TEN BIGGEST MISTAKES YOU CAN MAKE IN YOUR ESTATE PLAN

by Michael S. Kutzin
Goldfarb Abrandt Salzman & Kutzin LLP

Writing a “Top Ten” list for mistakes in an estate plan is especially challenging, as there are a myriad of mistakes that people, and their planners, can make. But in my years of being involved in all aspects of estates – from the drafting of wills, to administering estates after someone dies, to fighting in Court over them, the following issues stand out:

10. Do-It-Yourself Wills and Trusts
9. Improper Use of and Failure to Fund “Lifetime” Trusts
8. Failing to Write a Will or to Have a Revocable Trust at All
7. Failure to Coordinate Beneficiary Designations with Your Will
6. Failure to Coordinate Retirement Account Designations with your Estate Plan
5. Outright Bequests to Immature Children
4. Failing to Provide Flexibility in an Estate Plan
3. Trusting People to “Do the Right Thing”
2. Owning Your Own Life Insurance
1. Having a Non-Trusts & Estates Lawyer Prepare Your Estate Plan

Now that you have seen the list, I explain why each of them is part of my “Top Ten” mistakes to avoid.

10. Do-It-Yourself Wills and Trusts. As a Trusts & Estates and Elder Law attorney, I know there will be problems when someone dies and their family comes to me with a do-it-yourself will that the deceased person found on the Internet. Why? Because almost invariably, when someone does writes their own will, there are a myriad of mistakes and some lawyer will get paid lots of money to deal with the problems after the person dies. Everything from having to prove to a Court that the will was executed with the necessary formalities required by law for a will to be admitted to probate, to failing to take advantage of appropriate tax planning for a family, to having bequests go outright to minor children or to beneficiaries on governmental assistance.

Sometimes, a lawyer can persuade a judge to “reform” a will to revise some of these mistakes (at significant cost to the Estate), and sometimes, through something called “qualified disclaimers” a lawyer can, in a crude and often inefficient manner, achieve some tax savings. But if the person did not execute the Will properly, the Will may not be admitted to probate at all. In that case, the person’s property will instead pass by what is known as “intestacy” (see #8, below). That means that the person’s property will instead pass to the persons that the law of the state where he or she lived says inherits the property.

Do-It-Yourself Trusts have all of these potential problems, plus so many more that are unique to so-called “lifetime” trusts that I treat it as its own “big mistake” on this countdown (see #9, below).

9. Improper Use of and Failure to Fund “Lifetime” Trusts. In some states, such as Florida or California, probate is known as a difficult process, so people often set up what are called “lifetime trusts” to avoid probate. In those states, and states with similar laws, establishing lifetime trusts is often desirable. However, in states such as New York, where probate in a common family situation is not onerous, establishing lifetime trusts to avoid probate is not only costly, but as will be discussed, is often self-defeating.

A brief discussion of terminology is necessary. Trusts can be set up either by agreement between a Trustee and a person who contributes property (known as a “Grantor” or “Settlor”) or in someone’s will. Trusts established by will only become effective when the person dies and the will is admitted to probate. Lawyers refer to such trusts as “testamentary trusts.” Trusts established by agreements (sometimes also called Trust Indentures) are known as “inter vivos trusts” (Latin for trusts established during lifetime).

“Lifetime trusts” is the terminology sometimes used for what Trusts & Estates professionals know as “revocable trusts” (as opposed to irrevocable trusts). They are “inter vivos trusts.” To be clear, I will refer to them as revocable trusts. Revocable trusts act as will substitutes: the person who sets it up is the Grantor and usually is also the Trustee. The Grantor can use the property in any way that he or she wishes, including taking the property out of the trust altogether, and when the Grantor dies, the property passes under the terms of the revocable trust. The revocable trust does not have to be brought to a court to be admitted to probate, and unless a disgruntled potential beneficiary challenges it in court, there will not be the need to probate a will (at least in theory). Like a will, a revocable trust can be amended during a person’s lifetime. Also like a will, a revocable trust can establish one or more trusts to carry on after the person’s death.

A revocable trust, like a will, can be structured to minimize Federal and State Estate Taxes. However, avoiding probate DOES NOT avoid or eliminate Federal or State Estate Taxes. The taxation is identical, whether property passes by will or outside of probate, such as through a revocable trust.

So, if a will and revocable trust can both be used to pass assets at death, have the same tax consequences, and a revocable trust at least avoids the necessity of having a court admit the instrument to probate, why shouldn’t everyone use it?

