Avoid The Most Common Estate Planning Mistakes

1. Putting It Off. A large percentage of people in the United States die without having a valid Will in place. That means that state law will determine who receives your assets. The government’s plan may differ from what you would have chosen for yourself.

2. Not Naming a Guardian for Minor Children. Young people who have not accumulated significant assets often think a Will is unnecessary. However, one of the most important provisions of the Will names the guardian of minor children. In the absence of a Will, the court will appoint a guardian without knowing who you would have chosen.

3. Using Simple “I Love You” Wills. An “I Love You” Will simply leaves all assets to the surviving spouse. True, the estate tax marital deduction results in no estate tax after the first spouse’s death. But this arrangement could result in federal estate tax after the death of the second spouse to die, if his or her assets exceed the exempt amount (currently $1 million, increasing gradually to $3.5 million in 2009, with repeal scheduled for 2010 only, followed by reinstatement of the tax with a $1 million exemption in 2011). The solution is to have each spouse’s Will transfer the exempt amount of assets to a “Bypass Trust.” The Bypass Trust is so named because the assets “bypass” the taxable estate of the surviving spouse after the surviving spouse’s death, even though the trustee can make distributions from the trust to the surviving spouse during his or her lifetime.

4. Improper Form of Asset Ownership. Assets must be titled correctly in order to take advantage of the Bypass Trust described above. The most common error of this type is when spouses jointly own major assets such as the residence. Since joint property passes automatically to the surviving joint owner, it cannot be passed to the Bypass Trust. This can be corrected by changing the form of ownership to a tenancy-in-common. Similarly, joint bank and brokerage accounts can be separated into individually owned accounts so that each spouse has enough assets to fund the Bypass Trust in the event of that spouse’s death.

5. Assuming Your Will Covers All Your Assets. Many significant assets are not controlled by your Will. For example, beneficiaries under life insurance policies, retirement plans and IRAs are not named by Will. Instead, the beneficiary designation under the policy, plan or IRA trumps the Will. A common example involves divorced individuals who change their Will to eliminate the ex-spouse, but do not change the designation of the ex-spouse as beneficiary under their pension plans and insurance policies.

6. Owning Life Insurance Yourself. Life insurance proceeds are included in your taxable estate for estate tax purposes if you had any “incident of ownership” over the policy. Inclusion of life insurance proceeds could easily turn a non-taxable estate (under $1 million) into a taxable estate (over $1 million). Life insurance is by definition designed to benefit your beneficiaries after your death, not you during your lifetime. You can avoid holding any incident of ownership by establishing an irrevocable life insurance trust (“ILIT”) to own the policy. This will ensure that your beneficiaries receive the full amount of life insurance benefits unreduced by federal estate tax.

7. Not Taking Advantage of $11,000 Gift Tax Annual Exclusion. The unified federal estate and gift tax law allows each individual to make a gift of up to $11,000 per year to any individual without any gift tax consequences. These gifts can reduce your estate subject to estate tax, or perhaps even eliminate the potential estate tax. What’s more, the appreciation on the gifted asset is also excluded from your taxable estate. The amount of the gift in excess of the annual exclusion amount applies against the lifetime $1 million exemption (or is subject to gift tax if you have already exceeded the lifetime exemption amount).

8. Not Making Direct Gifts for Tuition and Medical Expenses. Federal gift tax law also allows you to make unlimited gifts that do not reduce the exempt amount ($1 million in 2003) if the gifts are in the form of direct payment of tuition or medical expenses. This is in addition to the $11,000 annual exclusion described above. Thus, you can directly pay the tuition bill of a child or grandchild (or anyone else) without any gift tax consequences, even if the bill exceeds $11,000 in a year. The same rule applies to the direct payment of medical expenses.

9. No Business Succession Plan. Family-owned businesses have only a 40% chance of surviving when passed from the first to the second generation, and that survival rate drops precipitously when we look at family businesses passed to the third or fourth generation. The failure of these businesses to survive being passed to lower generations can be explained by both tax and non-tax considerations, but the odds can be dramatically improved by careful planning.

10. Not Planning for Incapacity. Estate planning usually includes preparation for the possibility that you become incapable of making medical and financial decisions for yourself. You should execute documents that authorize someone else to act on your behalf in the event of your incapacity. Without these documents in place, court proceedings to name a guardian may be required no matter how costly and unpleasant for all concerned.