One of the most effective ways to direct the distribution of your assets upon your death is to make a Will.  Some Wills can be straightforward, while others can be very intricate, depending upon the wishes and goals of your estate plan.

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The primary reason for executing a Will is to provide written instructions regarding how your assets are to be distributed among your beneficiaries.  A properly drafted Will accomplishes the following:

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• instructs how your assets are to be distributed, including specific gifts of tangible personal property, such as jewelry, clothing and furniture

• designates an Executor who is responsible for taking inventory of your property; preserving your estate; paying creditors, administrative expenses and death taxes; and disposing of the remainder of your property among your beneficiaries

• appoints Guardians for your minor children in the event of the death of both parents, and

• establishes trusts to protect assets.

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It is important to note that a Will only controls the disposition of probate assets, which are those assets owned in your own name that do not have a named beneficiary (e.g., bank accounts or real estate in your name alone).  On the other hand, non-probate assets pass outside of the Will and transfer automatically to another person or designated beneficiary upon your death.  Non-probate assets include:

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• assets held in a revocable living trust

• assets held jointly with your surviving spouse, or with another person as joint tenants with a right of survivorship

• proceeds of an insurance policy where beneficiaries are named other than your estate, and

• balances of retirement plans, IRAs, Keogh accounts and tax-deferred annuities, which may be payable to designated persons rather than your estate.

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When designing your estate plan, it is important to consider your non-probate assets and to revisit your beneficiary designations on life insurance and retirement plans to ensure your assets pass to your intended beneficiaries.  All too often, individuals update a Will, but neglect to update beneficiary designations and inadvertently leave assets to former spouses, predeceased or unintended family members.  It is also not advisable to name minors as beneficiaries, as these assets will pass directly to them. 

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For individuals with larger estates (e.g., near or over the federal estate tax exemption ($12.06 million in 2022) or in states with state estate taxes, like New York, the plan should consider potential estate and income tax issues, including:

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• Portability.  “Portability” allows a predeceasing spouse’s estate to elect to transfer any unused federal estate tax exemption to the surviving spouse, eliminating the need for spouses to re-title property and create “credit shelter” trusts (“CSTs”) at the first death solely to ensure full use of each spouse's federal estate tax exemption.  Portability, however, has several limitations and should not be viewed as a wholesale replacement for estate and transfer tax planning for married couples.

  • Portability does not apply to the federal generation-skipping transfer (“GST”) tax exemption, which is lost if not used.

  • Federal portability does not apply to state exemptions, so individuals with state estate tax exposure (such as New York residents) may need to fund a CST to use state estate tax exclusions.

  • Appreciation in CST assets will not be subject to estate tax at the surviving spouse’s death, unlike assets held in a marital trust or by a surviving spouse.

    • Note that the surviving spouse has full control over assets left to them outright, as opposed to assets left in trust.  This is an important concern in blended families or if the surviving spouse remarries.

• Lifetime Gifts vs. Step-Up at Death.  Increases in the federal estate tax exemption and in federal income tax rates (including the 3.8% net investment income tax and the impact of state income taxes) have created a balancing act between lifetime gifting and holding assets until death, due to the potential income tax liability to recipients of gifted property upon later disposition.  Thus, planning for larger estates requires an overall tax analysis of whether and what assets, if any, to gift during life.

• Lifetime Gifts vs. Step-Up at Death.  Increases in the federal estate tax exemption and in federal income tax rates (including the 3.8% net investment income tax and the impact of state income taxes) have created a balancing act between lifetime gifting and holding assets until death, due to the potential income tax liability to recipients of gifted property upon later disposition.  Thus, planning for larger estates requires an overall tax analysis of whether and what assets, if any, to gift during life.

• Charitable Bequests.  Charitable deduction planning will be important for philanthropically-inclined individuals. Rather than just making an outright charitable bequest, the estate plan can customize the bequest to impose certain requirements on how the money should be used, or, for more control, make the bequest to a donor-advised fund, charitable trust or private foundation, possibly managed by selected friends or family.

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Testamentary Trusts

 

Trusts are very powerful estate planning tools that can provide asset protection, tax reduction, probate avoidance and many other benefits.  