The first, and probably most important, reason why revocable trusts are not appropriate in every situation (at least in states like New York) is that in the majority of cases that I’ve ever dealt with where people have attempted to avoid probate by establishing revocable trusts, some or all of the person’s assets were not properly transferred into the trust. In other words, the mere signing of a trust agreement alone is not sufficient. Nor is it sufficient for the assets that are to be contributed to the trust to merely be listed on a schedule at the end of the trust. If real estate is being contributed to the trust, a new deed must be prepared to transfer it into the trust. If bank accounts, or securities accounts are being transferred, the old accounts must be closed and new ones in the name of the trust must be established. If valuable artwork, jewelry, or other personal property is to be contributed, deeds of trust in conformity with the requirements of state law must be executed. Indeed, ALL of the person’s property (with the exception of retirement accounts and any accounts that otherwise pass by a beneficiary designation) must be retitled into the name of the trust (and see the discussion below regarding retirement accounts).

My colleagues and I have often seen people come into our office with either do-it-yourself revocable trusts or revocable trusts in impressive looking binders that some trust-mill sold them (or their dearly departed loved one), only to learn that none of the Grantor’s assets had been transferred into the trust! So what happens in those cases? A will has to be probated! And if there is no will, the property passes by intestacy –meaning that state law will determine who gets the person’s property (see #8, below).

Even the most meticulously planned revocable trust where the Grantor and the Grantor’s advisors worked hard to make sure every asset had been transferred into the trust usually requires that a will be probated, because some asset fails to find its way into the trust.

Aside from these difficulties, revocable trusts typically cost significantly more than does a will.

When my office does determine that it is appropriate for a client to have a revocable trust, we always have the client execute a “pourover will.” That simply means that any asset that does not make its way into the trust is transferred, through the will, into the trust.

In a state like New York, there are limited situations where using a revocable trust to pass assets is preferable to doing so through a will. The first case is where a person owns property in a number of states. So if you own your main house in New York, a vacation home in Cape Cod and, a condominium in Florida, your will would first have to be admitted to probate in one state, and then submitted for what is known as an “ancillary probate” in the other two states. In effect, three probates instead of one. So in that case, deeding all property into a revocable trust during lifetime to avoid multiple probates makes sense.

Another time that passing property via revocable trust rather than by will may make sense is if your only living relatives are distant relatives, such as cousins, nephews and nieces. This is especially true when your family is large, and you may have lost contact with some members of the family. In cases such as this (as opposed to the more typical case where a person dies leaving a spouse and/or children), the probate process in New York is far more difficult, costly and time consuming.

If a will contest is anticipated, a revocable trust rather than a will may be preferable. Suppose you want to leave a child out of your will. In New York, when the will is submitted for probate, that child will receive notice (called a “Citation”), and have the opportunity to object to the will being admitted to probate. While upsetting a will is exceedingly difficult, the disgruntled child could still cause a lot of trouble, including delays and significant additional costs for the estate. While a good estates litigator knows how to get his hands on a revocable trust and challenge it in court, it is more difficult to do so, and if the disgruntled child is not put on notice about the existence of the instrument that leaves him or her out of the estate, then it may discourage that child from challenging your estate plan. It is not a guarantee, but it may help.

Sometimes a client prefers a revocable trust because a revocable trust, unlike a will, is not a public document. A will is filed in court, and is accessible to the public. Famous people’s wills are routinely located, written about and posted on the Internet. A good recent example of this was Michael Jackson’s – but the terms of his estate plan remain private because while the will names guardians for his children (another reason to have a will instead of a revocable trust), the will is a “pourover will” into a revocable trust! The terms of that trust have not been published and likely never will.

Sometimes, as a matter of planning for long-term care, a home that would otherwise be subject to “estate recovery” for Medicaid benefits provided to a senior citizen might be transferred to a revocable trust. Such planning should only be done with the advice of a competent Elder Law attorney who is fully knowledgeable of the Medicaid laws of your state.

Absent these circumstances, though, a will functions just as well as a revocable trust. But at the very least, if your circumstances make a revocable trust desirable (or you’re just plain stubborn and HAVE to have a revocable trust), make sure that you actually fund it! Make sure that you (or your attorney) deed your real estate into the trust, transfer your co-op apartment into the trust (if your co-op board will even permit this), and the name of your bank accounts, brokerage accounts, stocks and bonds (except for retirement accounts, which are discussed in #6, below), from your name to the Trust.

8. Failing to Write a Will or to Have a Revocable Trust at All. I am still astounded by how many people choose to let the State determine who will receive their assets at their death. In a recent case that I worked on, an unmarried man who was very close to two of his cousins (by all accounts, the only people in the world who cared for him), died without a will. So what happened? His estate passed to 14 cousins (not just the two with whom he was close) PLUS two aunts living in Italy WHO HE NEVER EVEN MET! And that was after a lot of time, effort and money was spent proving who were his relatives.

