19 ESTATE PLANNING CHAPTER OVERVIEW We begin this chapter with the importance of estate planning. Its goal is to assure that the estate’s assets go to the rightful heirs, not Uncle Sam. Next, we present personal aspects of estate planning noting that if you are married, estate planning involves the interest of at least two people. But never having been married does not eliminate the need to organize your papers. Then, we discuss the legal aspects of estate planning. Simple will, traditional marital share will, exemption trust will, and stated dollar will are described and compared. We offer tips in writing a will, selecting an executor, and altering or rewriting a will. Next, we differentiate among living trust, testamentary trust, insurance trust, lifetime gifts and trusts. We conclude the chapter with an explanation of federal and state taxes; estate income taxes, inheritance taxes, and gift taxes are described. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: My Life LO 19-1 Analyze the personal aspects of estate planning. Estate planning is an essential part of retirement planning and an integral part of financial planning. The first part of estate planning consists of building your estate; the second part consists of transferring your estate, at your death, in the manner you have specified. The personal aspects of estate planning depend on whether you are single or married. If you are married, your estate planning involves the interests of at least two people—more if there are children. Never having been married does not eliminate the need to organize your papers. My Life LO 19-2 Assess the legal aspects of estate planning. In case of death, proof of claims must be produced, or the claims will not be processed. Among the papers needed are birth certificates, marriage certificates, legal name changes, and military service records. My Life LO 19-3 Distinguish among various types and formats of wills. The four types of wills are the simple will, the traditional marital share will, the exemption trust will, and the stated dollar amount will. Which type is best for you depends on your personal and financial circumstances. My Life LO 19-4 Appraise various types of trusts and estates. Establishing a trust can be an excellent way to manage your estate. Trusts are revocable or irrevocable. Popular forms of trusts include living trusts, testamentary trusts, and insurance trusts. An attorney’s help is needed to establish a trust. 19-1 LEARNING OBJECTIVES CHAPTER SUMMARY My Life LO 19-5 Evaluate the effects of federal and state taxes on estate planning. The tax aspects of estate planning have changed considerably because of recent major changes in the federal tax structure. The four major federal and state taxes that must be considered in planning your estate are estate taxes, estate income taxes, inheritance taxes, and gift taxes. 19-2 INTRODUCTORY ACTIVITIES • Point out the learning objectives (p. 659) in an effort to highlight the key points in the chapter. • Ask students to comment on the ”My Life” feature for the chapter (p. 659). • Ask students to give their opinions regarding estate planning aspects of financial planning. • Discuss the problems that can occur without appropriate estate planning. WHAT'S NEW TO THIS EDITION Revised content: New lifestyles New content: Social media will New content: Credit- shelter trust Revised content: Federal and State Estate Taxes New content: Estate Taxes Updated Exhibit 19-6: Estate tax law changes New Dashboard feature Provides the latest available information about gift and estate tax exemptions. Explains the importance of preparing a social media will, if social media is part of your daily life. Points out that a married couple will not pay any estate tax if their estate is less than $10.5 million in 2013. Provides the latest available information about gift taxes (2013). Points out that under the American Taxpayer Relief Act of 2012 (ATRA), the surviving spouse's estate in excess of $10.5 million (in 2013) faces estate tax of 40 percent. Shows the highest tax rates, gift exemption, and GST tax exemption amounts from 2001 to 2013. Explains the importance of estate planning to ensure that you have a secure future for yourself and your loved ones. 19-3 CHAPTER 19 OUTLINE I. Why Estate Planning? A. What Is Estate Planning? B. If You Are Married C. If You Never Married D. New Lifestyles E. The Opportunity Cost of Rationalizing II. Legal Aspects of Estate Planning A. Wills 1. Effect of Marriage or Divorce on Your Will 2. Cost of a Will III. Types and Formats of Wills A. Types of Wills 1. Simple Will 2. Traditional Marital Share Will 3. Exemption Trust Will 4. Stated Dollar Amount Will 5. Which Type of Will Is Best for You? B. Formats of Wills C. Writing Your Will 1. Selecting an Executor 2. Selecting a Guardian D. Altering or Rewriting Your Will E. A Living Will F. Ethical Will G. Social Media Will H. Power of Attorney I. Letter of Last Instruction IV. Types of Trusts and Estates A. Benefits of Establishing Trusts B. Types of Trusts 1. Credit-Shelter Trust 2. Disclaimer Trust 3. Living or Inter Vivos Trusts 4. Testamentary Trust 5. Life Insurance Trust B. Estates 19-4 1. Joint Ownership 2. Life Insurance and Employee Benefits 3. Lifetime Gifts and Trusts C. Settling Your Estate V. Federal and State Estate Taxes A. Types of Taxes 1. Estate Taxes 2. Estate and Trust Federal Income Taxes 3. Inheritance Taxes 4. Gift Taxes B. Tax Avoidance and Tax Evasion 1. Charitable Gifts and Bequests C. Calculation of Tax 1. Debts and Liabilities 2. Probate and Administration Costs D. Paying the Tax 19-5 CHAPTER 19 LECTURE OUTLINE Instructional Suggestions • This chapter discusses a subject most people would rather avoid: death—your own or that of your spouse. I. WHY ESTATE PLANNING? (p. 660) • Most people now live long lives. They think about and plan for the future. Yet a large percentage of people do little or nothing to provide for those who will survive them. What Is Estate Planning? (p. 660) • Estate planning is a definite plan for the administration and disposition of one’s property during one’s lifetime and at one’s death. • Estate planning is an essential part of retirement planning and an integral part of financial planning. • A n estate plan is usually implemented by a will and one or more trust agreements. If You Are Married (p. 661) • Legal requirements and responsibilities can create problems for married persons that are entirely different from the problems of single persons. • Your death will mean a new lifestyle for your spouse. If You Never Married (p. 662) • Never having been married does not eliminate the need to organize your papers. • Probably the single most important thing that you can do is take steps to see that your beneficiaries have the information and the knowledge they need to survive emotionally and financially if you die suddenly. The Opportunity Cost of Rationalizing (p. 662) • Morticians, clergy, lawyers, insurance agents, clerks of federal government agencies, and so on, will be sympathetic, courteous and helpful, but disinterested strangers. And your bereaved beneficiary may find it difficult to reveal confidences to them. • Use PPT slide 19-1 and 19-2. • Discussion Question: Why is estate a frequently overlooked aspect of financial planning? • Transparency