Planning for Testamentary Transfers of Property
By Nancy Faussett, CPA
Publication date: 08/18/2009
A testamentary transfer of property is made according to the provisions of a deceased person’s last will and testament. Your will is probably the single most important document contained in your estate plan.
Note: Although the estate tax is scheduled to expire in 2010, this is only for one year. Therefore, unless Congress acts to extend its repeal, the estate tax will be automatically reinstated on January 1, 2011.
Any estate plan must be sufficiently detailed and comprehensive in order to satisfy your objectives and be binding under both federal and state laws governing the transfer of property. It is always a good idea if you are the owner of the estate to speak to your intended heirs and advise them of your wishes and intentions, as well as the location of your will and trust documents. This is a crucial step that should not be overlooked when doing both wealth management and estate planning.
This article is intended as an overview of basic planning for testamentary transfers of property and the alternative approaches that are available to you.
Last Will and Testament
One’s last will and testament is the basic instrument used for transferring property to one’s heirs. Without an effective will, your estate is subject to probate and will be distributed to your heirs as prescribed by state law.
The following are the components that should be included in one’s will:
- Exordium clause: This identifies the testator and their current address. It also identifies that this is the decedent’s last will and testament, thereby negating any previous wills and testamentary documents.
- Payment of debts clause: This directs the payment of debts and the expenses relating to the administration of the estate, as well as payment of the funeral expenses. It also legitimizes any debts (such as with family members) and may direct the payment of secured debts (such as having the executor pay the deceased person’s mortgage before the property is transferred).
- Payment of taxes clause: This clause identifies all tax liabilities and assigns responsibility for their payment. It provides the executor with immunity from any tax liability. It should specify whether the taxes should be paid from the residuary estate or apportioned to all of the assets included in the estate. There are several considerations when doing this, especially when there are multiple beneficiaries. Also, if you decide on apportioning the taxes to several assets in the estate, you may want to exclude taxes from any charitable donations. Of course, the amount of tax owed is often diminished due to the unlimited marital deduction and the unified transfer tax credit.
- Disposition of property clause: This identifies which beneficiaries should receive specific items of property, both real estate and personal property.
- Specific bequests: This provides for specific gifts of cash or property to certain beneficiaries. Since such gifts, other than to one’s spouse, reduce the unified credit amount, it may be better to give them to one’s surviving spouse with instructions that future annual gifts should be made to certain people (although such a provision would not be binding on the spouse).
- Power of appointment clause: This identifies the source and date of any power of appointment held by the testator, and the property subject to that power.
- Residuary estate clause: This provides for the disposition of the residuary estate, i.e., the disposal of any remaining assets not specifically transferred to anyone. For example, these assets may be transferred into either a testamentary trust or into a previously established inter vivos trust.
- Disposition of trust assets clause: This describes the specific terms of each trust. It includes instructions for retaining, investing, and disposing of the income and the assets in each trust.
- Appointment of fiduciaries clause: This appoints both an executor of the estate and the trustees of any testamentary trusts (i.e., those trusts established by the will). Be sure to name an alternative executor, in case your first choice of an executor should die. One must also specify that these fiduciaries have the power to manage the property, including its disposition and distribution. This clause enables the payment of compensation to the estate’s fiduciaries.
- Powers clause: This vests the authority in the fiduciaries to retain, manage, lease, and sell property, including any investments. It allows the fiduciaries to settle any claims against the estate and to make distributions.
- Appointment of guardian clause: This designates a guardian for any minor children of the deceased and the children’s property. The guardian of the children may be someone different than the guardian of their property.
- Common disaster clause: If both spouses die in a common accident, this indicates which spouse is deemed to have survived. Basically, each spouse states in effect that all property goes to one’s spouse if he/she survives you by at least 30 days and, if not, all property goes to your children. This clause is important if the decedent has children by a previous marriage and to whom the decedent wishes to inherit the estate.
- Testimonium clause: This is usually at the end of the will and attests to the truthfulness of the document and that one is signing the will freely (i.e., there’s no fraud or duress), giving the date and location.
