Many people do not see an estate plan as necessary. Others recognize the need to plan, but have no idea whom to contact or how to begin.

Estate planning encompasses much more than simply protecting one’s assets; it provides peace of mind that your assets will pass according to your wishes at the least cost and administrative burden. Whatever one’s reasons for taking the risk of not planning, there is no doubt that it is a risk that one should not take.

Why Have an Estate Plan?

By neglecting to have even the most basic estate planning document-a will-you leave your estate planning to your state government, with possible adverse results. A local court may have to appoint an administrator to manage your estate. This person, possibly a stranger to you, must be paid. Even if the administrator named is your surviving spouse, a bond is generally required. The amount of time required to settle your estate may be unnecessarily long. Additionally, part of your estate may pass to the federal and state governments in the form of avoidable taxes. Finally, if you have children, then the court will have to appoint a guardian to care for them after you die, which will add emotional and financial burdens for the legal proceedings. Clearly, one imperative of estate planning is: Don’t die without a will.

While most people understand that a will is necessary to transfer assets at their death, they may not know its limitations. Property can actually be transferred several ways:

• By a properly executed will or trust,
• By contract, or
• By operation of law.

TABLE 1. Preserving and Transferring Your Wealth: Property Disposition CLICK ON IMAGE TO SEE FULL SIZE.

Table 1 provides some examples of how different assets are transferred at death.

Transfer by Will
As a general rule, a will provides for the transfer of property owned by an individual, including his or her interest in community property titled in the name of the other spouse. Specific bequests of tangible personal property (e.g., jewelry, furniture), may also be addressed in the will or in a separate memorandum referenced in the will, if permitted by state law. However, a will does not dispose of assets governed by contract or operation of law.

Transfer by Contract
Examples of assets that are governed by contract include annuities, IRAs, employee benefit programs or life insurance. A properly executed beneficiary designation form is necessary to ensure that these assets will pass to the intended persons. Regardless of what your will says, these assets will go to the person listed as the contract beneficiary. Additionally, your beneficiary designation may have both estate and income tax ramifications, particularly for IRAs or employee benefit programs. Therefore, it is important that the designations agree with your overall estate and financial plan.

Transfer by State Law
State law also may affect the disposition of your assets. Assets that pass by operation of law include anything that can be held in joint title, such as a bank account or a house. If you hold a house jointly with right of survivorship, then the house will automatically pass to the other person on the title at your death, regardless of what is stated in your will. In some states, you may be prohibited from disinheriting a spouse or other close relative. Additionally, if you reside in a state that follows the community property system of asset ownership, then state law will supercede the terms of your will in disposing of assets held with a spouse.

Other Estate Documents

Additionally, an estate plan includes more than disposition of your assets at death. It should also include the possible need to administer your assets or make health care decisions if you are temporarily incapacitated. Most financial planners recommend having sufficient savings to fund up to six months of your living expenses, but who would pay your bills if you are unable to do so? If you do not give someone explicit authority to do so, then even a spouse may need to seek court permission to act on your behalf. This again would cause unnecessary emotional and financial burdens at an already stressful time.

For these reasons, in addition to a will, you should consider establishing two types of powers of attorney:

1. A durable general power of attorney to delegate the ability to make and implement financial decisions, and 
2. A health care power of attorney to delegate the ability to make and implement health care decisions. The powers that can be delegated in these documents and the form of the documents differ greatly by state. A living will (sometimes called an advance directive) should also be considered to describe the type and extent of life-sustaining medical treatment that you prefer in the event that you are unable to communicate those wishes.

What Is the Estate Tax?

Estate taxes do not apply only to the very wealthy. Even relatively modest estates may be subject to estate taxes without proper planning. A typical individual with a house, a retirement plan, and life insurance is very likely to have assets that exceed the amount that is exempted from estate tax. For 2008 that amount is $2.0 million, the threshold at which you should think about doing estate planning. Therefore, it is important to understand not only federal estate and gift taxes, but also possible state estate, gift, and inheritance taxes.

The estate tax is really a transfer tax, because it applies to property transfers during lifetime (such as gifts) and at death (such as inheritances). Transfer taxes are progressive, which means that all lifetime taxable gifts are cumulative, so that over time you are subjected to higher tax brackets. Therefore, as the value of your estate increases, planning becomes more important.

