of the alternatives are fraught with legal and tax ramifications which must be very carefully considered before proceeding, and the appropriate solution must take into account the circumstances of each individual and family. 

 

THE MANY WAYS PROPERTY PASSES

 

           When we think about the property passing at death, it is always the will which comes to mind.  By no means, however, is the will the only method of creating a benefit for loved ones at death.  In fact, several other methods are very commonly used, sometimes without even recognition of the consequence.  We can refer to these various methods of transfer as "will substitutes" because of the way they operate.

 

           A.       Joint Property.

 

           All sorts of property can be owned by two individuals as joint tenants with right of survivorship. An important aspect of this type of ownership is that upon the death of one of the named owners, the other becomes sole owner of the entire asset.  We see joint ownership used most often with bank accounts or securities.  Joint ownership could be created in real estate, a car or other tangible property or in business assets.

 

           Once such ownership is created, the passage of the property to the surviving joint owner is automatic at death.  Although this provides simplicity, there are a number of consequences to joint ownership which are typically ignored or overlooked.

 

           When you add a name as a joint owner on your bank account, immediate rights are created for that owner. For example, the joint owner would be free to draw upon the bank account just as you could.  If you removed him from title on the account, or withdrew all of the funds, he might sue you for return of the one-half belonging to him. Similarly, if the joint owner got into financial difficulty, or entered a nursing home, his creditors would look to take his one-half.  This is so, even though you supplied all of the funds to create the account.

 

           With certain types of property, the creation of a joint ownership constitutes a gift for gift tax purposes.  If the value attributable to the new joint owner exceeds $13,000, a gift tax return could be required. When you die, the same property could be taxable in your estate for estate tax purposes.  If property is jointly owned between husband and wife, only one-half of the value is includable in the estate.  If the joint ownership is with anyone other than the spouse, there is a presumption that the owner who died provided all of the funds, and that the entire account is therefore taxable.

 

           Joint ownership is a very poor method to choose for handling ones financial affairs.  Very often an older person will put a child's name on the bank accounts so the child can help pay the parent's bills.  Upon death, there will be a presumption that the accounts were not so titled for convenience, but rather that the child was meant to receive all the money in the account.  This is not always the desired result from the parent's standpoint.

 

           B.       Totten Trust Accounts.

 

           Another method of owning a bank account is the Totten Trust.  This is not truly a trust, but rather a beneficiary form of bank account ownership.  You will typically see the title of such an account read "John Doe in trust for Mary Doe". Unlike the joint bank account, the Totten Trust does not pass rights to the beneficiary when it is created. Only at the death of the primary owner does the beneficiary receive the funds.  The owner is free to remove the beneficiary designation at any time, or to change it to someone else.  In fact, the owner can even change or remove the beneficiary designation on a Totten Trust by the terms of his will.


 

           An important advantage of the Totten Trust is that it eliminates many of the risks of joint ownership.  It has no tax advantage, but at the same time is has no disadvantage.  All funds contained in such accounts are fully includable in the estate of the owner for estate tax purposes.

 

           In an extremely simple situation (for example a widow or widower with only one child) the Totten Trust account can be a very useful estate planning tool.  As the number of beneficiaries begins to increase, however, the chance of confusion and unfairness also increases with the Totten Trust.  For example, if one were to create three equal bank accounts for each of three children using the Totten Trust account it would first appear that they would all benefit equally at the owner's death.  It is not necessarily so.  As the owner needs funds to pay bills or for other reasons, he will not likely withdraw from each account in an equal amount.   This will result in one child's account being significantly smaller than another, or even being depleted entirely.  The Totten Trust account does not provide for any method of correcting such inequities the way a will could.  If a Totten Trust beneficiary dies first, the account would pass by the owner's will (not to the children of the beneficiary).  This can create yet another unfair distribution.

 

           C.       Real Estate Titles.

 

           Real estate may be owned as joint tenant with right of survivorship.  When a husband and wife take title together, this creates a tenancy by the entirety.  This is a type of joint ownership which results in the surviving spouse owning the entire property, just as with joint ownership.

