Estate Planning While You're Young: Two Strategies For Structuring Your Assets
“I want to leave my children enough that they feel they can do anything, but not so much that they do nothing."
― Warren Buffet
“When the time comes to die, make sure that all you have to do is die."
― Jim Elliot
I would venture the guess that most of my friends think of estate planning as an activity for wealthy, aged people. And it most definitely is. But as the complexity of our lives increases with home ownership, the arrival of children, and a growing nest egg, the need to develop an estate plan starts knocking at our doors as well.
Unlike car insurance or filing tax returns, there’s no mandate or penalties that force us into estate planning. Like life insurance, estate planning is not something we have to do. It is also not something we do for ourselves, but for those we care about. If we establish a solid estate plan, it will save the people we care about a lot of headache around the time, cost, and effort, and it ensures that our assets will actually go to the people we care about.
This week we’ll go over the two common ways of organizing your estate as you build wealth. Note that these are not mutually exclusive; there are advantages to having both in place. I’ll also point out some considerations for those who have minor children and give a short primer on what to consider when your wealth grows over the estate tax limit.
Solution One: Properly Titling Assets and Keeping Beneficiaries Up To Date
As you can tell from reading last week’s post on assets that pass through beneficiary designations, you may be able to place the large majority of your wealth in these assets. Keeping a close watch on your beneficiary designations is the crucial step here. You (or your financial planner) may maintain a spreadsheet of all your accounts and deeds with current primary, secondary, and contingent designations and a schedule for reviewing them. As relationships change and death, divorce or the birth of children form and transform your priorities, you monitor and update these beneficiary designations to reflect your wishes. Make sure to notify your beneficiaries of your designation. Finally, drafting a will gives voice to your non-monetary desires as well as designating a guardian for children, and advanced medical directive and powers of attorney allow others to assist you if you were to become incapacitated. Neither beneficiary designations nor a living trust are substitutes for a will.
Solution Two: A Living Trust
While maintaining beneficiary designations provides one method for avoiding probate on most assets, a living trust can simplify the distribution of assets upon death. It serves as hub which holds title to your assets, and allows for you to structure distribution with a more holistic approach. It avoids the drawbacks of probate which we discussed last week (time, cost, privacy, and transfer issues.) A living trust is designed to set a process into motion should you pass away. Upon your death, the appointed trustee is charged with the distribution of assets according to the designations you included in the trust documents. Note that during your lifetime the control and use of the assets of the trust remain with you. Only upon your passing would the trustee begin to administer the transfer of assets according to your instructions.
Families With Children and A Note on Minors as Beneficiaries
Families with minor children have a unique reason for utilizing a living trust. If you have, or plan to have children in the near future, proper account beneficiaries (Solution One) will not suffice. In most cases minors are not allowed to own property. Banks won’t transfer your investment accounts to your 4-year-old and insurance companies won’t write them a check. For this reason, your minor children should never be designated as beneficiaries. Rather, creating a revocable living trust allows you to designate a trustee who would be mandated to act according to your wishes and your children’s best interest until they reach the age of majority. Keep in mind that a trust cannot provide for their guardianship. A will is still required for this.
Revocable vs. Irrevocable Trusts: A Word on Estates Over $5.49M
In 2017 each person is entitled to a $5.49 million federal estate tax exclusion (with portability, a married couple may combine for an exclusion of $10.98M). Currently the exclusion limit is adjusted for inflation and rises annually. Taxation on amounts over this limit is tiered. After the laddered rates on the first $1M, the remainder is taxed at a flat 40%. Thankfully, California itself has no additional estate tax.
If you are in the midst of your peak earning years this number may not appear to be relevant for you now. Your human capital is likely greater than your banked assets. Having “too much money” is definitely a problem we would all like to have. But stock options, equity compensation, business ownership, or long term investment growth can increase your assets to the level where this tax liability becomes relevant to you. Few people I know would be excited to “graduate life” and then give away 2 out of every 5 dollars of their wealth to the federal government. This becomes especially pertinent when wealth is tied to a family business or real estate, which might have to be sold to provide estate liquidity for tax payment.
You can use a number of estate tax minimization strategies. These include lifetime gifts, tax-deductible charitable donations, and the implementation of several types of trusts. These are used to avoid the estate tax and remove assets from the grantor’s estate by allowing the grantor to relinquish control on either the ultimate ownership, current cash-flow, or both. They are often designed as “irrevocable trusts” because they avoid estate taxation by giving up ownership control before your death. Maintaining a revocable living trust allows you to retain full control and take advantage of the lifetime estate tax exclusion, but an irrevocable trust can make an additional and significant dent in the coming estate tax. If you are building wealth over the five and a half million estate tax threshold it’s worth speaking to a qualified financial planner and estate attorney about both revocable and irrevocable trusts.
My hope is that this two-part dive into estate planning for the accumulating generation helps you formulate your own objectives around structuring your own estate plan. Do you rely primarily on beneficiary designations, or do you establish a living trust? What is your schedule for reviewing either one? The birth of children, the purchase of a home, the growth of a business, or simply your accumulating assets can all serve as impetus to establish a well-thought-out estate plan and trust. Finally, keep in mind the estate tax limit and begin to seek wise counsel early if you foresee your wealth growing beyond the estate tax exclusion.
So, how do you establish, a living trust? We'll go over that in our next post on estate planning.