By Stephen J. Dunn
This is the third post in a three-part series on estate planning for a married couple. The first post concerned ethical issues in estate planning for a married couple. The second post addressed making maximum use of each spouse’s unified credit, to pass as much property as possible to the next generation free of estate tax. This post examines estate plan funding issues for the spouses.
Earlier in my career, I saw estate plans consisting of a set of documents drawn and signed, and that was it. There was no attention at all to dealing with the clients’ assets. The clients’ assets remained titled in the spouses’ names. Upon the death of the first spouse to die, generally the surviving spouse succeeded to outright ownership of the marital property via tenancy by the entirety. If the deceased spouse owned property in his or her own name, his or her will bequeathed it to his or her trust, but such post-death funding of a trust requires a probate proceeding.
To avoid probate, the spouses should establish revocable trusts and transfer their property to the trusts during their lifetime. As noted in the first post in this series, marital property should be divided equally between the spouses’ revocable trusts. Both spouses should sign each of the documents transferring property to their revocable trusts, to avoid potential challenges to the transfers on grounds such as—
- That the transfers were in derogation of the non-signing spouse’s dower rights.
- That the non-signing spouse owns the property transferred to trust, or an interest therein.
- In a community property state, that the non-signing spouse has a community property interest in the property transferred to trust.
Bank accounts, mutual fund accounts, and brokerage accounts should be retitled in the name of the spouses’ revocable trusts.
Certificated stocks or bonds should be transferred to the spouses’ revocable trusts. If a brokerage firm is not available to assist in the transfer, the issuing company’s treasury or stock transfer agent will have to be contacted.
Closely-held business interests should be transferred to the spouses’ revocable trusts. This requires the assistance of counsel.
Dividing a closely-held business interest between the spouses’ revocable trusts can also save significant estate tax. If neither spouse’s revocable trust holds a controlling interest (more than 50 percent) in the closely-held business, valuation of the closely-held business interest in each spouse’s revocable trust should qualify for valuation discount. Valuation discounts for minority interest or lack of marketability commonly reduce the estate tax valuation of a closely-held business interest by 25 percent or more.
For example, assume that Closely Held Business, LLC, founded and exclusively owned and operated by Husband, has an appraised value of $8,000,000. By transferring a 50 percent ownership in Closely Held Business, LLC to each of Husband’ s revocable trust and Wife’s revocable trust, neither spouse’s revocable trust would hold a controlling interest in Closely Held Business, LLC, and each spouse’s estate could credibly assert a valuation discount for its interest in Closely Held Business, LLC. Assuming a valuation discount of 25 percent, the valuation of the 50 percent interest in Closely Held Business, LLC in each spouse’s gross estate is $3,000,000. Dividing the ownership interest in Closely Held Business, LLC between the spouses’ revocable trusts thus reduced their combined gross estate by $2,000,000.
Real property. Real property, including the couple’s residence and their vacation home, if they own one, should be transferred to their revocable trusts. I generally accomplish this with quit claim deeds. The deeds should be executed and recorded; nothing is worse than unrecorded deeds floating around clouding the title to real property.
Rental, commercial, or investment properties should not be conveyed directly into the couple’s revocable trusts. Rather, to protect the spouses and the rest of their property from liability claims arising out of these properties, the properties should be first conveyed into a limited liability company or a corporation, and the interest in the LLC or corporation then transferred to the couple’s revocable trusts.
Life insurance policies need not be transferred to revocable trusts, as their proceeds pass outside of probate. But it is important to update beneficiary designations to make sure that they reflect the spouses’ intentions. Most life insurance policies designate the policy holder’s spouse as primary beneficiary and children as contingent beneficiaries.
Retirement plan accounts should not be transferred to trusts, as transferring such an account to trust would constitute a taxable distribution from the account. Moreover, such accounts pass outside of probate.
Beneficiary designations on retirement plan accounts should be updated to make sure that they reflect the account owner’s intentions. A qualified retirement account, including an account in a defined benefit pension plan or a defined contribution retirement plan, an individual retirement account (“IRA”), or an annuity, should designate individuals as primary and contingent beneficiaries. If such a qualified retirement account designates a trust as beneficiary, and the account owner dies before distributions begin, then the account must be fully distributed within five years after the account owner’s death. But if the designated beneficiary is an individual, and distributions begin within a year after the account owner’s death, then distributions, and the deferral of income tax on them, may continue over the account owner’s life expectancy. If the designated beneficiary is the account owner’s surviving spouse, then distributions need not commence until the year in which the account owner would have attained age 70-½.
Retirement plan accounts are income in respect of a decedent, meaning that distributions from them are taxable income to the distributee, the obvious exception being a Roth IRA. For this reason, it makes sense to designate a tax exempt charitable, scientific, or educational entity as beneficiary of retirement plan accounts.
Vehicles. In some states, after a vehicle owner’s death the owner’s next of kin may have the vehicle retitled in their name by filing a document with the secretary of state. In any case, valuable vehicles and boats should be titled in the owner’s revocable trust during his or her lifetime. Aircraft, due to the potential of claims arising out of their use, should be titled in a corporation or limited liability company, the ownership interest in which should be held in a revocable trust.