 

           Real estate title may also be held as "tenants in common".  Unlike joint tenancies, the surviving tenant in common does not own the entire property.  If two owners have a tenancy in common and one dies, the fifty percent (50%) share of the decedent would pass pursuant to his will or by intestacy, not necessarily to the other tenant in common.  The ownership shares of a tenancy in common are not specifically identified in the property.  For example, one does not own the left side and the other the right of the property.  Rather, the entire property (undivided) is owned in percentages by each.

 

           D.       Ownership With Infants.

 

           Nothing prevents joint tenancies, Totten Trusts or tenancies in common from being created between an adult and a child under the age of 18.  If the adult owner died, however, problems can arise.  A person under 18 years of age is not legally competent to manage property alone.  If an infant was a surviving joint owner on securities, it would be impossible to sell the shares without the appointment of a guardian in Surrogate's Court. That is the case even though the infant's parents may be alive and well at the time.

 

           One solution to the problem of infant beneficiaries in titles is to substitute an adult custodian under the Uniform Transfers To Minors Act (UTMA) in place of the infant's name.  This allows an adult custodian of your choice to manage the property until the child reaches age 21. The custodian would be empowered to sell such assets and change to other investments, and could use the funds for the child's education or other needs.

 

           E.       Problems With Using Ownership Forms.

 

           If you have one child and would like everything to pass to that child, joint ownership and beneficiary designation might be an appropriate and easy way to do that.  Even then however, a problem which arises in the beneficiary’s life could have an impact on you which you didn’t anticipate. Most people have a more complicated disposition scheme than a single child. 

 

           Occasionally, people will try to treat all of their children equally by naming each as a joint owner or a beneficiary on an equal amount of account values.  Such a plan is fraught with danger.  It can cause property not to pass equally as planned, and can foster serious family disharmony. 

 

           When you make a will or when you provide a provision in a revocable trust calling for an equal distribution to several individuals at your death, no one can change the terms of those instruments.  That is not the case however with beneficiary forms.  Someone with a valid power of attorney, could in the process of paying your bills, liquidate accounts which are passing to one person while leaving another person’s in tact.  This could be intentionally or by mistake.  Understandably, a beneficiary whose share has been decimated by payment of bills would be disappointed.  If that loss is caused by an agent under a power of attorney, it can cause anger and lead to litigation.  It is best if the treatment of the beneficiaries is controlled exclusively by you, and that is best done in a will or a trust agreement.

 

PROBLEMS OF THE SECOND MARRIAGE

 

 

           More and more we see couples marrying where each spouse has children by a previous marriage and possibly substantial assets accumulated in advance of the wedding.  Without careful consideration of the problems and the law, unanticipated and unwanted consequences may disrupt the estate plans of the individuals.

 

           Certain legal rights arise at the time of marriage.  One of those is called the Spousal Right of Election.  Basically, it allows a surviving spouse to take a share from the estate of a deceased spouse, regardless of the terms of the decedent's will.  The share entitlement is the greater of 33 1/3% of the estate or $50,000.  The computation of this elective right takes into account more than property passing under a will.  It includes certain jointly owned property, the value of gifts made before death, and the value of all pension or profit sharing plans.  The surviving spouse has the legal right to pursue return of property if necessary to satisfy the elective share.

 

           Federal law further affects the pension benefits each spouse may be entitled to.  The right to change beneficiaries to other than a spouse is severely restricted.  If not carefully planned at the time of the marriage, it is possible that there will be no opportunity at a later date to designate a non-spouse beneficiary (without the consent of the spouse).

 

           In addition to the above rights, a surviving spouse is entitled to "exempt property" as defined in the law.  The survivor may take one automobile valued at no more than $15,000. plus $15,000. in cash.  Household goods and other property specified in the law may also be taken, even if the will disposes of these items to others.  If a surviving spouse claimed all possible exempt property and elected against the will, it would result in a minimum transfer to the spouse of $106,000. This is before any other beneficiary receives anything.

 

           Another concern of the couple may be the prospect of the new marriage ending other than by the death of one spouse.  The law provides for the definition of marital property, which would be divided between the parties upon dissolution of the marriage.  There is also a possibility of periodic maintenance payments being allowed to a spouse (formerly called alimony).  If these are not addressed in advance of the marriage, then it is left to the court to decide the issues.  As anyone knows who has gone through a separation or a divorce, this can be a very expensive and unpleasant experience.

