Since the passage of the Economic Growth Tax Relief and Reconciliation Act in 2001, (EGTRRA), estate tax rules have been in a state of flux. The federal estate tax exclusion credit has now increased to $2 million per person, and many Americans are waiting until 2011 to plan their estates. This, however, could be dangerous for several reasons, one of which is an essential part of estate planning -- life insurance. If a client waits too long, they could become uninsurable or pay much higher premiums.
Following are nine estate planning mistakes that you should help your clients avoid.
Mistake #1
The most prevalent mistake is the failure to have any estate plan or having an out-of-date or improper one. This alone can result in envy and confusion among surviving family members at a time when love and unity should prevail.
Mistake #2
Many have misunderstood EGTRRA and the impact it has had on estates. Some sighed in relief when President George W. Bush signed this bill. They believed that estate taxes had been, or would soon be, abolished. A closer look at the law, however, reveals that although the estate tax exclusion is scheduled to increase from $2 million in 2007 and 2008 to $3.5 million in 2009 with a total planned abolition in 2010, there is the always the onerous "sunset provision." This provision mandates that estate planning laws and credits must revert to pre-2001 levels, or to a meager $1 million credit.
Another critical element of the EGTRRA agenda is the loss of the "step up in basis." The current law allows heirs to inherit property with a cost basis based on the value of the estate at death. If this provision is lost, heirs would need to pay taxes at the capital gains tax rate on all gains greater than the original cost basis when an inherited asset is sold.
While many were relieved when EGTRRA came into being, reality can be cruel, and all of today's estate planning efforts should reflect the possibility that things will eventually revert to the pre-2001 law.
Mistake #3
Many clients feel that if they transfer the ownership of their holdings to a close relative, the transaction would help those relatives avoid probate. But if the joint tenant or co-owner of the assets is sued or files for bankruptcy, creditors could attack the asset. The beneficiary may lose it, even if the policyholder's home is among their assets. Furthermore, a spouse from a second marriage could disinherit their stepchildren, leaving the children with no inherited assets.
Mistake #4
Since the Tax Act of 1981 and the introduction of the 100 percent marital exclusion, 80 percent of America's affluent have elected to pass their total estate to their surviving spouse. While this may appear appropriate, it isn't necessarily good estate planning. In fact, for a joint estate valued in excess of $4 million or an estate with the potential to appreciate beyond that figure, passing everything to the surviving spouse will generate up to $900,000 in needless federal estate taxes, not to mention state inheritance taxes.
Mistake #5
The vast majority of affluent Americans don't understand the gift tax laws that allow clients to share their wealth (up to $12,000 annually per beneficiary). Also, many don't know the power those laws can create and the many estate tax benefits that can be realized if they apply this simple concept. In fact, in most cases, by leveraging the annual IRS gift allowance, clients can diminish the possibility of the estate's elimination.
Mistake #6
Perhaps the most expensive estate planning mistake is the failure to properly plan the distribution of retirement accounts, such as IRAs or 401(k)s. Too often, beneficiary forms are not reviewed when life events occur, such as divorce or death. And, most importantly, the recently permissible stretch options for non-spousal beneficiaries are not in place. Mistakes in retirement planning can cause beneficiaries to incur taxes in excess of 60 percent.
Mistake #7
Given the fact that 70 percent of today's affluent do not have a sound estate plan, most heirs will have to liquidate assets in order to generate enough cash to cover estate costs. Which assets will be sold first? Faced with time constraints, will they command top dollar? What if the market declines during liquidation? Will the family summer cabin survive taxation by the IRS? These are the types of questions that heirs will need to answer if a proper plan is not in place.
Fortunately, there are both economical and logical estate planning strategies that can significantly reduce the possibility of a diminished estate. These strategies, however, must be established before they are needed. In other words, an estate plan must always be in place.
Mistake #8
It is alarming how many large life insurance policies are owned by the insured and not a third party. Insureds have been told that life insurance proceeds are income tax-free, but they have not typically been told that those same proceeds are included in their estate. In many cases, life insurance policies can trigger an estate tax on other assets, and million-dollar policies can actually net a value, after estate taxes, of less than 45 percent of their desired amount.
Mistake #9
According to the Health Insurance Association of America, "Four in 10 Americans age 65 and older will need long term care at a cost of $40,000 to $80,000 a year." At that rate, a long illness could wipe out many assets, especially considering the fact that before anyone can be eligible for Medicare, they must first spend down their assets. With proper planning, however, investments should be protected from any medical costs.
David T. Phillips is the author of "Estate Planning Made Easy," "Profiting From the Insurance Revolution," and many special reports. He can be reached at 888-892-1102.
