Protect a Lifetime of Investing, Establish a Solid Estate Plan

Life happens. And there are only two things certain inlife; taxes is one of them. The other requires estateplanning. "The driving purpose behind estate planningshould be the disposition of property to designatedindividuals and/or charitable organizations, butfrequently the driving force becomes taxes," explainsRandi Schuster, partner and director of the FamilyWealth & Estate Planning practice at BDO Seidman,LLP. "The ultimate estate plan is one that accomplishesits personal objectives while paying the leastamount of estate tax." This sounds simple enough,and in many cases it can be. But changes in the socialfabric of our society over the years have complicatedthe process.

Second Marriage

Given the advent of frequent divorces in today'ssociety, estate planning attorneys often find themselvesmeeting couples where either one or both of the spouseshas had children by a prior marriage. Sam Levy, ofGreenburg Traurig in Denver, Colo, is an estate planningattorney with more than 25 years of experience.He explains that this scenario presents more than itsshare of challenges. "If you have two spouses and thisis the sole marriage for both of them, you can dothings in a way that is efficient from a tax planningpoint of view without worrying that after the death ofone spouse, the other spouse will do something that isinconsistent with the plan," Levy says. "That deviationcan be prompted when you have children from aprior marriage."

Patricia Powell of Powell Financial Group inMartinsville, NJ, echoes those thoughts. She explainsthat the spouse in the second marriage—let's assumethis is a man, for argument's sake—is often tornbecause he loves his children and he loves his newwife. He certainly wants to take care of his spouse, buthe wants his children to share in his legacy as well.More importantly, he doesn't want to create a financialand emotional tug-of-war between the people heloves most. "If he does nothing, it's a game ofroulette," Powell explains. "If he dies first and leavesall of his assets to his second wife, he satisfies only partof his desires. Will his wife leave the assets to herstepchildren when she dies? Maybe, but maybe not."

There are, Powell explains, techniques that can beused to avoid such conflicts. She offers the followingexample. A 55-year-old doctor has two children fromhis first marriage. They have completed their education;they are now adults and not dependent on himfor support. The doctor married a woman 15 yearsyounger than he is. They do not plan on having theirwants to take care of her. At the same time, he wantshis children to share in the fruits of his labor. A nonmaritaltrust might work for this situation. Upon thedoctor's demise, some of his assets could be put in atrust. His wife would be the income beneficiary ofthat trust. She might also have the right to draw onprincipal if certain conditions were met (eg, healthreasons). If she needed money to pay for an uninsuredmedical procedure, she could have the right towithdraw that from the principal. "Upon her death,whatever remained in the trust would pass to thedoctor's children as though it came directly fromhim," Powell says. "In 2006, up to $2 million can beput into a nonmarital trust without incurring anyfederal estate taxes."

Titling the Assets

Schuster points out that the best estate plan in theworld will fail if the title to an individual's assets isnot transferred. Since both husband and wife eachshelter a certain amount of assets upon their death,currently at $2 million, the titling of assets can bevery important. "If each spouse does not have at least$2 million in assets, the ability to shelter can go towaste," Schuster says.

To illustrate, Levy provides the scenario of a couplewhere the physician-spouse has a net worth of $4million in their own name, and the other spouse hasa far lesser net worth. "I would recommend that theyrearrange the ownership of the assets, kind of equalizethem, by transferring $2 million to the nonphysician-spouse so that they each have a $2-million networth," Levy explains. "That way, no matter whichspouse dies first, the other spouse can have the use ofall the assets, but none of it will be taxed on its wayto their children when both spouses have died." Eachspouse would sign a will indicating that they areplacing their $2 million into a trust. The trust wouldbenefit the surviving spouse to the extent of their lifeneeds. Following the second spouse's death, theremainder of the trust passes on to the children.

But Levy cautions that this plan works well only ifthe couple involved do not have children from a priormarriage. That's because the physician-spouse withthe $4-million net worth might want most of thoseassets to pass on to their children following the deathof both spouses. If both spouses have children froma prior marriage, and the physician-spouse dies first,the surviving spouse can take the $2 million ofassets and pass it on to their children. "It canoften be the case that what one spouse reallywants in their heart of hearts is not consistent withwhat the other spouse wants," Levy says.

