Elite Advisor Forum: Top Ten Wealth Planning Mistakes–Part 1 of 2

Jill Henderson and Burton Mitchell’s article titled “Top Ten Wealth Planning Mistakes (Part 1 of 2)” was published in the Elite Advisor Forum. Part 1 begins below.

Top 10 Estate Planning Mistakes (Part 1 of 2)

By Burton Mitchell and Jill Skinner

This article was first published as a two-part series by the Elite Advisor Forum,
a publication of CEG Worldwide and SourceMedia, and is reprinted with permission.

When we review estate plans, there are some common mistakes we come across. You may think some of these are obvious, but we have seen them enough to assure you that they are not. Here is our list of the 10 mistakes we see most often.

1. Skipping the basics. With the increase in the gift and estate tax exemptions to $5,00,000, which under current law is in effect through December 31, 2012, we are experiencing a renewed interest from clients in estate tax planning. Many clients are intrigued by the idea of using their $5 million lifetime gift tax exemption (or a portion of it) to transfer wealth to their children now. Is this a good idea? In many cases it is, but first things first.

The best made estate plan is built from the ground up, so make sure the basic estate plan is in place before diving into the more complex, and often irrevocable, estate planning. Why is this important? The process of planning the basic documents, such as the Will and revocable living trust, should uncover most issues. That process is the time to review the client’s financial picture and family dynamics, which is an essential consideration in any estate plan. If the basics are skipped, you increase the likelihood of missed issues or oversights. Typically, the more advanced estate tax planning involves irrevocable steps that cannot be easily undone, if at all.

The more advanced estate tax planning should be pursued in many cases, but it is important to slow down the pace if necessary and get the basics in place. A thoughtful plan is a more efficient and accurate plan.

2. Skepticism about life insurance. It is fairly common for clients to be hesitant about incorporating life insurance into their estate plan. Often clients have a negative view toward life insurance, because they are distrustful of life insurance agents and do not see the value in paying premiums on a policy that may never may pay or on paying large premiums over a potentially long period of time. However, there are many situations where life insurance is an invaluable aspect of an estate plan and, if properly explained to the client, can alleviate the client’s hesitation.

For example, a term life insurance policy is a relatively inexpensive way to provide a non-working or lower income earning spouse with comfort that they would not have to sell the family residence or dramatically change his or her lifestyle in the event of the death of the higher earning spouse. A “second to die” policy can provide the liquidity needed to pay estate taxes, so the beneficiaries do not have to sell assets they may prefer to retain. The use of an irrevocable life insurance trust should always be considered, although it may not always be necessary.

3. Ignoring the retirement plan coordination. In every estate plan, the beneficiary designations for the retirement plans must be coordinated with the wishes of the client. In some cases, the retirement plans are a critical part of the estate plan and in other cases they are only a small piece. Either way, an incorrect beneficiary designation, or no beneficiary designation at all, is a problem in the event of a death. The clients often need assistance completing these forms. Most importantly, the client should obtain written confirmation of the designations from the retirement plan administrator and should provide a copy of that confirmation to their estate planning attorney. The written confirmation ensures that both the client completed the form properly and that the retirement plan administrator processed the form correctly.

In the event of a marriage or divorce, new beneficiary designation forms must be completed. Forgetting to complete new forms when the marital status changes can result in the wrong person receiving the retirement plan.

In addition to making sure the beneficiary designations are correct, the income and estate tax aspects of retirement plans need to be considered. If the beneficiary is a trust, will the retirement plan proceeds be held in a “conduit trust” to extend the period of time over which the beneficiary will receive distributions? For the clients who are charitably inclined, should the beneficiary of the retirement plan be a charity? These income tax aspects should be considered. With respect to estate taxes, the living trust should be reviewed to ensure that the right party is paying any estate taxes related to a retirement plan.

Also, since the retirement plans pass outside of a living trust, this must be considered in the drafting. If the bulk of a client’s net worth is in a retirement plan, then the desired result may not be obtained under the living trust. While this sounds obvious, it is easy to overlook if focused on drafting the estate plan.

4. Overlooking the impact of federal and state estate tax. We all know there is a federal estate tax and we advise our clients about the current federal estate tax exemption and how it impacts them given their net worth. The federal estate tax exemption is not likely to be overlooked. However, what can be overlooked is what the estate plan says about payment of estate tax. Suppose there is a piece of real property held in joint tenancy. What does the living trust say about payment of the estate taxes on that joint tenancy asset? If it is supposed to be paid by the joint tenant, how will the trustee collect the estate taxes from that joint tenant? If there are specific distributions to be made to individuals, does the estate plan address whether or not those distributions are made free of estate tax? There are real economic consequences that result from these issues, so the boilerplate estate tax provisions need to be reviewed in each case to ensure the correct result.

In addition to the federal estate tax, some states have a state estate tax. We no longer have a state estate tax in California, but that does not mean we can ignore the issue for our clients. If a client owns real property in another state, we must evaluate if that state has an estate tax and how it would apply to our clients.

5. Too many seats at the table. A fairly common approach to dividing assets among different groups of beneficiaries is to give the separate groups a percentage. This creates a number of problems by giving that beneficiary a seat at the table, so to speak. A beneficiary that is entitled to a percentage of the estate will be concerned with any and all issues that effect the value of the estate, such as valuation issues and costs of administration, because each of these will impact the amount ultimately received by that beneficiary. On the other hand, a beneficiary that receives a specific dollar amount need not be concerned with issues, since it does not change his or her distribution. Where possible, encourage clients to stay away from percentages or formulas that can back fire. Instead, select a dollar amount that they are comfortable with and review it periodically.

To read Part 2, click here.

Burton A. Mitchell is the chairman of the Taxation, Trusts & Estates Department at Jeffer Mangels Butler & Mitchell LLP. A prominent tax and estate planning attorney in Los Angeles, Burton has been recognized in Los Angeles Times Magazine as one of Southern California’s Best Lawyers in 2008 – 2011 and has been featured in the Los Angeles Business Journal’s “Who’s Who in LA Law–The Best of the Bar, the Standout Lawyer for Trusts and Estates.” Contact Burton at 310.201.3562 or BAM@jmbm.com

Jill Skinner practice focuses on estate and gift tax planning, probate and trust administration. She advises individuals on a broad variety of matters, including living trusts, insurance trusts, qualified personal residence trusts, children’s trusts and defective grantor trusts; formation of partnerships and limited liability companies; and other transfer tax techniques. Contact her at 310. 785.5381 or jhenderson@jmbm.com