Quiz 15: Preserving Your Estate

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If you die without a valid will, the laws of your state will determine what happens to your property. That may be fine with people who have few assets, but it's not fine for people who care what happens to their property, and it's certainly not fine for people with dependents. In this project, you'll consider what your current will should contain and what changes you should make to your will based on your future circumstances. Look back through this chapter and review the common features of a will. Then write your own will, based on the sample clauses and examples of a representative will given in the text. List the property that you currently have, or expect to have in the near future, and name a beneficiary for each. Be sure to name your personal representative, and charge him or her with disposing of your estate according to your wishes. If you have children or expect to have children, or if you have other dependents such as an elderly parent or a disabled sibling, be sure to name a guardian and a backup guardian for them. Also prepare a letter of last instructions to convey any personal thoughts or instructions that you feel cannot be properly included in your will. Remember, this exercise should help you think about the orderly disposition of your estate, which is the final act in implementing your personal financial plans.

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Q 2

Discuss the importance and goals of estate planning. Explain why estates often break up. Distinguish between the probate estate and the gross estate.

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Discuss the importance and goals of estate planning: Estate planning is the process of developing a plan to administer and distribute the person's assets after death in a manner consistent with his wishes and needs of his survivors while minimizing taxes. To minimize the tax exposure is the major goal of estate planning. Estate planning is used by people to accumulate enough capital to meet their personal needs as well as financial security to the family members in case of death, major physical disability and retirement. Estate planning can be done mainly in the area of people planning and asset planning. People planning include predicting the needs, both psychological and financial, of close and loved ones and providing enough income and capital so that they can continue their life in the way in which they want. When an estate involves closely held business, estate planning is essential to stabilize and maximize its asset and income producing values, both during the owner's lifetime and at the owner's death or disability. Explain why estates often breakup: The estates often break up. The estate die with people because of number of reasons which includes; death related costs, inflation, lack of liquidity, improper use of vehicle of transfer, and disabilities. • Death related costs: During the lifetime, generally people do not account for death related costs. Sometime, death related cost is so much that they have to spend their whole estate to cover up them. Medical bills for final illness, funeral expenses, fees for attorneys, appraisers and accountants, administrative expenses, federal estate taxes and state death taxes, current bills unpaid, outstanding long term obligations and unpaid taxes are some of the examples of death related costs. • Inflation: The value of the money decreases with the time. So, the value of the estate has to be rearranging periodically to counter the effect of inflation someone fails to do so, then it can hamper the ability of assets to provide steady and adequate levels of financial security and reduces its usefulness. • Lack of liquidity: When people do not have enough capital to cover their death related cost, and then their estate tends to shrink. • Improper use of vehicles of transfer: It involves passing property to the unintended beneficiaries or to the proper beneficiaries in an improper manner or at an incorrect time. • Disabilities: Loss of income due to long term disability of a family wage earner may diminish the value of the estate. Difference between probate estate and gross estate: Probate estate consists of the real and personal property that can be transferred at death according to the terms of a will or in case of no valid will, under intestate law. Whereas, gross estate includes all the property- both probate and nonprobate- that might be subject to federal estate taxes at death. Life insurance, jointly held property with rights of survivorship, and property passing under certain employee benefit plans are examples of nonprobate assets that might be subject to federal estate taxes.

Q 3

In the late 1970s, Latafat Tilki, from Turkey, migrated to the United States, where he is now a citizen. A man of many talents and deep foresight, he has built a large fleet of oceangoing oil tankers during his stay in the United States. Now a wealthy man in his 60s, he resides in Aspen, Colorado, with his second wife, Karen, age 50. They have two sons, one in junior high and one a high-school freshman. For some time, Latafat has considered preparing a will to ensure that his estate will be properly distributed when he dies. A survey of his estate reveals the following: The house and the Gold Mines International shares are held in joint tenancy with his wife, but all other property is in his name alone. He desires that there be a separate fund of $1 million for his sons' education and that the balance of his estate be divided as follows: 40 percent to his sons, 40 percent to his wife, and 20 percent given to other relatives, friends, and charitable institutions. He has scheduled an appointment for drafting his will with his attorney and close friend, Gary Ingram. Latafat would like to appoint Gary, who is 70 years old, and Latafat's 40-year-old cousin, Ceylan Sadik (a CPA), as coexecutors. If one of them predeceases Latafat, he'd like Second National Bank to serve as co-executor. Critical Thinking Questions 1. Does Latafat really need a will Explain why or why not. What would happen to his estate if he were to die without a will 2. Explain to Latafat the common features that need to be incorporated into a will. 3. Might the manner in which title is held thwart his estate planning desires What should be done to avoid problems 4. Is a living trust an appropriate part of his estate plan How would a living trust change the nature of Latafat's will 5. How does the age of his children complicate the estate plan What special provisions should he consider 6. What options are available to Latafat if he decides later to change or revoke the will Is it more difficult to change a living trust 7. What duties will Gary Ingram and Ceylan Sadik have to perform as co-executors of Latafat's estate If a trust is created, what should Latafat consider in his selection of a trustee or co-trustees Might Gary and Ceylan, serving together, be a good choice