Master 19-1 provides an overview of the activities involved in estate planning. • Use PPT slides 19-3 through 19-5. • Exercise: Have students suggest factors that will influence various estate planning activities. • Use PPT slide 19-3 • Text Highlight: Refer students to "Financial Planning for Life's Situation" feature to point out some specific activities involved in estate planning. (p. 661) • Assignment: Have students talk to several individuals about the actions they have taken in the area of estate planning. • Supplementary Resource: Talk to a lawyer, accountant, and other financial planning experts to obtain information on their suggested actions related to estate planning. • Supplementary Resource: Estate Planning and Living provides material on estate planning and living trusts. Features estate planning FAQs, a calendar, and a free attorney search service. www.estateplanning.com • Practice Quiz 19-1 (p. 663) 19-6 CHAPTER 19 LECTURE OUTLINE Instructional Suggestions II. LEGAL ASPECTS OF ESTATE PLANNING (p. 663) • In case of death, proof of claims must be produced or the claims will not be processed. Some important needed papers are: Birth certificates Marriage certificates Legal name changes Military service records Wills (p. 664) • A will is the legal declaration of a person’s mind as to the disposition of his or her property after his or her death. • If you intestate—without a valid will—the state’s law of descent and distribution becomes your will. • Use PPT slides 19-6 and 19-7. • Text Reference: Use Exhibit 19-1 to show the consequences of dying intestate. (p. 665) • Use PPT slide 19-6. • Supplementary Resource: Nolo’s Estate Planning. Articles and advice on wills and living trusts, probate avoidance, and funerals and ceremonies. From Nolo Press Self-Help Law Center. http://www.nolo.com/ • Supplementary Resource: Wills and Estate Planning Law. Nolo.com’s legal encyclopedia provides a general guide to the ins and outs of living will and estate planning. Browse articles, links, and FAQs. III. TYPES AND FORMATS OF WILLS (p. 666) • The four types of wills are the simple will, the traditional marital share will, the exemption trust will, and the stated dollar amount will. • A simple will is one in which you leave everything to your spouse. Such a will is sufficient for most small estates. • Traditional Marital Share Will leaves one half of your adjusted gross estate to your spouse outright as a marital share. The other half of your estate could go to your children or other heirs. • Exemption Trust Will has gained popularity since 1987. Under this type of will, everything passes to your spouse with the exception of an amount equal to the exemption. • Stated Dollar Amount Will allows you to pass to your spouse any amount that satisfies your objectives. These objectives may or may not include tax considerations. • Which type of will is best for you? Prior to 1981, many experts advocated the traditional marital share will. Today, many attorneys believe that the exemption trust will is best. However, there is no one ideal will. Formats of Wills (p. 667) • A holographic will is a handwritten will that you • Practice Quiz 19-2 (p. 666) • Use PPT slide 19-8 through 19-17. • Exercise: Have students create a list of items that they believe would be desirable to include in a will. • Supplementary Resource: Talk to one or more lawyers about the format, content, and type of will recommended in certain situations. • Assignment: Have students obtain the cost of a will from a number of different lawyers. • Supplementary Resource: Write to Aetna Life Insurance and Annuity Company, 151 Farmington Avenue, Hartford, CT 06156 to obtain Don’t Wait Until Tomorrow: A Contingency Plan to Help Those You Leave Behind; and The Days Ahead. • Use PPT slide 19-8 and 19-9. 19-7 CHAPTER 19 LECTURE OUTLINE Instructional Suggestions prepare. It should not be witnessed. Some states do not recognize a holographic will. • A formal will is usually prepared with an attorney’s assistance. You must sign in the presence of two witnesses. • A statutory will is one type of formal will. It is a preprinted form that may be obtained from lawyers and stationery stores. Writing Your Will (p. 668) • The way to transfer your property according to your wishes is to write a will specifying those wishes. • Selecting an executor. Select an executor who is both willing and able to carry out the complicated tasks associated with the job. Your executor can be a family member, a friend, an attorney, an accountant, or the trust department of a bank. Fees for executors, whether professionals or friends, are set by state laws. • Selecting a guardian: A guardian is a person who assumes the responsibilities of providing the children with personal care and of managing the estate for them. • Discussion Question: Is it necessary to use the services of an attorney in preparing a will? Won’t preprinted forms available in a stationery store do? • Text Reference: Use the “Financial Planning for Life’s Situations” feature: The 10 Commandments of Making Your Will (p. 668) to discuss various factors associated with making a will. • Transparency Master 19-3 points out major responsibilities of an executor. (Exhibit 19-2, p. 669) • Use PPT slides 19-10 and 19- 11. • Use PPT slide 19-10 • Discussion Question: How should a person select a guardian for minor children? 19-8 CHAPTER 19 LECTURE OUTLINE Instructional Suggestions A trustee is a person or an institution that holds or generally manages property for the benefit of someone else under a trust agreement. Altering or Rewriting Your Will (p. 670) • If you have a will, you should review it if: You move to a different state You have sold property mentioned in the will The size and composition of your estate has changed You have married, divorced, or remarried New potential heirs have died or been born. • If you are rewriting a will because of a remarriage, consider drafting a prenuptial agreement. It is a documentary agreement between spouses before marriage. A Living Will and Advance Directives (p. 670) • A living will provides for your wishes being followed if you become so physically or mentally disabled that you are unable to act on your own behalf. Ethical Will (p. 672) • With an ethical will pass on your values and beliefs to your heirs. It is not a legally binding document, but it helps with estate planning. Social Media Will (p. 672) • If you are active online, you should consider creating a statement of how you would like your online identity to be handled. You should appoint someone you trust as an online executor. Power of Attorney (p. 672) • A power of attorney is a legal document authorizing someone to act on your behalf. Letter of Last Instruction (p. 673) • This document, though not legally enforced, can provide your heirs with important information. It should contain the details of your funeral arrangements, the names of the persons who are to be notified of your death, and locations of your bank accounts, safe-deposit box, and other important items. • Use PPT slides 19-13 and 19- 14. • Supplementary Resource: Estate Planning Links. For consumers and estate planning professionals, this resource contains links to estate planning, elder law, tax, and related services. www.estateplanninglinks.com • Exercise: Have