Basic Concepts of Estate Planning

Basic Concepts of Estate Planning2018-08-31T13:43:45+00:00


The process of developing a sound estate plan of your own begins with understanding the basic ingredients common to all good estate plans. Our decades of experience working with thousands of clients have taught us that an estate plan is sound only if it helps one accomplish several important goals. Almost universally, our clients state that they want their estate plans to achieve for them the following objectives:

• I want to control my property while I am alive;
• I want to take care of my loved ones and myself if I become disabled;
• I want to give what I have to whom I want, when I want, the way I want; and
• Whenever possible, I want to save tax dollars, professional fees, and court costs.

If you have these same goals for yourself and your family, then this book is written specifically with you in mind because a good estate plan can help you accomplish each of these objectives. Without a good estate plan, you and your family will probably lose control over your property, suffer through unnecessary court proceedings, and pay excessive taxes. The lack of an estate plan may also deprive your family of many other legal protections otherwise available and also deprive them of the opportunity to receive from you a lasting legacy designed to bring your family closer together. Fortunately, all of these ills can be easily avoided by implementing a sound estate plan that passes your property to your loved ones in the way that you want.

All good estate planning starts with making sure that your property is legally owned in an appropriate way. The legal community uses the technical term “title” to describe how property is owned and it is exceptionally important that you understand the legal rules that govern title.

Title is important to designing an estate plan because you cannot plan for the disposition of property you do not own. Although you would think it easy for everyone to know what they do or do not own, the rules pertaining to property ownership are more complicated than they first appear. Unfortunately every day families unintentionally lose control and ownership of their property to others because these rules are widely misunderstood.

For example, many people that have written a will or a trust assume that all of their property will pass to their heirs according to the instructions in that document, but that is not necessarily true! Of the thousands of estate plans we have reviewed for clients seeking a second opinion of their will or trust, we have discovered that a great number of them will not work the way the clients think they will because the client’s property has never been properly titled to ensure that it passes to whom they want, when they want, and how they want.

Regardless of what you may have heard or think, unless your property is correctly titled even the best estate plan will fail to distribute it properly. Thus, in order for you to design an estate plan that accomplishes your goals, it is essential that you first understand the basic rules that govern the titling of property.

Property can be titled in several different ways. The five most common ways of titling property are as follows:

• Fee simple;
• Tenancy in common;
• Joint tenancy;
• Tenancy in the entirety; and
• Community property.

Each of these ways of titling property differ from the others in three key ways:

• The amount of control the title owner possesses over the property while alive;
• The extent to which the owner is legally entitled to leave the property to others upon his or her death; and
• The extent to which creditors of the owner can make claims against the property.

Fee simple ownership exists when there is only one title owner. If you own property that is titled solely in your name you possess total legal control over it. This allows you to do with it whatever you want without anyone else’s permission. You are free to retain, sell, or give the property away whenever desired. You also may say who will receive the property after your death. Finally, since only your individual legal rights are involved, any creditor of yours can make a claim against any of your fee simple property to satisfy a debt.

Tenancy in common ownership exists when two or more title owners hold the property together as tenants in common. If you own tenancy in common property, you share legal control of it with others. For example, if you and one other person own property as tenants in common, and you both own equal shares, you each own a fifty percent interest in it. If the property were sold, you would divide the profits equally.

However, ownership of tenancy in common property does not have to be in equal shares. Your share could be smaller or greater than another tenancy in common owner’s share. The legal rule for tenancy in common property is that all co-owners share in the right to fully use and enjoy the property; Therefore, even if you owned only a small fractional interest in tenancy in common property, you still have the right to use it whenever you want. Although this arrangement is beneficial for those owning small shares, it can cause problems if two or more tenants in common desire to use the property at the same time or in different ways. If you are a tenant in common, during your lifetime you can keep, sell, or gift your respective share of the property. Likewise, as a tenant in common you also may say who will receive the property after your death; however, creditor claims against a tenant in common can be made only against that tenant’s share of the property.

Joint tenancy ownership is like tenancy in common in that two or more joint tenants own the property together and each owner has the right to enjoy its entire use. A joint tenant, like a tenant in common, also has the right while alive, to keep, sell, or gift their joint tenant’s interest in the property to others.

Unlike a fee simple owner or a tenant in common, a joint tenant has no right to leave their joint tenant’s interest to others at death. When one joint owner dies, by law that tenant’s interest in the property is automatically extinguished and the surviving joint tenants continue to own the property together as joint tenants. Ultimately there will be only one final survivor left when all of the others have died. If you are the final surviving joint tenant, you will end up owning the entire property in fee simple. Creditor claims against a joint tenant can be made only against that tenant’s share in the property.

