Putting your trust in a trust

You can also use estate planning tools to help prevent fraud and identity theft. For example, many people use revocable living trusts to achieve a variety of estate planning objectives, including avoiding probate and managing assets in the event they become incapacitated.  But trusts can also be an effective tool for preventing fraud, or at least catching it before too much damage is done. How?  The trustee has direct responsibility for managing and protecting the trust assets, in essence adding an extra layer of protection between you and potential fraudsters or identity thieves.

By appointing an experienced professional trustee, you ensure that an extra set of eyes evaluates any contemplated investments or distributions of the trust’s assets.  In addition, a professional trustee will be in a position to monitor the assets closely and respond quickly to any suspicious activity.

Before you establish a living trust, be sure to consult your estate planning advisor to determine whether it’s appropriate for you and to help you tailor the trust to meet your specific needs.

Safeguarding yourself

You likely invest much time and money into developing strategies to provide for your family and achieve your other estate planning objectives while minimizing gift and estate taxes.  To be successful, you also must safeguard your wealth against fraud and identity theft.

Keeping your identity safe

Identity theft is a growing problem in the United States, claiming around 10 million victims every year, according to the Federal Trade Commission (FTC). Thieves who steal your identity may use your personal information to run up charges on your credit cards, drain your bank accounts, and take any number of other actions to make off with your wealth or destroy your credit rating.

To protect your identity, it’s important to understand the many methods thieves use to obtain your Social Security number, bank and credit card account numbers, and other sensitive personal information. They include “dumpster diving” — that is, sifting through your trash for bills, receipts, bank statements, credit card offers or other documents; “phishing,” which involves sending phony e-mail messages from financial institutions or other companies asking you to reveal personal information; and old-fashioned stealing (your wallet or purse, for example).

If you become the victim of identity theft, there are steps you can take to restore your credit rating and recover stolen assets, but it can be a time-consuming, costly process. So at minimum take the following basic steps to protect your identity:

• Shred all paperwork that includes sensitive personal information.
• Don’t give out personal information unless you’re initiating the contact.
• Immediately report stolen credit cards, and check your credit report at least once a year.

When you share personal financial information with trusted third parties, don’t hesitate to ask them about their privacy policies and security measures. And don’t provide more information than necessary.

For example, even though employers, banks and businesses running a credit check need your Social Security number, most other businesses don’t. If someone asks for your Social Security number, don’t be afraid to ask why they need it, how it will be used, how they will protect it from theft and what will happen if you refuse to provide it.

In the next and final installment on this topic we will discuss how you can use estate planning tools to protect yourself again fraud and identity theft.

Wealth preservation typically focuses on protecting assets against creditors’ claims and lawsuits, but it’s also important to protect wealth from erosion by fraud and identity theft. There’s a common misconception that fraud victims usually are unsophisticated, but there’s no shortage of sophisticated investors who’ve been seduced by the promise of generous returns.  And, according to the Federal Trade Commission, 10 million people fall victim to ID theft every year.  This three part posting offers safeguards against fraud and ID theft.

Protecting your assets against fraud and ID theft

A fundamental estate planning objective is to provide financial security for your loved ones.  To achieve that objective, your estate plan must include strategies for creating wealth (financial planning), preserving wealth (asset protection) and distributing wealth cost effectively (tax planning).

Wealth preservation typically focuses on protecting assets against creditors’ claims and lawsuits, but it’s also important to protect your wealth from erosion by fraud and identity theft.

Fraud can happen to anyone

When it comes to fraud, the most dangerous attitude to have is: “It can’t happen to me.” There’s a common misconception that fraud victims usually are unsophisticated. True, fraudsters often target neophytes with get-rich-quick schemes, but there’s no shortage of sophisticated investors who’ve been seduced by the promise of generous returns.

Just consider the Bernard Madoff debacle.  Madoff’s $50 billion Ponzi scheme snared corporate CEOs, wealthy celebrities, prominent investment funds, universities, not-for-profit organizations and other experienced investors. Many of these investors lost millions of dollars. Some lost billions.

Although there are no guarantees in the investment world, the best way to protect yourself against fraud is to do your homework and seek professional advice. Even in the Madoff scheme, there were warning signs that might have tipped off cautious investors, including:

• Returns that were unusually high and consistent given the volatility of the markets,
• Investment strategy explanations that likely wouldn’t have held up to closer scrutiny,
• Use of the same investment strategy for every investor, regardless of his or her circumstances, and
• Lack of involvement of a third-party brokerage firm.

