by Keith Dorney
Inheritance Tax - Some states charge the beneficiary an inheritance tax when they receive assets from an estate. This is unlike an estate tax where the estate pays the taxes, not the beneficiary. Some beneficiaries, dependent on their relationship with the deceased, are exempt from paying inheritance tax.
Intestate Succession (Laws of) - Who gets what when you pass if you’ve failed to do any estate planning? That’s up to the laws of intestate succession that your state of residence has written. If you die “intestate,” assets are first probated and then distributed according to this list. The first person on that list may be the last person you want to get your stuff, so it’s best for you to decide now.
Irrevocable Life Insurance Trust - This is a sneaky way to avoid having the face amount of a life insurance policy included in your gross estate when you pass. A trust is created, and typically the grantor transfers an unfunded life insurance policy to it. The grantor pays the insurance premiums through gifts to the trust. These gifts are at or under the year’s gift tax exclusion amount. The sneaky part lies in creating a “present interest” for those gifts. Letters are written to the beneficiaries of the trust acknowledging the gifts, giving them the opportunity to collect their gift during a specific time period. If done correctly, upon the grantor’s death, the insurance payout to the named beneficiary is not included in the grantor’s estate. As the name implies, this is an irrevocable trust and the elements of the trust cannot be changed by the grantor once it is created.
IRS Form 709 - File this form to report gifts that are subject to gift tax or generation-skipping transfer tax. You probably won’t have to pay any tax until if and when you use up your estate and gift tax exemption of $11.58 million. That’s above and beyond the year’s current gift tax exclusion.
Living Trust - A revocable trust that can be used as a will substitute. There is a whole section on living trusts in this book.
Marital Assets - Assets acquired during one’s marriage with their spouse. In community property states, assets acquired during a marriage are considered marital assets regardless of which spouse paid for them or how it is titled, unless the property falls under one of the three exceptions: Property owned before the marriage that is kept separate; Gifts intended for one spouse; An inheritance intended for one spouse.
Mentally Incompetent - Whether because of an accident, an incident during surgery or through an end of life situation, there may be a time before your death when you are unable to make your own healthcare decisions or manage your finances. That’s why it’s smart to execute durable powers of attorneys and name individual(s) to act upon your behalf for these purposes if this ever happens. These days, it can be time consuming to legally have someone declared mentally incompetent, which is important when it comes to whether you want to include a “springing power” in the above referenced documents.
POD - Often referred to as a Totten Trust, Poor Man’s Trust, or Pay-On-Death. This designation grants the ability to transfer cash upon your death from a checking, savings, money market, or other cash account to a named beneficiary. PODs and TODs are valid will substitutes and assets avoid the probate process. After legal necessities are completed, including issuance of a death certificate, money is transferred directly to the named beneficiary without going through the probate process.
Power of Attorney - A legal document giving another the right to act on your behalf. It can be specific to a particular instance and time, or it can be more general. In estate planning, durable power of attorneys should be drawn for two purposes: healthcare decisions and financial management. “Durable” means that the powers granted are still valid if you are declared mentally incompetent. (A power of attorney without a durable moniker is not valid if you are declared mentally incompetent.) You may or may not want to add a “springing power” to your durable power of attorneys.
Present Interest - The yearly gift tax exclusion can only be used if the person receiving the gift has an immediate right to it. For example, if I put $15,000 in an irrevocable trust for you, but the terms of the trust say you can’t have it until I die, that’s not a present interest and I’d be required to file a gift tax return to report that $15,000 gift. It is important to create a present interest when making gifts to an irrevocable life insurance trust, for example.
Primary Beneficiary - Contracts for life insurance, IRAs, 401(k) type plans, annuities, stock awards, employee stock purchase plans and more give you the ability to name a primary as well as a secondary beneficiary. These designations are valid will substitutes, meaning assets pass directly to the beneficiary without going through the probate process. Naming someone a primary beneficiary overrides any contradictory information that may be contained in a will. Remember that the secondary beneficiary designation is there just as a backup if the primary beneficiary pre-deceases you or refuses the inheritance. If you want to split an inheritance, put all recipients as primary beneficiaries with the appropriate percentages.
Primary Residence - It’s the place that you call home. If you own both a primary and secondary residence, it’s the one where you spend the majority of your time. In most cases, the state where your primary residence is located determines your state of residence for tax purposes.
Probate - A legal process run by your state of residence to help close out a decedent’s last affairs, including distributing assets to heirs. Property bequeathed through a will is held, managed, and distributed through the probate process, as is property not named through a valid will substitute.
Probate Court - A specialized court run by your state of residence. Besides administering a decedent’s estate, probate court also has jurisdiction over matters of conservancy and guardianship.