The marginal gift and estate tax rates currently range from 18% to 45%. Certain credits and deductions are available to offset the tax. For example, every individual taxpayer can transfer a certain amount of property either during life or at death without paying estate or gift tax, due to a lifetime exemption amount. The lifetime gift exemption amount is currently $1 million. Additionally, transfers to grandchildren and certain other individuals are subject to another tax called the generation-skipping transfer (GST) tax that is imposed at the highest estate tax level.

For more information on the estate tax, gift tax and generation-skipping tax, go to the IRS Web site at www.irs.gov. Details can be found in Publication 950, Introduction to Estate and Gift Taxes; and Form 706 Instructions to the U.S. Estate Tax Return and Form 709 Instructions to the U.S. Gift Tax Return.

How Do I Start Planning?

Estate planning does not need to be seen as a complex set of questions. Instead, it can be a relatively easy process of six steps:

1. Identify the goals,
2. Gather the data and make assumptions,
3. Evaluate the feasibility of your goals,
4. Develop your strategies,
5. Implement the decisions, and
6. Review your progress.

In the estate planning process, these steps can be summarized as follows:

Identify the Goals
The starting point of a successful estate plan, as with any area of financial planning, is identifying and defining your goals. Here are some questions you should answer that will help you identify your goals:

• What is the most appropriate way to dispose of your assets at your death?
• Who will receive what, and when will they receive it?
• Will assistance in the management of the assets be required?
• If you have minor children, who will care for them the way you would, and with what financial resources?
• How can the costs of administering your estate, including taxes, be minimized?
• Have you appointed an agent to act on your behalf in the event of your disability?
• Will your family be adequately provided for in the event of your premature death?

Gather the Data and Make Assumptions
After you have identified your goals, you can begin to gather data. You will need to collect your current estate planning documents, including wills and trust instruments, beneficiary designations on retirement plans and insurance policies, and title documents that set out the ownership of major assets such as your home. In addition, you need to quantify the value of your assets and your liabilities. You must also consider non-financial issues, such as asset management and protection and the timing of when you want your assets to ultimately pass to your heirs.

Evaluate the Feasibility of Your Goals
Most goals dealing with the disposition of assets can be accomplished with estate planning. However, you cannot completely control how your heirs spend their inheritance. Similarly, in large estates, some amount of estate taxes may be incurred, even with planning. It may not be possible to meet goals of complete control or elimination of taxes.

Develop Your Strategies
Identify the planning documents that must be drafted or revised. Determine which tax planning strategies may be appropriate. Consider the individuals or entities to which you want to entrust your assets after your death. Assess the needs of your family members-including your spouse, parents, children, and grandchildren-in light of your death. Consider the financial security of your survivors and the adequacy of your life insurance coverage.

Implement the Decisions
Your decision is meaningless until you turn your words into deeds. In this step, you implement the strategies you developed and execute legal documents. Assign specific tasks to yourself and other family members, and determine whether professional assistance is needed.

Review Your Progress
This final step is easy to ignore, but it is among the most critical. Few decisions are static; we base our choices on a series of events and circumstances that can and do change. Every few years or after a major life event-a marriage, adoption or birth of a child, death of a child or spouse, disability, serious illness, inheritance, divorce, retirement or career change-you should reconsider the various aspects of your plan. Have your goals changed? Has the law changed? Have new or better options become available?

Conclusion

Once you have recognized the risks of not having an estate plan, and how relatively simple it can be to establish one, then perhaps you will be motivated to go through the process outlined above. At a minimum, a will and powers of attorney, coordinated with the proper titling of assets and beneficiary designations, can help you to administer your assets during life and at death.

If you may be subject to gift, estate or GST tax, then you may want to implement more sophisticated estate planning techniques, which would probably require consultation with a professional.

There is no doubt that estate planning can force some difficult decisions. However, if you ignore these issues, then you are risking not only unnecessary taxes, but also unnecessary administrative burdens or anguish for those you leave behind.
Ellen J. Boling, CFP, is director of Private Client Advisors for Deloitte & Touche, LLP, in Cincinnati, Ohio. Tracy Tinnemeyer, JD, is a manager of Private Client Advisors for Deloitte & Touche, LLP, in Pittsburgh, Pennsylvania.

© 2009 AAII Journal     E-MAIL   PRINT

Reprinted with the permission of:

American Association of Individual Investors (AAII)
625 N. Michigan Ave.
Chicago, IL 60611
(800) 428-2244
(312) 280-0170
(312) 280-9883 fax

www.aaii.com

The opinions and views expressed in this document do not necessarily reflect the views or opinions of InvestingMinds. InvestingMinds did not prepare and does not endorse such content. Please note that this document is intended for general circulation only and the recommendations contained herein do not take into account the specific investment objectives, financial situation or particular needs of any particular person. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy securities or other financial instruments. No part of this document may be reproduced in any manner without the written permission of InvestingMinds.

