Estate planning at every stage

May 2021

You may think of life as a journey marked by certain milestones, with some bumps along the way. As you accumulate wealth along your journey, there are optimal wealth planning actions you can take. Let’s take a trip, looking at the wealth planning you could do at each of those milestones – and some of the bumps.

Along the way you’ll want the help of your planning team – your accountant, estate planning attorney and wealth advisor. Be sure to take them along on your journey.

Basics for everyone

At this point in your journey, you’re just starting out in your career. Your employer has probably provided some life insurance, maybe even some stock options. You may have bought your first home. You may have a partner or spouse, even children. You’ll want to help protect what you have and who you care about.  Your estate attorney can help you create an estate plan consisting of several documents that address different possibilities.

1. Durable power of attorney for financial decisions and for health care decisions

The pandemic has magnified the need to have someone who can make decisions in case you can’t. The documents you create to make this happen are your powers of attorney. 

Think about who you would trust to speak on your behalf both for financial decisions and for medical ones. It can be the same person or two different people. And don’t forget to name backups.

Durable just means that it stays in effect even if (especially when) you become incapacitated. 

Discuss with your attorney whether to make your powers of attorney effective immediately or upon disability. There are pros and cons to both. An advantage of these documents being effective immediately is that no action, such as a doctor’s determination, is needed to make them work. But some people aren’t comfortable giving someone such broad authority right now and only want it to come into play if absolutely needed. Discuss this decision with your estate attorney.

2. Health care directive (living will)

Besides giving someone authority to make medical decisions, you can also clearly express your wishes about what you want to happen in case you were terminal or in a coma. Family members may disagree on how to handle your care if you don’t.

3. Will or revocable living trust

Your attorney can also help you describe how you want your property to be distributed after you are gone. (If you don’t set it out in a legally binding document the law of your state will choose for you.) Your attorney can help you choose whether to have a will-based plan or a revocable living trust.

Wills need to go through probate. Although in some states probate can be onerous, Washington State has a comparably streamlined process. 

However, if privacy is a concern a revocable living trust could be preferable because wills are generally filed with the court after you die and become public records. 

A revocable living trust can also be preferable if you own property in another state. If you have a will and own property in another state then there could be two probate proceedings. And generally, other states where you may own a vacation home have more onerous probates than Washington State.

Your will is also where you name a guardian for your minor children. Think about what you’d want to happen if you name a married couple as guardians and they get divorced, as well as if you want to give your kids their inheritance outright or in trust. 

4. Beneficiary designations

Some assets such as life insurance and retirement accounts pass by their beneficiary designation and not by your will or trust. Your attorney can help you coordinate your beneficiary designations with your estate plan.

5. Final arrangements

Besides disagreeing about end of life care, loved ones can also disagree – and vehemently - on final arrangements. For example, you may specify whether your preference is to donate your body to science, compost (in some states), cremate or burial.

6. Separate writing

Families often fight over sentimental items. You may write a list that says who gets Aunt Mabel’s silver tea set and who gets grandma’s engagement ring. This can be especially helpful when you have more than one child or family heirlooms. Some state laws have specific rules for referencing the written list in your will or revocable trust, and your estate attorney can guide you on those requirements.

Tax planning as your estate grows

Going beyond the basics and as you accumulate more wealth along your journey, unless you’re giving it all to charity, you’ll likely want to implement some tax planning. The milestone at which you may need tax planning is once your estate exceeds your state’s estate tax exemption amount.  The exemption amount is how much you can leave without triggering the estate tax on your assets when you die. That amount is currently $2,193,000 in Washington State (not currently being adjusted for inflation).

It may help to think about exemptions as buckets you get to fill up before your estate starts paying tax. Whatever doesn’t fit in the bucket gets taxed. Remember that most everything – even life insurance proceeds – are included in your taxable estate.

If you live in a state that doesn’t have an estate tax, then this first milestone will be a little further down the road - once your estate exceeds the federal gift and estate tax exemption amount, currently $11.7 million (but scheduled to be reduced at the end of 2025 to $5 million adjusted for inflation). 

