How to ensure your estate plan is doing things for you, not to you

Geoffrey M. Zimmerman, CFP®, senior client advisor, Mosaic Financial Partners, Inc.

Geoffrey M. Zimmerman, CFP®, senior client advisor, Mosaic Financial Partners, Inc.

Estate planning is more than just having documents. It needs to be tied to long-term intent and aligned with your goals. What works for one person may not work well for the next, and what worked 10 years ago may not work now.

Geoffrey M. Zimmerman, CFP® practitioner, senior client advisor at Mosaic Financial Partners Inc., says many treat their estate plan like a transaction, even though the moving parts may have changed.

“They may have a document that is doing things to them and to their beneficiaries, and not really working well for them,” he says. “That’s why it’s important to review the plan periodically. It might take a visit to your attorney and the cost of several hours of time to update it. But in terms of relieving the headache on a surviving spouse or beneficiaries, those can be dollars well spent.”

Smart Business spoke with Zimmerman about why your estate plan should be continually adjusted.

What recent changes make updating your estate plan important?

Although the estate tax exemption did not reset as many feared, there are new items to consider. Undistributed income from an irrevocable trust can reach the top federal income tax bracket of 39.6 percent plus the Medicare tax of 3.8 percent after only $11,950. Those trusts can also see capital gains rates increase from 15 to 20 percent. This might impact a surviving spouse with capital gains assets in a credit shelter trust (also called a bypass trust) and assets in a marital trust.

How could outdated plans create problems?

In 1996, a couple with a $3 million estate would typically use a bypass trust to allow both spouses to use their respective $600,000 exemption to non-spouse beneficiaries, effectively allowing $1.2 million to pass to heirs free of estate tax. The remaining $1.8 million — plus any additional growth — was taxed at the death of the surviving spouse at rates up to 55 percent. A common planning strategy at the death of the first spouse was to put growth assets into the trust, as there would be no estate taxes on those assets. Heirs would still pay capital gains taxes, but capital gains taxes were (and still are) lower than estate taxes.

Today, the estate tax exemption has increased to $5.25 million per person. In our example above, the surviving spouse’s estate of $2.4 million worth of property could more than double before reaching $5.25 million and triggering any estate taxes.

Also, with the new laws, there is a now a new feature called ‘portability,’ which allows the surviving spouse to use the deceased spouse’s unused exemption amount. So in theory, a surviving spouse could pass up to $10.5 million worth of assets to heirs free of estate tax without using a bypass trust.

Older trusts that call for the creation and funding of a bypass trust may incur other unintended consequences. For example, formulas that call for funding the bypass trust to the maximum amount available without triggering an estate tax could leave the surviving spouse at a disadvantage with little or no assets in the survivors trust. Subtrusts that contain highly restrictive conditions for distributions to the survivor can create further complications. Finally, estates that contain large amounts of illiquid  assets that would need to be split between multiple trusts may also be problematic.  Periodic reviews, including a flowchart to understand what assets are going where, may be particularly helpful.

Also, as mentioned earlier, undistributed income in the bypass trust can hit top tax rates at very low levels of income, whereas the surviving spouse may not reach top tax brackets until he or she reaches $400,000 in taxable income.

Does this mean subtrusts are no longer useful?

They are still useful in cases where control over the disposition of assets is important, such as preventing a surviving spouse from disinheriting children from a previous marriage. You must balance the need for control against the surviving spouse’s needs, and your goals for your non-spouse beneficiaries. The surviving spouse and beneficiaries may have different interests — income versus growth. Proper planning, which includes a good understanding of goals and motivations, can help improve the odds of a successful outcome.

Geoffrey M. Zimmerman, CFP® practitioner, is a senior client advisor at Mosaic Financial Partners Inc. Reach him at (415) 788-1952 or [email protected]

Insights Wealth Management & Finance is brought to you by Mosaic Financial Partners Inc.

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