- Attestation clause: This complies with local law as to witnesses who must sign the will in the presence of the testator.
- No contest clause: Also known as an “in terrorem” clause, it states that any beneficiary who contests the will forfeits their inheritance. Of course, if a will is challenged and found to be invalid, such a clause has no effect.
Use of Trusts
As mentioned above, included in one’s last will and testament may be instructions for the establishment of a testamentary trust. A testamentary trust takes effect after the owner’s death (versus an inter vivos or living trust, which is effective during the grantor’s life).
There are many reasons to use trusts. If correctly set up, a trust is often used to save both federal and state income and estate taxes. Furthermore, future legislative changes to the estate tax are always a possibility, which is why so many people prefer the use of trusts (either revocable or irrevocable) for the distribution of property. A trust allows the trustee to react to these changes should the grantor become mentally incapacitated, as well as being able to react to certain other developments that the grantor could not have anticipated.
Another reason to establish a trust is that a trust bypasses probate and allows the trustee to distribute the property according to the decedent’s instructions. (Note that property held in joint tenancy with the right of survivorship also bypasses probate and can pass directly to the beneficiaries.) Transferring property into a trust provides a certain amount of privacy due to it being outside of the probate system and thereby avoids having the property identified in the court records.
A trust is often used to manage investments and to protect assets for the beneficiaries. There should always be a “powers clause” to specify the administrative authority granted to the trustee. Some grantors of trusts are very explicit as to what the trustee may do (including how it will be done) while others give the trustee broad discretionary powers.
The grantor of a trust also has several available options for controlling the distributions from the trust. For example, a trust can be set up to make mandatory distributions to the beneficiaries upon their attaining a specified age, or for a specified purpose. The instructions for the distributions may differ according to whether the distributions are made from the trust’s current income versus those made from the trust’s principal. Giving the trustee adequate guidance is of paramount importance to ensure the grantor’s wishes are followed.
A trust can have a special (or limited) power of appointment bestowed on an individual to do certain things. For example, a special power of appointment may enable an individual to make changes to the trust based on future developments that affect the trust and which could not have been foreseen at the time the trust was established. Also, a special power of appointment may authorize the right to make dispositions of property, designate future beneficiaries, or even replace the trustee. A special power of appointment also allows a significant amount of post-mortem estate planning. For example, it allows the holder to react to economic changes of the beneficiaries or other family changes.
Trusts can be either “simple” or “complex” trusts, a determination made annually for federal income tax purposes. A simple trust is required to distribute all of its income currently, can make no distributions from the trust’s principal, and cannot make any charitable contributions. A simple trust is not subject to federal income tax (although its beneficiaries are). Complex trusts are all other trusts, including those that are required to accumulate income. When it is a complex trust, the federal income tax is allocated between the trust and its beneficiaries. A complex trust is a separate taxable entity that is taxed at the highest noncorporate federal income tax rate.
The following are the most common types of trusts that may be established:
- Bypass trust: Also known as a “credit shelter trust” or a “family trust,” a bypass trust is used in long-term planning. It ensures that one’s surviving spouse will not have to pay taxes on the property transferred into the bypass trust after they die. Although your estate will still have to pay estate taxes on it, at least the property will be taxed only once. However, a bypass trust somewhat limits the surviving spouse’s access to the trust’s assets.
- QTIP trust: A “qualified terminable interest” trust (also known as a “marital deduction trust”) allows a surviving spouse to delay the payment of estate taxes until their death. It allows the surviving spouse to use the trust property and then at their death, the property is transferred to the beneficiaries named by the first spouse to die. (This is often used when the decedent has children by a previous marriage and wishes those children to receive the assets once the current spouse dies.)
- Power of appointment trust: This is where an interest in the decedent’s property passes to the surviving spouse, qualifying for the estate tax marital deduction. There is a requirement that the surviving spouse be entitled for life to all the income from such interest and must hold a general power to appoint the entire interest either to themselves or to their estate. Furthermore, the trust’s income, to which the surviving spouse is entitled, must be paid out annually at a minimum.