Once you retire, if you start drawing from your investment and savings accounts in the wrong order, you greatly increase the odds that your money will run out or that your heirs will be left with less than they could have inherited.

Common mistake: Many retirees as­sume that they should start withdraw­ing money from their IRAs, 401 (k)s and other retirement accounts as soon as they retire-retirement is, after all, what this money is intended for.

Reality: Your financial future could be a lot brighter if you leave retirement accounts un­touched for as long as govern­ment rules and your financial situation allow. That way, you sharply reduce your annual tax payments.

Example: Two people retire at age 65. Each has a total of $1.4 million-$1.1 million in retirement accounts, such as IRAs and 401(k)s, and $300,000 in taxable nonretirement accounts. Each earns an 8% annual return on his/her overall investments and-drawing on both principal and investment re­turns-spends $8,000 per month on expenses. How they diverge: Mr. A starts living off his retirement accounts as soon as he retires-and sees his sav­ings run out at age 98. Ms. B lives off her taxable investments for as long as possible before tapping tax-protected retirement accounts-and still has $1.2million remaining at age 98 (see chart).

THE BEST ORDER

Once a retiree passes age 70 1/2, gov­ernment rules require specific minimum annual withdrawals from most tax-deferred retirement accounts, including traditional IRAs and 401 (k)s. A retiree’s tax bracket, health and personal priori­ties can alter the order in which assets should be withdrawn. These caveats aside, most retirees should tap accounts in roughly the fol­lowing order…

1. Taxable income. Pension distri­butions, earned income from re­tirement jobs and income from divi­dends and interest in accounts other than IRAs and 401 (k)s should be spent first. If you already have begun to receive Social Security payments, that money should be used as well (If you have not yet started receiving your Social Security benefits, see item 4 below.)

2. Traditional IRA and/or tradition­al 401(k) distributions if your tax bracket Is low. This is an exception to the general rule that you should leave tax-deferred retirement accounts untouched for as long as possible. If your retirement income is low enough to keep you in the 10% or 15% tax bracket, withdraw money from your tax-deferred retirement savings just un­til you reach the taxable income limit of the 15% tax bracket. In 2007, the limit is $63,700 for a married couple filing jointly and $31,850 for an individual. Example: After deductions, a retired married couple’s taxable investment income, pension benefits and other retirement income total $50,000 for 2007. They withdraw $13,700 from their traditional IRA and remain in the 15% tax bracket.

Better: If you can live without this income for now, instead of taking a distribution, convert a portion of your traditional IRA to a Roth IRA (whose assets will never be taxed in the future), but not so much that the converted as­sets push you out of the 15% tax brack­et. (The converted assets count toward your income for tax purposes.)

3. Taxable investments and savings. Among these assets-including stocks, bonds and mutual funds outside of retirement accounts-there are three basic steps to consider…

First, sell those that have dropped in value and are no longer attractive so that you can use the capital losses to offset capital gains.

Second, draw on any assets that are in cash (including money market funds) and fixed-income investments, such as matured bonds and matured certificates of deposit (CDs). By reduc­ing these assets, you lower the amount of taxes you pay on future interest and dividends. If this action shrinks your overall allocation for fixed-income investments, you can raise the amount of fixed-income investments you have in IRAs and 401 (k)s.

Third, sell taxable investments that have appreciated in value but are no longer attractive, especially those that have appreciated the least. Any long ­term capital gains-on assets held for more than one year-are taxed at no more than 15%.

4. Social Security benefits. Retirees who have not yet begun to receive Social Security benefits might consider delaying the start of their benefits until as late as their 70th birthdays if they can afford to do so.

Retirees can receive Social Security checks at age 62. However, the size of the checks will increase by 7%, 7.5% or 8%-depending on the year the retirees were born-for each year they delay from age 62 until 70. There is no ad­vantage to delaying the start of benefits past age 70. Retirees who will benefit from waiting…

Have enough other retirement as­sets and income to cover their expenses and don’t have to dip into their tax-deferred retirement accounts (except as mentioned in item 2) and…

Are healthy and come from families in which members tend to live a long time. The longer you expect to live, the more sense it makes to delay the start of Social Security benefits. If your health or family history suggests that you might not live much past age 84, start benefits by age 66.

