The 5 Goals of Estate Planning

Jul 19

Estate planning is about protecting your family's future. It’s about making sure the right things go to the right people at the right time. It’s about ensuring your wishes are followed when you are unable to speak for yourself or long after you’re gone. Estate planning is about legacy and fulfilling promises that you’ve made to those you care about most.

Given the broad purpose of estate planning, it can seem like an overwhelming task. But, the reality is, estate planning can be accomplished in a simple manner if you understand what your goals are.

Here are the 5 goals of estate planning.

Goal #1: Avoiding Probate.

Probate is by far the most frustrating and unnecessarily time-consuming thing for a family to go through. To be fair, the purpose of probate is actually in your best interest - to act as a backstop to protect your wishes. In other words, the court is trying to figure things out for people who failed to plan ahead. The problem with this approach is that the probate court has to rely on state laws which are generic and often misaligned with your intentions.

By design, the court has very strict rules and procedures on how things need to be done. And it is those procedures that can often cause further complications, delays, and additional fees that prolong the process and have the potential to cause further problems within the family.

Money makes people think and act in strange ways, and the longer the process takes, the more emotions fester and eventually boil over into outright litigation.

Since the probate courts (especially after Covid) are drowning in cases, there are no reasonable estimates or timelines on when your case will be reviewed or approved assuming you end up with formal probate (requiring a judge’s approval). In fact, a lot of the horror stories you may hear about probate really come down to relying on the government to make decisions that your parents, aunts/uncles should’ve made themselves.

I sometimes hear parents jokingly say that they aren’t worried about their kids. That they’ll figure it out when the time comes. And many times, these parents are absolutely right - the children are cooperative, patient, understanding, and eventually work their way through the process.

However, if you can think of one person in your family whether it be a child, son-in-law, daughter-in-law, whoever, that may not see eye-to-eye when it comes to finances - or, maybe someone is holding a grudge dating all the way back to childhood that they swept under the rug for decades - then you may be unexpectedly lighting a match that blows everything up after you’re gone.

On a positive note, probate can easily be avoided with a simple revocable trust. Further explained in trusts aren’t just for rich people.

Goal #2 Minimizing Taxes.

I know how much people love to read about tax laws, so I’ll be sure to keep this brief. There are four layers of taxes that you need to be aware of.

The first is called estate taxes.

Estate Taxes

Estate taxes are taxes owed by the estate (your estate is you after you’re dead).

This means that before your assets can be distributed in accordance with your wishes, the government has to get their piece of the pie first.

The good news is that the federal estate tax threshold is extremely high. For a single person the current exemption in 2022 is hovering just above $12 million, and for married couples (with the use of something called portability) it is effectively about $24 million. So if federal estate taxes are a concern for you, then you may need to do some irrevocable trust planning immediately to capture estate tax savings before the tax laws change.

The reason for this trust/tax planning is because by the end of 2025, the federal exemption (the $12 million) is expected to be cut in half to about $6 million per person. Once again, for married couples you can effectively double the exemption amount using portability and or proper trust planning, but if you’re above the $12 million, then you should start reviewing your options now while you still have time to consider time-sensitive tax opportunities.

For the 99.7% of other people reading this article (myself included), you likely don’t have to worry about federal estate taxes at the moment. But, you do have to know about state estate taxes. In particular, if you live in Massachusetts, then you may not be surprised to learn that we have one of the worst state estate taxes in the country.

In short, in Massachusetts, if you have a taxable estate greater than 1 million and are domiciled in Massachusetts, then you should review your trust to see if a credit shelter trust sometimes referred to as a family trust makes sense for you (please see The Million Dollar Estate Tax Tip For Married Couples in Massachusetts for more information on this).

If you already have a trust in place, but it was written prior to 2010, then you should review the trust to see whether the provisions in place still make sense under current estate tax laws.

So that’s the estate taxes in a nutshell.

Now let’s talk about income taxes.

Income Taxes

Income taxes are the taxes you pay on your wages, interest, dividends, rents, capital gains, etc.. In other words, income taxes are what you owe each year when you file your 1040 - individual tax return.