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(1) Yes, Person L needs a will. Since he has property in his name alone, he will want to make sure that it is clear who he wants to leave it to when he dies. If he were to die without a will, and the state will determine how to distribute his property, and it may not be as he desired. Without a will, the state gets to decide how the assets of the deceased will be distributed. For example, even if the deceased had wanted the spouse to inherit the assets, their children will still be given part of the estate. A will can provide detailed instructions about who gets which part of the estate. Since he has specific desires about how to split up the funds, as well has specific percentages to be given to other relatives, friends and charitable organizations, he should have a will depicting these specific desires. Without a will, these parties may not receive the amounts he desires. In the unfortunate event that both Persons L and his wife die when their children are still young, it is important to have a will to identify the guardian for their children. Without a will detailing who will have custody, a judge will decide who will have custody of the children. (2) A will should have the following features: • An introductory clause that states the testator's name and residence, which will determine which country has legal jurisdiction for tax purposes. • A direction of payments clause which directs the estate to make payments of particular expenses • A disposition of property clause which deals with such situations as the disposition of personal effects, donations to charities or the distribution of residual assets after gifts have been made. • An appointment clause that names the executors of the will, guardians for minor children and trustees. • A tax clause that states whether the beneficiaries of the estate will be responsible for all taxes, or if these taxes will be paid out o the estate. • A simultaneous death clause that describes what happens if both spouses die at the same time. • An execution and attestation clause that shows the will signed by the testator. • A witness clause that requires two witnesses to the testator sign the will. • A residual clause can be used to distribute any assets that were overlooked in the will so that there are no loose ends. Any residual portions can be donated to individuals or charities. (3) The title to property can be held in two forms: • Joint tenancy may include any number of people, related or unrelated. Each joint tenant can unilaterally sever the tenancy. • A tenancy by entirety only exists between husband and wife, and always includes the right of survivorship. Tenancy by entirety can only be severed by mutual agreement, divorce, or conveyance by both spouses to a third party. It is possible that the manner in which the title of his other property is held may that his estate planning desires. The title to the other property is in his name alone. If there are claims by his creditors, heirs or personal representatives, the property may not pass to the person he wishes. The Right of survivorship means that the title passes directly to the surviving joint tenant(s). It is free from the claims of the decedent's creditors, heirs, or personal representatives, by law. This offers a quick way to transfer title to a beneficiary upon his death. If he wishes to transfer the property to a particular person or persons upon his death, it would be best if the title were held in joint tenancy or in tenancy by entirety, whichever is appropriate. (4) A living trust is a trust that is created and funded during Peron L's lifetime. A living trust can be revocable or irrevocable. It can last for a limited period or last after Person L has died. He could use a living trust to set up the $1 million funds for his sons' education. A revocable living trust would be an appropriate part of his estate plan as it would have the following advantages: • The trust will continue to operate after the Person L has died. Probate is unnecessary. • The trustee takes on the burdens of investing and management. • The details of the estate plan and the value of assets in the trust are private knowledge. The living trust could change the nature of his will. His will should be rewritten so that it "pours over" assets into a living trust that was previously established. The pour-over will typically has a clause passing the estate to an existing living trust after debts, expenses, taxes and specific bequests have been distributed. The pour-over will is written to ensure that any property left out of the living trust will pour over into the trust. He could also set up a minor's section 2503(c) trust for each of his sons so that they can receive tax-free gifts. Note that assets must be distributed to each of them before each turns 21. (5) He might consider making gifts to his sons while he is still alive. A very large transfer might be subject to gift taxes. If he wishes to give his sons money, he could give up to a certain amount per calendar year to each of his sons without incurring any gift taxes. In 2012, this amount was $13,000. If he and his wife each give their sons $13,000 each, then $26,000 can be passed on to each son, each year, without gift taxes. Since his children are minors, if Person L has income-producing property, he can save some money on taxes. Each year, each child can receive a specified amount of unearned income. He could realize some tax savings in this manner. If the beneficiary is under 14 years of age, then the beneficiary's income from the trust would be taxed at the same rate as the beneficiary's parents. This is important to note if his wish is to reduce taxes. (6) If Person L believes he may want to revoke or change his will at a later date, he may do so using a codicil. A codicil is a document that legally modifies a will without revoking it. The purpose of the codicil is to adapt the will to changing circumstances such as health, births, deaths, marriages, divorces, or changes in the tax law. If the will has significant changes, it would be better to create a new will, and destroy the old will. A will can be revoked in any of the following ways: • Making a later will that specifically states all prior wills are revoked. • Making a codicil that expressly revokes all wills before the will that is being modified. • Making a later will that is inconsistent with a former will. • Physically destroying the will in any of the following ways: mutilating, burning, tearing, or defacing the will with the intention of revoking it. A living trust can be revocable or irrevocable. A revocable living trust would give Person L the right to revoke the trust and regain trust property. An irrevocable living trust requires that Person L relinquish title to the property in the trust. Person L would also give up the right to revoke or terminate the trust. He will want to use a living trust so that he has the power to revoke or change it. It is not difficult to change a revocable living trust. It is difficult to change an irrevocable living trust. (7) As co-executors, Persons GI and CS would have to perform the following duties upon Person L's death: • Manage his assets until they are distributed to beneficiaries or used to pay creditors. This may involve deciding whether to sell properties or securities he owned. • Decide whether probate court proceedings are required. • Determine who inherits the property left behind and supervise its distribution. The executor reads the will to determine who receives which property. If there is no valid will, the executor will have to look at state law to determine the beneficiaries. • File the will in the local probate court. • Terminate leases and credit cards, and notifying banks and government agencies of his death. Agencies include the Social Security Administration, the post office, and Medicare. • Set up an estate bank account to hold money that is owed to the decedent. • Use estate funds to pay expenses such as funeral expenses, administrative expenses, and mortgages. • Pay debts. If there is a probate proceeding, the executor must notify creditors of it. • Pay taxes. An income tax return must be filed, covering the period from the beginning of the tax year to the date of death. A trustee is an organization or individual selected by Person L to manage and conserve property placed in the trust for the benefit of the beneficiaries. The trustee should have the following qualities: • Have sound business knowledge and judgment. • Have a good knowledge of the beneficiary's needs and financial condition. • Understand investment and trust management. • Be young enough to be available to beneficiaries after the decedent's passing. • Be able to make impartial decisions. Person GI and CS, serving together, would be a good choice, if they both posses the qualities outlined above, because if one is unable to serve as trustee, the other could be available.