- Qualified charitable remainder trust: This provides income to the surviving spouse for life and then, at the surviving spouse’s death, the property transfers to a charity. To learn more about trusts and charitable donations, read the article Wealth Management, Tax Planning and Charitable Donations on this site.
- Generation skipping trust: This is an irrevocable trust to benefit the surviving spouse and/or children during the survival period and then the children and grandchildren after that. Distributions are limited based on the specified needs or purposes such as healthcare, maintenance, or education.
- Estate trust: This type of trust accumulates all income during the surviving spouse’s lifetime and is not distributed. At the surviving spouse’s death, the income and principal is transferred to the spouse’s probate estate. This is, therefore, used when the surviving spouse does not need the income. Ultimately, it is the surviving spouse’s will that identifies the beneficiaries.
Conclusion
Sound estate planning and good wealth management go hand-in-hand. You want to maximize the economic benefits from your assets during your lifetime and you want to transfer your remaining assets to your heirs while minimizing the effects of any estate and transfer taxes.
As you can see from this article, there exist many alternatives for good estate planning and wealth management. While your last will and testament is fundamental to all planning for the transfer of your property, this is only the starting point. There are a large number of alternatives for handling your assets that include many different kinds of trusts for their conveyance. There is, of course, no one-size-fits-all solution but both estate planning and wealth management software are two of the most popular tools available to assist you and your clients. BNA Software offers both of these applications. Both the BNA Wealth Manager™ and the BNA Estate & Gift Tax™ Planner enable you to see the results of these different plans before undertaking them. Doing side-by-side comparisons of different approaches is the best way to ensure the most beneficial results.
You can find out more about the BNA Wealth Manager™ at: http://www.bnasoftware.com/Products/BNA_Wealth_Manager.asp and the BNA Estate & Gift Tax™ Planner at: http://www.bnasoftware.com/Products/BNA_Estate_Gift_Tax_Planner.asp.
Helping your clients achieve their lifetime financial goals and delivering expert professional estate planning and wealth management are made much easier when using BNA Software.
Planning for Testamentary Transfers of Property
By Nancy Faussett, CPA
Publication date: 08/18/2009
A testamentary transfer of property is made according to the provisions of a deceased person’s last will and testament. Your will is probably the single most important document contained in your estate plan.
Note: Although the estate tax is scheduled to expire in 2010, this is only for one year. Therefore, unless Congress acts to extend its repeal, the estate tax will be automatically reinstated on January 1, 2011.
Any estate plan must be sufficiently detailed and comprehensive in order to satisfy your objectives and be binding under both federal and state laws governing the transfer of property. It is always a good idea if you are the owner of the estate to speak to your intended heirs and advise them of your wishes and intentions, as well as the location of your will and trust documents. This is a crucial step that should not be overlooked when doing both wealth management and estate planning.
This article is intended as an overview of basic planning for testamentary transfers of property and the alternative approaches that are available to you.
Last Will and Testament
One’s last will and testament is the basic instrument used for transferring property to one’s heirs. Without an effective will, your estate is subject to probate and will be distributed to your heirs as prescribed by state law.
The following are the components that should be included in one’s will:
- Exordium clause: This identifies the testator and their current address. It also identifies that this is the decedent’s last will and testament, thereby negating any previous wills and testamentary documents.
- Payment of debts clause: This directs the payment of debts and the expenses relating to the administration of the estate, as well as payment of the funeral expenses. It also legitimizes any debts (such as with family members) and may direct the payment of secured debts (such as having the executor pay the deceased person’s mortgage before the property is transferred).
- Payment of taxes clause: This clause identifies all tax liabilities and assigns responsibility for their payment. It provides the executor with immunity from any tax liability. It should specify whether the taxes should be paid from the residuary estate or apportioned to all of the assets included in the estate. There are several considerations when doing this, especially when there are multiple beneficiaries. Also, if you decide on apportioning the taxes to several assets in the estate, you may want to exclude taxes from any charitable donations. Of course, the amount of tax owed is often diminished due to the unlimited marital deduction and the unified transfer tax credit.