When you inherit property, one of two things can happen with respect to income taxes.

Retirement Accounts

With respect to taxed deferred retirement accounts (for example traditional 401(k)s 403B’s, and IRA’s), your children or beneficiaries will inherit them in the form of an inherited retirement account. Then your children will need to pay income taxes as they take withdrawals from such accounts.

The only difference for most non-spouse beneficiaries, if done correctly, is that they’ll have a 10-year window to take such required minimum distributions (previously, you could do a stretch-IRA under the old law). This 10-year window allows your beneficiaries to push such distributions into the last year if they so desire, which allows beneficiaries to do some income tax playing on their end.

The question then remains: what should you be doing from an estate planning standpoint to minimize the overall tax burden on your beneficiaries? How can you position your assets to give your beneficiaries the best after-tax result?

In that scenario, I typically advise clients to consider spending down their traditional retirement accounts first if it makes sense for them based on their own income tax situation. The reason for this is because inherited money not only carries an estate tax burden, but (as was just discussed) it can also carry a hidden income tax burden when received by the beneficiaries.

On the flip-side, other assets that are not held in traditional retirement accounts don’t have the same income tax disadvantages. For example, a taxable brokerage account or real estate - whether it be your primary residence, vacation home, or investment properties - get the benefit of something called a stepped up basis when you die.

A stepped up basis is huge for inheriting assets, because it means the beneficiaries, if they decide to sell the property within a short time after your death, may pay virtually no capital gains tax or income tax on the sale of those properties. And that is because the stepped up basis rule (as is currently written) allows the cost basis of such property to reset to its fair market value when you die.

So, just to give one example scenario - if you bought a multi-family in Somerville 20 years ago for $200,000 and its since appreciated to $1 million (and you’ve also depreciated the building for tax purposes) so the cost-basis is now close to nothing, then when you sell that property you would’ve paid a capital gain on the difference for the cost basis (which once again is close to zero at that point) and the fair market value which is 1 million. This huge appreciation (almost $1 million depending on the value of the land and not the building at the original purchase price) means that you would probably owe somewhere around 20 to 30% in income taxes after account for federal income taxes, Massachusetts’ income taxes, and potential net investment income taxes (additional medicare tax for high earners, etc.).

Once again, you would only pay that 20-30% in taxes if you sold the property while you are living.

But if you hang onto the real estate, then when you die the property gets a full step up in basis so the cost basis is now 1 million dollars (or whatever it’s worth at the time of your death) so when your children or spouse go to sell it, they are not going to pay capital gains tax (a form of income tax) if sold within a short period of time after your death. And, if they decide to hold onto the property, then they may be able to re-depreciate the building all over again (if it’s an investment property) - although I’d check with your tax guy first before doing so.

What this all means, is that you are much better off if you have the option to die with real estate in your estate, rather than traditional retirement accounts because (although both are included for estate tax purposes) one gets a huge income tax advantage over the other.

That is why when I have clients who have a large portion of their net worth locked up in real estate and are considering selling the properties, I first make sure they understand the long-term tax implications of doing so with respect to their children inheritance.

For more information on stepped-up basis, you may want to check out Stepped-Up Basis: The Best Kept Secrets of the Rich (part 1 of 3)

What are the other taxes I should be aware of?

There are two other taxes that may or may not be a concern to you for estate planning purposes.

The first is called the gift tax, which is coupled with the estate tax exemption. This means that under current law for federal estate tax purposes that $12 million exemption is tied to your gift tax exemption (it used to be a separate exemption that acted independently of one another). So you can give up to $12 million away under current estate tax law and effectively not have to worry about federal gift or federal estate taxes on that transferred property.

Regardless of the exemption amount, you still have to file a gift tax return to show the the value of the gift - with a major caveat being that if the gift is less than $16,000 (in 2022), then it qualifies for the annual gift tax exclusion and no gift tax return is required (so long as it's a present interest gift as opposed to a future interest gift).

