Reflect on the Future with Your Estate Plan

Deaf ears:

Thomas Mann, the German novelistand critic, wrote, "Orderand simplification are the firststeps toward mastery of a subject."Although written long ago, thesewords reflect the approach that everyphysician-investor should take whendeveloping their estate plan. Unfortunately, not every physician-investorhas an estate plan.

A recent survey commissioned byCharles Schwab & Company indicatesthat while the majority (58%) of affluentAmericans age 45 and older agrees thatit's important to leave an inheritance totheir children or beneficiaries, 25% ofthem haven't made any plans for theirestates. In addition, less than one third(28%) has taken advantage of the annualgift tax provision that is available.

"People are procrastinators bynature," says Rick Blaser, advance salesconsultant for Hartford Life (www.hartfordlife.com). "And if it's somethingthat's not even going to be paid duringtheir lifetime, many people opt to do itlater. But the biggest mistake you canmake is to have no estate plan."

When it's viewed in its entirety,estate planning can seem complicated.However, in reality, estate planning canbe as complex or as simple as you wantit to be. Every physician-investor needsto realize that there are 2 fundamentalissues to address when they're creatingan estate plan: Where do you want yourassets to go, and when?

Estate Plan Facts

The future isn't certain. And asBlaser points out, "the more uncertainthe future, the more important it is tohave an estate plan." The problem isthat many people are banking on theestate tax disappearing in 2010, as it'scurrently scheduled to do. But will itdisappear? Even if it does, wouldn't youwant to ensure that the assets you'veworked hard to accumulate are passedon in the manner you desire?

"The fundamental issue of estateplanning really hasn't changed," explainsBard Malovany, CFP®, FinancialCouncil, Inc (410-821-9200; www.financialcouncil.com). "It's directinghow you want your estate distributedafter your death. That's what estateplanning should be about, that and tryingto minimize taxes."

Of course, there are certain factors tokeep in mind when you're creating anestate plan. The following example illustratesthe importance of a detailed, yetflexible estate plan. Dr. A's estate is valuedat $3 million. Upon his death, he wants$600,000 to go immediately to his childrenand the rest to go to his spouse. Dr.A's estate plan stipulates that his childrenreceive the amount that was exempt fromfederal taxes (ie, $600,000).

"That was fine when the federal taxexemption amount was $600,000,"explains Mark Papalia, CLU, ChFC,CFP®, founder and president of PapaliaFinancial Services (800-626-1027; www.papaliafinancial.com), "but what happensif the physician dies a few years fromnow when the exemption is $3.5 million?In that case, the way the estate plan iswritten, the children will receive everythingand the spouse will get zero."

Tax laws have changed over the pastfew years, and they continue to change.The federal tax exemption, currently at$1 million per individual, increases to$1.5 million next year. By 2006, it rises to$2 million. It continues to rise until itreaches $3.5 million by 2009. Withoutflexibility built into an estate plan, andunless that plan is reviewed on a regularbasis—most advisors suggest at leastevery 2 years—you could find yourselfwith an estate plan that accomplishesexactly what you did not want it to.

To make certain you avoid that pitfall,you need to know what you want tohappen to your estate after you die. Estateplanning can get complicated, especiallyin situations of second marriages, whereassets are being left for a spouse, childrenfrom a first and/or second marriage, parents,charities, and so on.

"It's always a good time to start anestate plan—even if you're young,"Malovany explains. "You may have a2-year-old daughter or a newborn son.Don't you want to make certain they'reprotected should something happen toyou?" Of course you do.

Invaluable Tools

Presently, the amount of money thateach individual can pass along free ofgift or estate tax is $1 million. Make certainthat both you and your spouse havethat exclusion equivalent in your estateplan and that the money goes into a non-maritaltrust after the death of the firstspouse—this is often called a unifiedcredit trust, a bypass trust, or a familytrust. The money will not be taxed onthe death of the first spouse, and as longas it stays in the trust, it will not be taxedon the death of the surviving spouse.

Another reason why trusts are goodestate planning tools, according toLloyd Leva Plaine, a trusts and estatespartner with Sutherland Asbill &Brennan (www.sablaw.com), is becausethey have a generation-skipping transfer(GST) exemption. Each spouse avoidstaxes not only on their death, but alsoon the death of their children. Each individualcurrently is allowed a GSTexemption of $1.12 million. And theGST, Plaine explains, is not portable. Ifyou don't use it, you lose it.

Taking advantage of the annual gifttax exclusion, which is currently at$11,000 per person, is also an attractivestrategy. For that reason, 529 savingsplans have become increasingly popular.According to Malovany, the law allowsyou to lump 5 years' worth of givinginto 1 year. And if you have 2 grandchildren,you can gift $110,000 in 1 shot."The dollars grow over time," Malovanyexplains, "and any future growth getsattributed to the beneficiary."

Blaser is an advocate of a tool called asurvivorship access trust. This tool allowsindividuals to fund an irrevocable lifeinsurance trust (ie, a trust that holds a lifeinsurance policy) with 1 spouse as thegrantor of the trust and the other spouseand children as the beneficiaries of thetrust. "It's a very flexible option," Blasersays. "If permanent repeal of the estatetax was actually enacted and there was noneed to plan anymore, and the individualsdidn't need life insurance, the grantor ofthe trust could distribute the life insurancepolicy to the nongrantor spouse. In thiscase, you're covered no matter what happensin 2010 to the estate tax."

A wide range of trusts and gift-givingstrategies can be employed when it comesto estate planning, but the key, Plainesays, is to plan. If you don't decide howyour property will be distributed, thestate will. "Some states will give half toyour spouse and half to your children,but others may only give one third toyour spouse. Each state is different. Thinkof a well-developed estate plan as benefitingthe mental health of your family."

Exit Strategy

One of the most overlooked elementsof an estate plan, particularly for physicianswith ownership in a medical practice,is an exit strategy. It's a very difficultelement to plan for, and perhaps for thisreason, most physicians have no type ofexit strategy in place. According toMalovany, it's difficult to pin a value to amedical practice. The truth is medicalpractices don't have much value outside ofaccounts receivable and depreciatedassets. That could vary, however, dependingon the size of the practice.

"The larger the practice, the morevalue it's likely to have, and that's somethingthat needs to be taken intoaccount," Malovany explains. "If I'm apartner in a 10-doctor practice and I passaway, what is my share of that practiceworth? In those cases, it makes sense tohave some type of key person insurance ora buy-sell arrangement in place."

The problem, according to Papalia, isthat most buy-out arrangements dealwith what happens if a physician dies orbecomes disabled. Very few come upwith a method for dealing with a physician'sretirement. "Often," Papalia explains,"the remaining physician isunable to run the practice alone anddoesn't want to lay out the dollars to doso because they usually aren't much differentin age than the retiring physician."

It's a good idea, Papalia explains, totake in a younger doctor who can eventuallybecome a young partner and thentake over the practice under the rightbuy-sell arrangement. Still, Papalia cautionsphysicians against relying too heavilyon income from the sale of their practice."In most cases, physicians shouldprovide for themselves outside the valueof the practice because it's not going tobe the most liquid asset they have."

Papalia points out that most medicalpractice income is driven by thephysician, whereas other businesses aredriven by the sale of a specific product."What somebody is buying when theypurchase a medical practice is the clientbase and the reputation of the previousdoctor."