As stated above, a joint tenant’s interest is automatically extinguished upon that person’s death. A benefit of this arrangement is that no probating of joint tenancy property ever occurs. The decedent’s name is simply removed from the title and the others continue owning it together as joint tenants. While the probate free transfer of an asset is an attractive benefit of joint tenancy ownership, it often causes rather serious and unexpected consequences. Problems involving joint tenancy ownership include the following situations that frequently occur:

• Often family members purchase property together and title it as joint tenants without understanding that the last survivor will end up as the property’s sole owner. Instead, they mistakenly think that if one of them dies that owner’s share will pass to his or her spouse or children. Thus the family of the first joint tenant who dies is rudely surprised to learn they lose all rights to the property. If that were not bad enough, under the law the decedent joint tenant is treated as having made a gift of his or her interest in the property to the survivors. Thus the family of the decedent might have to pay gift taxes from the decedent’s estate for property they never get;

• If a parent remarries and retitles the family home in joint tenancy with the new spouse, the children of the first marriage will lose all rights to the home if the parent dies before the new spouse;

• If an elderly parent puts the family home in joint tenancy with an adult child, the parent loses exclusive control over the home. The parent will not be able to refinance or sell the home without the child’s approval. Also, the parent’s home becomes exposed to the child’s liabilities including automobile accidents, debts, bankruptcies, and claims of the child’s spouse if there is a divorce. If there is more than one child named as joint tenant, all of these dangers are multiplied;

• If an elderly parent retitles savings or investment accounts in joint tenancy with one child, expecting that child to share it with siblings after the parent passes on, there can be unintended gift tax consequences, even assuming the child shares it with the others (which does not always happen); and

• If a child named as a joint tenant dies first, the property might be probated and taxed first in the child’s estate and then probated and taxed a second time in the parent’s estate.

Tenancy by the entirety ownership is a way married couples in some separate property states, can title their primary residence to provide creditor protection for a surviving spouse. Following the death of the first spouse, the home titled as tenancy by the entirety automatically passes to the surviving spouse free of probate. Creditors of both spouses (such as a mortgage company or credit card company) may take this property, but creditors of only one spouse cannot. This form of ownership may be a good choice of title if either spouse might someday be subject to business or professional liability since the property is protected from creditor claims.

One major concern arises with property titled in tenancy by the entirety if there are children from a prior marriage of either spouse. When one spouse dies the surviving spouse will inherit the home while the children of the deceased spouse will be disinherited.

Community Property ownership is a way married couples in community property states can title their property to reflect that they each own half of the property. In some states community property is also referred to as “Marital Property.” Owning property as community property can help couples escape unnecessary capital gains taxes. Upon the death of one spouse the entire amount of community property gets a step-up in cost basis. This means the surviving spouse can sell property without having to pay capital gains tax after the death of his or her spouse. Community property tax treatment is available in only a limited number of states.

If you do not plan your estate, you will leave what is legally known as an “intestate estate”, one in which the deceased has left no instructions. The families of those who fail to plan their estates have a rude surprise awaiting for them – the government will fill in the blanks with its own plan. After debts, probate costs, and taxes are paid, the courts will divide the estate according to the laws of intestate succession.

If you do not plan your estate, you may not know who your beneficiaries are. Some states provide that the estate of a married decedent goes entirely to the surviving spouse, provided there are no children from another marriage. Other states provide that the surviving spouse receives only half of the decedent’s estate with the other half going to any children or their decedents. The first example may result in the children being disinherited, especially if the surviving spouse remarries, while the second example may leave the surviving spouse with inadequate resources to maintain an adequate lifestyle.

If you do not plan your estate, and a minor child is entitled to receive an inheritance by law, the court will place the inheritance in a custodial trust. No withdrawals can be made without first obtaining the permission of the court. Whatever is left of your child’s inheritance will be given to your child on his or her eighteenth birthday – with no guidance whatsoever. Since few eighteen year olds have the maturity to properly handle a windfall inheritance, it is likely the inheritance will be totally wasted in a short period of time.

If you do not plan your estate, and you have no spouse or children, most states provide that distributions will be made to your parents. If your parents are in a nursing home or receiving government assistance, who do you think gets the inheritance?

If you do not plan your estate and fail to appoint the personal representative (executor) you want to administer it, the court will fill in the blank by appointing one of its own choice for you according to statutory formula. Children or other heirs may have an equal legal right to be named the estate’s personal representative and may fight over who should be named. This often leads to family feuds and court battles that could have been avoided had the parents simply named their own personal representatives.