QTIP Election – This election gives the executor of an estate the option of either taking advantage of the unlimited marital deduction and passing on the value or a portion of the value of a QTIP Trust to the surviving spouse or including the value or a portion of the value of the estate in the decedent’s estate. This flexibility can be important when trying to minimize estate taxes for both spouses. Besides limiting the surviving spouse’s access to the corpus of the trust and disallowing changes as to the eventual beneficiaries of the trust, a QTIP Trust and potential QTIP Election can be an important tool to help minimize the estate taxes paid by a couple.
QTIP Trust - Stands for qualified terminal interest property trust. This trust is often used in estate planning to protect one’s assets acquired prior to a marriage from becoming a marital asset. A life estate is created for the benefit of a beneficiary from assets transferred to the trust upon death of the grantor. This beneficiary, often the spouse the divorced grantor married after a prior marriage with kids, enjoys the assets during their lifetime. Upon the passing of this beneficiary, property in the trust reverts to other named beneficiaries, often the first spouse to die’s children from a previous marriage. QTIP trusts are also used in state estate and gift tax planning to maximize each spouse’s state estate and gift tax exemption, as well as to help minimize generation-skipping transfer taxes.
Real Property - For our purposes we are talking your personal residence, secondary residence, land, income property and other interests in real estate you own. Protecting real property from probate is a primary reason for creating living trusts.
Rights of Survivorship - A designation for accounts and real estate that acts as a will substitute. Upon the death of an owner or “tenant,” their share of assets passes equally to the surviving tenant or tenants without going through probate.
Secondary Beneficiary - Contracts for life insurance, IRAs, 401(k) type plans, annuities, stock awards, employee stock purchase plans and more come with not only the ability to name a primary beneficiary but a secondary one as well. It gives you a “backup” in case your primary beneficiary pre-decease’s you. Your Bus List includes planning for the unexpected, so be sure both your primary and secondary beneficiary designations are filled out on all accounts that come with beneficiary stateme
nts, and keep them updated.
Springing Power - A durable power of attorney may contain this power, which means it only becomes valid or “springs” into action upon occurrence of an event, in this case if you are ever declared mentally incompetent. Spouses who trust and love each other usually don’t include a springing power when naming their spouse as their durable power of attorney since having one declared legally incompetent can be a time consuming process.
Stepped-Up Basis – Assets passed along to beneficiaries through one’s estate, i.e. through your death, enjoy what’s known as stepped-up basis. With gifts made during your lifetime, the one receiving the gift assumes the person giving the gift’s original basis. Basis is simply what was paid for the asset, plus any capital improvements (if applicable). It’s what is subtracted from the sale price of an asset to determine capital gains tax. When assets are bequeathed through your death, the asset’s basis gets “stepped-up” to the market value of the asset at the time of your death. This is especially important with highly appreciated assets. Large amounts of capital gains liability can get “wiped away” through such an after-death transfer.
Successor Trustee - A person named in a trust that takes over management of the trust once the original trustee no longer can serve because of death, withdrawal, or dismissal. In a living trust the successor trustee, in most cases, assumes duties after the grantor’s death. (A typical living trust arrangement has the grantor of the trust also acting as the trustee of the trust during their lifetime.) The successor trustee is bound to act by the terms of the trust (written by the grantor) and has a fiduciary duty in regards to the beneficiaries.
Survivorship Rights - A designation for accounts and real estate that acts as a will substitute. Upon the death of an owner or “tenant,” their share of assets passes equally to the surviving tenant or tenants without going through probate.
Tax Cuts and Jobs Act - Signed into law by President Trump on December 22, 2017, this legislation dramatically changed the taxation landscape for 2018 and beyond. For businesses, corporate taxes were slashed to a flat 21%, a new 20% deduction in taxable income for “pass through businesses,” and the alternative minimum tax was repealed. These tax changes are permanent (or until Congress decides to change them again) and have no sunset. Personal taxes were lowered substantially too, but these changes expire (sunset) at the end of 2025 and include the following: Seven new tax brackets of 10%, 12%, 22%, 24%, 32%, 35%, and 37% to determine taxable income along with more tax-friendly thresholds; Stricter limits on deductibility of state and local income taxes and mortgage interest; The repeal of deductions for personal exemptions and miscellaneous itemized deductions; The nearly doubling of the standard deduction and an expanded child tax credit; A crackdown on the Kiddie Tax and a more tax-friendly AMT calculation; Expanded limits on federal gift and estate tax.
Tenancy by the Entirety - This form of ownership is for married couples only, and is not available in all states. Generally, community property states offer community property with the rights of survivorship ownership and common law states tenancy by the entirety ownership. It affords the same advantages as joint tenancy with the rights of survivorship, including survivorship rights and undivided ownership, but may offer greater protection from the debts of a spouse.
Tenant - When used in estate planning, a tenant does not refer to a landlord-tenant relationship. Rather, it refers to owners of real property. In a joint tenancy with the rights of survivorship vesting, each tenant or owner has undivided equal ownership, and when one tenant passes, their share goes equally to the surviving tenants.