 

A trust is a legal entity that is established by an agreement.  Under the trust agreement, you, as the Grantor of the trust, dictate the terms of the trust and decide what assets to put in it.  You also select a Trustee or Trustees to hold and manage the property under the terms of the agreement.  Finally, you name the beneficiaries of the trust, which may include yourself, family members, charities or anyone else you want to benefit.  The Trustee manages and uses the assets in the trust for the benefit of your named beneficiaries.

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A trust can be created either during your life (living or inter vivos trust) or at your death according to the terms of your Will (testamentary trust).  A trust may also be revocable or irrevocable, depending upon its purpose.  A revocable trust allows you, as Grantor, to retain complete control of the assets and allows you the power to change the terms of the trust at any time.  If you establish an irrevocable trust, you give up certain rights to the property and have limited ability to change the terms of the trust.

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You can establish a testamentary trust under the terms of your Will in order to ensure that your assets are held, managed and distributed in the manner which you specify.  You can direct that the Trustee of the trust manage certain assets for the benefit of your beneficiaries, and distribute certain amounts to named individuals at specific times, as set forth in your Will.  For instance, some individuals may be concerned about what will happen to their assets if the surviving spouse remarries.  To deal with this concern, a trust can be created that provides income and principal for the surviving spouse during their life, but preserves the remaining principal for the testator's children upon their death, rather than transferring outright all assets to the new spouse or the new spouse's children.  Similarly, if an individual is leaving assets to children or other minors (such as nieces, nephews or grandchildren), they should consider using a trust to ensure that they do not receive the assets until they reach a certain age or maturity level, or dictate in the trust document that funds shall be used only for certain purposes, such as health, education, maintenance and support.

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There are many compelling reasons to establish trusts under your Will.  Testamentary trusts can be used to address the following issues:

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• Minor children:  Outright bequests to minors will typically require the court appointment of a guardian and court supervision over expenditures for the benefit of the minor children.  Establishing a trust for minor children would avoid such court proceedings and supervision.

• Federal estate tax:  Although the 2012 Tax Act lessened or eliminated the burden of federal estate tax for most people, it is still a serious concern for others that must be addressed with appropriate trust planning.  

• New York State estate tax:  Trust planning must be utilized in order to mitigate or eliminate the cost of this tax for those with estates in excess of the State Basic Exclusion Amount.

• Divorce:  An outright bequest to a beneficiary who later gets divorced could result in at least a portion of the bequest being lost as part of the divorce settlement.  A properly designed trust can eliminate this risk.

• Re-marriage:  The use of a trust (as opposed to an outright bequest) can ensure that, in the event of the surviving spouse's remarriage, the inheritance of the deceased spouse's children will not be diverted to a future spouse and/or the children of that spouse.

• Second marriage:  A trust may be used to provide for the surviving spouse during their lifetime, while still ensuring the eventual inheritance of children from a prior marriage.

• Spendthrift provision:  Young adults, and sometimes mature adults, may have difficulty managing their financial affairs.  A trust can be designed to include spendthrift provisions and other limitations on distributions in order to ensure that the beneficiaries are adequately provided for, without the risk that a newfound inheritance will be squandered.  

• Substance abuse:  This type of trust can be established for a beneficiary with a drug problem, such that no distributions shall be made until the results of a drug test are clean for a specified period of time.  

• Disabilities or special needs:  Beneficiaries with special needs often receive public benefits.  Outright bequests can interfere with a beneficiary's qualification for these benefits and can place the beneficiary's inheritance at risk.  A properly drafted Supplemental Needs Trust may be used to prevent disqualification for benefits.

• Creditor protection:  An outright bequest will be available to the creditors of a beneficiary.  A trust may be used to make trust assets available to the beneficiary without exposing them to creditor's claims.

• Multi-generation trust:  A multi-generation trust can be created to provide for a child during the child's lifetime, with the remainder passing to grandchildren (or other family members) after the child's death.

• Charitable giving:  A trust can be designed to provide for a beneficiary during the beneficiary's lifetime, with the balance paid out to a charity upon the beneficiary's death.