- Disposition of property clause: This identifies which beneficiaries should receive specific items of property, both real estate and personal property.
- Specific bequests: This provides for specific gifts of cash or property to certain beneficiaries. Since such gifts, other than to one’s spouse, reduce the unified credit amount, it may be better to give them to one’s surviving spouse with instructions that future annual gifts should be made to certain people (although such a provision would not be binding on the spouse).
- Power of appointment clause: This identifies the source and date of any power of appointment held by the testator, and the property subject to that power.
- Residuary estate clause: This provides for the disposition of the residuary estate, i.e., the disposal of any remaining assets not specifically transferred to anyone. For example, these assets may be transferred into either a testamentary trust or into a previously established inter vivos trust.
- Disposition of trust assets clause: This describes the specific terms of each trust. It includes instructions for retaining, investing, and disposing of the income and the assets in each trust.
- Appointment of fiduciaries clause: This appoints both an executor of the estate and the trustees of any testamentary trusts (i.e., those trusts established by the will). Be sure to name an alternative executor, in case your first choice of an executor should die. One must also specify that these fiduciaries have the power to manage the property, including its disposition and distribution. This clause enables the payment of compensation to the estate’s fiduciaries.
- Powers clause: This vests the authority in the fiduciaries to retain, manage, lease, and sell property, including any investments. It allows the fiduciaries to settle any claims against the estate and to make distributions.
- Appointment of guardian clause: This designates a guardian for any minor children of the deceased and the children’s property. The guardian of the children may be someone different than the guardian of their property.
- Common disaster clause: If both spouses die in a common accident, this indicates which spouse is deemed to have survived. Basically, each spouse states in effect that all property goes to one’s spouse if he/she survives you by at least 30 days and, if not, all property goes to your children. This clause is important if the decedent has children by a previous marriage and to whom the decedent wishes to inherit the estate.
- Testimonium clause: This is usually at the end of the will and attests to the truthfulness of the document and that one is signing the will freely (i.e., there’s no fraud or duress), giving the date and location.
- Attestation clause: This complies with local law as to witnesses who must sign the will in the presence of the testator.
- No contest clause: Also known as an “in terrorem” clause, it states that any beneficiary who contests the will forfeits their inheritance. Of course, if a will is challenged and found to be invalid, such a clause has no effect.
Use of Trusts
As mentioned above, included in one’s last will and testament may be instructions for the establishment of a testamentary trust. A testamentary trust takes effect after the owner’s death (versus an inter vivos or living trust, which is effective during the grantor’s life).
There are many reasons to use trusts. If correctly set up, a trust is often used to save both federal and state income and estate taxes. Furthermore, future legislative changes to the estate tax are always a possibility, which is why so many people prefer the use of trusts (either revocable or irrevocable) for the distribution of property. A trust allows the trustee to react to these changes should the grantor become mentally incapacitated, as well as being able to react to certain other developments that the grantor could not have anticipated.
Another reason to establish a trust is that a trust bypasses probate and allows the trustee to distribute the property according to the decedent’s instructions. (Note that property held in joint tenancy with the right of survivorship also bypasses probate and can pass directly to the beneficiaries.) Transferring property into a trust provides a certain amount of privacy due to it being outside of the probate system and thereby avoids having the property identified in the court records.
A trust is often used to manage investments and to protect assets for the beneficiaries. There should always be a “powers clause” to specify the administrative authority granted to the trustee. Some grantors of trusts are very explicit as to what the trustee may do (including how it will be done) while others give the trustee broad discretionary powers.
The grantor of a trust also has several available options for controlling the distributions from the trust. For example, a trust can be set up to make mandatory distributions to the beneficiaries upon their attaining a specified age, or for a specified purpose. The instructions for the distributions may differ according to whether the distributions are made from the trust’s current income versus those made from the trust’s principal. Giving the trustee adequate guidance is of paramount importance to ensure the grantor’s wishes are followed.