 

           A solution to all of the above problems can be found in a carefully planned and drafted pre-marital agreement.  Such an agreement can cut off the right of election of each spouse in the estate of the other, waive rights to exempt property, authorize the change in pension or profit sharing plan beneficiaries and define the rights of each spouse in the event of termination of the marriage.  The agreement is binding on both parties so long as there is a full disclosure of the underlying facts and no fraud.  The agreement can even be entered into after marriage, but often the parties are less prone to do so then, particularly if marital difficulties have already started.

 

           Addressing the issues involved in this process can be awkward for the parties when they are in love and engaged.  That awkwardness, however, must be weighed against the difficulties which would be encountered if the problems are left to be worked out as they arise.  The execution of such an agreement should put the children of the previous marriages more at ease with the new spouse, since the spouse can now be looked upon as a new family member and not as an economic competitor.

           Another estate planning tool frequently used in the second marriage situation is life use of a residence. If one spouse owns the house in which the couple lives, a provision can be added to that person's will giving the surviving spouse the right to use the house for life, but then transferring the property to the children of the owner at the death of the survivor.  This can provide the double benefit of protecting the property for the children while protecting the living arrangements for the spouse.  Such provisions have complications which must be addressed, however, such as responsibility for payment of repairs and expenses.  Also, it must be decided what is to happen to the property if the spouse is unable to live in it or chooses to move.  With the new provisions of the right of election law, the life use of real estate would not satisfy the spouses right, and would leave the spouse able to elect a share outright.  A spousal right which terminates will not satisfy the elective share, except in very limited circumstances.

 

           If a pre-marital agreement has not been executed, there are still several courses of action which can be taken by the estate owner to maximize the property passing to the children and minimizing the damage to the plan caused by the spousal rights. Addressing the difficult questions of a second marriage early on, however, can preserve property for the children as well as keeping all of the members of both families on much better terms.

LIVING TRUSTS

 

 

           In recent years there has been a mass of information published about the living trust.  In newspapers and magazines we read about use of the trust to impoverish ourselves so as to qualify for Medicaid, if nursing home care becomes necessary.  We also hear about living trusts which can assist with financial management for an older person, trusts which can avoid the probate process and those which can reduce or eliminate estate tax which might be due at death.  Trusts do accomplish all of these purposes and more. The concept of a trust and the numerous types of trusts, however, cause much confusion.

 

           A trust is a legal "entity" which is created to accomplish a planning purpose.  It has an existence separate from any of the individuals involved in it, so in a sense it is similar to a corporation or partnership. The trust may be created in two ways. The provisions of a will may call for creation of a trust at death, and this type of trust is called a testamentary trust.  An agreement may be signed during life, which would be called a living trust.  It is the second type which we are concerned with now. 

 

           The agreement creating a living trust would be made between the creator of the trust (typically referred to as Grantor or Settlor) and one or more Trustees.  The Trustee is responsible for taking possession of the property which makes up the trust and carrying out all of the provisions of the trust agreement.  It is, therefore, very important that the agreement be complete.  The Trustee must have very clear instructions about what the creator expects to be done at each point along the way.

 

           To illustrate how a simple trust might operate, let us assume that grandparents are creating a trust to receive gifts from them for the education of their grandchild.  The Trustee of such a trust might be their child. The Trustee would be instructed by the agreement to invest the gifted funds and accumulate the income in the trust. When the grandchild reaches the age for college the Trustee would be instructed to pay college expenses from the trust.  Since the trust must end at some point, this agreement will provide that upon the grandchild reaching age 22, any remaining funds in the trust shall be paid to him and the trust will terminate.  Upon signing an agreement containing these terms, we would have a valid living trust. Even though it would be valid, such a simplistic trust would not be appropriate in the real world.  It fails to address numerous questions which might come up.  For example, what if grandchild dies before reaching age 22?  What if grandchild doesn't go to college?  Are there any restrictions upon what the Trustee invests in?  May other grandchildren receive distributions from this trust under any circumstance?  Will income tax problems be created by the trust?  Each of these problems and more must be addressed in the well drawn trust.