students create situations in which a will would need to be revised. • Discussion Question: Is it prudent to write a prenuptial agreement in case one remarries? • Use PPT slide 19-16. • Supplementary Resource: Estate Planning Articles. Recent articles on estate planning and trusts from attorneys throughout the country. www.ca- probate.com/news_idx.htm. • Text Highlight: Use Exhibit 19- 3 to explain the purpose of a living will. (p. 671) • Use PPT slide 19-17 • Transparency Master 19-2 points out the main components of a letter of last instruction. • Practice Quiz 19-3 (p. 673) 19-9 CHAPTER 19 LECTURE OUTLINE Instructional Suggestions IV. TYPES OF TRUSTS AND ESTATES (p. 673) • A trust is a legal arrangement through which your assets are held by a trustee for your benefit or that of your beneficiaries. In a revocable trust, you retain the right to end the trust or change its terms during your lifetime. In an irrevocable trust, you cannot change its terms or end it. Benefits of Establishing Trusts (p. 674) • Some common benefits of setting up a trust are: reducing estate taxes, avoiding probate, freeing yourself from management of your assets, providing income for your beneficiaries, and ensuring that your property serves a desired purpose after your death. Types of Trusts (p. 674) • There are many types of trusts: 1. A credit shelter trust (a bypass trust, a “residuary” trust, an A/B trust, an exemption equivalent trust, or a family trust) is designed to allow married couples to take full advantage of the exemption that allows $625,000 in every estate to pass free of federal estate taxes. 2. A disclaimer trust is appropriate for a couple who does not yet have enough assets to need a credit-shelter trust but may need one in the future. 3. A living, or inter-vivos trust is a property management arrangement that you establish while you are alive. 4. A testamentary trust is established by your will and becomes effective upon your death. 5. A life insurance trust is established while you are still living. • Use PPT slides 19-18 through19-23 • Supplementary Resource: Trusts can help you reduce estate taxes. A trust can dramatically lower the tax bill for the person or group you designate. But which one should you choose? Here’s a primer on living trusts, Qualified Personal Residence Trusts, charitable trusts and life insurance trusts. http://moneycentral.msn.com • Use PPT slide 19-20. • Supplementary Resource: LifeNET—Estate Planning. Learn about the need for estate planning and wills. Provides information on basic, tax-saving, pour-over, and qualified domestic wills or trusts. • Supplementary Resource: NNEPA. National Network of Estate Planning Attorneys. Includes information on estate planning, an attorney’s database, a list of associations, and links. www.netplanning.com 19-10 CHAPTER 19 LECTURE OUTLINE Instructional Suggestions Estates (p. 677) • Your estate is everything you own. It includes all of your property—tangible and intangible. • Community property is “any property that has been acquired by either of the spouses during their marriage, but not by gift, devise, bequest or inheritance, or, often, by the income there from.” • Joint ownership of property between spouses is very common. While joint ownership may avoid probate, it does not avoid federal estate taxes. There are three types of joint ownership: • Joint tenants with the right of survivorship • Tenants in common • Tenancy by the entirety • Life Insurance and Employee Benefits. Life insurance proceeds are free of income tax, excluded from probate, and wholly or partially exempt from most state inheritance taxes. • Lifetime Gifts and Trusts. Gifts or trusts with strings attached, such as retaining the income, use, or control of the property, are fully included at their date of death value, whether your rights are expressed or implied. • Assignment: Talk to legal and financial planning experts to contrast the cost and benefits of wills and trusts. • Text Highlight: Discuss the various types of joint ownership presented on page 679. • Use PPT slide 19-21 Settling Your Estate (p. 680) • If you have a will, your executor will carry out your wishes in due time. If you have not named an executor, the probate court will appoint an administrator to carry out the instructions in your will. • Practice Quiz 19-4 (p. 680) 19-11 CHAPTER 19 LECTURE OUTLINE Instructional Suggestions V. FEDERAL AND STATE ESTATE TAXES (p. 680) • The maximum tax rate on estates and gifts is gradually declining. You can reduce your taxable estate by giving assets during your lifetime. Types of Taxes (p. 681) • The four major taxes of this kind are estate taxes, estate income taxes, inheritance taxes, and gift taxes. 1. An estate tax is a federal tax levied on the right of a deceased person to transmit his or her property and life insurance at death. 2. Estates and Trusts Federal Income Taxes. In addition to the federal estate tax, estates and certain trusts must file federal income tax returns with the IRS. 3. Inheritance Taxes: An inheritance tax is levied on the right of an heir to receive all or part of the estate and life insurance proceeds of a deceased person. 4. Gift Taxes. The federal and state governments levy a gift tax on the privilege of making gifts to others. • Many states have gift tax laws. The state gift taxes are similar to the federal gift tax laws. Tax Avoidance and Tax Evasion (p. 682) • Tax avoidance is the use of legal methods to reduce or escape taxes; tax evasion is the use of illegal methods to reduce or escape taxes. • Gifts made to certain recognized charitable or educational agencies are exempt from gift, estate, and inheritance taxes. Calculating the Tax (p. 683) • The estate tax is applied to your net taxable estate at death. • Debts and Liabilities: In arriving at your taxable estate, the amount of your debts and other creditor obligations are subtracted. • Probate and Administration Costs. These costs include fees for attorneys, accountants, appraisers, executors or administrators and trustees, court costs, bonding and surety costs, and miscellaneous other expenses. • Use PPT slide 19-24. • Text Highlight: Use the material on pages 681-682 to provide an overview of types of taxes associated with an estate. • Assignment: Have students contact a local tax preparer to determine the services provided relating to estate taxes. • Exercise: Develop a list of suggested actions that can help to reduce the tax burden on an estate. • Text Highlight: Point out Exhibit 19-6 “Estate Tax Law Changes.”. • Software: The software that accompanies Personal Finance may be used to calculate estate tax liability. 