Frequently asked questions:

1. What is an estate?
2. What is probate?
3. How can probate be avoided?
4. How is a living trust different than a will?
5. Is joint tenancy a good idea?
6. Who should be my executor?
7. Who is a good choice for trustee?
8. Is my estate subject to estate tax?
9. What can I do to minimize or avoid estate taxes?
10. Are life insurance proceeds taxable?
11. What are the tax consequences of making gifts?
12. What is a Durable Power of Attorney for Property?
13. How does a Durable Power of Attorney for Health Care work?
14. How often should I review my estate plan?

1. What is an estate?

Each of us has several different "estates" for estate planning purposes The first is your "taxable estate," which consists of the assets you own that will be includable in your estate for estate tax purposes. This "estate" includes all the things you own or have control over at the time of your death. Your taxable estate will include all of your clothing, furniture, jewelry, collectibles, antiques, bank accounts, investments, real estate, retirement accounts, life insurance policies - in short, everything. If there is any question in your mind regarding whether or not something will be includable in your taxable estate, it is safe to resolve your doubt in favor of inclusion. Since the estate tax is a tax on the transfer of assets, the value of the assets owned by the decedent is the amount that is subject to the tax. That is why a life insurance policy is includable at its death benefit value, not on its cash or surrender value.

The other kind of estate is your "probate estate". Your probate estate consists of all of the things that you personally own at the time of your death. An exception is assets other than real estate to the extent they do not exceed $50,000 in total value. Also excluded from your probate estate are joint tenancy or tenancy by the entirety assets, and assets such as life insurance, retirement assets, annuities, etc. having a beneficiary designation. Joint tenancy and tenancy by the entirety assets carry with them an automatic right of survivorship, so they pass by operation of law to the surviving joint tenant or tenant by the entirety. A beneficiary designation supersedes the disposition provisions of a will, trust or the laws of intestacy, so they are not subject to those documents or laws but simply pass to the person you name as beneficiary on an appropriate beneficiary designation form provided by the life insurance or annuity company or the custodian of the retirement account. Everything in your probate estate is also a part of your taxable estate, but not necessarily the other way around.

2. What is probate?

Probate is the court administration of an estate at death. Probate becomes necessary when you die owning assets titled in your individual name and which have no beneficiary designation. The idea behind probate is that, since you are not here to sign your assets over to your loved ones, the courts must oversee that process. Even if you die with a valid will (testate estate), the will does not avoid probate. The will acts essentially as a letter of instruction to the court defining who you want to administer your estate (your executor) and to whom you want your assets distributed (your beneficiaries). If you do not have a will (intestate estate), the state in which you resided at the time of your death has laws that will determine the administration and distribution of your estate.

The executor must first file the will. The court process is usually initiated by an attorney, who prepares appropriate documents for filing with the court. If the judge finds everything to be in order, he or she will admit the will to probate and issue Letters of Office to the executor named in the will, or to an Administrator if there is no will. The executor or administrator then has authority to access the decedent's assets to pay bills, taxes and ultimately make distribution of the remaining assets. Publication of notice of these proceedings is posted in a local newspaper, and anyone with standing has a right to contest the will and the proceedings. In Illinois, the estate must remain open for at least 6 months to permit creditors of the estate to file their claims. It typically takes 9 months to as long as 2 years to conclude the administration of an estate. It is not unusual for the cost and expense of probate to average 3% to 10% of the value of assets being probated.

2. How can probate be avoided?

Probate can be avoided in many ways. Assets such as life insurance, annuities, retirement funds, and IRA accounts can avoid probate if a proper beneficiary is designated. Designating your estate is not an advisable designation. Assets titled in joint tenancy pass automatically to the surviving joint tenant and thereby avoid probate. However, joint tenancy can create a tax trap, and result in loss of control over the property as discussed elsewhere on this site. Certain designations on assets such as "POD" (pay on death) or "TOD" (transfer on death) also avoid probate. These too, however, have drawbacks which should be taken into consideration in planning your estate.

By far the best way to avoid probate is through the use of a properly funded revocable living trust. A trust is defined in more detail elsewhere on our site. However, a living trust is basically a document that contains your wishes for the administration of your assets both during your life and after your death. Your assets must be transferred to your trust during your life if the trust is to accomplish probate avoidance. If you choose, you can be your own initial trustee (self-declaratory trust) and thereby control your trust assets yourself. At your disability or death, you name the person or institution that will control your assets as successor trustee as you instruct. Because the assets are not in your name (they are in the trust's name), they avoid probate.

