The 10 Most Common Estate Planning Mistakes…
And How to Avoid Them
by David T. Phillips, Guest Columnist, Investment U
Friday, June 13, 2008: Issue #807
Nearly 55% of Americans don’t have written wills. Yet proper estate planning could actually save you millions in taxes over time. Do you remember the short story of Rip Van Winkle as told by George Washington Irving?
Van Winkle goes to sleep after a game of bowling and much drinking in the mountains with a band of dwarves. He awakens 20 years later, an old man. Back home, Rip finds that all has changed: his wife is dead, his daughter is married, and the American Revolutionary War has taken place.
Since the passage of the Economic Growth Tax Relief and Reconciliation Act in mid-2001, (EGTRRA), the majority of wealthy Americans have used Rip Van Winkle as their role model. It seems that because estate taxation rules have been in flux, and the federal estate tax exclusion credit has now increased to $2 million per person, they are content to sleep it off and wait until they wake up in 2011 to do any estate planning…
The 10 Most Common Estate Planning Mistakes
By catching the 10 most common estate planning mistakes now, you can avoid these financial pitfalls before they get costly.
- Mistake 1: Of the 10 most common estate planning mistakes, the most prevalent one is the failure to have any plan at all, or having an antiquated or improper plan. It surprises many that 70% of all affluent Americans are devoid of an estate plan. This failure can lead to confusion, envy and anger at a time when love and unity should prevail.
- Mistake 2: Misunderstanding the 2001 Tax Act (EGTRRA) and it’s the true impact has on your estate, is the next mistake. Many sighed in relief when President George W. Bush signed the bill. They believed that estate taxes had been, or would soon be, abolished.
A closer look at the scheduled increase in the estate tax exclusion reveals credits of $2 million in 2007-2008 to $3.5 million in 2009, with total elimination in 2010. However, there is an onerous “sunset provision,” as a tag line.
This provision mandates that estate planning laws and credits revert to pre-2001, or to a meager $1 million credit. The Wall Street Journal predicted that soon after 2010, the credit will “roar back from extinction… with a top rate of 55% and an exempt amount of only $600,000.”
Another critical element of the EGTRRA agenda is the loss of the “step-up-in-basis.” Current law allows heirs to inherit our property with a cost basis based on the value at death. If this provision is lost, all gains greater than the original cost basis would be taxed to the heirs at the capital gains tax rate when an inherited asset is sold.
While EGTRRA appeared to produce relief, reality is cruel; all planning today should to reflect the possibility that things will revert to pre-2001 law. - Mistake 3: Many feel that if they transfer ownership of their holdings to a close relative, the transaction will side-step probate. Perhaps they saw this maneuver in some movie or heard about it on a talk show. If the joint tenant or co-owner is sued or files bankruptcy, the creditors will attack the asset and they could lose it, even if it is their home.
Furthermore, upon death, a spouse from a second marriage could totally disinherit children from a previous marriage. Exposing ownership transfers as much riskier that originally thought. - Mistake 4: Since the Tax Act of 1981 and the introduction of the 100%-marital-exclusion, 82% of Americans have elected to pass their total estate to their surviving spouse. While this tactic may appear appropriate, it isn’t necessarily good estate planning.
In fact, for a joint estate currently valued in excess of $4 million or an estate with the potential to appreciate beyond that figure, passing everything to the surviving spouse will generate up to $920,000 in unnecessary federal estate taxes, not to mention state inheritance taxes. - Mistake 5: The vast majority of Americans don’t comprehend the current gift-tax law that allows one to share their wealth- up to $12,000 annually per beneficiary. Furthermore, they don’t understand the power this “leverage” can create and the benefits that can be realized. In most cases, by leveraging the annual IRS gift allowance, the majority of estate shrinkage can be totally eliminated.
