Retirement Watch : trusts

Having the Last Word

Bob Carlson — Thu, 05 Nov 2009 21:49:00 GMT

Most estate plans are missing a key ingredient. Many estate planners don’t recommend it, and it isn't even mentioned in many estate planning discussions. One reason might be that, despite its importance, the document is not legally binding on anyone.

This document can clear up a lot of issues. It can save time and money in processing the estate, answer many questions of loved ones, and prevent the heirs from going to court. The document also can make clear one's final wishes in many areas that are not covered in wills and trusts.

The document often is called a letter of final instructions. That is a bit of a misnomer, because properly done it is more than a letter. It should be several documents contained in a three-ring notebook or other device that makes it easy to update the papers yet keep them together.

The letter of instructions is your last word on a number of issues. It also is a practical guide to handling your estate and managing the property. It can provide advice and guidance. Preparing a letter of instructions also is an excellent way to help do your planning and uncover forgotten information. Let's take a look at the details.

Contacts. Your executor will need to contact your estate planning attorney, accountant or tax preparer, life insurance agent, and any other financial professional who helped you. There also might be investment managers and employers or former employers who are paying benefits. Also include personal contacts: friends, relatives, organizational leaders. Include the name, address, telephone number, and e-mail address of each.

Where to look. Unfortunately, in many cases much of an executor's time is spent looking — for documents, account statements, contact information, personal items, or long-forgotten assets. May you know where everything is (though you probably don't). Make things easy and inexpensive for your executor by leaving behind an inventory of assets that includes where the assets and any documents related to them can be found. If you keep valuables in a safe deposit box or safe, be sure to note this and how the executor can gain entry. Let the executor know where you keep receipts, canceled checks, and any other supporting documents.

How it is divided. Your will, beneficiary designations, trusts and other documents legally determine who gets what. But you can make a plain English explanation of the division in your letter. You might explain why things are divided as they are — especially if you think someone might be surprised, disappointed, or have questions.

If you own a business, be sure to get periodic valuations and asset inventories. The business might own assets your heirs might not be aware of. You should provide separate detailed information about the business, its assets, its operations, and suggested actions to take with it.

You probably have several credit cards and belong to one or more associations, societies, or other groups that offer membership benefits. The benefits might include some kind of life insurance, disability insurance, or medical insurance. Take the time to review your benefits and list them somewhere. Provide full information, such as the brochure received from the provider. Your executor can make claims and boost your estate.

All of these lists can be included as separate statements that are attached to the letter or included in a separate divider in the binder. Also include in the binder copies of recent tax returns for you and your business along with your will and any other estate planning documents. Of course, a copy of your will and any trusts should be included. Recent copies of statements from any financial accounts and employee benefits also should be attached.

In most states, your instructions on funeral arrangements and some other matters are not legally binding even if included in the will. You also don't want to update the will each time a new idea occurs to you. These items can be included in the letter of instructions or notebook. Here are topics to consider:

* Burial, organ donation, and similar preferences. Naturally, if arrangements have been made in advance, these should be explained.

* A suggested obituary or items to include in an obituary.

* Preferences for the funeral, memorial service or other ceremony. You can be as detailed or general as you would like.

* The disposition of special collections or assets, pets, and memorabilia.

* Care for dependents who are incapacitated or for minor children or grandchildren.

Every estate planner with any experience has stories about searches for assets or disputes over seemingly minor matters. You can avoid being part of one of these stories by leaving a letter of instructions.

A letter of instructions has the benefit of being easy to update. You don't need to incur lawyer's fees or have a signature witnessed. Sit down once a year, review it, and determine what needs to be updated. After the revisions, make some copies. Your lawyer and executor each should have a copy, and there should be one in your desk drawer or other place you keep documents.

Preparing a letter of final instructions can provide benefits now. The letter ensures that your financial affairs and documents are organized. It probably will cause you to throw away unneeded items and carefully consider some items that have been put off or neglected. The process will cause you to do things that should have been done some time ago. Make it easy by not trying to do the entire project at once. Break it into manageable pieces and give each the attention it deserves.

When You Don’t Prepare

Without a letter of instructions and good organization, the heirs are forced to engage in the old-fashioned property and document search. Sometimes it is comical. Sometimes things get ugly. Always a lot of time and effort is wasted.

Estate planners tell stories of important documents that never are found and of other documents that are found in the most unlikely places. Cash, jewelry, and other property are found hidden in the backs of closets, in attics, or under floorboards. Sometimes evidence of real estate or stocks is found stuffed where they are discovered only by accident.

When heirs remember seeing property, such as jewelry, or hearing the loved one talk about real estate, suspicions are aroused when the property or documents are not found during the estate settlement process. The results can include accusations, lawsuits, and broken relationships.

Don’t leave your heirs in this position. Prepare a proper letter of instructions and supporting documents. In the process, you probably will re-learn things about the estate you forgot and also realize that some important papers need to be replaced.

Bob Carlson is editor of the monthly newsletter Retirement Watch and the web site www.RetirementWatch.com. He also is author of the books The New Rules of Retirement and Invest Like a Fox…Not Like a Hedgehog.

Avoiding Estate Planning Mistakes

Bob Carlson — Thu, 17 Sep 2009 19:40:00 GMT

The success or failure of an estate plan often depends on small details. Amid all the big picture issues (taxes, trusts, gifts, business interests), these matters may seem too small to deserve much time. Don’t have that attitude. It could cost you and your heirs.

Don’t make these very common estate planning mistakes.