It appears that many investors had an emotional response to the prospect of enormous monetary gains and skimped on their due diligence on the basis of Madoff’s reputation as a highly successful and well-respected investment advisor. A qualified, independent investment advisor can help you take emotion out of the equation and evaluate your investment options objectively and thoroughly.

In the next posting on this topic we will discuss simple things you can do to keep your identity safe.

Dotting the i’s and crossing the t’s
A common mistake people make with DIY estate planning is to neglect the formalities associated with the execution of wills and other documents. Rules vary from state to state regarding the number and type of witnesses who must attest to a will and what, specifically, they must attest to.

Also, states have different rules about interested parties (that is, beneficiaries) serving as witnesses to a will or trust. In many states, interested parties are ineligible to serve as witnesses. In others, an interested-party witness triggers an increase in the required number of witnesses (from two to three, for example).

Keeping abreast of tax law changes
Legislative developments during the last several years demonstrate how changes in the tax laws from one year to the next can have a dramatic impact on your estate planning strategies. DIY service providers don’t offer legal or tax advice — and provide lengthy disclaimers to prove it. Thus, they cannot be expected to warn users that tax law changes may adversely affect their plans.

Consider this example: In 2003, Dave used an online service to generate estate planning documents. At the time, his estate was worth $2 million and the federal estate tax exemption was $1 million.

Dave’s plan provided for the creation of a trust for the benefit of his children, funded with the maximum amount that could be transferred free of federal estate tax, with the remainder going to his wife, Ann. If Dave died in 2003, for example, $1 million would have gone into the trust and the remaining $1 million would have gone to Ann.

Suppose, however, that Dave dies in 2011, when the federal estate tax exemption has increased to $5 million and his estate has grown to $4 million. Under the terms of his plan, the entire $4 million — all of which can be transferred free of federal estate tax — will pass to the trust, leaving nothing for Ann.

The outcome might be even worse if Dave lives in a state that has “decoupled” from the federal exemption. If, for example, the applicable state exemption is $2 million, half of the money transferred to the trust will be subject to state estate tax.

While even a qualified professional couldn’t have predicted in 2003 what the estate tax exemption would be at Dave’s death, he or she could have structured a plan that would provide the flexibility needed to respond to tax law changes.

Don’t try this at home
These are just a few examples of the many pitfalls associated with DIY estate planning. To ensure that you achieve your estate planning objectives, it’s important to have your documents prepared — or, at the very least, reviewed — by a qualified professional. Then, have a professional review your plan periodically to be sure it’s up to date.

Appointing a Guardian
If you have minor children, appointing a guardian for them in your will may be the single most important estate planning decision you’ll make. If you don’t name a guardian, then in the event of your untimely death a court will make the decision for you. Consider both family and nonfamily members, based on a variety of criteria – from religious beliefs and educational values to age and financial security.

Be sure to discuss your wishes with potential guardians to be sure they want the job. And once you make a decision, name at least one backup guardian in the event your first choice dies, becomes disabled or simply changes his or her mind.

Avoiding Probate 
Estate planning can also help you avoid probate. Probate is a court-supervised proceeding for establishing the validity of your will, valuing your estate, paying certain expenses and distributing your assets to your heirs. Not only can probate be expensive and time consuming, but it also exposes your financial affairs to public scrutiny. You can avoid probate by using a revocable “living” trust – except in certain limited circumstances. Further, use of beneficiary designations and other techniques that allow assets to be transferred directly to your heirs outside your will can eliminate the necessity of a probate estate.

Protecting Your Assets
Many estate planning techniques can protect your assets against creditors’ claims (both your creditors and those of your family members). Asset protection is important regardless of the potential for estate tax liability.

Simple asset-protection techniques include transferring assets to family members, titling property in a manner that avoids certain claims, and making contributions to qualified retirement plans. More sophisticated techniques include domestic or offshore asset-protection trusts and family limited partnerships.

Shaping Your Legacy
Money can be a powerful motivator. Regardless of your estate tax situation, you may want to share your values with your heirs and influence their behavior. For example, you can design a trust that provides your child with a financial safety net but also offers incentives to lead a responsible, productive life.

You can condition trust distributions on virtually any criteria you wish, such as graduating from college, staying gainfully employed, or simply reaching a certain age. One common technique is to link trust distributions to beneficiaries’ earnings – the more money they make on their own, the more they receive from the trust.

Keep in mind, that this approach can penalize heirs who make less money yet lead lives you’d be proud of. One possible solution is to outline general criteria – both financial and nonfinancial – for distributing trust funds and let the trustee determine whether your heirs have met them.