Keep in mind that states may have their own gift tax so you’ll also need to be aware of your state’s gift tax laws. This is the one area where most people in Massachusetts can sigh with relief because, at the time of this writing, there is no Massachusetts gift tax. Instead Massachusetts will simply reduce the estate tax filing threshold for the state.

So, if you live in Massachusetts, and you are giving a substantial amount (like $100,000 in a single year), then Massachusetts will simply subtract that money from your $1 million exclusion amount for estate tax purposes. In other words, Massachusetts will try to get their tax money on the backend.

You can easily get around this by moving out of Massachusetts before you die, to a state like New Hampshire or Florida. Or, you could just make sure that your annual gifts are below $16,000.

This annual exclusion amount can be doubled if you are married, and it applies separately for each donee. So, for example, if you have four children, then you could give them $16,000 each year in cash or a kind. Or, if you and your spouse are on the same page, then you could give them $32,000 each year.

Over 10 years or so, you could easily gift away a substantial amount of money if you decide that makes sense for you, given your financial situation. Especially if you have grandchildren to also gift to (just don’t go over the limit or you might have GST tax issues).

There’s also something known as front-loading a 529 which is a college savings account. That lets you put five years worth of a gift tax exclusion upfront into a 529 for each of your children or grandchildren. Keep in mind that if you do this approach, that means you’ve used five years of exclusions and have to wait out those five years before you can gift again to that same person without worrying about gift tax consequences.

So that’s gift taxes.

And then there’s something called the generation skipping transfer tax, which is also coupled with the federal estate tax threshold. Fortunately, this generally only applies to the super wealthy who plan to leave substantial wealth directly to or for the benefit of their grandchildren (as opposed to their children or charities).

As of right now, it only comes into play if you have more than $12 million ($24 million if married) under current tax law. I’m not going to bore you with the details in this article, but if you want to go down that rabbit hole then check out 3 Reasons Why You Should Have Generation Skipping Transfer Tax Language in Your Trust.

Given all of the tax implications associated with estate planning, many of my clients like to know how they can use trust or gifting strategies to minimize their family taxes while accomplishing their other goals. Every family is different so you’ll need to speak with your local estate planner to see which options are feasible given your asset mix and preferences.

Did I say that part would be brief?

Goal #3 Protecting yourself in the event of incapacity.

If you become mentally incapacitated, you don’t want to rely upon the government to pick who has legal authority of your person or your possessions. Even if they end up picking the right person, it will be a public fiasco that could easily be avoided with two documents: (1) your healthy care proxy and (2) your power of attorney.

Whether you are mentally out of the loop, or simply need someone to help you with the everyday aspects of life, these documents can streamline the legal authority required to help you continue living life to the fullest.

Let’s discuss each in turn.

Health Care Proxy

Your healthcare proxy is a fairly straightforward document. If you are unable to make medical decisions for yourself, then who would you like to be your advocate and speak to your doctors, nurses, and other medical providers on your behalf?

When deciding on who should be your healthcare proxy, trust is always the primary criteria, but the next most important consideration is that person's geography.

All things being equal, if one person lives in your state and another lives across the country, then there should be no doubt in your mind who is in the best position to serve as your first choice for healthcare proxy.

There is also some confusion about advanced medical directive, living wills, DNR’s, and other miscellaneous healthcare forms.

In Massachusetts, it’s the healthcare proxy that dominates everything. As long as your healthcare proxy is properly drafted, then the person you appoint within will be authorized to do all things necessary to make sure you are taken care of.

However, if you are older or have a terminal illness, then you may want to check out What is a Medical Order Life Sustaining Treatment (MOLST) Form?

Power of Attorney.

A power of attorney, at least in Massachusetts, is referring to the person who would have financial powers over your stuff. In other words, this is generally the person who would be able to access your retirement accounts, your bank accounts, pay your bills, file tax returns, or speak with the government or other financial service providers on your behalf.

You’ll often hear a power of attorney referred to as durable power of attorney.

The reason for this is because durable means that the power of attorney will remain in effect regardless of your mental capacity. While that may seem like a no-brainer to most people since the power of attorney is expected to only be used in the event of incapacity, if you fail to put that language into your power of attorney, then your document may be useless in practice.