It is important to understand that probate and federal estate taxes have nothing to do with one another. In 2001* for example, you are allowed to pass assets valued at $675,000 or less to a non-spouse with no federal estate tax. This does not mean that these assets will not be subject to probate. Probate is the administration of your estate, and estate tax is the transfer tax on all of the assets you own at your death (probate and non-probate).

* See our article in this website outlining the new changes in the Federal estate tax laws.

4. How is a living trust different than a will?

A will is what estate planners typically refer to as a "testamentary instrument". That means that a will takes effect only upon your death. A living trust, on the other hand, takes effect as soon as it is signed and assets are transferred to it. Both a will and a living trust are, at their core, a set of instructions for the administration and disposition of assets and payment of administration expenses and taxes at death. A living trust, however, also directs the management of assets during life. As a result, if you have a properly funded living trust, your incapacity will not require a guardianship proceeding; your successor trustee can simply continue to manage the assets in your trust without court intervention or supervision. Likewise, if you have a living trust to which all your assets have been transferred, your estate will avoid probate at your death. All of your assets will simply pass according to the instructions you left in your living trust and, although an administration process is still necessary, it is usually accomplished outside the courtroom at a much lower cost, and with the help of your estate planning and administration attorney. Even if you have a properly funded living trust, you must still have a will, though it will be a different kind of will. A will that is a companion to a living trust is often called a pour-over will. A pour-over will serves several functions, including the appointment of an executor, the appointment of a guardian for minor children, the disposition of personal property, and the transfer (pour-over) of non-trust assets into your living trust. It has been our experience that there are almost always assets outside the trust at death, and the pour-over will insures that those assets will end up in the trust and be distributed along with your other trust assets.

5. Is joint tenancy a good idea?

That depends. (Spoken like a true lawyer!) In some circumstances, joint tenancy can be an acceptable form of title. Joint tenancies for a young couple with a non-taxable estate (no federal estate tax exposure) would be acceptable if that couple also has a will providing disposition of assets at the death of the survivor as well as contingent trust provisions for any minor children. Joint tenancy will avoid probate.

The problems with joint tenancy are that upon creation of a joint tenancy:

• You lose some control over your property
• You subject it to the other joint tenant's creditors
• You may be creating unintentional gift tax problems
• You create potential estate tax problems

For example, a parent who puts a home in joint tenancy with a child cannot sell the home without the child's consent. If the child has a judgment entered against him or her, the child's creditors can attack the child's interest in the home. A husband and wife with assets exceeding the federal estate tax exemption ($675,000 in 2001*) who place their assets in joint tenancy are creating a federal estate tax trap for their children at the death of the surviving spouse.
* See the article on this Web Site outlining the new changes in Federal estate tax laws.

6. Who should be my executor?

Any candidate for executor is often also a good choice for trustee. An executor oversees the administration of a will, either through probate or, if no probate is required, outside of probate. Some of the same issues apply to the choice of both an executor and a trustee, though an executor is discharged when the estate is closed, whereas a trustee may have ongoing responsibilities. An executor is named in your will and, in a probate situation, appointed by the court. The executor is charged with the duty of notifying heirs of estate proceedings, taking an inventory of the estate assets, giving notice to creditors, evaluating and paying claims against the decedent, filing income and estate tax returns as needed, managing the properties of the estate within the limitations established by the decedent's will and the probate laws, and eventually distributing the estate which remains after payment of attorneys' fees, executor's fees, estate and income taxes, and other costs of administration.

7. Who is a good choice for trustee?

A good candidate for trustee, whether an individual or corporate fiduciary, needs to possess certain fundamental characteristics. First, and above all, the candidate must be knowledgeable about what a trustee is and does. A trustee must be trustworthy, reasonable, well-organized, responsible and must possess good listening skills. A trustee should also have either direct experience with investments, tax laws, legal issues and accounting, or access to those professionals who provide such expertise. Last but not least, the candidate must be able to get along with the beneficiaries of the trust and work effectively with them. In choosing a trustee, keep in mind that a trustee's duties may last over a long period of time if trusts of longer duration are established.