19-12 CHAPTER 19 LECTURE OUTLINE Instructional Suggestions Paying the Tax (p. 684) • The federal estate tax is due and payable in cash nine months after your death. Practice Quiz 19-5 (p. 684) 19-13 CONCLUDING ACTIVITIES • Use the "My Life Stage" feature to highlight the main financial planning activities from the chapter for various ages and life situations. (p. 685) • Point out the summary of objectives (p. 686) and key terms in the text margin (p. 687). • Discuss selected end-of-chapter Financial Planning Problems, Financial Planning Activities, Financial Planning Case, and Continuing Case • Use the Chapter Quiz in the Instructor’s Manual. . WORKSHEETS FROM PERSONAL FINANCIAL PLANNER FOR USE WITH CHAPTER 19 Use the "Your Personal Financial Planner in Action" activities to encourage students to plan and implement various financial decisions. Sheet 65 Estate Planning Activities Sheet 66 Will Planning Sheet Sheet 67 Trust Comparison Sheet Sheet 68 Estate Tax Projection and Settlement Costs CHAPTER 19 QUIZ ANSWERS True-False Multiple Choice 1. T (p. 664) 6. C (p. 666) 2. T (p. 666) 7. A (p. 667) 3. F (p. 668) 8. A (p. 673) 4. F (p. 669) 9. C (p. 674) 5. F (p. 674) 10. B (p. 684) 19-14 Name ________________________________________ Date____________________________ CHAPTER 19 QUIZ TRUE-FALSE _____1. Every adult should have a written will. _____2. In a simple will (I love you will), you leave everything to your spouse. _____3. An executor cannot be a family member or a friend. 4. A trustee is a person who assumes the responsibilities of providing the children with personal care and managing the estate for them. 5. A living trust is a trust established by your will that becomes effective upon your death. MULTIPLE CHOICE _____6. Which type of will has been gaining popularity due to the increased exemption? a. Simple b. Traditional marital share c. Exemption trust d. Stated dollar amount _____7. A handwritten will that you prepare yourself is called a ____________ will. a. holographic b. formal c. statutory d. beneficiary _____8. Trusts can be a. revocable or irrevocable. b. callable or noncallable. c. cumulative or noncumulative. d. participative or nonparticipative. 9. Which type of trust is perhaps the most common estate planning trust? a. Disclaimer b. Marital-deduction c. Credit-shelter d. Self-declaration 10. Probate and administration costs of your estate may run between __________ percent of your estate. a. 2 to 4 b. 5 to 8 c. 9 to 12 d. 15 to 20 19-15 SUPPLEMENTARY LECTURE: 19-1 Estate Tax Questions* Reminder: Most relatively simple estates (cash, publicly-traded securities, small amounts of other easily-valued assets, and no special deductions or elections, or jointly-held property) with a total value under $2,000,000 do not require the filing of an estate tax return. Q: What is the Estate Tax? The Estate Tax is a tax on your right to transfer property at your death. It consists of an accounting of everything you own or have certain interests in at the date of death (Refer to Form 706). The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your "Gross Estate." The includible property may consist of Cash and Securities, Real Estate, Insurance, Trusts, Annuities, Business interests and other assets. Once you have accounted for the Gross Estate, certain deductions (and in special circumstances, reductions to value) are allowed in arriving at your "Taxable Estate." These deductions may include Mortgages and other Debts, Estate Administration expenses, property that passes to Surviving Spouses and Qualified Charities. The value of some operating business interests or farms may be reduced for estates that qualify. After the net amount is computed, the value of lifetime taxable gifts (beginning with gifts made in 1977) is added to this number and the tax is computed. The tax is then reduced by the available unified credit. Presently, the amount of this credit reduces the computed tax so that only total taxable estates and lifetime gifts that exceed $2,000,000 will actually have to pay tax. In its current form, the estate tax only affects the wealthiest 2% of all Americans. Q: Where do I file the return? Use the below mailing address for all tax forms filed at the Cincinnati Service Center including Estate and Gift tax returns: Internal Revenue Service Cincinnati, Oh 45999 To mail FedEx packages, please use the following street address: Internal Revenue Service 201 W. Rivercenter Blvd Covington, KY 41011 For questions about return accounts and extensions only, (no tax law questions) call: 1-866-699-4083 All tax law questions can still be answered by calling: * Source: http://www.irs.gov. 19-16 1-800-829-1040 Q: When is the return due? Generally, the estate tax return is due nine months after the date of death. A six month extension is available if requested prior to the due date and the estimated correct amount of tax is paid before the due date. Q: When can I expect the Estate Tax Closing Letter? There can be some variation, but for returns that are accepted as filed and contain no other errors or special circumstances, you should expect to wait about 4 to 6 months after the return is filed to receive your closing letter. Returns that are selected for examination or reviewed for statistical purposes will take longer. Q: What is included in the Estate? The Gross Estate of the decedent consists of an accounting of everything you own or have certain interests in at the date of death. The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them. The total of all of these items is your "Gross Estate." The includible property may consist of cash and securities, real estate, insurance, trusts, annuities, business interests and other assets. Keep in mind that the Gross Estate will likely include non- probate as well as probate property. Q: I own a 1/2 interest in a farm (or building or business) with my brother (sister, friend, other). What is included? Depending on how your 1/2 interest is held and treated under state law, and how it was acquired, you would probably only include 1/2 of its value in your gross estate. However, many other factors influence this answer, so you would need to visit with a tax or legal professional to make that determination. Q: What is excluded from the Estate? Generally, the gross estate does not include property owned solely by the decedent's spouse or other individuals. Lifetime gifts that are complete (no powers or other control over the gifts are retained) are not included in the Gross Estate (but taxable gifts are used in the computation of the estate tax). Life estates given to the decedent by others in which the decedent has no further control or power at the date of death are not included. Q: What deductions are available to reduce the Estate Tax? 1. Marital Deduction: One of the primary deductions for married decedents is the Marital Deduction. All property that is included in the gross estate and passes to the surviving spouse is eligible for the marital deduction. The property must pass "outright." In some cases, certain life estates also qualify for the marital deduction. 2. Charitable Deduction: If the decedent leaves property to a qualifying charity, it is deductible from the gross estate. 3. Mortgages and Debt. 4. Administration expenses of the estate. 5. Losses during estate administration. Q: What other information do I need to include with the return? 19-17 See Form 706 and Instructions and Publication 950. Among other items listed: 1. Copies of the death certificate 2. Copies of the decedent's will and/or relevant trusts 3. Copies of appraisals 4. Copies of relevant documents regarding litigation involving the estate 5. Documentation of any unusual items shown on the return (partially included assets, losses, near date of death transfers, others). Q: What is "Fair Market Value?" Fair Market Value is defined as: "The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts. The fair market value of a particular item of property includible in the decedent's gross estate is not to be determined by a forced sale price. Nor is the fair market value of an item of property to be determined by the sale price of the item in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate." Regulation §20.2031-1. 