* Overlooking non-probate assets. These assets are excluded from the “probate estate” and avoid the probate process, so their disposition is not covered by the will. (They likely are included in the gross estate for tax purposes.) They are covered by law or by contract. These assets include IRAs, employer retirement plans, life insurance, and annuities. Living trusts and all the assets in them also avoid probate.

Retirement plans, annuities, and life insurance have beneficiary designations that must be completed, either as a section of the account application or contract or in a separate document. For each of these non-probate assets, the custodian or account sponsor looks only at the forms in its records. Whoever is listed as beneficiary gets the asset. Often, a beneficiary designation form was completed many years ago, perhaps before the owner was married or had children. In the ensuing years, the owner’s marital or family situation could change. Yet, many people forget about their designation forms and do not update them.

Every estate owner should keep a copy of all beneficiary designation forms and review them every couple of years. More frequent updates are necessary as family situations, goals, and objects of affection change.

A related mistake is not to name contingent beneficiaries. These are needed because a beneficiary might pre-decease the owner or otherwise be unable to inherit. Another reason to have contingent beneficiaries is the primary beneficiaries might realize that due to changed circumstances it would be better for all concerned if someone else inherits the asset. The named beneficiary (or beneficiaries) could file a document known as a disclaimer, refusing the inheritance. The account then would go to the next contingent beneficiary.

* Many people set up living trusts but neglect to fully implement them or update them as needed.

One often overlooked detail with living trusts is that ownership of assets must be transferred to them. Only the assets legally owned by the trust avoid probate and are controlled by the trust’s terms. Too many people do not do the work of transferring the legal title of homes, vehicles, and financial accounts to their trusts, making the trusts useless.

It also is important to check with financial institutions to determine if they need a copy of the trust on file. A number of financial institutions are hesitant to recognize succession clauses in a living trust unless a copy of the trust agreement was filed with them in advance or they have other proof of the initial trustee's intent before transferring power over the accounts.

As with a will, there also might be a need to change trustees and beneficiaries. There should be successor clauses for beneficiaries and trustees that automatically make changes in certain circumstances. The clauses should be carefully written, updated as needed, and the successors made aware of the situation.

* A financial power of attorney is essential to every estate plan. Most estate plans focus on one's demise, but the possibility of disability also must be considered. Someone should have legal authority to manage the finances during a period of disability. If plans haven't been made, loved ones must go to court to have someone appointed. At that point, the owner has no control over the choice.

One reason to get started on the POA is that most financial institutions require that a copy of their own POA form be signed and on record to be effective. They might not accept the form drafted by an attorney or might delay its acceptance for some time. They also might not accept a form that is not filed with them until the principal is disabled.

* There are other details that are part of a complete estate plan. Parents of minor children should designate guardians in case of the demise of both parents. An estate owner also should create a beneficiary book that contains most important financial documents, plus descriptions and locations of other assets and records. There also should be instructions for the estate executor and those who inherit special assets. Funeral, memorial service, and burial instructions can be suggested by the estate owner and should be included in the book. I have discussed all these issues in more detail in regular issues of my newsletter, Retirement Watch.

Over the years estate planning has become synonymous with tax planning. There are other issues that are as least as important as taxes. A goal of estate planning is to manage assets and transfer them as efficiently as possible to the objects of one’s affection. Reducing taxes is part of that process, but there are other aspects that also affect how much of the assets reach loved ones and how efficiently that transfer occurs.

The Four Goals of Legacy Planning

Bob Carlson — Fri, 14 Aug 2009 00:29:00 GMT

Perhaps one of the worst effects of high estate taxes is the way tax planning diverts attention from other important estate planning issues. For many years, I have stressed that estate planning is about much more than taxes, but most people believe estate planning and estate tax planning were the same thing. Though wrong, it was understandable when the lifetime estate tax exemption was $600,000. Many "modest millionaires" who considered themselves middle class would be hit by high estate and gift taxes without planning.

Unfortunately, the idea that estate planning is all about tax reduction still is widely held. With the estate tax exemption at $3.5 million and likely to stay there or higher, many people simply are neglecting estate planning. Since estate taxes are not going to be a problem for them, they see no reason to put together a plan.

One way to avoid falling into this trap is to think about legacy planning instead of estate planning. Everyone needs a legacy plan, even those with less than $1 million in assets. With a new estate tax law likely to come down the pike this year and stabilize the tax picture, 2009 is a good time to put together your legacy plan.

Legacy planning has four key goals. Consider these goals and how to accomplish them. Working with an estate planner will be easier and faster when you understand legacy planning this way, and it will make meeting these goals easier and more likely.

Financial security for you and the objects of your affection is a priority of legacy planning.

Though few people realize it, putting yourself first should come be the priority of legacy planning. Establishing a legacy involves giving to or providing things (not necessarily money) for others. Yet, you are best able to give to others when your own standard of living is secure. You won’t be able to give to or provide for others when your own situation is precarious. As the plan is developed, keep returning to the question of whether a strategy would put your standard of living at risk under some circumstances. The sharp decline in asset prices in 2008 brought that home to many people.

Once comfortable with your financial security, establish goals for the ultimate disposition of your wealth. Often, the spouse is the first beneficiary of the wealth. After that, children, grandchildren, and charities are the usual recipients of the wealth. You need to decide who will benefit from your estate, the order in which they will benefit, and the amount or percentage of your wealth they should receive.

After determining who should benefit from the wealth, the next issue is how they will benefit. That issue often is determined by the other goals of legacy planning.