The individual trustee. An individual candidate for trustee must be a person of good reputation, have personal integrity and be impartial and free of potential conflicts of interest. If you would like to name a family member as trustee, you should realistically assess whether the family circumstances are such that the proposed trustee could be effective in administering the trust. Family harmony is sometimes very difficult to maintain when one child is given power as trustee to determine when or whether a sibling will receive discretionary distributions from the trust. Second marriage situations may present a potential conflict of interest when either the surviving spouse or a child from the first marriage is named to act as trustee. Where the trust will hold stock in a family business, naming a child as trustee who is also a principal in the business may give rise to conflict with beneficiaries who are not employed by the business. An individual serving as trustee should also be familiar with your philosophy and be capable of implementing that philosophy within parameters of appropriate trust administration and according to the terms of your trust. A major reason for naming an individual trustee is to have a trustee who matches well with beneficiaries: someone who is understanding, yet not controlling or controllable. Serving as trustee is serious, time-consuming work. Therefore, it is highly important that you realistically assess whether the personal circumstances of a particular individual will allow him or her to perform the duties of a trustee. As a practical matter, an otherwise well-qualified individual may be unable to accept appointment for reasons ranging from existing personal and professional responsibilities to poor health.

The corporate trustee. If you are considering a bank or trust company as trustee, you should meet with a representative of the institution to obtain answers to these fundamental questions:

The "inappropriate" trustee. The word "appropriate" implies that some choices may in fact be "inappropriate." There are times when the selection of either an individual or a corporate fiduciary may be inappropriate for a particular trust. For example, an individual may be selected on an other-than-rational basis:

• "His feelings will be hurt if I don't pick him to be trustee."
• "I've got to choose her because she's the oldest."
• "I can't play favorites; let them all be trustees."

Estate planning is one of those times when individuals are brought face to face with things they do not like to think about: disability, death and taxes for certain. But it is also one of the few times when a person cannot avoid confronting potential or actual conflicts that may exist within family relationships. Where the relationship between a trustee and a particular beneficiary or group of beneficiaries is not good, trouble is likely to follow. An individual may find it difficult to serve as trustee of a trust specifically established for another family member who has had behavioral or financial "problems" in the past. Similarly, a child may not be able to act impartially when serving as trustee of a trust established for the benefit of a stepfather he or she has long resented.

There are also times when the selection of a corporate trustee may be inappropriate. For example, the selected corporation may not be authorized to administer trusts in a jurisdiction where the trust holds real estate. Corporate trustees are also increasingly reluctant to accept appointments as trustees of irrevocable life insurance trusts prior to the deaths of the insureds. A corporate trustee may also be an inappropriate choice for a small trust where the fees charged may not be proportionate to the size of the account.

8. Is my estate subject to estate tax?

Yes. All assets in which you have any ownership interest at the time of your death are subject to estate taxes. This includes insurance proceeds payable at death, interest in joint tenancy assets, retirement funds, homes - everything.

However, the law provides you with some relief. All assets passing to a surviving spouse generally pass free from estate tax regardless of value. This is the result of the unlimited marital deduction. As the term indicates, this deduction is unlimited.

Additionally, we are each given an exemption against federal estate taxes for assets passing to a non-spouse beneficiary. In 2004 that exemption is $1,500,000.* This simply means that if the value of your total estate, net of bills and expenses is $1,500,0000 or less, there will be no federal estate tax.

If your estate exceeds the exemption amount, the effective tax rates that determine your federal estate taxes begin at 45% and can be as high as 48%* of the excess over the exemption amount. The tax is literally confiscatory and can result in serious estate shrinkage!

* The exemption amounts will increase and federal estate tax rates will decrease over the next several years. See our article on this web site regarding the federal estate tax laws.

9. What can I do to minimize or avoid estate taxes?

For many people, the minimization or elimination of estate taxes becomes the primary focus of their estate planning. Though tax considerations are certainly important, they should not drive the estate plan; in other words, the tail should not wag the dog. The primary objective of any estate plan should be the disposition of assets to the beneficiaries you intend, in a manner consistent with your wishes, taking into consideration the age and aptitude of those beneficiaries, and the protection of minors and those not able to manage their assets themselves.

Having said that, however, there are a number of things that can be done, within the planning process, to minimize, or even eliminate, in some cases, the estate tax. Since the size of your estate determines the amount of tax that will be owed, the extent to which you can reduce the size of your estate will correspondingly reduce the amount of tax that will be owed at your death. There are generally two ways that this can be accomplished: (i) making gifts that remove assets from your estate, or (ii) discounting the assets which remain in your estate so that they are worth less for estate tax purposes.