19-18 SUPPLEMENTARY LECTURE: 19-2 Estate Planning “If you’re fortunate enough to accumulate a substantial amount of wealth during your lifetime, you’ll want to see that your heirs get as much of it as possible,” says Goodman. “Sound estate planning can minimize the tax bite.” Your estate is your personal net worth accumulated from a lifetime of earning, saving and investing and any inheritances. Effective estate planning minimize a tax bite of as much as 55 percent. In one nightmarish scenario, a failure to plan may mean that your beneficiaries will have to sell newly-inherited wealth in order to pay the estate tax. To assist you with your retirement planning, visit FinanCenter’s calculator: Once you enter your personal data (they are not saved), click from the menu of buttons at the bottom of the calculator to find answers to retirement-related questions on future spending and saving. Federal estate tax law allows you to pass on to your heirs, tax-free, assets worth $5.25 million in 2013 You may wish to revise your will to reflect the new exclusion limits. For assets in excess of the new limits, you may want to establish a trust, or start giving the assets to your children over several years in order to reduce estate taxes. Some ways to avoid being hamstrung by estate taxes include: • Simplifying probate by creating and executing a will. • Avoiding probate by creating a trust. • Reducing your estate by making gifts and charitable contributions. • Using the gift tax marital deduction. • Using the unlimited marital deduction. Probate is the legal process of disposing of your assets and discharging your liabilities after you die. The process is administered by the probate court system, and can be costly and time-consuming, not to mention a violation your privacy. By writing and executing a will—a legal document that assigns your assets to persons or organizations that you specify—you can simplify the probate process in the document. Otherwise, the probate court is left trying to make these decisions on your behalf. Four ways to avoid probate altogether include: • Giving away you assets while still alive. • Holding your assets in joint tenancy. 19-19 • Making effective use of such contractual instruments as life insurance and pensions. • Establishing a trust or trusts. The gift tax marital deduction allows you to allocate your assets to your spouse, so that you can each have the maximum amount in your estates without being liable for taxes. The unlimited marital deduction allows you to transfer your entire estate to your spouse, tax-free, when you die. The surviving spouse then disposes of assets to reduce his or her estate. 19-20 SUPPLEMENTARY CASE: 19-1 Lyn and Larry are graduate students, both in their mid 20s. They are about to marry, and even though they have almost no assets, they write a short statement of principles. Their marriage will be an equal partnership—each will balance individual and career decisions with the other. Lyn and Larry will be jointly responsible for all expenses and debt. Furthermore, they will share income and assets equally, regardless of who acquires them. Fifteen years later, they decide to divorce. Lyn, having earned more money than Larry, seeks a larger share of the property settlement. But the court upholds the original agreement because the contract was “properly drawn and freely entered.” Questions: 1. Should Lyn appeal the judge’s decision? 2. Are prenuptial agreements legally binding? 3. Will you consider such a marriage contract? Explain. 19-21 SUPPLEMENTARY CASE: 19-2 A Plan for the Endgame Harry Frank talked to his lawyer about drafting a living will, but never completed one. Then, in 1995, he suffered severe brain damage in an automobile accident and spent three years in a persistent vegetative state. Last year, after his wife moved him to a nursing home to be close to his parents, she requested that his feeding tube be removed. Other family members objected. The device eventually was withdrawn, and Frank died—but only after an agonizing legal battle that tore his family apart. Imagine suffering a stroke or being left in a coma as a result of an auto accident. Would you want to be kept on life support, fed through a tube, or given pain-controlling drugs, even it they hastened your death? You have the right to make these choices. You’ll need two documents, called advanced directives: a living will that tells doctors and hospitals how you want to be cared for should you become terminally ill, and a health-care proxy who designates an advocate who can make sure your wishes are honored. Living wills do not give a hospital the right to “pull the plug” without consent of a patient’s legal representative. If you want doctors to exhaust every effort to keep you alive, no matter what, you can also request that in a living will. You can say: “I don’t want anything done,” or you can say: “I want absolutely everything.” Lawyers say it is important to be as specific as possible. If you want morphine or other pain medication in your last days, even if it is addictive or makes you drowsy, say so. If you want life support turned off if you are near death, write that down, too. Whatever its contents, a living will is one legal document that should not be kept in your safety deposit box. Give copies to your lawyer, your doctor, and your adult children, and take one to the hospital on your next visit. Putting your wishes in writing does not guarantee that a hospital will honor them, however. To make sure it does, you’ll need to appoint a legal representative, usually a relative or friend, who can handle your health-care decisions if you cannot. You make this choice by executing a designation of health-care proxy, health-care surrogate, or medical power of attorney. You might want to make your spouse your representative. But think about giving backup power to an adult child if you are not sure your spouse could handle such difficult decisions at a time of great stress. Questions: 1. How can you protect your wishes and your peace of mind with a living will? 2. Would you want to be kept on life support? Why, or why not? 3. In your opinion, who should have the right to make life-and-death decisions? 4. Should you keep your living will in a safety deposit box? Why, or why not? 19-22 ANSWERS TO PRACTICE QUIZZES, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, FINANCIAL PLANNING CASE, AND CONTINUING CASE PRACTICE QUIZZES Practice Quiz 19-1 (p. 663) 1. If you needed information about estate planning, would you go to the library or the Internet? Why? Student responses will vary. 2.. Why is estate planning an important component of financial planning? Estate planning is an essential part of retirement planning and an integral part of financial planning. It has two parts. The first consists of building your estate through savings, investments, and insurance. The second consists of transferring your estate, at your death, in the manner you have specified. Nearly every adult is involved with financial decision making and must keep important records. Whatever your status—single or married; male or female; Ph.D. professor or U.S. marine; taxi driver, corporate executive, farmer, rancher, sports champion, or coal miner—you must make financial decisions that are important to you. Those decisions may be even more important to others in your family. Knowledge in certain areas and good record keeping can simplify those decisions. There are things you should know—and do—to protect your interests and those of your heirs. 