Continuing the management and caretaking of the estate is the next goal. If you are like most people, you have been calling the shots if not doing all the management. Too many estates, regardless of their size, dwindle rapidly after the first owners pass them on. Often the successors did not understand how the assets were to be managed or did not share the values and outlook of the founder.

This issue is particularly important with small businesses. The founding owner must decide who will own the business, who will benefit from its income, and who will manage the business. Those are three separate categories and do not have to consist of the same person or people. A key to successful legacy planning for a business, however, is to have a succession plan in place and to follow it. Succession planning is an issue we have discussed in my newsletter, Retirement Watch from time to time.

Even estates without businesses need to address the issue of the stewardship transition. It could be that the people you want to benefit from the wealth are not likely to manage it well over the long term. In that case, you want to consider trusts and other arrangements that separate management and ownership. It is important to recognize that those who benefit from the assets do not have to be the managers.

Protecting the estate is another key element of the plan. This goal is particularly important to small business owners and professionals. They feel a greater need to protect assets from potential creditors and lawsuits. But others might need asset protection from those sources as well as disgruntled family members, irresponsible family members, and ex-family members in divorces.

There are simple, low-cost vehicles that will protect assets, including different ways to hold title to assets, IRAs, annuities, and umbrella liability insurance. These work for estates of any size. For larger estates, there are vehicles that can be used to protect assets, including trusts and limited partnerships. Your fears, needs, and the various methods can be discussed with your estate planner. The key is to identify the assets you want protected and the potential harms from which you want protection. Surprisingly, the size of the estate often is not a factor. Many estate planners report that the worst fights are over the smaller estates.

The legacy plan must address the potential tax burden. Once you have established who should benefit from the wealth, you want to transfer the wealth to them in the ways with the lowest possible tax bill that meet your other goals. For many estates, that has become easier each year for about a decade, but easier tax reduction probably won't continue after 2009.

One reason many people do not develop estate plans is they do not realize how valuable the estate is and the potential tax burden. There often are "hidden assets" that are included in the taxable estate such as annuities, life insurance, IRAs, and some trusts. Other people "forget" about some of their assets or do not know their true value.

Even when federal estate taxes are not a problem, state inheritance or estate taxes could be. A number of states have these taxes, and some impose taxes on estates or assets with values as low as $250,000.

Income taxes on beneficiaries also need to be considered in the plan. For example, the beneficiaries of IRAs face an income tax burden many people overlook. That burden is one reason it might benefit you or your heirs to empty an IRA early, pay the taxes, and put the IRA assets in a taxable account to compound over the years. If you do not consider income taxes, your beneficiaries could benefit from far less of your wealth than you expected.

Planning a legacy involves far more than reducing estate taxes. It is time to start determining your goals and putting your plan together. Once the new estate tax law is final, push forward with the final details and implementation.

Better Strategies for Estate Planning Gifts

Bob Carlson — Fri, 10 Jul 2009 15:07:00 GMT

Gift giving is the surest way to help loved ones of all ages, establish a legacy, and reduce estate taxes when the estate is large enough. Yet, many people are hesitant to make significant gifts to loved ones, because of the potential pitfalls. Those pitfalls, however, can be avoided with some shrewd and creative giving strategies.

Potential givers see several risks in making substantial gifts. The wealth could be wasted or spent unwisely by the recipients. Simple mismanagement by an unsophisticated heir might cause the money to disappear in scams or unwise investments or spending. The wealth also could be dissipated though gambling, substance abuse, or bankruptcy. A common concern is that part of the wealth eventually could leave the family in a divorce.

Many of these risks can be reduced by giving through trusts, but there are many reasons why people do not want to give through trusts. It costs money to set up the trusts and keep them going. A trustee must be located to manage the property. It also is a statement to the beneficiary that he or she is not trusted with the money.

While the risks of giving are real, there are ways to give that reduce or eliminate the risks without the expense and inconvenience of trusts. The benefits of making gifts today can be reaped while protecting wealth from the perils.

529 plans. College savings plans authorized under section 529 of the tax code have become one of the best estate planning vehicles in recent years, while tax law changes have diminished the value of other vehicles. Most states now offer multiple 529 plan options, and any person can set up an account for the benefit of someone else and contribute to it. Plan contributions qualify for the annual gift tax exclusion, which is up to $13,000 for 2009. In addition, up to five years' worth of exclusions can be used in one year for a tax free lump sum contribution of up to $65,000. The money given to the account is out of the donor’s estate. Under many state plans the owner has some choice over how the account is invested.

Income and gains in the account compound tax free. Withdrawals are tax free if they are used for qualified education expenses of the beneficiary.

A distinctive advantage of the 529 plan is the owner can retrieve assets from the account for any reason. There is no tax penalty if the owner asks for the return of the assets, though the plan sponsor can impose a penalty of up to 10%. The owner also can change the plan beneficiary at any time.

Some states limit the duration of an account to a number of years or to the 25th or 30th birthday of the initial beneficiary. Others have no time limit.

A 529 college savings plan provides a tax-free way to remove assets from an estate, place them in a tax-free savings vehicle, and benefit an heir. But the beneficiary has no current control of the assets and can be denied future access if the situation changes. The donor can retrieve the assets if his or her needs change.

Bill paying assistance. Many people hesitate to make gifts because they are concerned the gifts will be wasted. They would like to help loved ones but do not want their gifts funding frivolous expenditures or being lost in unwise investments.