- Mistake 6: Perhaps the most expensive estate-planning mistake is the failure to properly plan the distribution of retirement accounts, such as an IRA or 401k. Too often beneficiary forms are not reviewed when life events occur, such as a divorce or death, and the recent “stretch” options for non-spousal beneficiaries are not in place. These mistakes can incur taxes in excess of 85% to beneficiaries.
- Mistake 7: One of the most destructive enemies of fortune is the loss from investment choices. We could lose the vast majority of what we have accumulated. Consider that on March 10, 2000 the NASDAQ composite reached a high of 5,132. By October 10, 2002 it had fallen to just 1,108.
A hypothetical $100,000 invested during its high and held to its low would have been plummeted to a dismal $21,590, a loss of more than 78%. A return of 463% or 20 years at 8% would be required to recoup the loss.
Failing to plan for a what-if situation in the market could lead to difficulties in reaching your goals. - Mistake 8: Given the fact that 70% do not have a sound estate plan, most heirs will be required to liquidate assets to generate enough cash to cover estate costs. Which assets will be sold first? Faced with time constraints, will they command top dollar? What if the market declines during liquidation? Will the family summer cabin survive the tentacles of the IRS?
Liquidating assets at inconvenient times is one of the difficulties heirs will be required to face if a plan is not in place. Fortunately there are strategies that can solve these problems. However, these plans must be established prior to the day that they are needed. - Mistake 9: It is alarming how many life insurance policies are owned by the insured, and not a beneficiary. Life insurance proceeds are income tax free, but not if these proceeds go through the estate. In those cases, life insurance policies can trigger an estate tax on other assets.
Life insurance policies can actually net less than 45% of their desired amount, if they aren’t properly set up. - Mistake 10: Long-term care at a cost of $40,000 to $80,000 a year will be needed for 40% of Americans 65 and older. A lengthy illness could wipe out many estates. Especially considering that before one can be eligible for Medicare’s financial assistance for long-term care, they must first “spend down” their assets.
Prior planning must occur in order to shield investments from the expensive costs of the medical industry.
Preparing Proper Distribution of Your Assets
In short, we need to prepare the proper distribution of our assets, big or small, to those who actually deserve to receive it. If we don’t, if we stay asleep like Rip Van Winkle, we will allow creditors, predators and the IRS to confiscate the wealth that we have worked our entire lifetime to create.
It is a huge error to think of a legacy in financial terms only. If properly told, virtually anyone’s life story could be made into a riveting Hollywood movie. For the most part however, these unique histories are not recorded for posterity and these memories disappear. This could be the biggest mistake of all.
So I urge you to set up an estate plan for yourself, and for your family.
Good investing,
David Phillips
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Today’s Investment U Crib Sheet - How to Save Thousands Creating Your Will
- If your estate is simple and relatively small, you can create a will yourself using Quicken Willmaker Plus 2008. This program can help you create a Living Will, Living Trust, Bypass Trust, Financial Power of Attorney and other legal forms. You can make changes to your will whenever you like, without consulting an attorney. (A Willmaker will is valid in every state in the U.S. except Louisiana.)You can buy the program at Amazon.com for less than $50. Here’s the link for Quicken Willmaker Plus 2008.
- To receive a complimentary copy of The Ten Most Common Estate Planning Mistakes and How to Avoid Them, or to purchase the book Estate Planning Made Easy, contact Estate Planning Specialists toll free 888-892-1102 or visit www.empez.com.
- If your estate is more complicated, you probably need some planning advice. For example, if you’re estate is worth more than $2 million, you may be subject to special estate taxes, which can run as high as 46%.To get more information on retirement planning, including four of our extreme catch-up ideas, go to our Retirement Planning Zone.
Related Articles:
- Target Retirement Funds: How to Put Your Investment Portfolio on Autopilot
- The Gone Fishin’ Portfolio - Get Wise, Get Wealthy… & Get on With Your Life
- Your Retirement Plan: Have You Calculated Your Number?