5. Traditional IRAs, 401(k)s and oth­er tax-deferred retirement accounts. Withdrawals from these accounts gener­ally should be delayed as long as possible to take maximum advantage of tax-deferred investment growth. Eventually, however, either your financial situation or tax rules may force you to start with­drawing money.

Strategy I: Married couples who must tap into tax-deferred accounts before tax laws require should draw on the older spouse’s accounts first. That way, the older spouse will have already met part of the minimum required distribution.

Strategy II: Tax laws typically require that annual withdrawals from tax-deferred retirement accounts begin April 1 of the calendar year following the year in which the retiree turns 70 1/2. Most retirees, however, should begin taking withdrawals in the same calendar year that they turn 70 1/2, not the one after. That way, you don’t end up taking two required distributions - the initial one and the second one - in a single year, which could push you into a higher tax bracket. (See IRS Publication 590, Individual Retirement Arrangements, or www.paytaxeslater.com/calculator to calculate required withdrawals.)

Exceptions: Minimum required distributions from a traditional 401(k) often can be delayed as long as you are still working for the company that sponsors the 401(k). You also might be able to delay minimum distributions until age 75 on contributions made before 1987 to a 403(b), a type of retirement account offered by nonprofit organizations.

6. Roth IRAs. Assets held in Roth IRAs and Roth 401(k)s generally shouldn’t be spent until all other assets have been exhausted, because there are no future taxes on Roths - including on investment gains - even for heirs. And there are no minimum required distributions for you or your surviving spouse from your Roth IRA. To avoid minimum required distributions on your Roth 401(k)s, roll them into your Roth IRA.

Types of Accounts

Tax-deferred retirement ac­counts. These include traditional IRAs and 401(k)s for which taxes have not yet been paid. No taxes are paid as long as the money remains in the account, but taxes must be paid at regular income tax rates on any with­drawals, including interest, dividends and even capital gains.

Roth IRAs and Roth 401(k)s. Tax­es were paid before the initial contri­butions were made, and no further taxes will ever have to be paid on the initial contributions or the interest, dividends and gains (as long as cer­tain conditions are met).

Reprinted with the permission of:

Bottom Line/(name of publication/website)

Boardroom, Inc.
281 Tresser Blvd, 8th Floor
Stamford, CT 06901
www.BottomLineSecrets.com

The opinions and views expressed in this document do not necessarily reflect the views or opinions of InvestingMinds. InvestingMinds did not prepare and does not endorse such content. Please note that this document is intended for general circulation only and the recommendations contained herein do not take into account the specific investment objectives, financial situation or particular needs of any particular person. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy securities or other financial instruments. No part of this document may be reproduced in any manner without the written permission of InvestingMinds.

Many of you, being responsible investors, have also been planning for the future. Hopefully you have established a retirement savings account such as an IRA or 401(k). After spending years contributing to these plans and investing wisely, many of you will have sizable accounts that you might leave one day to your heirs. You might also find yourself as the beneficiary of someone else’s plan. There are many important details concerning inheritance of these funds, especially in cases where the beneficiary is not a spouse of the account holder. Through careful planning you can ensure that these accounts continue to grow tax-deferred for many years beyond the death of the original account holder.

The first priority is to make certain that a beneficiary is detailed for each of your plans. Not having a beneficiary listed can preclude your estate from taking advantage of very favorable tax treatment. The beneficiary of an IRA must have a life-expectancy upon which to base minimum annual withdrawals. Without an actual person named, the entire account must be withdrawn, and taxes paid, within five years. (If the deceased had already started to take distribution, the original distribution plan could also stay in effect.)

Kevin Pollock is an attorney with a Masters in Taxation who focuses on estate planning. He stresses the importance of designating beneficiaries properly. “This ensures that your hard-earned money goes where you want it to go. The biggest mistake is made when simple names are used instead of making a formulaic allocation.”

An example of this is if you had two children, Joe (childless) and Jane (with two children of her own). If you list Joe and Jane as beneficiaries, each would receive half of your account. If Jane dies, Joe would receive everything. If your intention is for Jane’s two children to receive her share, your beneficiary designation must be written in such a formulaic way as to convey your true intent.

Even with new rules providing more favorable tax treatment to non-spousal beneficiaries, leaving your retirement accounts to your spouse is still the most simple and advantageous route to take for most people. The spouse can roll the fund over to his or her own IRA or a new IRA, continue to make contributions, and not have to withdrawal the funds until he or she reaches 70 ½.