One way to prevent that outcome is to make direct payments on behalf of the beneficiary. The beneficiary never touches the money, and the gifts pay for what the donor intended. For example, checks for education or medical expenses can be written and sent directly to the provider. Some people pay directly for vacations, summer camps, furniture, clothing, cars, and whatever other expenses they want to pay.

Direct payment of gifts qualifies for the annual gift tax exclusion. In addition, qualified education and medical expense payments made directly to the provider qualify for an unlimited gift tax exclusion.

Purchasing services is safer than paying for assets. Assets can be divided in a divorce or sold or pawned to fund other spending. A possible disadvantage is that paying for items might put loved ones in the habit of asking for assistance whenever they want something. A better approach is to have a plan in which the amount and object of gifts for the year are discussed and set in advance, or even multi-year plans are developed.

Home equity loan match. Suppose loved ones need an expensive item, but the parents are not able or willing to part with a large lump sum or want to stay within the annual gift tax exclusion limit. A strategy, if the children have adequate home equity and credit, is for the children to make the purchase with a home equity loan. The parents then can agree to make all or part of the loan payments either directly or by sending money to the children. This allows the parents to help the children, stay within the gift tax exemption amount, and spread the payments over time in manageable amounts. The children deduct the interest if they make the payments.

Expense matching. Some donors to charities make challenge matches. They offer to match, up to a maximum amount, whatever amount the charity raises from other donors for a specific purpose. Parents can do the same with children. If the children need or want a car, for example, the parents can offer to match whatever amount the children spend. The match does not have to be dollar for dollar. The parents can offer to pay fifty cents for every dollar the children pay.

Some parents believe it is important the children contribute some of their own earnings to a major expenditure. The cost sharing makes it more likely that the children will choose wisely and take care of the asset. It also makes the children less dependent on the parents.

Marital agreements. When gifts are not made because the parents do not want to risk that they will be divided in a divorce, parents should discuss this with the children. The problem could be remedied with a premarital or postmarital agreement stating any lifetime gifts or estate bequests received by one spouse will not be considered part of the marital estate to be divided in a divorce. Many parents and grandparents will not make estate planning gifts unless there is such a marital agreement.

Maintaining separate accounts. In many states assets owned before a marriage plus gifts and inheritances are not included in the marital estate if they are not commingled with other assets. Parents should check the state's treatment of the gifts, and then can require that their gifts be kept in separate financial accounts

Trusts. Of course, the classic way to protect assets is by placing them in trusts. In this posting I have offered a number of ways to protect assets without the expense and restrictions of a trust. Trusts can be fashioned to accept tax-free gifts, take property out of an estate, protect assets, and provide incentives for the beneficiaries.

Estate owners have legitimate concerns about what might become of their estate planning gifts. These concerns can be resolved with some creative gift giving, enhancing the lives of loved ones while protecting hard-earned wealth.

Your IRA and Your Heirs

Bob Carlson — Fri, 29 May 2009 20:22:00 GMT

The unfortunate fate of many IRAs shows why everyone needs an estate plan, even when the value of the estate is far below the taxable level. Few people are aware of what could happen to their IRAs when the next generation inherits them. Most people, and discussions of IRAs, focus on building the balance through contributions and investments. If your IRA is a meaningful portion of your estate, however, you better consider what will happen to it. Effective estate planning strategies for IRAs tend to be different from the rest of the plan.

An estate plan for IRAs should answer these questions: What will be the bills for estate taxes and income taxes? Who will pay those taxes? Who will receive the IRA? In what form will the IRA be received?

There is a great deal of confusion about how inherited IRAs are taxed. The value of the IRA will be included in the owner's estate. Unlike other assets, ownership of the IRA cannot be given away during life or put into a trust for the benefit of others. If the IRA owner's estate will be large enough to incur estate taxes, the owner has to use other assets to reduce the tax or purchase life insurance to pay the estate tax. Most likely the IRA also will incur any state death or inheritance taxes.

Estate taxes can be avoided when the surviving spouse is the sole primary beneficiary of the IRA. The IRA’s value will be included in the owner’s estate, but there will be an offsetting marital deduction when the spouse inherits.

When estate taxes are incurred on an IRA the next issue is: Who pays the taxes attributable to the IRA?

Most standard wills provide that estate taxes are paid from the residuary estate or from the surviving spouse's share. Other estates apportion the taxes against specific assets or shares of the estate. If the IRA is a large percentage of the estate and taxes are paid from the residuary estate or surviving spouse's share, the taxes attributable to the IRA could really shrink the after-tax value of the shares paying the taxes.

Having the taxes attributable to the IRA paid by the beneficiaries of the IRA could create problems. If the beneficiaries do not have sufficient other assets to pay the taxes, they will have to take a distribution from the IRA to pay the taxes. The distribution will be included in their gross income for income tax purposes, so they will have to take an extra amount to pay the income taxes on the distribution they take to pay the estate taxes.

The best solution depends on the particular estate and the beneficiaries. The IRA owner should take care to consider how much the estate taxes will be and which part of the estate will pay them or whether life insurance should be purchased to pay the taxes.

After the payment of estate taxes isre resolved, or even if estate taxes are not an issue, there are income taxes to consider.

Unlike when other assets are inherited, there also will be income taxes due when the beneficiary takes distributions from the IRA. The beneficiary pays the same income taxes on distributions that the owner would have paid. These taxes cannot be avoided, and the fact of them might influence who is named beneficiary of the IRA or how much is left to different beneficiaries.