Another common question about powers of attorney is whether they should be effective immediately or whether they should be springing (meaning they only come into effect when you are proven incapacitated).

While the springing power makes complete sense in theory - because you normally don’t want someone having those powers unless absolutely necessary - in practice, determining exactly when someone reaches the point of “incapacitated” makes the document itself much less effective. Because now the agent appointed under your power of attorney has to prove to everyone (potentially every time they use it) that you are in fact incapacitated.

In addition to the practical implications of making a power of attorney springing, you should not be appointing anyone as your power of attorney unless you trust them 100%. In other words, if there is any sense of doubt in your mind as to whether a person will be acting in your best interest, then you should not be granting that person a power of attorney.

For that reason, when I’m drafting powers of attorneys for my clients, we often discuss the scope of the power of attorney with one major variation being called a general durable power of attorney - meaning that person can do virtually anything, including (but not limited to) making legal documents like trusts for the client or even amending existing trusts for the client.

Whereas a non-general power of attorney may intentionally have certain limitations, such as limitations on gifts to persons other than your spouse, limitations on the changing of beneficiary designations, and the inability to change existing documents like your trust, but that power of attorney may still have the ability to place assets in a trust created by my client prior to such incapacity (in case they forgot or never got around to placing an asset in trust.)

By having a healthcare proxy and power of attorney in place, you protect yourself in the event of incapacity and also avoid the public court process of having a guardian or conservator appointed for you. Because these documents allow you to avoid court involvement, you’ll notice it draws a parallel to the relation of having a trust in place to avoid probate - it’s all about making choices for yourself rather than having the state make those choices for you.

Goal #4: Protecting your assets

Asset protection is a broad category so let’s first define what I mean by asset protection.

Generally, clients want to protect their assets from creditors, lawsuits, bankruptcy, and/or divorce.

The five most common scenarios clients want to protect assets from are:

Nursing home
Children’s divorce
Children’s financial immaturity
Children’s substance abuse issues
Remarriage risk

Some attorneys will make taxes one of the asset protection categories, but since I’ve already blabbed on and on about that above, I’m going to omit it from this section (just keep in mind that taxes are another important thing to try and protect your assets from - see goal #2 above if you missed that section).

Protection From Nursing Home Care

Many clients adamantly want to protect their assets from nursing home or long-term care, which means that they would prefer to get full state benefits and still be able to preserve their assets for the benefit of their children or spouse. In such a scenario, you would most likely be interested in irrevocable trusts (not to be confused with revocable trusts).

Irrevocable trusts designed to protect assets from the nursing home are also known as Medicaid trusts, MassHealth trusts, or income only trusts.

The type of trust used for this specific type of asset protection requires someone other than the creator of the trust (also known as the “grantor”) or the grantor’s spouse from serving as trustee. So, in most scenarios, if a client wants to move forward with an irrevocable trust, then they typically name their children to serve as trustees. They then structure the trust so that they (the client) cannot have access to the principal of the trust under any circumstances. This is known as the “any circumstances test”. Since you have cut yourself off from the principal, the state generally can’t get it either.

There is often confusion over what is principal and what is not principal for the purposes of this trust. The simple way to look at it is that anything you contribute to the trust - for example, your home - would no longer be available to you (the person creating the trust) and if the house is eventually sold, then any of the proceeds from the sale of the house should also not be made available to you. Therefore the only thing that the creator of the trust would still have access to would be the income generated from the trust, if any. Income means interest, dividends, or rental income, if applicable. Everything else you should generally assume is considered principal just to be safe.

There are many traps you need to be aware of before doing a medicaid irrevocable trust, so check out Does my trust protect me from the nursing home? if you want to learn more on this topic.

Protection from children’s divorce

We’d all like to think our children will marry the perfect person and live happily ever after. But we also know that the divorce rates hover around 40-50%. And the last thing you want is your money to go to your child’s ex-spouse or get caught up in a divorce proceeding.

So, for clients who are either not fans of their child’s significant other, have been divorced themselves, or have children who are now young adults but still in search of their soulmate, you may want to consider adding divorce protection provisions in your trust.