Plan Now 
|The $5 million exemption may make estate taxes seem like a remote possibility. But keep in mind that, unless Congress intervenes, the exemption amount will drop to $1 million beginning in 2013. So you need to be prepared for that contingency. Even if you’re confident that Congress will make the $5 million exemption permanent, however, the nontax issues are at least as important as – and perhaps more important than – reducing taxes.

Note: On November 17th, House Representative James McDermott of Washington introduced legislation (HR 3467) to lower the exemption amount to $1 million and raise the estate tax rate from 35% to 55% beginning January 1, 2012. 

You need to update your plan if:

1. Your net worth or the value of certain assets substantially increases or decreases.

2. Your family circumstances change (for example, marriage, divorce, or birth of a child or grandchild).

3. A beneficiary dies or his or her financial circumstances change.

4. A person you named as an executor, trustee or guardian dies or is no longer suitable.

5. You move to a new state.

6. Your estate planning goals change.

7. It’s been more than 3 years since you last reviewed your estate plan.

Contact our office at 817.462.5454 to get the latest information on estate tax law changes and to discuss whether your plan should be modified in light of legislation or changes in your specific situation.

The objective of portability is laudable — namely, to allow married couples to take advantage of their combined exemptions without the need for complex estate planning strategies. But on closer inspection, its value is limited.

Use it or lose it

Before portability, married couples who wished to take full advantage of both spouses’ exemptions had to “use it or lose it.” Each spouse had to have enough assets in his or her name to make use of the exemption. If one spouse owned most or all of the couple’s wealth and the “nonowner” spouse died first, the latter’s exemption amount would be wasted.

Also, each spouse’s estate plan had to be designed to avoid taxation of otherwise exempt amounts in the surviving spouse’s estate. Suppose, for example, that each spouse owned $5 million in assets and their wills provided for those assets to pass to the survivor.

The transfer would be tax exempt under the unlimited marital deduction (provided each spouse was a U.S. citizen), but the assets eventually would be taxed in the survivor’s estate. Assuming the survivor had $10 million in assets at death and the exemption hadn’t changed, $5 million would be subject to estate tax. Again, the first spouse’s exemption would be wasted.

Traditionally, the solution to the first problem has been to equalize the spouses’ estates by transferring assets from owner to nonowner. And the most common solution to the second problem has been for each spouse to establish a credit shelter (or bypass) trust.

Generally, credit shelter trusts are funded with the maximum amount that can be sheltered from tax by the deceased spouse’s exemption. The trust pays income to the surviving spouse for his or her life and subsequently distributes the remaining assets to the couple’s children or other beneficiaries.

Because the surviving spouse never gains control, the trust assets bypass his or her estate. In the previous example, the use of a credit shelter trust would have avoided estate taxes altogether. The first spouse’s $5 million exemption amount would pass into the trust. Then, when the surviving spouse dies, his or her exemption would cover the remaining $5 million. In such a case, neither spouse’s exemption would be wasted.

A limited solution

Portability seems to offer a simple solution, allowing couples to make the most of their exemptions without transferring assets or establishing complicated trusts. In most cases, however, it’s no substitute for traditional estate planning. Here’s why:

It’s temporary. Relying on portability is risky because, unless Congress intervenes, it won’t be available after 2012. Even if one spouse dies before portability’s expiration, the surviving spouse must die or use up the deceased spouse’s exemption via lifetime gifts before portability expires, or the exemption will be lost.

It doesn’t protect your assets. Even if Congress extends portability, it won’t protect your assets from your spouse’s creditors, nor will it guarantee that he or she will manage the funds wisely or ultimately pass them on to your children. A credit shelter trust offers creditor protection, management oversight by a trustee you select and assurances that your wealth will ultimately benefit your children.

It doesn’t avoid taxes on appreciation. Unlike a credit shelter trust, portability doesn’t lock in asset values for gift and estate tax purposes on your death, so appreciation can trigger unnecessary tax liability.

Suppose that you and your spouse each own $5 million in assets and that you leave your entire estate to your spouse. If you die in 2012 without having made any taxable gifts, portability allows your spouse to use your entire $5 million exemption. Let’s say portability and the $5 million exemption are made permanent. If, when your spouse dies, the value of your assets has grown to $8 million, the $3 million of appreciation will generate $1.05 million in estate taxes (assuming a 35% rate and that your spouse’s own $5 million exemption is being used to protect his or her original $5 million).

A credit shelter trust would have avoided estate taxes — in both your estate and your spouse’s estate — on the entire $8 million. This is true regardless of whether portability is extended and even if the estate tax exemption has been reduced at the time of your spouse’s death. (Note that assets in your spouse’s name that are in excess of his or her own available exemption at death would still be subject to tax.)