A non-IRA asset is more valuable to an heir than an IRA of equal value is, because there will be income taxes due on distributions from the IRA. The heir really inherits only the after-tax value of the IRA. The non-IRA asset, on the other hand, can be sold and no capital gains taxes would be due on the appreciation that occurred during the owner's holding period.

The income taxes due on IRA distributions are a reason to consider making charitable gifts with the IRA instead of other estate assets. The IRA will be included in the estate, but there will be an offsetting charitable contribution deduction, for no net estate tax. In addition, a charity that is named beneficiary of an IRA will not owe income taxes when it takes distributions, so it will benefit from the full value of the IRA. If there is an inclination to make charitable gifts through the estate, it often is better to make the gifts through an IRA and maximize the non-IRA assets left to other heirs.

You do not have to leave the entire IRA to a charity. If the IRA’s value exceeds the amount you want to leave to charity, leave a portion of the IRA to charity and a portion to other heirs. Or split the IRA into two, leaving one entirely to charity and the other to other beneficiaries.

Another issue is the beneficiary selection, if it is not to be a charity. An IRA owner wants to be sure to name one or more beneficiaries. Failure to do so, or naming the estate as beneficiary, removes the tax deferral benefits of the IRA. Distributions will be required from the IRA on an accelerated schedule.

Naming the beneficiary is not as complicated as it used to be. Before 2001 and 2002 regulations, the beneficiary choice greatly influenced the amount of the required minimum distributions during the owner’s lifetime. Now, an IRA owner should consider only which beneficiary he or she really wants to receive the IRA.

In most cases, the surviving spouse is the primary beneficiary and the children are contingent beneficiaries. In larger estates, the owner might name a charity to receive at least some of the IRA as discussed above.

Yet, it makes a lot of sense for an IRA owner to have a back up plan for the beneficiary selection. The regulations allow the estate executor to name the Designated Beneficiary by September 30 of the year after the year of the IRA owner's death. In most cases, there won't be any reason to change from the standard practice of naming the surviving spouse as beneficiary. But circumstances can change, and the regulations allow the executor to adapt to changing circumstances.

For the executor to take advantage of the flexibility, the IRA owner must name contingent beneficiaries on the beneficiary designation form. The Designated Beneficiary named by the executor must be on the list of primary and contingent beneficiaries named by the owner.

When more than one person is beneficiary of an IRA, the beneficiaries can split the IRA into separate ones, but they might not realize this or the IRA custodian might be resistant to it. If the beneficiaries do not split the IRA, the age of the oldest determines the required minimum distributions from the IRA. In addition, the beneficiaries have to agree on management of the IRA and on the policy for taking distributions that exceed the required minimum.

The IRA owner should ensure that the beneficiaries know they can split the IRA. The owner also should check the IRA custodian’s policy for splitting inherited IRAs. Some discourage it or charge fees. Some IRA owners decide to split their IRAs themselves, naming one primary beneficiary for each.

Instead of leaving the IRA directly to individual beneficiaries, the owner might want to name a trust as beneficiary. The trust can control when distributions are made to the beneficiary. This arrangement might increase income taxes, however, and tricky rules must be followed when drafting the trust. Do not name a trust as IRA beneficiary without working with an estate planning attorney who is experienced in this area. The wrong language in the trust can terminate the tax deferral benefits of the IRA and require distributions on an accelerated schedule.

Because of the income and estate taxes and the nuances of naming beneficiaries, some IRA owners choose to empty their IRAs early, pay the taxes, and invest the after-tax assets in taxable accounts. Once out of the IRA, the assets can be given away as part of the estate plan or can be invested for long-term gains.

Emptying the IRA early generally is a strategy for those who have sufficient assets outside the IRA to support their standard of living or have such large IRAs that they consider the IRA primarily a savings account or something to be left to the next generation. If the strategy is used, it is best to empty the IRA as early as possible, because time is needed to make up for paying the income taxes early. I discuss the strategy in detail in my book, The New Rules of Retirement and have discussed it in past issues of Retirement Watch.

For similar reasons, people convert traditional IRAs into Roth IRAs, which also is discussed in those sources.

IRA owners need to know that wills and living trusts have no effect on an IRA. Only the beneficiary designation form on file with the custodian determines who inherits an IRA. IRA owners need to keep copies of the form and review it regularly. They also should check with the IRA custodian to be sure it has the current form on file.

The ABCs and XYZs of Trusts

Bob Carlson — Wed, 06 May 2009 15:17:00 GMT

Trusts are fairly simple. Lawyers and estate planners make them seem more complicated than they are. That’s too bad, because to ensure they have effective estate plans nonlawyers need to understand the different types of trusts and how they work.

Trusts used to be for only the very wealthy or for special situations. But now trusts are included in many estate plans, because they can help achieve so many goals. Almost everyone needs a working knowledge of trusts, and you should brush up on them before the estate tax is changed later in 2009.

A trust is simply a contract with three parties. The parties can be groups, because more than one person can share any of the roles. A person can have more than one role, even all three.

One party to the contract is the grantor or creator. This is the person who wrote the trust agreement and usually puts all the assets in the trust. Another party is the trustee. The trustee agrees to manage the assets according to the terms of the trust agreement and the law. Legally the trustee acts as owner of the assets, but the actions the trustee can take are limited by the trust agreement. In addition, the assets cannot be reached by personal creditors of the trustee.

The third party is the beneficiary. Beneficiaries have rights to receive income or principal or both according to the terms of the trust agreement, and the trust assets are managed for the benefit of the beneficiaries. Sometimes beneficiaries have other rights, such as the ability to change trustees or name who receives their interests after they pass away. Either the beneficiaries or grantor normally can sue the trustee for violating the trust agreement or mismanaging the assets.

