Estate Planning Traps Remain, Even with the New Tax Bill

In the 30 years I’ve been involved with wealth preservation, I’ve encountered a recurring belief in immortality among many of my clients. They don’t literally believe that they will live forever. But they act as if they will.

This takes many forms. For instance, one poor widow who contacted me after her husband’s sudden death told me he had handled all the finances, and she couldn’t even log into his online accounts to pay utility bills. The untimely death of another client led to his longtime partner being completely disinherited by his children.

A textbook example of poor estate planning is now before a probte court in Minnesota. The court is charged with the task of dividing up the estate of Prince, the pop star who died in 2016 without a will.

Under Minnesota law, as with most states, if you die without a will, complex rules determine who gets what. In Prince’s case, his parents and grandparents are dead, as are two of his half-siblings. He was married and divorced twice and had one son, but the child died soon after his birth. So, Prince’s estate will be divided between his sister and all of his living half-siblings, who are treated like full siblings in Minnesota.

Prince’s estate is reportedly worth $100 to $300 million. And sorting out all the claims and counter-claims is time-consuming, not to mention expensive. It’s become so costly that three of Prince’s beneficiaries recently filed a lawsuit against the law firm hired by Comerica Bank & Trust. The courts appointed Comerica Bank & Trust to administrate Prince’s estate. The lawsuit claims that Comerica and its lawyers have extracted nearly $6 million from the estate so far, plus another $125,000 in monthly fees.

And once the estate is finally settled, the IRS will get 40% of it, less the $5.45 million exemption for 2016. If there’s $200 million left once the legal vultures have had their fill, the IRS will get nearly $78 million.

Prince’s poor planning recently came up in a conversation I had with a client I’ll call Susan. I told Susan I found it unbelievable that someone as wealthy and seemingly sophisticated as Prince hadn’t put together a full-fledged estate plan that includes a will, trust, and strategies to reduce the value of his estate.

For instance, Prince was reportedly very religious, yet the church he attended won’t receive anything from his estate. Every dollar he contributed to the church would have reduced his beneficiaries’ estate tax by 40 cents.

Prince was also supportive of aspiring musicians. He could have set up a foundation to benefit promising young musicians. The foundation could have purchased musical instruments, helped finance musical education, etc. Again, any money he conveyed to the foundation would have left his estate permanently. At his death, control of the foundation would have passed to whoever he designated to run it.

But the biggest tragedy in the lack of an estate plan is that Prince has no say in who will control his musical legacy. And it’s not just his famous recordings that are at stake. Another 2,000 unreleased songs are reportedly held in a vault.

What my client said in response to my comments about Prince was typical. “I’m not nearly as wealthy as Prince,” she told me. “Plus, I’ve heard that because of the Trump tax plan [that Congress enacted at the end of 2017], there’s no need for anyone except the super-rich to worry about estate planning.”

Unfortunately, this is a common attitude. It’s also very shortsighted.

No matter how wealthy you are, you should have at the very least three basic estate planning documents prepared:

1. A living will, which describes the type of care you desire if you become permanently incapacitated or terminally ill. For instance, it will address the circumstances under which you wish to receive treatment that will prolong your life.

2. A durable power of attorney for health care, which is a formal appointment of someone you trust to be your health care agent. This person will make the necessary care decisions for you if you are unable to do so.

3. A “regular” will, which memorializes your instructions for the division of your wealth among those you care about. The individual or company you name in your will as your executor, or “personal representative” in some states, must present your will to probate court. A judge will then authorize the executor to gather your assets and distribute them to your beneficiaries after any debts are paid.

Another document I recommend to all of our clients is a living trust. The biggest benefit is that the assets in a living trust, or that are controlled under its provisions, need not go through probate. The trust works in conjunction with a document called a “pour-over will.” This is a will created with a provision which states that the property in your estate not already conveyed to your living trust is transferred to the trust at your death.

While a living trust provides little if any asset protection, it can be drafted to provide asset protection to a surviving spouse. At the death of the first spouse, a second testamentary (created upon death) trust can spring into existence to hold the assets of the deceased spouse. The surviving spouse will be the beneficiary of this trust, and their creditors will generally be unable to gain access to those assets.

Susan was right in one respect: fewer Americans estates are now subject to estate tax. The Trump tax reform bill doubles the estate tax exemption from $5.6 million to $11.2 million (2018 exemptions, indexed annually for inflation).

For a married couple, these exemptions are “portable.” This means a surviving spouse can add the deceased spouse’s unused exemption to their own exemption. For instance, let’s say Susan’s husband Joe dies in 2018 with an estate of $8 million. Since $3.2 million of Joe’s estate tax exemption was not used, it can then flow to Susan, giving her a total exemption of $14.4 million.

There are some important details to keep in mind:

• Portability is not automatic. Your executor must make a portability election on an estate tax return (IRS Form 706). That’s true even if your estate is less than $11.2 million.

• If you have an older will or living trust, it may be linked to an outdated exemption amount. Make sure to update those documents.

• The higher estate tax exclusions are set to expire in 2026, unless Congress makes them permanent. At that point, they’ll revert back to the 2017 limit ($5.49 million, adjusted for inflation between 2017 and 2026).

I’ve been telling clients that if they or their parents are 90 years old or older, they’ll likely benefit from the reduced estate tax. We recommend everyone else plan for the estate tax to reset to 2017 limits (adjusted for inflation) in 2026.

There is one estate planning opportunity that might survive a rollback of the estate tax exemption in 2026. I discussed it in a recent issue of our Nestmann Inner Circle Alert subscription service. Members can read it here.