Gifts fall within a number of different categories. Charitable gifts give you a dollar-for-dollar credit against estate taxes. Gifts to Charitable Trusts can provide you with an ongoing stream of income and provide you with an income tax deduction, and reduce your estate at the same time. Gifts to individuals can be present interest gifts, or future interest gifts, such as gifts to trusts for the benefit of a child, where the child benefits down the road. An effective use of gifting is to give away something that has little value during life, but a substantially higher value at death, such as a life insurance policy. Imagine being able to reduce your taxable estate by several hundred thousand dollars simply by transferring a life insurance policy to a trust, rather than owning it yourself.

You can also leverage your gifting, by using vehicles such as Grantor Retained Annuity Trusts or Family Limited Partnerships. A discussion of such methods of estate tax reduction is beyond the scope of this brief explanation.

10. Are life insurance proceeds taxable?

It is very important to distinguish between income taxes and estate taxes. Most people have the understanding that life insurance proceeds are not "taxable." In most cases life insurance proceeds are not subject to income taxes. However, the proceeds of a life insurance policy over which the decedent had any incidents of ownership are subject to estate taxes. Income taxes and estate taxes are two entirely different forms of taxation, and should not be confused.

Estate taxation of a life insurance policy depends on who owns the policy at death and who has control over the various aspects of the insurance contract, such as the right to change beneficiaries, to borrow against the policy, etc. If you own the policy or have any incidents of ownership, the policy proceeds will be includable in your taxable estate, and subject to estate tax. If you do not have any incidents of ownership (for example, if the policy is owned by an irrevocable trust), the proceeds will generally not be includable in your estate for estate tax purposes. The single exception is a life insurance policy that was transferred to an irrevocable trust by its owner. In that event, the policy will continue to be included in your taxable estate until 3 years have passed from the date of transfer. This 3-year rule does not apply to policies on your life initially purchased by the irrevocable trust.

11. What are the tax consequences of making gifts?

Making gifts is often a very effective way to reduce the size of your estate. Although all gifts are taxable, there are several gift tax exclusions of which you can take advantage. The first is the annual exclusion (also called the annual per donee exclusion), which exempts annual gifts of $11,000 (indexed for inflation) per "donee." Simply put, each individual can make gifts of $11,000 per year to an unlimited number of people. Thus, if you have 3 children, you can make a gift of $11,000 to each of them this year, and then again each year thereafter. Each of those gifts qualifies for the annual exclusion. If you are married, each spouse can make such gifts, resulting in total gifts of $66,000, without gift tax consequences. Assuming that each of those 3 children is married and has 2 children of their own, a married couple can now make gifts each year to the 3 children, their spouses, and their children, thus effectively reducing the couple's taxable estate by $264,000 (12 donees times 2 donors times $11,000) with no adverse gift tax consequences. You also have a lifetime gift tax exemption of $1,000,000.* So, in addition to the annual exclusion gifts mentioned above, you may make gifts totaling the gift tax exemption amount during your lifetime. If the exemption is used during life, it will not then be available for transfers at death. From a tax perspective, however, lifetime gifts are almost always more advantageous than gifts at death, because (i) gifts are tax exclusive while bequests are tax inclusive, (ii) as the money you give away grows in value, that value is also outside your taxable estate, and (iii) any income earned by the gifted funds is income to the recipient, rather than being income to you.

An effective use of your annual gift tax exclusions and your lifetime exemption is to give away assets that have a low value while you are alive and a much higher value at death.** The prototypical asset that falls within this category is a policy of life insurance. During your life, a life insurance policy has a relatively low value, but at your death, the full death benefit will be subject to the estate tax. Making gifts to irrevocable trusts, such as a Grantor Retained Annuity Trust, can also effectively leverage your gift tax exemption by allowing you to give away more than the actual value of the gift.
* The lifetime gift tax exemption will remain at $1 million under current law, rather than increasing as does the estate tax.
** In making lifetime gifts, you should consider the effects of carry-over income tax basis of the assets being gifted.

12. What is a Durable Power of Attorney for Property?

A Durable Power of Attorney for Property is a written document giving authority to an individual (an agent) to handle your financial affairs.

This is a very powerful document and should be created with great care. It is also a very essential document for everyone over the age of 18.

The importance of creating a Durable Power of Attorney for Property is to insure that if, for any reason, you are incapable of handling your own financial affairs due to accident, illness, or unavailability, the person you name (your agent) can step in and handle these matters for you. The Power of Attorney for Property will allow your agent to deal with those assets which have your name on the title such as assets you own in your own name, in joint tenancy or tenants in common with others. It does not give authority to deal with assets you hold in a trust. Only the trustee has authority over those assets.