Trusts are very flexible. There are few limits to the terms that can be put in the trust agreement. To make their work easier, lawyers have shorthand names for trusts that are designed to achieve specific goals. The tax law also gives names to trusts with certain provisions. The flexibility and different names can make trusts seem confusing.

In general, it is easiest to think of trusts in four categories. In each category there are two possible labels. Most trusts have a label from more than one category and some from each category.

Living vs. post mortem. A living trust simply is a trust created during the grantor's lifetime. A post mortem trust is one created in or as part of the will. A living trust often is given the Latin name inter vivos trust.

Keep in mind a trust can be created but not funded. For example, a grantor and trustee can sign the trust agreement. That creates the trust. But the trust has no effect and there is no business for it to do unless property is transferred to it. It is not unusual for grantors to create trusts then fail to transfer title to any assets to them. Also a trust can be created during life but funded under the will.

When most people hear the phrase "living trust" they actually are thinking of a revocable living trust, which we will discuss next.

Revocable vs. irrevocable. A living trust can be revocable or irrevocable. In a revocable trust, the grantor reserves the right to revoke the trust or change its terms. The right to change might apply to some terms or to all the trust terms. For example, the grantor might reserve only the right to change the beneficiaries but not the rest of the terms. An irrevocable trust is what the name says. Its terms cannot be changed by the grantor after the trust agreement is signed.

A very common trust is the revocable living trust. It is used to avoid probate in states with high probate costs or long probate procedures, especially California and Florida.

Under the revocable living trust the grantor transfers title to almost all his or her property to the trust, including homes, cars, checking accounts, investment accounts, and household furnishings. The grantor and grantor's spouse usually are both the initial trustees and beneficiaries. They generally treat the property the same as they did before the trust was formed, except everything must be in the trust's name, and they manage it as trustees. The trust agreement spells out who succeeds them as trustees and beneficiaries.

Property owned by a trust is transferred to the next generation of beneficiaries under the terms of the trust agreement. A will has no effect, and property owned by a trust avoids the probate process. There is no public recording of the trust, and the trustees do not have to ask a court to transfer title to heirs. Instead, the trust agreement controls. That is why a revocable living trust also is called a will substitute.

There are serious tax differences between revocable and irrevocable trusts. When a grantor creates a revocable trust, the grantor is treated as the owner of the property for tax purposes, and the trust assets are included in the grantor's taxable estate. Income and gains of the revocable trust generally are taxed to the grantor as earned, whether or not money is paid from the trust to the grantor.

Irrevocable trusts can reduce income and estate taxes. When properly structured, irrevocable trust property is not included in the grantor's estate, and trust income and gains are taxed to either the trust or the beneficiary instead of the grantor. While irrevocable trusts can reduce taxes, they really must be irrevocable and the grantor cannot have the right to retrieve the property or be paid the income.

Income vs. total return. The next category refers to how annual payouts to the beneficiary are determined. Traditionally, the income beneficiaries of a trust receive only income earned by the trust's assets. Income generally is defined as interest, dividends, royalties, and rents. Capital gains are not income. They are added to trust principal. A standard trust term is to pay all income to the grantor’s spouse for life. After the spouse's demise, the children receive the remaining trust principal.

The income trust has become less feasible as interest rates declined and the cost of living increased. Income stays the same or declines as the income beneficiary's cost of living rises. The trustee could try to increase income by investing in riskier income vehicles, but that puts the principal at risk. Another tension is the remainder beneficiaries want some of the trust invested for growth. Otherwise, the purchasing power of their remainder interest declines because of inflation. But the needs of the income beneficiary discourage growth investing.

A total return trust solves these problems. The “income beneficiary” is paid either a percentage of the trust assets or a fixed amount. The trustee does not worry about restricting payouts only to income. Instead, the trustee invests for long-term growth with a diversified portfolio. The income beneficiaries can be paid from income, capital gains, or principal. The total return trust is the better way to structure trust payouts today.

Discretionary vs. nondiscretionary. This category refers to the trustee's ability to vary distributions or payouts. In a nondiscretionary trust, the trustee is told in the trust agreement how much to distribute to income beneficiaries each year or how to calculate the distributions. The trustee also is told when to distribute principal and how much to distribute. For example, one third of the principal might be distributed to a beneficiary upon turning age 21, another third at 25, and the remainder at 30.

A discretionary trust allows the trustee to exercise judgment at least part of the time. The trustee might distribute to the surviving spouse all income earned by the trust plus whatever principal or capital gains are needed to maintain the spouse's standard of living in the trustee’s judgment. Or the trustee might be able to withhold any distribution when the trustee believes it is in a beneficiary's best interest, such as when the beneficiary has a substance abuse or gambling problem.

These are the broad ways of categorizing trusts. There are many specialized trusts. There are charitable trusts (several types of them), dynasty trusts, grantor retained annuity trusts, grantor retained income trusts, and many more. These specialized trusts usually are used to accomplish certain goals at a minimum tax cost, and the tax law dictates the details of the trusts. But each of these specialized trusts also can be defined by the categories we discussed. They are specialized trusts within the categories.

Now, you know the basics of trusts. You can intelligently review and discuss estate plan options, know the key questions to ask about a trust and the consequences of the answers. You are ready to put together a more effective estate plan and to avoid having a trust you don't need or that does not meet your goals.

