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Traps and Pitfalls to Avoid in Estate Planning



Americans work hard for a long period prior to retirement. We expect a lifetime of earnings and wealth to be waiting for us at the end of that toil when we seek to pass our estates to future generations. However, that sweat equity and hard work can evaporate quickly with nonexistent or improper estate planning.

Procrastination in estate planning and preparation can take a huge toll if you die intestate (without a will). In such cases, the state government steps in to decide how your estate will be distributed and to whom. Your assets are taxed to the highest possible extent. The goal of estate planning is to maximize wealth and assets passed to future generations and to minimize tax burdens associated with that estate. And there are a number of common estate-planning traps and pitfalls that you will want to avoid.

Avoid Surviving Spouse Wills in Most Cases

Most married testators create "I-love-you wills" that mandate that when one spouse passes, all of his or her property is devised to the surviving spouse. When both spouses pass, all of their property then goes to their mutual kids. However, this type of simple will is not appropriate in all circumstances. It is not a "one size fits all" solution. In fact, it is usually most appropriate with only modest-sized estates. If an estate exceeds one million dollars, it is no longer sufficient. There are thresholds for dollar amounts for assets that may be transferred without estate tax liability for individuals and married spouses. Generally, that figure is $600,000 for individuals and $1.2 million for married spouses. If the goal is to maximize wealth that passes to children, then there should be specific provisions included in wills. Alternatively, a living trust agreement should be prepared that creates a bypass trust or credit shelter trust. This trust is triggered upon the passing of the first spouse in a married couple.

Avoid Disproportionate Ownership of Property Between Spouses

Bypass trusts or credit shelter trusts perform most optimally when both spouses own nearly the same amounts of property and assets. In this way, a trust can serve to best avoid estate tax liability up to $600,000 in assets for each spouse. Yet, if one spouse owns the majority of property and the other spouse owns very little, then the trust is more or less wasted in situations in which the spouse with the modest estate passes first. The entire purpose of the trust is to maximize such a benefit. In order not to sacrifice the utility of such a benefit, both spouses should equalize property ownership.

Fund a Trust With a Life Insurance Policy

Many wealthy estates contain a life insurance component of some size. Life insurance benefits are popular with financial planners and trusts and estates attorneys because they are considered to be good sources of ready liquidity when cash is needed and policy proceeds are not taxed. This prevailing logic is flawed, though, and not entirely accurate. While it's true that life insurance death benefits are usually not taxed as income, proceeds are subject to estate taxes if policies are held by the insured at the time of the policyholder's passing. Estate taxes can evaporate as much as 60 percent of the policy's value, sadly. The way to avoid estate taxes is to transfer ownership of the policy to an irrevocable trust. This is appropriate for policies that are supposed to pass to future heirs and generations.