A trust can have a special (or limited) power of appointment bestowed on an individual to do certain things. For example, a special power of appointment may enable an individual to make changes to the trust based on future developments that affect the trust and which could not have been foreseen at the time the trust was established. Also, a special power of appointment may authorize the right to make dispositions of property, designate future beneficiaries, or even replace the trustee. A special power of appointment also allows a significant amount of post-mortem estate planning. For example, it allows the holder to react to economic changes of the beneficiaries or other family changes.
Trusts can be either “simple” or “complex” trusts, a determination made annually for federal income tax purposes. A simple trust is required to distribute all of its income currently, can make no distributions from the trust’s principal, and cannot make any charitable contributions. A simple trust is not subject to federal income tax (although its beneficiaries are). Complex trusts are all other trusts, including those that are required to accumulate income. When it is a complex trust, the federal income tax is allocated between the trust and its beneficiaries. A complex trust is a separate taxable entity that is taxed at the highest noncorporate federal income tax rate.
The following are the most common types of trusts that may be established:
- Bypass trust: Also known as a “credit shelter trust” or a “family trust,” a bypass trust is used in long-term planning. It ensures that one’s surviving spouse will not have to pay taxes on the property transferred into the bypass trust after they die. Although your estate will still have to pay estate taxes on it, at least the property will be taxed only once. However, a bypass trust somewhat limits the surviving spouse’s access to the trust’s assets.
- QTIP trust: A “qualified terminable interest” trust (also known as a “marital deduction trust”) allows a surviving spouse to delay the payment of estate taxes until their death. It allows the surviving spouse to use the trust property and then at their death, the property is transferred to the beneficiaries named by the first spouse to die. (This is often used when the decedent has children by a previous marriage and wishes those children to receive the assets once the current spouse dies.)
- Power of appointment trust: This is where an interest in the decedent’s property passes to the surviving spouse, qualifying for the estate tax marital deduction. There is a requirement that the surviving spouse be entitled for life to all the income from such interest and must hold a general power to appoint the entire interest either to themselves or to their estate. Furthermore, the trust’s income, to which the surviving spouse is entitled, must be paid out annually at a minimum.
- Qualified charitable remainder trust: This provides income to the surviving spouse for life and then, at the surviving spouse’s death, the property transfers to a charity. To learn more about trusts and charitable donations, read the article Wealth Management, Tax Planning and Charitable Donations on this site.
- Generation skipping trust: This is an irrevocable trust to benefit the surviving spouse and/or children during the survival period and then the children and grandchildren after that. Distributions are limited based on the specified needs or purposes such as healthcare, maintenance, or education.
- Estate trust: This type of trust accumulates all income during the surviving spouse’s lifetime and is not distributed. At the surviving spouse’s death, the income and principal is transferred to the spouse’s probate estate. This is, therefore, used when the surviving spouse does not need the income. Ultimately, it is the surviving spouse’s will that identifies the beneficiaries.
Conclusion
Sound estate planning and good wealth management go hand-in-hand. You want to maximize the economic benefits from your assets during your lifetime and you want to transfer your remaining assets to your heirs while minimizing the effects of any estate and transfer taxes.
As you can see from this article, there exist many alternatives for good estate planning and wealth management. While your last will and testament is fundamental to all planning for the transfer of your property, this is only the starting point. There are a large number of alternatives for handling your assets that include many different kinds of trusts for their conveyance. There is, of course, no one-size-fits-all solution but both estate planning and wealth management software are two of the most popular tools available to assist you and your clients. BNA Software offers both of these applications. Both the BNA Wealth Manager™ and the BNA Estate & Gift Tax™ Planner enable you to see the results of these different plans before undertaking them. Doing side-by-side comparisons of different approaches is the best way to ensure the most beneficial results.
You can find out more about the BNA Wealth Manager™ at: http://www.bnasoftware.com/Products/BNA_Wealth_Manager.asp and the BNA Estate & Gift Tax™ Planner at: http://www.bnasoftware.com/Products/BNA_Estate_Gift_Tax_Planner.asp.
Helping your clients achieve their lifetime financial goals and delivering expert professional estate planning and wealth management are made much easier when using BNA Software.
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