Q 4

Generate a list of estate planning objectives that apply to your personal family situation. Be sure to consider the size of your potential estate as well as people planning and asset planning. Estate planning is not just about taxes.

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Q 5

Briefly describe the steps involved in the estate planning process.

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Q 6

Robert Hancock, of Charlotte, North Carolina, was 65 when he retired in 2005. Alyssa, his wife of 40 years, passed away the next year. Her will left everything to Robert. Although Alyssa's estate was valued at $2,250,000, there was no estate tax due because of the 100 percent marital deduction. Their only child, Nathan, is married to Mary; they have four children, two in college and two in high school. In 2007, Robert made a gift of Apple stock worth $260,000 jointly to Nathan and Mary. Because of the two $13,000 annual exclusions and the unified credit, no gift taxes were due. When Robert died in 2012, his home was valued at $850,000, his vacation cabin on a lake was valued at $485,000, his investments in stocks and bonds at $1,890,000, and his pension funds at $645,000 (Nathan was named beneficiary). Robert also owned a life insurance policy that paid proceeds of $700,000 to Nathan. He left $60,000 to his church and $25,000 to his high school to start a scholarship fund in his wife's name. The rest of the estate was left to Nathan. Funeral costs were $15,000. Debts were $90,000 and miscellaneous expenses were $25,000. Attorney and accounting fees came to $36,000. Use Worksheet 15.2 to guide your calculations as you complete these exercises. Critical Thinking Questions 1. Compute the value of Robert's probate estate. 2. Compute the value of Robert's gross estate. 3. Determine the total allowable deductions. 4. Calculate the estate tax base , taking into account the gifts given to Nathan and Mary (remember that the annual exclusions "adjust" the taxable gifts). 5. Use Exhibit 15.7 to determine the tentative tax on estate tax base. 6. Subtract the appropriate unified tax credit (Exhibit 15.8) for 2012 from the tentative tax on estate tax base to arrive at the federal estate tax due. REFERENCES:

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Q 7

David and Cheryl Allen are in their mid-30s and have two children, ages 8 and 5. They have combined annual income of $95,000 and own a house in joint tenancy with a market value of $310,000, on which they have a mortgage of $250,000. David has $100,000 in group term life insurance and an individual universal life policy for $150,000. However, the Allens haven't prepared their wills. David plans to draw one up soon, but the couple thinks that Cheryl doesn't need one because the house is jointly owned. As their financial planner, explain why it's important for both David and Cheryl to draft wills as soon as possible.

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Q 8

What is a will Why is it important Describe the consequences of dying intestate.

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Q 9

Prepare a basic will for yourself, using the guidelines presented in the text; also prepare your brief letter of last instructions.

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Q 10

Describe the basic clauses normally included in a will and the requirements regarding who may make a valid will.

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Q 11

State the topics you would cover in your ethical will. Would you consider recording it digitally

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Q 12

How can changes in the provisions of a will be made legally In what four ways can a will be revoked

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Q 13

Your best friend has asked you to be executor of his estate. What qualifications do you need, and would you accept the responsibility

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Q 14

Explain these terms: (a) intestacy , (b) testator , (c) codicil , (d) letter of last instructions.

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Q 15

George Reed, 48 and a widower, and Debbie Moore, 44 and previously divorced, were married five years ago. There are children from their prior marriages, two children for George and one child for Debbie. The couple's estate is valued at $1.4 million, including a house valued at $475,000, a vacation home at the beach, investments, antique furniture that has been in Debbie's family for many years, and jewelry belonging to George's first wife. Discuss how they could use trusts as part of their estate planning, and suggest some other ideas for them to consider when preparing their wills and related documents.

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Q 16

What is meant by the probate process Who is an executor , and what is the executor's role in estate settlement

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Q 17

Use Worksheet 15.2. When Russell Hypes died unmarried in 2012, he left an estate valued at $7,850,000. His trust directed distribution as follows: $20,000 to the local hospital, $160,000 to his alma mater, and the remainder to his three adult children. Death-related costs and expenses were $16,800 for funeral expenses, $40,000 paid to attorneys, $5,000 paid to accountants, and $30,000 paid to the trustee of his living trust. In addition, there were debts of $125,000. Use Worksheet 15.2 and Exhibits 15.7 and 15.8 to calculate the federal estate tax due on his estate. (Reference Worksheet 15.2 and Exhibits 15.7 and 15.8 )

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Q 18

Describe briefly the importance of these documents in estate planning: (a) power of attorney, (b) living will, (c) durable power of attorney for health care, and (d) ethical will.

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Q 19

Summarize important legislation affecting estate taxes, and briefly describe the impact on estate planning. Explain why getting rid of the estate tax doesn't eliminate the need for estate planning.

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Q 20

Define and differentiate between joint tenancy and tenancy by the entirety. Discuss the advantages and disadvantages of joint ownership. How does tenancy in common differ from joint tenancy

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Q 21

What is the right of survivorship What is community property, and how does it differ from joint tenancy with regard to the right of survivorship

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Q 22

Describe the basic trust arrangement, and discuss typical reasons for establishing trusts. What essential qualities should a trustee possess

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Q 23

What is a living (inter vivos) trust Distinguish between a revocable living trust and an irrevocable living trust.

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Q 24

Explain each of these terms: (a) grantor , (b) trustee , (c) beneficiary , (d) pour-over will , (e) testamentary trust , and (f) irrevocable life insurance trust.

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Q 25

What is a gift, and when is a gift made Describe the following terms as they relate to federal gift taxes: (a) annual exclusion , (b) gift splitting , (c) charitable deduction , and (d) marital deduction.

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Q 26

Discuss the reasons estate planners cite for making lifetime gifts. How can gift giving be used to reduce estate shrinkage

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Q 27

Explain the general nature of the federal estate tax. How does the unified tax credit affect the amount of estate tax owed What is the portability concept

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Q 28

Explain the general procedure used to calculate the federal estate tax due.

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Q 29

The two basic techniques of estate planning are (1) dividing your estate and (2) deferring income to minimize taxes. Describe and discuss each of these techniques.

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Quiz 15: Preserving Your Estate

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