3. Why is estate planning important for single as well as married individuals? For “new” lifestyle individuals? If you are married, your estate planning involves the interests of at least two people—more if there are children. Legal requirements and responsibilities can create for married persons problems that are entirely different form the problems of single persons. Situations become more complex. Possessions accumulate. The need for orderliness and clarity becomes greater. Never having been married does not eliminate the need to organize your papers. For persons who live alone, as for married persons, it is essential that important documents and personal information be consolidated and accessible. Remember that in the event of your death difficult questions and situations are going to confront some person at a time of severe emotional strain. That person may not be prepared to face them objectively. Practice Quiz 19-2 (p. 666) 1. What are the legal aspects of estate planning? In case of death, proof of claims must be produced or the claims will not be processed. If no thought was given to gathering the necessary documents beforehand (with a sufficient number of copies), a period of financial hardship may follow until proof is obtained. If needed documentation cannot be 19-23 located, there may be irretrievable loss of funds. Your heirs may experience emotionally painful delays until their rights have been established. 2. What is a will? Why is it an important estate-planning tool? A will is the legal declaration of a person’s mind as to the disposition of his or her property after his or her death. Thus, a will is a way to transfer your property according to your wishes after you die. Whether you prepare a will before you die or neglect to take that sensible step, you have a will. If you fail to prepare your own will, the state in which you legally reside steps in and controls the distribution of your estate without regard for wishes that you may have had but that you failed to define in legal form. Thus, if you die intestate—without a valid will—the state’s law of descent and distribution becomes your will, as shown in Exhibit 19-1. (p. 665) 3. How does marriage or divorce affect a will? Effect of Marriage or Divorce on Your Will. If you already have a will and you are about to be married or divorced, review your will with an attorney for necessary changes. Upon divorce, only provisions favoring a former spouse are automatically revoked; provisions favoring family members of your ex-spouse—such as stepchildren, nieces, nephews, in-laws—are not affected. If you marry after you have made a will, the will is revoked automatically unless certain conditions are met. Practice Quiz 19-3 (p. 673) 1. Distinguish among the four types of wills. Simple Will. A simple will, sometimes called an I love you will, is one in which you leave everything to your spouse. Such a will is sufficient for most smaller estates. But if you have a large or complex estate, especially one involving business interests that you want to pass on to your children, a simple will may not meet your objectives. It might also cause a greater overall amount of taxation because everything would then be taxed in your spouse’s subsequent estate. Traditional Marital Share Will. The traditional marital share will leaves one half of your adjusted gross estate (the gross estate minus debts and costs) to your spouse outright as a marital share. The other half of your adjusted gross estate could go to your children or other heirs or be held in trust for your family. A trust could provide your spouse with a lifelong income and would not be taxed at your spouse’s death. Exemption Trust Will. The exemption trust will has been gaining in popularity due to its increased exemption ($600,000 since 1987). Under this type of will, everything passes to your spouse with the exception of an amount equal to the exemption, which would pass into trust. The amount passed to your spouse could be by will, trust, or other means. The exemption trust can provide your spouse with a lifelong income. Stated Dollar Amount Will. This type of will allows you to pass to your spouse any amount that satisfies your family objectives. These objectives may or may not include tax considerations. For example, you could pass the stated amount of $600,000. But the stated amount could be related to anticipated income needs or to the value of personal items. 2. What are the two formats of wills? Wills may be holographic or formal. A holographic will is a handwritten will that you prepare. It should be written, dated, and signed entirely in your handwriting—no printed or typed information should be on its pages. It should not be witnessed. Some states may not recognize a holographic will. A formal will is usually prepared with an attorney’s assistance. It may be either typed or in a 19-24 preprinted form. You must sign the will and acknowledge it as your will in the presence of two witnesses, neither of whom is a beneficiary (a person you have named to receive property under the will). The witnesses must then sign the will in your presence. 3. What are the steps in writing your will? Selecting an Executor. Select an executor who is both willing and able to carry out the complicated tasks associated with the job. These tasks are preparing an inventory of assets, collecting any money due, paying off any debts, preparing and filing all income and estate tax returns, liquidating and reinvesting other assets to pay off debts and provide income for your family while the estate is being administered, distributing the estate, and making a final accounting to your beneficiaries and to the probate court. Selecting a Guardian. In addition to disposing of your estate, your will should name a guardian and/or trustee to care for minor children if both parents die at the same time, such as in an automobile accident or a plane crash. A guardian is a person who assumes the responsibilities of providing the children with personal care and of managing the estate for them. 4. What is an ethical will? An ethical will is a way to pass on your values and beliefs to your heirs. Even though it is not a legally binding document, ethical wills help estate planning. 5. What is a power of attorney? A power of attorney is a legal document authorizing someone to act on your behalf. At some point in your life, you may become ill or incapacitated. You may then wish to have someone attend to your needs and your personal affairs. You can assign a power of attorney to anyone you choose. 