If you do not plan your estate, the personal representative may be forced to pay for an expensive bond to insure the estate. This is money that could otherwise have gone to your loved ones.

If you do not plan your estate and you and your spouse both die prematurely, the probate court will appoint the guardian it chooses for your minor children instead of the ones you could have, but failed, to name yourselves. In other words, a stranger to the family will get to decide who tucks in your children at night and takes care of all of their other needs.

If you do not plan your estate, the courts will also maintain continuing jurisdiction over any inheritance left for your children. Court permission is needed to use the inheritance and the court is likely to require an annual accounting of every penny spent. The result is additional accounting and attorney’s fees, paid out of the inheritance, every year until your child becomes eighteen.

You can prevent having an intestate estate by leaving written instructions of your own. One way of leaving such instructions is by writing a will.

A will is a written document that tells the court how to divide your property at the time of your death. It also tells the court who should be the guardian for your minor children and your personal representative. Wills are filed with the court at time of death, and the court oversees the administration of the will through a process known as probate.

Probate is a legal court proceeding, supervised by a probate court judge, that is used to gather a deceased person’s assets, pay creditors, court costs, and taxes and then distribute what is left to those entitled to receive it. In probate proceedings, the court sets the time limit in which creditors may file claims. The probate estate cannot be closed until the period for filing claims has expired and settlement with each creditor has been resolved. In general, you can expect a probate proceeding to last one year or longer. There have been many notable cases that have been tied up in probate court for several years.

The probate process allows creditors to make claims for debts incurred during the deceased’s lifetime and allows the estate to pursue other legal actions pertaining to the decedent. Notice of the probate proceeding must be given to all known creditors and to all creditors who might be known after careful investigation. It must also be given to all relatives who may be legal heirs, even if they are not included in the will.

Advocates of probate argue that because probate proceedings are held in open court, it benefits potential heirs by providing everyone equal access to information contained in the probate record. They also argue that court supervision of the probate process benefits society by providing an orderly way of wrapping up a decedent’s estate. They further argue that additional benefits exist in that institutions dealing with probate court orders recognize them as binding, that rights of lost heirs are severed, that claims not timely filed can be legally barred, and that the estate may pursue any litigation deemed necessary.

The disadvantages of probating a will are many. The probate process is expensive, time consuming, and intrusive. Court costs, attorney fees, personal representative fees, bonds, and accounting fees all add up. The cost of probate is often between 3% and 8% of the gross value of an estate (up to eight thousand dollars for a hundred thousand dollar estate). If your estate is probated without a will, the costs of probate may be even greater. The probate process is a notoriously protracted legal procedure. Studies in one state reveal that the median time for settlement is thirteen months. If the probate proceedings are contested, the ensuing legal battle can take several years.

Probate proceedings also intrude on a family’s privacy. Probate proceedings take place in open court where the family’s private financial records are made a public record. The family is forced to reveal for public inspection a listing of all of the family’s savings, investments, and real estate. Also, now that many probate courts are making their records available on -line, anyone with a computer can easily access your family’s probate records.

The estate is vulnerable to attack during probate proceedings from unhappy relatives and to suits from creditors who must receive certain legal notices. It is not unheard of for someone to file a claim in a probate proceeding simply as a way of forcing the estate to settle the claim in order to avoid an expensive legal fight.

Yes, fortunately probate can be avoided. As already discussed, probate proceedings can be avoided by titling property with someone else in joint tenancy. Such property will be transferred to the surviving joint tenant probate free. Because joint tenancy property passes probate free, many individuals mistakenly believe they do not need further planning if everything is titled in joint tenancy. But as discussed above, joint tenancy can result in property passing to unintended heirs, risks unforeseen tax consequences, and can result in loss of assets to lawsuits and other misfortunes.

Furthermore, an estate plan that relies only on joint tenancy ownership fails to provide any protection if one or both joint tenants become disabled by illness or accident. For example, if a husband and wife own property as joint tenants and the husband suffers a stroke, it may be legally difficult or impossible for the wife to make the decisions necessary to handle the couple’s property without petitioning the court to be appointed the legal guardian of the disabled husband. This is a major pitfall of joint tenancy ownership that many couples unfortunately fail to anticipate.

In some community property states, probate can also be avoided for married couples who title their property as marital property so that it passes probate free to the surviving spouse. Again, this provides no protection if one or both spouses become disabled and does not provide a mechanism to transfer assets to the next generation at the death of the second spouse.

Yes! A simple and superior way of avoiding probate is to place your property in a trust so that it passes probate free. To learn more about trusts, turn to the next chapter.

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