 

           With a grasp of the definition of a trust, let us look at some different types of trust.  When you create a trust during life, it can be made revocable or irrevocable.  A revocable trust can be amended or terminated by the creator at any time. An irrevocable trust cannot.  The tax law treats these types of trusts very differently.  Generally, a revocable trust provides no tax advantages.  All of the income earned by such a trust is taxed to its creator. At death, all of the contents of the trust are taxable in the creator's estate.  In the above example of a gift for the education of a grandchild, it is important that the income from the gifted property be taxed either to the trust or to the grandchild rather than to the grandparent.  Such a trust must, therefore, be irrevocable.

 

           Because of the lack of tax advantage, the revocable trust is used almost exclusively as an aid for financial management.  The creator of the trust may designate someone to handle his investment assets while retaining the right to change the Trustee or terminate the trust if he is not completely satisfied with how it operates.  The revocable trust has the advantage of allowing the property in it to pass at death to beneficiaries designated in the trust agreement. Since the trust property would not pass through the creator's estate, it would not be subject to "probate". The avoidance of probate, however, provides only very limited advantage in New York State.  The principal advantage of avoiding probate is that an Executor would not be entitled to an executorial commission on the trust property. In most cases, the Executor chosen in a will is the primary beneficiary under the will.  In that circumstance, it is fairly rare for the Executor to take a commission in any event.  Reducing the size of the probate estate would also reduce the filing fee due the Surrogate's Court when the will is probated.  At its minimum, the filing fee is $45.  For an estate in excess of $500,000, the filing fee is $1,250.  The other substantial cost of estate administration, legal fees, are not necessarily reduced by the existence of the trust.  Most of the legal services performed at death are related to estate tax, income tax and the accounting of the estate.  All of these services would still be performed, and would likely be of the same level of complexity with or without a trust.  If there are complex problems with the probate of the will, legal costs could be reduced substantially by avoidance of probate however.  Such a problem might be close relatives who can not be found or a possible will contest.  While the trust may provide an excellent management tool, care must be taken not to spend more on creating and maintaining it than is saved by having it. Given the aggressive sales efforts for high priced trust packages you must be very careful evaluating the proposal. It is an excellent case for “buyer beware”.

 

           Among the irrevocable trusts, we hear most about the Medicaid trust today.  Like other living trusts, the agreement establishes it and gives it direction.  This trust is intended to receive one or more gifts from the creator of it.  It must prohibit the return of the gifted property, thus it is irrevocable.   The creator of the trust usually receives an income interest for life from it. The reason for creating the trust is to protect the principal of it from the claims of Medicaid should nursing home care be required for the creator.  Recent statutory changes prevent a trust of this sort from terminating, or the share of the creator of the trust from being reduced as a result of the creator going into a nursing home.  The share must continue.  For example, if the creator was receiving the income, it must continue to be paid for life.

 

           Trusts are very often used when an adult wants to make a substantial gift to a child.  These can be structured in any number of ways, and the tax consequences vary dramatically depending upon how it is done.  A single trust could be created for the benefit of a single child.  A more complex arrangement could be established where a single trust exists for the benefit of several children.  When the object of the trust is to provide education funds, such a trust allows the benefit to be concentrated in those children who go on to higher education.  The benefit from the trust can be "sprinkled" to some while ignoring others.  The price of using such a sprinkling trust is added complexity and some tax disadvantage.

 

           Those who would anticipate federal estate tax possibly being due (family assets in excess of $650,000) most often use trusts to limit the tax exposure.  A frequently used tool in the estate planning process is the irrevocable life insurance trust.  The creator of such a trust will transfer a life insurance policy on his life into the trust, or will give cash to the trust with which to pay the premium on a new policy.  Subject to some limitations, this can result in the entire proceeds of the policy escaping any estate taxation at death. 

 

           Sometimes an individual has an interest in making a large gift to charity.  When the gift is to be made during lifetime, a trust can be used to provide a benefit back to the donor during life.  Very substantial income tax and estate tax advantages can be generated through the use of such charitable trusts, and they are often of interest to the larger estate owner.

 

           Many of the tax related trusts mentioned here are discussed in much more detail in the author's later booklet "BEYOND THE BASICS"

 

LIFE INSURANCE

 

 

           Life insurance and estate planning are subjects which must be considered together.  It is not uncommon in an estate to find life insurance to be the largest single asset.  This is particularly true with younger people who have not accumulated other resources.