The simplest way to do this is to delay the distribution dates or split up distributions, but these techniques typically require a third-party trustee (someone other than your child) to act as a legal protective barrier to your hard earned assets.

Protection from financial immaturity.

This one is obvious if your kids are minors, but is also helpful if your children are now young adults.

The idea of leaving hundreds of thousands or perhaps over a million dollars to your child may seem a little crazy, so (similar to above) you can easily provide some protection just by delaying the distributions and putting a third-party trustee in place temporarily until your child has reached an age that you think would be appropriate to receive the money outright.

Once again, you can split up distributions (for example, one-third at 25, one-half of the remainder at 30, and all the remainder at age 35) to mitigate your risk. It’s also important to note that even though your child doesn’t have direct access to the money prior to the distribution dates, the trustee can use the money for the benefit of your child during that time. So it’s not like they are cut off from their inheritance until that age, they just have an intermediary to stop them from buying or spending money on silly things in the meantime.

For more information on this topic, you may want to check out How do I pass money on to my children without spoiling them?

Protection from substance abuse or gambling issues.

Trusts that are built for the benefit of children with substance abuse, gambling, or other addictions can allow your child to have financial support without allowing creditors from being able to attach the trust assets. Whether it’s bankruptcy, lawsuits, or divorce, these trusts tend to last longer and have more specific instructions for the trustee.

Since these trusts tend to last longer than other types of trusts (sometimes for the entirety of the child’s life) there should be a way for an independent trustee to be appointed in the event that the successor trustee is no longer able to serve. In other words, you want clear provisions on how to fill a trustee vacancy if such scenario arises.

For more information on how a trust could protect the your assets from your children’s creditors, you may want to check out How a Spendthrift Clause Protects Your Children’s Inheritance.

Protection from remarriage risk

If you are in a blended family with children from a prior relationship (or if your spouse has children from a prior relationship), then you understand the risk of predeceasing your spouse and having some of your money potentially going to the wrong person. But, what if you are happily married for 10, 20, 30 years and are concerned that if you predecease your spouse, that he or she may find another lifetime companion that may convince him/her to adjust his/her estate planning to incorporate the new spouse (or boyfriend/girlfriend and their kids)?

What should you do in that scenario?

In that case, you can design your trust to a QTIP trust so that your spouse could have the benefit of your assets after you are gone (and also qualify for the marital deduction), but you could place certain restrictions on those assets to make sure they ultimately go to your children and aren’t circumvented before their death.

Please note, I only recommend this approach to clients who either have substantial wealth or have good reasons for suspecting a client’s spouse may be vulnerable in such circumstances. For most happily married couple with children only from their relationship (no outsiders), you can still employ a QTIP trust for tax purposes, but may find that the restrictions are too limiting to your surviving spouse to move forward with it.

In other words, you usually only use a restricted QTIP if you are in a blended family scenario.

Goal#5 Clarifying your intentions

If you hit upon all the above goals, then clarifying your intentions usually falls into place as a result of achieving your goals, however, if there is certain precatory (non-legally binding) language that you want to include in your estate plan, then you may decide to insert such language accordingly.

For example, if you are choosing to give a particular child more than another, then you may want to mention why you are doing that. Perhaps one of your children needed more financial support during life, whereas the other never asked or needed a thing. Perhaps one child took a “loan” that they haven’t yet paid back. Maybe you have a business and only one child participates in that business, whereas the other child went off and did their own thing.

The same applies for intentional omission when you’ve decided to purposely not include certain beneficiaries. Make such intentions clearly stated in the document to remove any ambiguity. To go one step further, you may even want to insert a no-contest clause.

With all that being said, you generally do not want to include the emotional details of your intentions in the legal documents themselves. That will just make things messier if you ever need to amend the documents. Rather, you are much better off putting the long version of the stories in a private letter to be kept in the same folder as your estate planning documents.

If you are unsure which language should be put in your trust vs. your own private letter, then speak with your attorney about it and he/she should be able to give you proper direction.