In other words, his estate passed by intestacy – the laws of the State of New York determined who would inherit and in what percentages because this man did not write a will.

But there are even less obvious situations where the failure to write a will has unexpected, and undesirable, consequences. Suppose a man dies leaving a wife and two children. In New York, the estate does not automatically pass to the surviving spouse. Instead, the surviving spouse will receive the first $50,000 plus ½ of the rest of the estate, and the two children will each receive ¼ of what is left. This precludes good tax planning. It also puts assets into the hands of children who may be too young, irresponsible, or suffer from additions or creditor problems to receive property outright (see #5, below). In short, a mess.

While property, like bank accounts with beneficiary designations, life insurance with named beneficiaries, and real estate owned by husbands and wives will not be affected by a will (or the failure to write one), usually a person has enough assets that do not pass by operation of law for the default of intestacy to be inappropriate and undesirable in most cases.

At the very least, you owe it to yourselves and your families to sit down with an estate planning professional and see whether intestacy plus your beneficiary designations will suffice (in almost every case, it will not).

On top of that, if you have minor children, you should have a will to appoint guardians for your children if you and your spouse die before they turn 18. If you do not choose guardians yourself, you can almost be assured that members of your family will fight over this, creating emotional and financial turmoil for your children at the worst possible time.

7. Failure to Coordinate Beneficiary Designations with Your Will. I think that every Trusts & Estates attorney has encountered a situation where a person recently died, and the family brings the will to them to be probated. The will provides a thought-out estate plan, complete with appropriate tax planning. But when the attorney starts investigating, he finds that the person’s estate plan does not work. Why? Because a substantial portion of the person’s assets pass by operation of law (such as by beneficiary designations) to persons who were not supposed to receive the property under the will.

It is not sufficient to merely write a will. Beneficiary designations must be reviewed to make sure that someone who you no longer wish to inherit does not receive property, that no one receives more than you intended, and that enough money is available to fully fund any bequests that you wish to make in your will.

6. Failure to Coordinate Retirement Account Designations with Your Estate Plan. Planning for distributions from retirement accounts is so important in most estates that it deserves special mention. Except for Roth IRAs, retirement account benefits (including 401(k) accounts) consist of money on which you have not paid income taxes. Generally, you have to take what are called “required minimum distributions” (RMDs) each year, beginning with the year after you turn 70 ½ (the year 2009 was an exception). If you fail to name a beneficiary, then the retirement account passes to your estate. This is a bad result, because if you have a designated beneficiary (assuming that the financial institution will permit it), your beneficiary spread out RMDs over the beneficiary’s lifetime. This permits your beneficiary to defer income taxation until a distribution is actually taken.

That doesn’t mean that your beneficiary is restricted to taking only the RMD – if your beneficiary wants, more that the RMD can be taken out in any year, but of course by doing so, your beneficiary will incur income taxation on that additional amount distributed.

If there is no designated beneficiary of a retirement account (including a contingent beneficiary if the first named beneficiary predeceases) and the estate is treated as the beneficiary, then the retirement account must be distributed over a period of time not to exceed five years. And on top of having much more income to be taxed upon, an estate is taxed at the highest marginal income tax rate once an estate has income of approximately $11,000. So there is the potential for extremely adverse tax consequences.

If, for example, testamentary trusts are going to be established for the benefit of children, the trust itself can be named as the designated beneficiary (and this is preferable to simply naming the children as the beneficiaries if trusts are otherwise advisable – see #5, below). Those trusts (and indeed the will itself) will have to be carefully drafted to conform to many technical rules to take advantage of tax deferral while ensuring that the beneficiary cannot obtain outright access to the retirement benefits until you intend for him or her to obtain access to trust property.

5. Outright Bequests to Immature Children. Far too often, I see simple wills where either young adults (18 years old) or even minors would receive large inheritances outright. Forgetting about the fact that minors cannot even receive property themselves, it is also a mistake in the large majority of cases for younger adults to come into substantial inheritances. Most 18 year olds are simply not ready to handle substantial sums of money. Instead, a will should provide that, until a child either reaches a certain age or achieves something like graduating college, the child’s money should be held in trust. The trust can provide for the child’s college education, as well as anything else that the trustee determines is appropriate. You can set the guidelines for when distributions can be made, and can even provide that your child will get portions of the trust principal at different ages. With very rare exceptions, this makes far more sense than simply putting a very large sum of money in the hands of a young person without any restriction.