 

           There are a number of reasons for purchasing insurance.  More than ever before, both spouses tend to be employed outside the household.  If one passes away, the loss of that income could be devastating to the standard of living of the family. Insurance can be purchased to protect against that risk.  It also can provide funds from which children's college education can be provided if a parent dies before that is completed.

 

           Even when the children are grown, there still may be several reasons for life insurance to be owned.  A surviving spouse who has little or no income might find it very difficult to continue a comfortable life style without insurance proceeds.  Sometimes the property owned by a decedent has a very substantial value, but is not easily sold.  It might not develop very much income either.  In a large estate life insurance can provide the cash needed to pay estate tax, without the necessity of forcing a quick sale of real estate or a closely held business.

 

           Insurance falls basically into two categories.  The first is term insurance which is considered as temporary.  The cost of term insurance is very low when the insured is young.  This is because death is unlikely at an early age, so the insurance company will not have to pay off on many term policies.  As the age of the insured increases, so does the annual premium.  Eventually the premium cost becomes prohibitive, causing the insured to cancel the policy.  There is no cash value built up on such insurance and no investment component to it.  This would be the appropriate coverage when trying to provide maximum protection for a spouse and young children, at the absolute lowest cost.

 

           There are also several types of permanent insurance.  The common factor among permanent insurance is that the premium stays level when you get older (and the risk of death increases).  If, for example, the insurance is needed to provide cash for payment of estate tax or to finance the purchase of a business interest, that need would likely be permanent, and a permanent insurance would be the appropriate choice.  The type of permanent insurance we see most often is the "whole life" policy.  With a whole life policy, a higher premium is paid in the early years than would be paid on a comparable term policy.  To the extent the premium exceeds the cost of term insurance, the excess is held within the policy in the form of cash value. In the later years of the policy, when the cost of the term protection would get very high, the cash value is generating enough income to pay the higher cost without the premium rising. Another type of permanent insurance which includes an investment component, is called "universal life".  There are also many variations on these basic types, designated to fit the needs of the insured.

 

           When life insurance is needed to provide cash for the payment of estate tax, that cash need usually arises at the death of the second spouse.  This results from the planned use of the estate tax marital deduction to prevent a tax at the first spouse's death.  A life insurance policy on either one of the spouses alone might be collected well in advance of its need for estate tax purposes therefore.  A policy can be obtained which pays its death benefit only upon the death of the second spouse.  This type of policy is commonly called "second-to-die" insurance or "survivorship life".  In addition to providing the cash just when needed, such policies tend to be substantially less expensive than comparable single life coverage.

           When the proceeds of a life insurance policy are collected, they are fully includable in the estate of the insured for estate tax purposes if the insured owned the policy or had any of several rights over the policy (such as the right to change beneficiary).  This presents an obvious problem when purchasing insurance to pay estate tax.  The policy which is to provide the tax cash would generate tax itself, thus making less cash available for payment of the tax on the other property. This problem of estate taxation of insurance proceeds in larger estates is often solved by use of the irrevocable life insurance trust.

 

           The irrevocable life insurance trust is a trust created during the life of the insured.  The trustee of the trust would become owner of any existing policies (which are transferred to the trust by a gift).  If new policies are contemplated, the trustee would receive gifts of cash from the insured which would be used to purchase the new policy.  The trustee would be the owner of each policy and its beneficiary.  Each year the insured would make gifts to the trust of cash to pay the premiums on all policies.  The trust would provide for use of the funds for the family members, just as the will does.  Subject to a number of complex rules, this approach causes all of the proceeds of the policies in the trust to escape estate taxation in both spouses' estates. It also allows for all of the cash from the policies to be available for payment of estate tax, undiminished.

 

           With large estates, the life insurance trust can be a very powerful tool in the tax saving plan. In addition to avoiding taxation at the first generation, it can be structured to escape many further levels of taxation which would be applied on younger generations, thus skipping multiple generations of the estate and gift tax.