6. What is a letter of last instruction? In addition to your will, you should prepare a letter of last instruction. This document, though not legally enforced, can provide your heirs with important information. It should contain the details of your funeral arrangements. It should also contain the names of the persons who are to be notified of your death and the locations of your bank accounts, safe-deposit box, and other important items. Practice Quiz 19-4 (p. 680) 1. Distinguish among the various types of trusts. A credit shelter trust (a bypass trust, a “residuary” trust, an A/B trust, an exemption equivalent trust, or a family trust) is designed to allow married couples to take full advantage of the exemption that allows $5.25 million (in 2013) in every estate to pass free of federal estate taxes. A disclaimer trust is appropriate for a couple who does not yet have enough assets to need a credit- shelter trust but may need one in the future. Living or Inter Vivos Trusts. A living trust is a property management arrangement that you establish while you are alive. You simply transfer some property to a trustee, giving him or her instructions regarding its management and disposition while you are alive and after your death. Testamentary Trusts. A testamentary trust is a trust established by your will that becomes effective upon your death. Such a trust can be valuable if your beneficiaries are inexperienced in financial matters or if the potential estate tax is substantial. Like a living trust, a testamentary trust provides the benefits of asset management, financial bookkeeping, protection of the beneficiaries, and 19-25 minimizing of estate taxes. Life Insurance Trusts. In many families, the proceeds of life insurance policies are the largest single asset of the estate. A life insurance trust is established while you are living. The trust receives your life insurance benefits upon your death and administers them in a manner agreed on. Such trusts can be canceled if there is a change in your family or financial circumstances, or if you wish to make new plans for the future. 2. What is included in an estate? Your estate is everything you own. It includes all of your property—tangible and intangible, however acquired or owned, whether inside or outside the country. It may include jointly owned property, life insurance and employee benefits, and property you no longer own. Thus, an important step in estate planning is taking inventory of everything you own. 3. What are the three types of joint ownership? In joint tenancy with the right of survivorship, the property is considered owned 50-50 for estate tax purposes and will automatically pass to your spouse at your death. In tenancy in common, each of the tenants in common is considered to own a proportionate share for tax purposes, and only your share is included in your estate. Tenancy by the entirety is limited to married couples. Both spouses own the property; when one spouse dies, the other gets it automatically. Depending on your circumstances any one of the above ownerships can serve your needs. Practice Quiz 19-5 (p. 684) 1. What are the four types of taxes that must be considered in planning your estate? Federal and state governments levy various types of taxes that must be considered in planning your estate. The four major taxes of this kind are estate taxes, estate and trust income taxes, inheritance taxes, and gift taxes. An estate tax is a federal tax levied on the right of a deceased person to transmit his or her property and life insurance at death. An inheritance tax is levied on the right of an heir to receive all or part of the estate and life insurance of a deceased person. Federal and state governments levy a gift tax on the privilege of making gifts to others. These taxes provide revenues to governments and distribute wealth. 2. How is the estate tax calculated? The estate tax is applied, not to your total gross estate, but to your net taxable estate at death. This estate is your testamentary net worth after your debt, liabilities, probate costs, and administration costs have been subtracted. These items, all of which are taken off your estate before calculating your tax, are cash requirements to be paid by your estate. The federal estate tax is due and payable in cash nine months after your death. 19-26 3. What are the various ways to handle the payment of the estate tax? One way to handle the estate tax is to set aside or accumulate enough cash to pay it when it falls due. The trouble with this suggestion is that you may die before you have accumulated enough cash and that the cash you accumulate may be subject to income tax during your life and to estate tax at your death. Another way to handle the estate tax would be for your family to sell assets to pay taxes. The first assets that might be sold are stocks, bonds, gold or silver coins, and similar liquid assets. But these assets may be the source of your family’s income after your death, and the market for them may be down. Such assets as real estate might also be sold, but prices on forced sales are usually only a fraction of the fair value. Your family could consider borrowing, but it is unusual to find a commercial lender that will lend money to pay back taxes. And if you do find one, it may require personal liability. In any event, borrowing does not solve the problem; it only prolongs it, adding interest costs in the process. Borrowing from the IRS itself in the form of deferred payments or installments may be possible for reasonable cause. Tax extension and installment payment provisions are helpful, but they still leave a tax debt to be paid by your heirs at your death. Paying that debt, even over an extended period of time, could be a real burden and severely restrict their income and flexibility. Life insurance may be a reasonable, feasible, and economical means of paying your estate tax. Instead of forcing your family to pay off the estate tax and other debts and costs by borrowing or selling, through insurance you can provide your family with tax-free cash at a fraction of the cost of borrowing. FINANCIAL PLANNING PROBLEMS (p. 688) Problems 1, 2 and 3 are based on the following scenario. In 2013, Joshua gave $14,000 worth of XYZ stock to his son. In 2014, the XYZ shares are worth $25,000. 1. Calculating the Gift Tax. What was the gift tax in 2013? The gift tax was zero in 2013. 2. Calculating the Gift Tax. What is the total amount removed from Joshua’s estate in 2014? $12,000 + $13,000 = $25,000 3. Calculating the Gift Tax. What will be the gift tax in 2014? The gift tax in 2014 is zero. 4. Calculating the Gift Tax. In 2013, you gave a $14,000 cash gift to your best friend. What is the gift tax? There is no gift tax for up to $14,000 in 2013. 19-27 Questions 5, 6 and 7 are based on the following scenario: Barry and his wife Mary have accumulated over $4 million during their 45 years of marriage. They have three children and five grandchildren. 