Estate Planning 101

When people hear the term “estate planning,” they may imagine that this is a luxury reserved for wealthy individuals with lots of assets. However, many couples and individuals may benefit from some estate planning, regardless of the size and complexity of their estate. Another hang-up people commonly have is that they figure that estate planning is too complex and decide that whatever the benefits of planning ahead may be, they are outweighed by the headache inducing process of slogging through an estate plan. But many estates can be planned using relatively simple devices that may save your loved ones invaluable time and money in the long run. This short introduction to the topic of estate law in Arizona should serve to familiarize visitors with some of the most basic concepts in estate law and demystify what can be an intimidating topic.

This space will serve as a short introduction to the world of estate planning. Each of these topics will be explored in further depth in subsequent post, but here we will provide a basic outline for some of the most popular planning devices and some of the basic vocabulary.

Estate

In the context of estate law, an estate simply refers to the real estate and personal property that a person possesses at their time of death.

Trust

A trust generally refers to a legal relationship whereby property is held by one person (trustee) at the request of another (settlor) for the benefit of a third party (beneficiary). There are various permutations of the basic trust structure, and occasionally one person or entity may occupy more than one roll, but the structure outlined above is the most common form of trust.

Standard AB Trust

An AB trust is a type of trust created by married couples for the purpose of minimizing their estate’s tax liability. An AB trust, so called because it divides the property of the spouses into two trust (trust A and trust B) upon the death of one of the spouses, gives spouses some control over how their estate will be managed should they be survived by their spouse and may allow their beneficiaries to avoid paying onerous estate taxes. The way it works is relatively simple: both spouses create a trust that will be funded once the first spouse dies. Once this happens, the couple’s property will be divided into two halves. One half will contain the deceased spouse’s assets and the other the living spouse’s assets, with the living spouse retaining control over both trust. However, the surviving spouse will have only limited control over the property of the deceased spouse’s property. The surviving spouse will still be able to live in the couple’s home and draw income form the assets in the deceased spouses trust, provided these terms are stipulated in the trust. Upon the death of the surviving spouse, the property from both trust A and B passes to the beneficiaries named in the trust instrument (usually the children). Because the property in trust A is not considered the property of the second spouse’s estate, the property may (depending on the size of both trust) pass through the trust without being taxed.

A short illustration may further clarify the advantages of using an AB trust. Husband and Wife have assets totaling 12 million dollars. The federal estate tax exemption is currently 5 million dollars (as of 2015). Thus, if Husband passes away and leaves his entire estate to Wife, Wife will not pay taxes on the transfer since spouses are exempt from estate taxes in cases such as this. However, once Wife passes away and leaves the entire estate to Child, Child will get an exemption on the first 5 million and will be taxed at a rate of 40% on the next 7 million.

Had Husband and Wife used an AB Trust they could have significantly reduced Child’s tax burden. When Husband passed away, half of the couples assets would have gone into trust A (worth 6 million) for the benefit of Wife during her life to be distributed to Child upon Wife’s death. The other one-half of the assets would go into Trust B (likewise, worth 6 million) for the benefit of Wife with Child receiving the Trust property upon her passing. Under the usual terms of such a trust, Wife may not sell off any of the property now held in Trust A, but may collect any income that the property generates. She may do as she sees fit with the property in Trust B. When Wife passes, Child receives all of the property in both Trusts A and B. Because Child is technically receiving two different inheritances—the one from her father from trust A and the one from her mother from trust B—each one of these is subject to the 5 million dollar exemption. Child will receive the first 5 million from both Trust A and B tax-free. Child will only have to pay taxes on the last 1 million from each trust. Thus, Child would only have to pay taxes on 2 million dollars in this scenario, as opposed to having to pay taxes on the last 7 million in the previous one.

As the illustration above shows, a substantial amount of money could have been saved had Husband and Wife taken the time to create an AB trust. In addition to providing potential tax benefits for couples with large estates, an AB trust could be used by couples with smaller estates as way of separating out the estates of husband and wife and allowing each some measure of control over the estate should they be survived by their spouse. This is most commonly done when spouses have children from pervious relationships. Because the trust becomes “irrevocable” (i.e., unchangeable) upon the death of one of the spouses, the terms of the trust for that spouse’s half interest get locked in at that time, securing at least some part of the trust for the benefit of the deceased spouse’s designated beneficiaries.

Probate

Probate is the judicial procedure by which a will is established to be legally valid and enforceable. Additionally, probate is the court proceeding through which an estate gets settled, meaning that it will determine the estate’s liabilities, pay them, and then distribute the remaining assets (if any are left) according to the decedents will or, in the absence of a valid will, the state’s default laws of succession (“intestacy law”, see below). This can be a lengthy process depending on the estate.

Laws of Intestate Succession

Laws of intestate succession or intestacy laws are a state’s default scheme for the distribution of the property owned by persons at the time of their death in the absence of a valid will. It is sometimes said that those who do not leave a will allow the state legislature to write one for them. Intestate law will also dictate the disposal of any assets not disposed of in a will. In the state of Arizona, if you’re married and all of your children are also your spouse’s children, all of your property will pass to your spouse; if you are unmarried with children, all of your property will pass to your children in equal proportion. However, things can sometimes get complicated when one or both spouses have children of their own. Instead of hoping that the state legislature has gotten it right, it is preferable to make one’s wishes clear through some type of legally valid testamentary device.

Pour Over Will

A pour over will is a will that gives money or property to an existing trust. Upon death, all of the person’s assets automatically go into a trust, thus, avoiding probate proceedings.

Power of Attorney (“POA”)

A power of attorney is a document granting someone authority to act as an agent or allowing them to perform certain transactions on someone else’s behalf. Normally, such POAs terminate automatically upon the death or incompetence of the person who granted it (i.e., the “grantor”).

Durable Power of Attorney

A durable power of attorney is a document that remains in effect during the grantor’s incompetency; such instruments commonly allow an agent to make healthcare decisions for a patient who has become incompetent.

Healthcare Power of Attorney

A healthcare POA (sometimes referred to as attorney-in-fact for healthcare or heath care proxy or surrogate) is a document in which you appoint someone to make healthcare decision for you in the event that you are unable to make or communicate your wishes to healthcare providers.

Living Will

A living will is document that may be attached to a healthcare POA or may be a stand-alone document that is intended to direct or guide the healthcare decisions that are made on your behalf in the event of incapacity. It is important to note that a living will has no bearing on how your property will be distributed. Its purpose is to outline the types of treatments that you would like to receive should you become incapacitated only.

Revocable Living Trust and Irrevocable Trust

An irrevocable living trust is trust that can no longer be altered. This is distinct from a revocable trust, which may be changed during the life of the person or persons whose property is put into the trust. Revocable trusts become irrevocable when the settlor passes or becomes incapacitated. For example, an AB trust (discussed above) is a revocable trust during the life of Husband and Wife. However, once one of the spouses passes away, the trust becomes irrevocable.

Some of these topics will be discussed in greater depth and detail in further blog entries, but this should be enough to give the reader a general overview. Please note that the preceding information is informational only, and is not intended to be legal advice. If you, or someone you know needs advice about setting up or modifying a will or trust, or any legal matter, contact the experienced Tucson attorneys at Harlow Spanier & Heckele PLLC. (520) 495-0869 or [email protected]