Tenants in Common - Unlike joint tenancy with rights of survivorship, where ownership is equal and a decedent’s share passes to the surviving tenants equally, tenants in common is divided ownership without survivorship rights. Ownership can be unequal and of any percentage, and ownership can be sold or passed on to heirs without restriction or permission from other tenants (assuming no partnership agreement is in place that says otherwise).
Terms of the Trust - A legal trust has five elements (grantor, beneficiaries, trustee, terms of the trust, and trust property). The terms of the trust act as instructions as to how assets in the trust are managed and distributed. In an irrevocable trust, the terms cannot be altered. In a revocable trust the terms of the trust, as well as the other elements of the trust, may be changed during the grantor’s lifetime. Once the grantor of a living trust passes, the trust typically becomes irrevocable and the successor trustee is bound by the terms of the trust.
Testamentary Trust - One of the main functions of trusts is to avoid the probate process by transferring assets to a trust during your lifetime. A Testamentary Trust is an exception to that rule: It is created through a will and is funded through probate and is a part of the probate process. Testamentary Trusts are often created to plan for an event that is unlikely to happen, like the death of a single parent or simultaneous death of both parents before a child reaches the age of 18. Designated assets are transferred into the Testamentary Trust. You name a trustee who is in charge of managing those assets. Assets bequeathed to children can be managed until they reach the age of majority or a later date if you so desire. You designate that date through the terms of the trust. Make sure you also designate guardian(s) for your minor children via your will.
TOD - Stands for Transfer-on-Death. Similar to a POD except it affords assets rather than cash to be transferred to a named beneficiary upon the death of a decedent. Use TODs to avoid probate and transfer assets like stocks, bonds, and even real estate in some states. TODs for real estate are often referred to as beneficiary deeds.
Totten Trust - A Totten Trust is simply another name for a POD (Pay-On- Death), so see POD for a definition. The name dates from a 1904 court decision that first created this valid will substitute.
Trust - A trust is a document that creates a separate legal entity. Assets transferred into the trust by the grantor become the property of the trust, not the grantor. There are many different types of trusts used for myriad reasons. Trusts can be revocable or irrevocable.
Trust Property - A legal trust has five elements (grantor, beneficiaries, trustee, terms of the trust, and trust property). The trust property or corpus is what is transferred into the trust by the grantor. It is then legally owned by the trust, not the grantor, and avoids probate upon the grantor’s death.
Unified Credit - The unified credit is used for calculating both estate and gift tax liability. Unified refers to the fact that the estate and gift tax schedules are one in the same. You see, Uncle Sam doesn’t care whether you gift your assets during your lifetime or through your death: He gets the same tax either way. Making gifts over the gift tax exclusion amount for the year erodes your unified gift and estate tax exemption. No tax is due until the exemption amount is reached (currently $11.58 million in 2020). Whether that occurs before your death via extraordinary gift giving or after via your estate, Uncle Sam still receives the same tax.
Will – Most folks think of a will’s main function as designating who gets what when you die. Using a will in this manner is fine for items of lesser value, but for your most valuable of assets use a Will Substitute instead. Assets passed along by your will are subject to probate, which may be time consuming and expensive for your named beneficiaries. You’ll still need a will, however, to name your executor or executrix, designate guardian(s) for minor children, set up a Testamentary Trust, as well as other functions.
Will Substitute - Refers to TODs, PODs, beneficiary deeds, trusts, beneficiary designations, rights of survivorship, and other legal designations where assets are transferred directly to beneficiaries rather than through the probate process.
About Keith Dorney
Thank you for reading my book on essential estate planning. Once you’ve written your own Bus List and have the big stuff covered, you sleep a bit easier at night.
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You might be interested in another financial planning-related topic that I’m passionate about: Employer-offered Roth options and Roth IRAs. Why do I get so excited about these accounts? The tax advantages potentially make them the top performers in your arsenal of retirement savings vehicles.
The trick is to know when and how to invest in them. Money socked away now in Roth accounts will probably have a bigger bang for the buck than Roth money invested later. Tax-free earnings compound into big tax-free numbers the longer they have to percolate.
It can get complicated, trying to decide not only what type of contributions to make, but how to invest those contributions.
Best Roth! A Beginner’s Guide to Roth IRAs, Employer Roth Options, Conversions, and Withdrawals can help. It explains your options and helps you formulate your own investment plan for both now and in the future.
I’m proud of my accomplishments as a financial author and teacher, but you may know me better as a former football player. Check out all my books at www.KeithDorney.com.
After moving on from the NFL and the Detroit Lions, my wife Katherine and I settled in Sonoma County, California, where we raised our two kids and still reside. Besides teaching and writing, I enjoy hanging out in the garden and spending time with family and friends.