What happens in cases where a physician-spousedoesn't have $2 million to put into a trust? Powellsuggests making use of an irrevocable life insurancetrust. The trust is established when the physicianspouseis alive, and the trust purchases life insuranceon the physician's life. The physician gifts the moneyto the trust to pay the life insurance premium. Thetrust then owns the life insurance policy and is thebeneficiary of the policy. The children are made beneficiariesof the trust. "Since the doctor does not ownthe life insurance policy, it is possible for the deathbenefit to be paid outside of the doctor's estate, makingit free of both income tax and estate tax," Powellsays. The one downside is that there is a cost to createthe trust, and the annual premium needs to bepaid out of the cash flow.

Conflicts of Interest

Levy believes that estate planning attorneys oftenfind themselves in a conflict-of-interest situation, particularlyin the case of a second marriage where thereare children from prior marriages. "This is somethingthat a lot of lawyers are less than thoroughabout, and a lot of clients don't recognize the danger," Levy explains. Most lawyers, Levy says, willshow the clients an engagement letter stating that thespouses recognize that the attorney is in a conflict-ofinterestsituation because the spouses have conflictinginterests in terms of the ultimate disposition oftheir assets. Levy states he is at the point where heasks one of the spouses to get separate counsel. Levyhas experienced situations where one spouse diedand indicated certain arrangements in their will. Thechildren of the deceased spouse will come to him andsay, "Dad couldn't have wanted that," or, "Is it truethat you also represent her?"

Levy will often make the recommendation thatone of the spouses find a separate attorney. But thatrecommendation is not always taken well. "Peopledon't make these distinctions; a lawyer is a lawyer tothem," Levy explains. "They'll say, ‘You mean I haveto bring someone else into this situation who's goingto charge me another fee?'And I may end up representingneither of them, which has happenedbefore." Levy points out that it doesn't mean alawyer is doing something unethical if they were torepresent both parties. He simply believes it's a matterof judgment as to what's best for the clients, andwhat's best for him.

Best Practices

When it comes to estate planning, there are somekey elements to put in place. Jim Davis of GunsterYoakley suggests that each person should have abasic will leaving assets to the spouse and then, contingently,to the children in trust. Individuals shouldalso have a durable power of attorney, living will,and health care surrogate designation, unless theydesire otherwise.

"Life insurance, IRAs, and qualified plan benefitsshould be left to the spouse," Davis explained. "Andif there is no spouse, to the children's trusts.Residences should be jointly held. Life insuranceshould be acquired early on to cover a prematuredeath for the protection of the spouse and the children.And everyone should have a personal liabilitypolicy with umbrella coverage of between $1 millionand $2 million."

Schuster points out that the most common error inestate planning usually occurs with married coupleswho think that there is no tax if they leave everythingto the other spouse. Or, people who think they haveavoided all taxes because everything is in joint names."While there is no tax on the first death, the tax hasactually increased on the death of the survivingspouse because there has been no use of the lifetimeexemption in the first estate," Schuster explains."People also overlook that there is special planningthat has to be done if one of the spouses is not a UScitizen." For physicians with their own practice, afamily limited partnership in the right circumstancescan be a great management and gift-giving tool.Schuster points out that there have been severalcourt decisions in the last few years that urge morecaution when using this type of tool within an estateplan. If certain rules are not followed, the results canbe disastrous. "All business owners need to considerwhat happens to their business upon their death,and how the estate taxes will be paid," Schustersays. "A good review of life insurance is a must forbusiness owners."

Along those lines, Powell believes that if a physicianhas partners in a practice, the old-fashioned buysellagreement funded with life insurance is still agood choice. Assume the doctors agree that the medicalpractice is worth $1 million. If there are two partners,each could purchase a life insurance policy onthe other. When one doctor dies, the remaining partneruses the proceeds from the life insurance policy tobuy out the surviving spouse. A good buy-sell agreementaddresses death and disability, as well as retirement,Powell notes. It might also provide an exit strategyif the doctors decide to dissolve the partnership."Talking about these issues can be difficult," Powellacknowledges. "But it is essential to having an estateplan that meets your wishes."