A Durable power is one that will still be effective even if you are disabled or incompetent. This is important because it is at these times that the power is most needed. A properly draft Durable Power of Attorney for Property can avoid court proceedings called Guardianship in the event of your incompetence.

It is very important that the person you name as agent is trustworthy and reliable. It is also important to name successor agents to act in the event your first choice is unable to do so. You cannot name co-agents; only one at a time.

It is also important to understand that the Power of Attorney for Property is void at your death. It cannot be used, for example, to transact business or avoid probate upon your death. Therefore, the need for a revocable living trust should be carefully considered.

13. How does a Durable Power of Attorney for Health Care work?

A Durable Power of Attorney for Health Care is a statutory form in Illinois, and in most other states. This is the more important of the two advance medical directives, the other of which is a Living Will. By signing this document you entrust the agent named with the legal authority to make medical decisions for you if you are unable to do so. The person selected as agent is often a spouse or other family member.

The Durable Power of Attorney for Health Care includes the right to make medical decisions, to withdraw life support, and to authorize the donation of vital organs. This document transfers the responsibility of withdrawing life support systems from the attending physician to the person designated as agent once the physician has determined that there is no hope of recovery. It lifts from the shoulders of the physician the potential liability for withdrawing life support.

As with powers of attorney for property, a non-durable power of attorney ends when the principal becomes incompetent while a "durable" power of attorney does not. All powers of attorney end automatically upon death. If the principal (you) becomes incompetent, the Durable Power of Attorney for Health Care continues to be valid. You may revoke this power of attorney at any time.

In the Illinois form, any limitations to be imposed upon the powers of the agent can be set forth in the space provided for that purpose. Also, three choices are provided regarding standards by which the agent is to be bound in the event the agent must make end-of-life decisions on your behalf. You may indicate your instructions to the agent by initialing the appropriate provision of the form. Failure to initial any of the three subparagraphs indicates your intent to give the agent full discretion to act in what he or she deems to be your best interests. If none of the three options of the Illinois form accurately describes the standards to which the agent is to be bound, specific standards can be drafted to bind the agent.

The Illinois form allows you to designate when the Durable Power of Attorney for Health Care is to become effective; generally such a power of attorney should become effective immediately. If its effectiveness is to be postponed, an appropriate effective date or event may be inserted. The date of termination of the power of attorney must also be specified; it is generally best not to have the power of attorney expire until after death. If another termination date is preferable, an appropriate date or event can be inserted.

In addition to the initial agent named in the power of attorney, one or more successor agents can be named. As in the case of agents acting under a Durable Power of Attorney for Property, in Illinois only one agent under a Durable Power of Attorney for Health Care is allowed to act at any given time. Two or more agents cannot be named to act together, but only in succession.

The second of the two commonly used advance medical directives, often referred to as a living will, applies only if you have an incurable and irreversible injury, disease or illness which is judged to be a terminal condition by your treating physician. It directs your doctors and health care providers to use no artificial, life-preserving procedures to prolong the dying process in that event. Obviously, this document applies only under a very narrow set of circumstances, unlike a Durable Power of Attorney for Health Care, which has much broader applicability. In addition, under Illinois law, your doctor should seek the input of an agent acting under a Durable Power of Attorney for Health Care before acting under this Declaration. The living will, therefore, is subordinate to a Durable Power of Attorney for Health Care in situations where both documents are present and applicable.

14. How often should I review my estate plan?

The creation of your estate plan should be viewed as a process not an event.

Because there are ever changing circumstances in our lives, the process is continuous. Just as you maintain your car or have regular physical checkups, it is important to maintain your estate plan to insure it is keeping up with the changes going on in your life.

The following are circumstances that would necessitate a plan review:

• A birth or death in the family;
• A divorce;
• A change in your desire for the distribution of assets;
• A change in your financial circumstances;
• A desire to change one of your fiduciaries, such as your executor, successor trustee, or agent under a Durable Power of Attorney; or
• A change in the tax laws.

A review should be initiated under any of the above circumstances. If none of these circumstances are present, it is advisable to review your plan with your estate planning attorney and other advisors at least annually.

In a review, we insure that your assets are properly titled (and balanced between husband and wife, if you are married and you have a taxable estate). Ownership of assets and balancing of asset values are critical to an effective estate plan. Periodic reviews insure that these aspects of your estate are addressed on an ongoing basis.

Finally, over time new and innovative ways to help you provide for your loved ones and save taxes come to our attention. These new techniques can be discussed at your review to effect the best plan for you and those you wish to benefit at your death.