Safe Ways to Give Wealth

Bob Carlson — Fri, 24 Apr 2009 12:49:00 GMT

Gift giving is the surest way to reduce estate taxes, help loved ones of all ages, and establish a legacy. Yet, many people are hesitant to make significant gifts to loved ones, because of some potential pitfalls. Those pitfalls, however, can be avoided with some shrewd and creative giving strategies.

Potential givers see several risks in making substantial gifts. The wealth could be wasted or spent unwisely by the recipients. Simple mismanagement by an unsophisticated heir might cause the money to disappear in scams or unwise investments. The wealth also could be dissipated though gambling, substance abuse, or bankruptcy. A common concern is that part of the wealth eventually could leave the family in a divorce.

While these risks are real, there are ways to give that reduce or eliminate the risks without the expense and inconvenience of trusts. As I have stated in past posts, this is a good time to make estate planning gifts, because asset values are down. Estate and gift taxes are based on the value of property. The lower the value of property is when it leaves your hands, the lower the transfer taxes. The benefits of making gifts today can be reaped while protecting wealth from these and other perils. Consider these strategies for structuring gifts.

529 plans. College savings plans authorized under section 529 of the tax code have become one of the best estate planning vehicles in recent years, while tax law changes have diminished the value of other vehicles. Most states now offer multiple 529 plan options, and any person can set up an account for the benefit of someone else and contribute to it. Contributions qualify for the annual gift tax exclusion, currently up to $13,000 per year. In addition, up to five years' worth of exclusions can be used in one year for a tax free lump sum contribution of up to $65,000. The money given to the account is out of the donor’s estate. Under many state plans the owner has some choices over how the account is invested. The IRS generally restricts investment changes to one per year, though the limit is suspended for 2009.

Income and gains in the account compound tax free. Withdrawals are tax free if they are used for qualified education expenses of the beneficiary.

Some states limit the duration of an account to a number of years or to the 25th or 30th birthday of the initial beneficiary. Others have no time limit.

Direct payment of gifts qualifies for the annual gift tax exclusion. In addition, qualified education and medical expense payments made directly to the provider qualify for unlimited gift tax exclusions.

Purchasing services is safer than paying for assets. Assets can be divided in a divorce or sold or pawned to fund other spending. Another possible disadvantage is that paying for items might put loved ones in the habit of asking for assistance whenever they want something. A better approach is to have a plan in which gifts for the year are discussed and set or even multi-year plans are developed.

Home equity match. Suppose loved ones need an expensive item, but the parents are not able or willing to part with a large lump sum or want to stay within the annual gift tax exclusion limit. A strategy, if the children have adequate home equity and credit, is for the children to make the purchase with a home equity loan. The parents then can agree to make all or part of the loan payments either directly or by sending money to the children. This allows the parents to help the children, stay within the gift tax exemption amount, and spread the payments over time in manageable amounts. The children deduct the interest.

Some parents believe it is important the children have some of their own assets in a major expenditure. The cost sharing makes it more likely that the children will choose wisely and take care of the asset. It also makes the children less dependent on the parents.

Trusts. Of course, the classic way to protect assets is by placing them in trusts. In this post we have offered a number of ways to protect assets without the expense and restrictions of a trust. When the strategies discussed here do not meet the donor’s goals, trusts can be fashioned to accept tax-free gifts, take property out of an estate, protect assets, and provide incentives for the beneficiaries.

Bob Carlson is editor of the monthly newsletter Retirement Watch and the web site www.RetirementWatch.com. He also is author of numerous books and reports, including The New Rules of Retirement and Invest Like a Fox…Not Like a Hedgehog.

Asset Declines=A Planning Opportunity - Part 2

Bob Carlson — Fri, 20 Feb 2009 16:46:00 GMT

Last week we discussed how today’s economic distress creates estate planning opportunities. Because of today’s reduced asset values, estate owners can shift assets out of their estates tax at much lower tax cost than they could have a year or two ago. We went over basic strategies for taking advantage of the situation. This week, let’s look at ways to leverage these strategies.

Family loans. Many families like the concept of loans to family members. If you might need the money in the future, a loan lets you provide benefits to family members now while retaining future access to the wealth. The IRS requires you to charge a minimum interest rate on a family loan to avoid income and gift taxes. The minimum rates are based on treasury debt rates. Because the Federal Reserve has been pushing down short-term rates and investors have been reducing intermediate and long-term rates in the flight to safety, the required minimum rates are low. The rates are changed monthly, and depend on the loan's maturity or term. They are known as “federal applicable interest rates” and are published monthly by the IRS in its Internal Revenue Bulletin.

Family loans are very flexible, but here is how one common strategy works. You lend $100,000 to a child for five years. Let's say the law requires you to charge 2% interest. Your child can invest that money for five years. If the investments earn more than 2% annually, the child keeps that excess return. You receive the $100,000 plus 2% annual interest after five years.

Alternatively, you could lend the money to allow a child to buy a home in today's depressed market. You might set the term of the loan at 10 years. There are several actions the child could take by the end of 10 years. The home could be sold at a profit, with the child keeping the return above the interest rate you charge. Or once the credit markets loosen, the child could refinance the home with a traditional mortgage and return the borrowed money plus interest to you.

The benefits of the family loan can be increased with a variation. If you do not need the money to maintain your standard of living, each year you can use the annual gift tax exclusion to forgive the interest and part of the principal. This shifts the money and future appreciation out of your estate tax free over time while enabling your children to benefit from having the cash now.