5. Calculating the Gift Tax. How much money can Barry and Mary gift to their children in 2013 without any gift tax liability? $28,000 × 3 children = $84,000 (Each can gift $14,000) 6. Calculating the Gift Tax. How much money can Barry and Mary gift to their grandchildren? $28,000 × 5 grandchildren = $140,000 7. Calculating the Gift Tax. What is the total amount of estate removed from Barry and Mary’s estate? $84,000 + $140,000 = $224,000 8. Calculating the Estate Tax. The date of death for a widow was 2008. If the estate was valued at $2,129,000 and the estate was taxed at 45 percent, what was the heir’s tax liability? Value of the estate = $2,129,000 Exemption in 2008 = 2,000,000 Taxable estate = 129,000 Tax @ 45 percent = $129,000 x 0.45 = $58,050 9. Calculating the Estate Tax. Joel and Rachel are both retired. Married for 50 years, they’ve amassed an estate worth $2.4 million. The couple has no trusts or other types of tax-sheltered assets. If Joel or Rachel dies in 2008, how much federal estate tax would the surviving spouse have to pay, assuming that the estate is taxed at 45 percent rate? If Joel or Rachel dies in 2008, there will be no federal estate tax liability since there is an unlimited marital deduction for the surviving spouse. Only when both die there will be an estate tax liability over the $2 million exemption amount. FINANCIAL PLANNING ACTIVITIES (p. 688) 1. Prepare a Written Record of Personal Information. Prepare a written record of personal information that would be helpful to you and your heirs. Make sure to include the location of family records, your military service file, and other important papers; medical records; bank accounts; charge accounts; the location of your safe deposit box; U.S. savings bonds; stocks, bonds, and other securities; property owned; life insurance; annuities; and Social Security information. The purpose of this activity is to organize important information before it is needed. 19-28 2. Using the Internet to Obtain Information about Wills. Visit Metropolitan Life Insurance Company’s web page at http://www.lifeadvice.com. Using this information, prepare a report on the following: (a) Who needs a will? (b) What are the elements of a will (naming a guardian, naming an executor, preparing a will, updating a will, estate taxes, where to keep your will, living will, etc.)? (c) How is this report helpful in preparing your own will? The purpose of this activity is to emphasize the importance of having a valid will with all relevant elements. After conducting the research, students should be able to draft their own will. 3. Preparing the Letter of Last Instructions. Prepare your own letter of last instruction. The students’ responses will vary. 4. Determining Criteria in Choosing a Guardian. Make a list of the criteria that you will use in deciding who will be the guardian of your minor children if you and your spouse die at the same time. You should take great care in selecting a guardian for your children. You want a guardian whose philosophy on raising children is similar to yours and who is willing to accept the responsibility. 5. Using the Internet to Obtain Information about Estate Planning. Visit the Prudential Insurance Company of America Website at http://prudential.com. Gather information on various estate planning topics such as an estate planning worksheet; whether you need an estate plan; when to update your plan; estate taxes, wills, executors, trusts, etc. Then prepare a report to help you develop your estate plan. The students’ responses will vary. Let students gather important information about the various topics in estate planning. FINANCIAL PLANNING CASE (p. 689) Estate Planning 1. What triggered Charlie and Linda to start thinking about planning their estate? The death of their acquaintance, Lloyd Feldman. 2. According to attorney Rick Fenelli, what is the first step in estate planning? To identify all assets, including the life insurance proceed. 3. Who writes your will if you don’t? The state in which you live, and that will may not be what you wanted. CONTINUING CASE (p. 690) Estate Planning 1. What types of estate planning activities should the Lawrences consider at this time? The importance of estate planning is obvious—to assure that dependents, family members, friends, or organizations receive intended care and financial well-being. While most people think that estate 19-29 planning means having an up-to-date will, there are many other aspects that are often overlooked. You may want to review the materials on the Legal Aspects of Estate Planning as you discuss this question with your students. Finally, you may want to review the material on Types of Trusts and Estates. 2. Explain how Shelby and Mark might use the Personal Financial Planner sheets on Estate Planning Activities and Will Planning. The couple will benefit by developing a plan related to estate planning; investigating the type of will appropriate for their life situation; comparing the benefits and costs of trusts; and identifying strategies that would minimize future estate taxes. DAILY SPENDING DIARY (p. 690) Analysis Questions 1. What information from your spending patterns can help you plan for the long-term needs of you and family members? Student answers will vary. 2. What estate planning activities are you planning to take action on the next few years? Student answer will vary. 19-30 TM 19-1 Components of Estate Planning Name executor of your estate Review and update your will on a regular basis Organize current financial records and documents, and make them easily accessible for family members Create and review trust as required Prepare letter of last instruction 19-31 TM 19-2 Components of a Letter of Last Instruction • Individuals and institutions to be notified • Funeral arrangements • Location of personal papers, bank account information, safe deposit box location, and contents • List of credit accounts and numbers • Location of deed and mortgage information • Insurance policies, company, and agents name • Automobile registration information • Location of recent federal and state income tax returns • List of investments and stockbroker's name and address • Type and financial institution of trusts • List of loans and amount due • List of debts owed to you • List of other sources of dependent benefits not named in the will, such as Social Security or veteran's benefits • Other financial documents and records 19-32 TM 19-3 Major Responsibilities of an Executor (Exhibit 19-2) 19-33 Name ______________________________________ Cha pt er 19: Est a t e Pla nning C H A R I T A B L E R E M A I N D E R T R U S T T R A D I T I O N A L M A R I T A L S H A R E W I L L G E N E R A T I O N S K I P P I N G T R U S T S T A T E D D O L L A R A M O U N T W I L L M A R I T A L D E D U C T I O N T R U SS T E L F D E C L A R A T I O N T R U S P R E N U P T I A L A G R E E M E N TT C H A R I T A B L E L E A D T R U S T A D J U S T E D G R O S S E S T A T E L I F E I N S U R A N C E T R U S T E X E M P T I O N T R U S T W I L L C R E D I T S H E L T E R T R U S T T E S T A M E N T A R Y T R U S T C O M M U N I T Y P R O P E R T Y S P E N D T H R I F T T R U S T I R R E V O C A B L E T R U S T P O W E R O F A T T O R N E Y H O L O G R A P H I C W I L L D I S C L A I M E R T R U S T R E V O C A B L E T R U S T I N H E R I T A N C E T A X E S T A T E P L A N N I N G S T A T U T O R Y W I L L L I V I N G T R U S E TT H I C A L W I L L B E N E F I C I A R Y S I M P L E W I L L L I V I N G W I L L F O R M A L W I L L I N T E S T A T E E S T A T E T A X G U A R D I A N T R U S T O R T R U S T E E P R O B A T E G I F T T A X C O D I C I L E S T A T E T R U S T G R E A T W I L L Q P R T 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 Instructor Manual for Personal Finance Jack R. Kapoor, Les R. Dlabay , Robert J. Hughes, Melissa M. Hart 9780077861643, 9781260013993
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