That being said, portability does have one appreciation-related advantage: Unlike assets in a credit shelter trust, assets you’ve transferred to your spouse are entitled to a stepped-up basis when your spouse dies, reducing or eliminating capital gains taxes should your beneficiaries sell the assets. In most cases, however, the immediate estate tax savings produced by a credit shelter trust will outweigh the future additional income tax cost related to having a lower basis.

It doesn’t apply to generation-skipping transfer (GST) tax. The GST tax exemption isn’t portable. If you wish to provide for your grandchildren, therefore, you’ll need to use traditional estate planning techniques.

It may not be available for state estate tax purposes. If you rely on portability for federal tax purposes but live in a state that doesn’t recognize it for state estate tax purposes, you’ll forfeit any unused state exemption. (As of this writing, the states that have a separate estate tax system haven’t adopted portability.)

If your spouse remarries, the benefit may be lost. Portability is available only for a person’s most recently deceased spouse. If your spouse remarries and his or her second spouse dies, portability will be limited to the second spouse’s unused exemption, even if there is little or nothing left of it.

Is portability right for you?

If you believe that Congress will maintain the current estate tax regime and that you and your spouse’s combined estates won’t grow beyond $10 million, portability might work for you. Under those circumstances, you can avoid gift and estate taxes and achieve a stepped-up basis for your children with minimal estate planning.

If you and your spouse have estates worth more than $10 million or if you aren’t willing to take the risk that Congress will eliminate portability or reduce the estate tax exemption, traditional estate planning strategies may be your best bet.

First, you may be surprised just how much your estate is actually worth. For example, if you own an insurance policy on your life, the death benefit will be included in your estate, which may be enough to trigger estate tax liability.

Second, the gift and estate tax exemptions are scheduled to drop to only $1 million in 2013. Unless Congress extends the current exemptions or makes them permanent, you’ll need to know the value of your assets to identify appropriate estate planning strategies.

Third, obtaining a qualified appraisal can limit the IRS’s ability to revalue your assets. If you make gifts that exceed the $13,000 annual gift tax exclusion, you’ll need to file a gift tax return, even if the gift is within your $5 million lifetime exemption. Generally, the IRS has three years to audit gift tax returns and challenge reported values for gifted assets. But that period doesn’t begin until the gift has been “adequately disclosed.”

For assets that are difficult to value — such as closely held business interests or real estate — the best way to satisfy the adequate-disclosure requirements and avoid an IRS challenge is to include a qualified professional appraisal with your return.

Finally, knowing the value of your assets can help you distribute the property according to your goals. If you wish to divide your assets equally among your children, knowing what your assets are worth will help ensure you’re treating your children fairly.

1. Take inventory. Make a list of potential guardians — people you trust to love and care for your children.
2. Make value judgments. Consider the values that are important to you, such as religious and moral beliefs, parenting philosophy, educational values, and social values. Determine which people on your list share these values most closely.
3. Consider the intangibles. It’s also important to consider potential guardians’ intangible qualities such as their personalities and whether they’d be a good “fit” for your children.
4. Consider age. The age of the guardian as well as the ages of your children are factors to consider. If your children are very young, a grandparent or other older person may not have the energy to keep up with them.
5. Be practical. Consider factors such as where potential guardians live, whether they have other children and whether their homes are large enough to accommodate your kids.
6. Don’t dismiss the possibility of separate guardians. If you have more than one child, it’s generally best for all concerned to keep them together. But sometimes it’s preferable to split them up.
7. Talk it over. Narrow your list of potential guardians to a primary choice and one or two alternates, and discuss your plans with them.
8. Put it in writing. Nominate a guardian in your will and include at least one alternate in the event your primary choice is unavailable or changes his or her mind. To avoid uncertainty and disputes, be sure that you and your spouse nominate the same guardians.
9. Choose a temporary guardian. In addition to nominating a permanent guardian, it’s a good idea to name a temporary guardian, who is close by, to care for your children in the event you’re unable to do so (i.e., for health reasons).
10. Be flexible. As your children grow older, their personalities, interests and needs change. The best guardian today may not be a good fit 10 years from now, so it’s important to review your guardian designation periodically.

Keep in mind that a court’s obligation is to do what’s in the best interest of your children. The court isn’t bound by your guardian appointment but will generally honor your choice unless there’s a compelling reason to do otherwise. It’s a good idea to prepare a letter explaining the reasons you believe your appointees are best equipped to care for your children.

In addition to naming a backup guardian, your estate plan should list anyone you wish to prevent from raising your children.