Things get a little more complicated when you inherit an IRA from someone other than a spouse. The funds cannot be co-mingled with any IRAs you might already have. You must set up an Inherited or Beneficial IRA. It is extremely important that the account is named correctly. Mess up here and the tax consequences could be huge, as in having to pay taxes on the lump sum that year. Ouch! The name of both the deceased and the beneficiary must be on the account, with the more detail the better. An example; “Mary Jones (deceased 3/15/07) Inherited IRA for the benefit of Sally Smith, beneficiary.” It is very important that the transfer of funds be done properly. The check must be made out in the name of the deceased and sent to the institution that will house the Inherited IRA. If the check is made out to the beneficiary, it would be considered a lump sum distribution and taxes would be due. Again, ouch!

Now that the Inherited IRA has been established, the beneficiary must start taking minimum required distributions (MRD). Unlike spouses, who can wait until they reach age 70 ½ to begin withdrawals, the non-spousal heir must begin these distributions by December 31of the year following the account-holder’s death. The distribution will, however, be based on the life expectancy of the beneficiary, no longer the deceased. Younger heirs can withdraw the lower MRD, allowing the principal to continue to grow over their entire lifetime.

There is still the option of taking the lump-sum distribution instead of setting up the Inherited IRA. The funds would then be considered taxable income. This can result in a double-whammy of sorts, as the large sum of taxable money often bumps the beneficiary into a higher tax bracket as well.

A third option of the beneficiary is to give the funds away. This usually occurs when someone doesn’t need the money and they want their younger children to have the money. This is best arranged during the life of the account holder. The fund can be left to the spouse, with the children listed as contingent beneficiaries. If the spouse doesn’t need the money and refuses the bequest, it would then be inherited by the children, who would have to set up Inherited IRAs or take the lump sum. They would have an even longer life expectancy upon which to grow the account balance tax-deferred. There are many more details involved than there is room here, so make certain to consult a tax or estate planning specialist before attempting to set any of this up on your own.

The Pension Protection Act of 2006 provides similar treatment for the inheritance of 401(k)s by non-spouses by permitting your non-spousal heirs to transfer these assets to an IRA. One unforeseen problem is that the Act doesn’t mandate that companies provide this option. Some companies have opted not to make the necessary changes to their policies due to the time and expense it would take. Now is a good time, if you plan on leaving your 401(k) to someone other than your spouse, to check with your company and ensure that your beneficiaries will be allowed to move the funds to an Inherited IRA if they choose.

Some still recommend that you roll your 401(k) into an IRA of your own when you leave a company, which is permitted by all plans. Although the Pension Protection Act now provides better options for non-spousal beneficiaries of a 401(k), an IRA will give you greater investment options and ensure that your heirs can stretch the distributions over their lifetime. The possible negative is if you need to make use of these funds between ages 55 and 59 ½. Taking an early withdrawal from your 401(k) at these ages will not result in a penalty. If you’ve moved the funds into an IRA, you would have to pay a 10% early withdrawal penalty.

Bill Christensen, Vice President Investment Advisors with Fifth Third Bank, reminds us how timing can be critical. “You have until December 31 of the year after the death of the account-holder to create an Inherited IRA and begin taking MRDs. Miss this date and you’re back to a major tax hit, as well as the loss of future growth of those tax-deferred funds.” To preserve all of your inheritance options, it is best to make certain decisions within nine months of the death. The IRS does not take ignorance of the rules, or grief, as an excuse for missed deadlines.

Christensen also stresses that “the issue of retirement fund inheritance will continue to grow in importance. As firms move away from pensions and the uncertainty of social security looms in the future, more of an individual’s net worth will be tied up in IRAs and 401(k)s than in the past.”

Once again, the common recommendation is to consult a tax professional or estate planner not only before taking distributions from an inherited retirement account, but also while setting up your own plans. Make certain the individual is up-to-date on the ever-changing rules related to your qualified plan. There are so many possible mistakes that can be made, resulting in not only major tax consequences, but also the loss of valuable long-term earning potential for either you or your intended heirs.

The opinions and views expressed in this document do not necessarily reflect the views or opinions of InvestingMinds. InvestingMinds did not prepare and does not endorse such content. Please note that this document is intended for general circulation only and the recommendations contained herein do not take into account the specific investment objectives, financial situation or particular needs of any particular person. This document is for information purposes only. No part of this document may be reproduced in any manner without the written permission of InvestingMinds.