This previously published article is part of 12 Days of Wealth Management: The Year in Review.
For high-net-worth families, estate plans are rarely simple. Relationships may be complicated, and estate and tax laws change over the years.
As a result, plans usually become more involved over time. Even if they are filled with features that made sense at the time of creation, plans may be subject to internal inconsistencies - provisions that work at cross-purposes and that could be revised profitably.
Below are some of the inconsistencies that bedevil many estate plans.
POWER OF ATTORNEY
Powers of attorney are ubiquitous in estate planning, since naming an agent to handle financial, tax and legal matters in the event of illness is an essential protective measure. Yet many clients are highly inefficient in designating when an agent can act on their behalf.
Many clients are not comfortable in authorizing an agent to act immediately. Instead, they employ a safeguard that lets an agent's authority to act take effect only when a client is disabled. This is called a springing power because it springs into effectiveness only when a client is disabled.
But a springing mechanism can be problematic since it requires a third party, like a wealth manager, to be persuaded that a client is in fact disabled. Some states, notably Florida, even prohibit these types of powers.
Sometimes, there is a logical inconsistency in what a client is doing. After all: If a client trusts the agent, why not make the agent's authority effective immediately? Nevertheless, if the client is not comfortable with a power of attorney taking effect at once, there should be a better solution. For instance, a client could create a monitor relationship, in which an agent has to send reports to an independent person for review. A CPA or wealth management firm could then review bank and brokerage statements on a monthly basis, comparing them with a prior budget to protect against inappropriate spending.
If a client has concerns over empowering an agent to act immediately, it's logical to create checks and balances.
Estate planning attorneys tend to devise plans based on a current balance sheet, rather than beginning with a financial projection, to identify what wealth a client is likely to leave behind. That may be insufficient.
If a client remains a net saver and his or her wealth will grow, it might be worthwhile to engage in more aggressive estate-tax minimization. If the burn rate is too high, on the other hand, a client may face a substantial risk of running out of money before death - making any bequest irrelevant.
Often, projections will support a middle ground of estate planning: An advisor might take some tax-minimization actions, but not create as costly or complex a plan as the balance sheet might appear to justify.
Many power of attorney documents give an agent a right to make certain gifts - perhaps to continue financial help a parent had been giving adult children, to reduce estate taxes or to accomplish another goal.
Although less frequently used, revocable living trusts are likely to increase in use as the older population increases - whether to avoid probate or to facilitate management of assets as a client faces health challenges.
These living trusts also may include gift provisions, but planners should ensure these are coordinated with power of attorney documents. Is the same person named agent and trustee? Are the gift provisions different? Which controls? If different fiduciaries are named, who coordinates between the two?
In many estate plans, the tax allocation clause is ignored as boilerplate. It should not be.
For clients facing a 40% federal estate tax, the provision in their will that determines which bequests bears this cost could be significant in determining who inherits what. For clients facing a state estate tax instead of a federal one, this provision is particularly important.
For example, assume a client has a $4 million estate and lives in a state with a $1 million exemption. Assume further that the estate will face a $400,000 state estate tax. The client bequeaths $2 million to a son, with the remaining estate to be divided equally between two daughters. If the objective is primarily to benefit the son, perhaps the daughters should bear the tax burden.
Understanding the client's objectives is critical. If the bequest to the son is to a trust because of unique challenges the son faces, then perhaps the residuary should bear any tax or other cost.
Many clients have wills that include long lists of specific bequests - $10,000 to an old college buddy, $20,000 to a local church and so forth. In this manner, some clients bequeath large sums relative to their overall net worth. Yet if a client has a net worth of $3 million and makes $1 million of specific bequests, is that reasonable?
If the clients say they want to make specific bequests, most estate planners will craft a will or living trust accordingly, as long as the bequests are consistent with the client's financial projections. If the client's estate declines to $2 million before death, the $1 million of bequests is still viable. But did the client intend to primarily benefit the remainder beneficiaries or the specific bequests?
Amid complex family relationships and nuanced bequests, the need to project who may inherit what is important.
Perhaps this philanthropically minded client might be better served leaving one-third of the estate to be divided in shares and two-thirds to other intended beneficiaries.
A typical client might have a will distributing assets to trusts to heirs, as well as an irrevocable life insurance trust providing trusts for heirs. The two documents may have been created at different times with different objectives, so the terms may differ.
What was the real intent? Are multiple trusts efficient? Do they serve any purpose?
If a wealth manager is dividing a family's wealth into several trusts for various children, that may be reasonably manageable. But if that wealth is fractionalized into several different trusts for each child, advisors could face a significant administrative burden. If the trusts have different trustees, decision-making might become difficult - not to mention the tax planning complications, administrative costs and headaches.
Advisors should be sure to investigate inconsistencies among the trusts and address them. Simply amending a will or other instrument that is not irrevocable could be the solution. For multiple irrevocable trusts, it may be feasible to merge the trusts or roll the slightly different trusts into one, newly established trust.
Martin M. Shenkman, CPA, PFS, JD, is a Financial Planning contributing writer and an estate planner in Paramus, N.J. He runs laweasy.com, a free legal website.