Senior Regional Fiduciary Manager
Senior Trust and Fiduciary Specialist
Partner, McGuireWoods (Contributing Author)

In this Wealth Planning Update:

  • We have been dealing with the impacts from two new laws that have significantly changed the tax landscape. But should these tax changes drive your estate plan? 
  • Focusing on your estate planning goals and treating these tax changes as a secondary consideration may be a better strategy. 
  • We propose three questions you may want to consider exploring with your wealth planner that may lead to more effective planning.   

With the recent passage of both the American Taxpayer Relief Act of 2012 and the Patient Protection and Affordable Care Act , we spent quite a bit of time talking about taxes last year. Although the impacts from these two laws are still being sorted out, the one thing that has become clear about income and transfer taxes is that nothing is clear. Use of traditional transfer tax savings techniques, like credit shelter trusts, that once were considered almost automatic now must be carefully analyzed for their potentially negative income tax consequences.  

In light of this confusion, perhaps one way to deal with these tax changes is to focus instead on the core reasons for your estate plan. After these core issues are identified, the tax planning choices become much easier to make. For instance, one approach that might prove useful is to review the following three questions in order with your wealth planner. Once these questions have been addressed, you, along with your wealth planner and tax advisor, can begin to make tax-based decisions that are right for you and your beneficiaries.

1. How much is enough? While most spouses choose to leave everything to their surviving spouses (either outright or in trust), there is always an exception to the norm. For example, more and more couples are questioning whether all of their wealth should pass to their children on the death of the surviving  spouse. As an alternative, many are considering giving at least some property to more distant relatives, key employees or charity.

2. Do any beneficiaries need protection? And if so, from whom? In the final analysis, trusts are designed to protect beneficiaries from someone or something; identifying  what those things are makes the drafting process clear. Consider the following examples:

  • Minors, spendthrifts or those with substance abuse problems often need at least temporary protection from themselves.
  • Beneficiaries from blended families sometimes  need protection from each other, at least in the sense that second spouses  and children from prior marriages  often need clear rules about who is to receive inherited  property and when.
  • Any beneficiary could need protection from potential  creditors, including those arising from divorce or bankruptcy.
  • Beneficiaries from wealthier families need protection from transfer taxes, resulting in trusts designed to avoid those taxes.

In each of these cases, a trust can help provide that protection—provided it is drafted correctly.

3. Who will act for when you when you are no longer able to do so? In some ways, this is another protection issue, but it’s different because it deals with planning for your own incapacity, and not your heirs. The issues deal more clearly with intangibles, like where you will live, what level of care you will receive, and who will make those decisions for you if you become incapacitated.

Answering these questions in this order can lead to more effective planning. Start with how much each beneficiary is to receive and then look to the form in which each beneficiary is to receive property (for instance, what kind of protection does he or she need, given the amount of property he or she is to receive?). Finally, in light of these first two issues, determine who should be in charge of administering the property, either when you are incapacitated or following your death.

Example of effective planning in action

Assume that a husband and wife have been married for 40 years and each have a net worth of $3 million (for a total net worth of $6 million). Their three children are in their early to mid-thirties and all are in stable marriages. The couple decides that the surviving spouse should have all of the couple’s property when the first spouse dies, and that each child should receive $1.5 million when both spouses are gone (a total of $4.5 million to the children), with the remaining $1.5 million going to charity. In this case, the couple might draft wills or revocable trusts leaving everything outright to the survivor, with an optional disclaimer trust, and leaving the gifts to their children and charity outright.

Changing the facts, though, can lead to a different result. Assume now that the couple has only been married five years, and the husband has two children from a prior marriage while the wife has one child from a previous marriage. The children are in their 30s and in stable marriages. The couple’s plan in this case might provide that the spouse who dies first leaves everything in trust for the surviving spouse, with the remainder of the trust property passing at the surviving spouse’s death to the first spouse’s child or children only. The purpose of this trust is to “protect” the assets for the benefit of the surviving spouse during his/her lifetime and upon death for the benefit of the children.

Note that, in each case, tax planning has played a very minor role. In the first case, everyone ultimately will get their inheritance outright, and the surviving spouse probably will rely on portability for federal estate tax planning. The disclaimer trust is inserted as a “backstop” in the event of changed circumstances, like a large increase in the couple’s wealth or a change in the federal estate tax system. In the second case, the trust for the surviving spouse is designed for protection purposes, and whatever tax savings that may be gained (from dividing the trust into two for tax purposes, for example) are of much less importance.

These examples demonstrate the significant shift in thinking that the change in tax law has brought about. In previous years, the estate planner probably would have talked with this couple a great deal about the kind of shelter trust planning they needed. Now, however, the tax planning often will be little more than an afterthought. Instead, the planner probably will be focused on the “real world” issues that the couple is likely most concerned  about.

In fact, these tax changes may very well improve the quality of the planning conversation. The best way to understand how all of this affects your family’s particular situation is to sit down with your relationship team for a goals-based discussion and estate plan review. Aligning your objectives and your planning are imperative to protecting your legacy. Contact your relationship manager today. 

This Wealth Planning Update is an excerpt of the Wells Fargo Private Bank white paper titled, “The More Things Change, the More They Stay the Same: Tax Laws Change, Fiduciary Duties Don’t.”