 

LIFETIME CONCERNS

 

 

           Most of the planning encompassed in "estate planning" has to do with the passage of property at death.  There are also lifetime concerns which must be addressed in order for the planning to be complete.  Thought should be given to how your affairs would be handled if you were to become incompetent as a result of illness or injury.  Who would pay your bills?  Who would make your necessary medical decisions?

 

           A.       Power of Attorney.

 

           A power of attorney is an instrument by which you designate an individual to handle your financial affairs.  The power could be very limited in scope, as when you designate someone to sign on a single bank account.  It can also be very broad and allow the holder to handle all of your financial affairs.  The law allows you to give a general power of attorney which is defined in the statute and grants very sweeping powers.  A general power of attorney does not authorize the holder to "self deal" or to give himself any of your property, but otherwise it gives broad, sweeping power. Because of this, and because there is no regular outside supervision of the power holder, it is critical that such a general power of attorney be given only to someone who is totally trust worthy and dependable.  General powers of attorney are very often given by one spouse to the other with the expectation that it will be used only upon an incapacity.

 

           You may give the power to one person or more than one to use together.  You also may designate an alternate to act if the primary choices die or resign.

 

           The term "durable" is often used with power of attorney.  Durability means that the power will not lapse upon the incompetence of the person who gave it (the principal).  Most forms for power of attorney contain such a durability clause in their printed text.  Contrary to popular belief, the power of attorney becomes effective as soon as you sign it, not when you become incompetent. 

 

           It is possible in New York to have a "springing power of attorney".  This power would spring into existence upon your becoming incompetent.  While most people find this more attractive than a currently effective power, it has several practical problems.  Defining the incompetence which would trigger it is difficult.  What degree of incapacity is required?  Who decides?  What happens if you regain competence?  Most banks and other institutions hesitate to accept a springing power, because they do not want to be forced to determine if the triggering event of incompetence has occurred.

 

           The great advantage that may come from executing a general durable power of attorney is in avoiding expensive court proceedings for appointment of a conservator or committee should incapacity occur.  A provision can also be included to allow gifts to be made from your property. When there is not an appropriate person available to be designated on a power of attorney, or when the disability anticipated is more likely (for example, the early stages of Alzheimer's disease) it may be more appropriate to use a trust for financial management, rather than depending solely upon a power of attorney.

B.       Health Care Proxy.

 

           New York recognizes health care proxies and has an approved form for it.  A health care proxy is a document by which you appoint someone you trust to make decisions about your health care treatment on your behalf if you are no longer able to do so.  Unlike the general power of attorney, the health care proxy does not become effective until, and unless you are unable to make your own health care decisions.  If this occurs, the agent you designate can make decisions in accordance with your religious or moral beliefs, your express preferences, or simply those decisions which are in your best interest.  The proxy gives authority over all health care decisions, except the withholding of artificial feeding (nutrition or hydration).  Withholding of feeding is an authorized power only if you have specifically provided for it in the proxy.  You may also add provisions further limiting the authority of the agent if you wish.

 

           The law allows for appointment of a primary and alternate agent on the proxy.  It is not clear, however, whether more than one person may be designated to act together.  Under the circumstances, it is best not to choose two people to act at the same time. You may revoke a health care proxy at any time, just as you may revoke a power of attorney.  This allows you to make new designations whenever you like.

 

           C.       Living Will.

 

           The living will expresses your attitude and wishes about your health care.  For example, you may describe the circumstances under which you would not want your life to be artificially prolonged.  In the alternative, you could provide that every available means be used to extend your life, although this is rarely chosen.

 

           Specific instructions could be added to a health care proxy thus combining the living wills and proxy.  If you have someone designated in whom you have complete faith, it may be preferable to make a separate living will.  This prevents the statements you use in the living will from being used by a medical provider to try to interpret or limit the authority of the proxy holder.  The separate living will may be treated as a communication between you and the agent, while leaving the agent with unencumbered authority to act on your behalf.  The living will is not recognized by New York statute, but the courts of the state do honor such a directive as evidencing your right to chose your own health care.  The document must be clear and unequivocal.

 

           Both the health care proxy and living wills are executed before two witnesses.  Neither of the witnesses should be a person who has been designated on the proxy.  Only one original need be signed, and copies may be used for distribution to doctors or other providers of health care.

 

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