The good news is that there is no tax due when one spouse passes away and leaves everything to the survivor. But you should think about whether to leave your assets outright to your spouse or in a trust, like a credit shelter or bypass trust, where your spouse may access assets but you direct where remaining assets are distributed after your spouse passes.

Using a trust can be important in Washington State because if you leave everything to your spouse, then when they  die, they have all of the assets you left them plus their own assets in their estate and only one exemption bucket, potentially exposing more assets to taxation.

This isn’t true with federal estate tax because of portability rules. If you died first without any tax planning at all, your spouse could claim your exemption bucket and still have yours and theirs when they died, potentially subjecting less assets to estate taxes. 

So when the value of your estate is below the federal exemption amount you have some choices. You can choose whether to use a credit shelter trust or rely on portability. You may need some help from your professional advisors in evaluating this decision because (for the time being) the estate tax burden should be compared with the capital gains tax and other considerations; this decision can be complex. 

Currently estates get a step up in basis on death, meaning that when the heirs sell an asset, they will pay capital gains tax on the difference between the value at the time it is inherited (instead of the value of the asset when you acquired it) and the current value. This is typically a good tax benefit to your heirs. In Washington State, which is a community property state, the step up is pretty much on the entire community property estate. You can decide whether to include the trust assets in the federal estate of the second spouse to die and receive a second step up (provided the laws around step-up don’t change). 

Your financial advisor can help you compare the numbers, and your legal and tax advisors will also add value to this discussion. But be sure to get advice as these tax laws may change, potentially making the analysis even more difficult.

Bumps in the road

Even if you don’t need tax planning, you may still want to use a trust for control. If you have kids from a prior marriage you may want to consider a trust for your spouse (who is not the biological parent of your children) so that it is more likely your children (or other beneficiaries) receive some of those assets after your spouse dies. Otherwise, if you give everything outright to your spouse then you are letting them decide where it goes on their death – and that may not be to your children from that first marriage, their step-children.

In addition to permitting control, trusts can provide creditor protection. So if you have a loved-one who is prone to creditor issues, you may want to use a trust. These considerations should be discussed with your estate planning attorney.

Over the top

As your estate continues to grow—maybe that start up really took off and you’re worth more than you could have imagined and your estate is overflowing your bucket—you’ve reached another milestone. 

At this point, when your estate is above the federal estate tax exemption or you’ve used up all of your exemption with lifetime gifts, then in addition to basic tax planning, you may consider additional strategies. 

1. Charities

Perhaps you have been gifting to charity along the way, but now you are in a place to make a bigger commitment. Not only are you doing good, charities don’t pay income tax, so low basis assets like that start-up stock can be tax efficient gifts. Using irrevocable trusts such as Charitable Remainder Trusts (CRTs) and Charitable Lead Trusts (CLTs), this can also be done in a way that splits the benefit between charities and your other chosen beneficiaries. 

2. Trusts

Trusts can be irrevocable, meaning you (mostly) can’t change them. The irrevocable feature is designed to help minimize estate taxes by keeping assets out of your estate. And when the assets inside the trusts grow, that growth happens outside of your estate. If your goal is to pass more to your beneficiaries rather than charity, then you may consider more advanced planning strategies such as Grantor Retained Interest Trusts (GRITs), Spousal Lifetime Access Trust (SLATs), and Intentionally Defective Grantor Trusts (IDGTs), to name a few.

To determine which strategy is best suited to your specific assets and goals, engage the help of your wealth advisors to crunch some numbers and quantify results to help inform your decisions. 

Get ready for more change

In light of potential changes in tax law, consider putting structures in place now so that if and when the landscape changes you will be ready put that planning into action. Consult with your attorney and team of advisors on how to best plan for these potential changes.

Author: Sandy Cairns, Senior Wealth Planning Strategist, Wells Fargo Bank, N.A.