4. Failing to provide flexibility in an estate plan. As most people understand, the Federal Estate Tax currently provides that, in 2010, the Federal Estate Tax disappears, but then returns with a vengeance in 2011 (only a $1 million exemption for each decedent, and a maximum marginal tax rate of 55%). There have been one proposal after another to “fix” this problem, but at this late date, nothing has been done.

Good estate planning now requires that a will provide for the most flexibility possible. In order to take advantage of whatever the laws may be when you die, if you have a spouse and children (and the children are also the children of your spouse – in other words, not a second marriage/stepchildren situation), we suggest that, in most cases, everything be left to the surviving spouse, but that the spouse have the option of “disclaiming” property into a trust for the benefit of the spouse and children. By providing this option, depending on what the Federal Estate Tax laws are when you die, your spouse can take advantage of whatever tax exemption may then exist and reduce ultimate taxation that your children will incur.

A disclaimer trust can provide extremely liberal benefits for your spouse while preventing the disclaimed property from being included in the surviving spouse’s estate for tax purposes.

Similarly, too many wills are too rigid in terms of when beneficiaries of trusts established under wills can be given distributions. You will be gone, and you cannot possibly anticipate every change in law or every change in circumstances of your loved ones. To the extent possible, your will and estate plan should provide for flexibility.

3. Trusting People to “Do the Right Thing.” Sometimes, a person leaves a loved one out of a will with the expectation that another beneficiary will “take care” of that person. Sometimes this is done because the loved one receives governmental assistance. Other times it is because the loved one has creditor problems or is in the middle of a divorce.

Perhaps I’ve been a Trusts & Estates lawyer too long, but I have seen too many cases where the person who was supposed to “do the right thing” did anything but. It may cost more money, and result in something more complicated than simply giving property outright to a trusted beneficiary, but a lot of trouble is avoided if you establish an appropriate trust in such a case.

Remember, even if the “trusted” beneficiary has the best of intentions, that person could suffer creditor problems and become unable to care for the loved one left out of the will. And that does not even take into account sheer greed or sense of entitlement.

Don’t “trust.” Establish a trust.

2. Owning Your Own Life Insurance. Life insurance is often sold to people with the assurance by well-meaning brokers that, upon the death of the insured, the beneficiary will receive the money tax-free. That statement, however, is only partially correct. The proceeds from a life insurance policy that you purchase will be paid to your beneficiary free of income taxes, but not from estate taxes if you own the policy (or have what are known as “incidents of ownership” over the policy) within three years of your death.

So suppose you are a widow with two children, and your estate (including your home, your retirement accounts and other assets), aside from life insurance, is worth $3 million. If you have a $1 million life insurance policy and you die when the exemption from Federal Estate Tax is $3.5 million (as it was in 2009), you will have a taxable estate because the life insurance will be included. If the marginal estate tax rate at that time is 45% (as it was in 2009), it will have cost your heirs $225,000.

Of course, if the exemption from Federal estate tax is lower than $3.5 million at the time of your death or the marginal tax rates revert to 55%, the potential loss to your heirs is far greater.

There are two ways that you can avoid this problem. The first is, if the beneficiaries are adults, have no creditor or marital problems, and will not be tempted to dispose of the policy (or raid the cash value or not make premium payments), they can become the owners of the policy. If that is not the case, such as where the children are minors or you also need to provide for a surviving spouse without having the proceeds included in your spouse’s estate, then you can have the policy owned by an irrevocable inter vivos trust. You cannot be the trustee, and the trust should be drafted to permit you to pay the premiums into the trust without being treated as taxable gifts by you. There are also specific procedures that whoever acts as the trustee will have to follow. But the cost savings to your family can be substantial.

1. Having a Non-Trusts & Estates Lawyer Prepare Your Estate Plan. If you have a headache, would you go to your urologist for a diagnosis? I will never understand why people ask their divorce lawyers, the lawyer who did their real estate closing, their medical malpractice lawyer, or their commercial lawyer to “do their wills” for them. “Dabblers” have no business writing wills, trusts or preparing estate plans. While “dabblers” usually know enough to draft a will that can be admitted to probate at your death (and even that is not always the case), they often do not know enough about planning to minimize Federal and State Estate Taxes, providing for necessary flexibility, providing appropriately for children or disabled persons, or minimizing taxation on retirement accounts to draft appropriate wills or trusts.

Poorly drafted wills and poorly conceived estate plans can cost your family far more in the long run than the few extra dollars it takes to have someone who concentrates in Trusts & Estates and Elder Law work with you to devise and implement an appropriate estate plan.