In some circumstances a minimum interest rate need not be charged on a family loan if the principal is low enough. I won’t go into the details here. They are available in the members’ section of my web site at www.RetirementWatch.com and also from www.irs.gov.

Grantor retained annuity trusts. Today's low interest rates make these trusts a potentially great opportunity.

The grantor creates a trust that pays a fixed income to him for life or a period of years. After that the remainder of the trust goes to the beneficiaries. The present value of the remainder is a gift. The present value is determined by IRS tables, and current interest rates are a factor in determining the amount of the gift. The lower the interest rates, the smaller the value of the gift. If the return actually earned on the asset exceeds the IRS interest rate, the excess becomes a tax-free gift to the heirs.

A GRAT should be created with assets that are expected to appreciate rapidly within a few years or earn high income. Studies show value is maximized by creating a GRAT to last two years. After the trust expires, consider creating a new trust with different assets.

Charitable trusts. If you are inclined to make significant charitable gifts, consider making them now through a charitable trust. In particular, charitable lead annuity trusts are most advantageous when rates are low.

The CLAT pays income to a charity for a period of years. The payments are either a percentage of the trust’s value or a fixed annual amount. After the income period expires, the remainder in the trust goes to the other beneficiaries, usually the children of the trust creator.

The present value of the remainder for the children is a taxable gift when the trust is created. Again, because of today's low interest rates the taxable gift will be less than at other times. In addition, the combination of low interest rates and low asset values create the potential that the appreciation of trust assets will significantly exceed the income paid to the charity and the amount on which gift taxes were paid. The result could mean a significant amount of wealth is transferred tax free to heirs.

The creator of a CLAT can take a tax deduction for the present value of the gift to the charity. Doing so, however, obligates him to pay taxes on the income and gains of the trust. Foregoing the deduction avoids the taxes on the income and gains. The CLAT is irrevocable. Once created, you cannot get the money back or change the terms of the trust.

Today's low interest rates and decline in asset values present estate planning opportunities. Some of these are straightforward and easy to implement. Others, such as trusts and family loans, should be done only with the help of a tax or estate planning expert. Once the current crises end, the benefits from making the moves now could be significant.

Bob Carlson is editor of the monthly newsletter and web site Retirement Watch at www.RetirementWatch.com. He also is the author of The New Rules of Retirement and Invest Like a Fox…Not Like a Hedgehog.

Taking Advantage of the 0% Capital Gains Tax Rate

Bob Carlson — Fri, 30 Jan 2009 22:21:00 GMT

For the two lowest tax brackets, the tax rate in 2008 through 2010 is 0% for qualified dividends and long-term capital gains. This compares to the 15% top rate others will pay on those types of income. Single taxpayers with taxable income up to around $33,000 and married couples filing jointly with taxable incomes up to about $65,100 qualify for the 0% rate. The 0% rate applies to any long-term capital gains that qualify for the 15% rate for other taxpayers, not to just to gains on publicly-traded stock.

But there is a lot of confusion and misunderstanding about the 0% tax rate.

It is not an all-or-nothing situation. Because the tax rates are graduated, even some taxpayers with incomes above the threshold could have some income taxed at the 0% rate.

Many retired couples have taxable income below $65,100. Suppose a couple normally has taxable income of $30,000. In 2009 they realize a long-term capital gain of $70,000, bringing their taxable income to $100,000. The first $35,100 or so of that capital gain is taxed at the 0% rate. The rest of the gain is taxed at the 15% rate.

Keep in mind that interest from tax-exempt bonds is not counted in determining the threshold, so well-off taxpayers can qualify some or all of their qualified income for the 0% rate.

This situation provides opportunities for low-bracket retirees to realize some long-term capital gains on asset they otherwise might not held and pay a 0% rate on at least part of the gains. There also is an incentive to switch some investments to dividend-paying stocks that qualify for the 15% rate for other taxpayers.

Another opportunity presents itself for taxpayers who are supporting parents in a low tax bracket. The taxpayers could give some appreciated securities to the parents, who sell them and pay 0% tax. The amount given should stay within the annual gift tax exclusion amount of $13,000 to avoid owing gift taxes or using part of the lifetime gift tax exemption.

Gifts of appreciated securities also could be made to children in low tax brackets, but the gifts would have to be made to adult children. Congress changed the law on the Kiddie Tax to prevent high income parents from giving securities to their minor children to sell and pay 0% capital gains taxes. To avoid the restrictions, the children must be over 21, or over 23 if they are full-time students. The restrictions also can be avoided if the children do not qualify as dependents on their parents’ tax return by providing more than 50% of their own support and earning income. Youngsters who do not meet those exceptions must have incomes less than $1,800 to qualify for the 0% rate.

Couples receiving Social Security benefits will have to be careful when executing these strategies. Increasing taxable income through the recognition of long-term capital gains also could make more Social Security benefits subject to income taxes.

In most cases, the additional tax on the Social Security benefits will be quite low and will make the effective tax rate on taking the capital gains just a few percentage points. Even so, one should run the numbers to determine the effect such a transaction would have on the full tax picture.

A taxpayer needs to consider the non-tax picture before plunging ahead to take advantage of the 0% tax rate. There must a reason for selling the asset other than to cash in the gains at a low rate. The difference between the 0% rate and 15% rate is going to be small in actual dollars, especially considering that only the gains below the taxable income thresholds for the lowest brackets qualify for the 0% rate.

Yet, if someone planned to sell the asset in the next few years, needs to reposition a portfolio, or has a new opportunity, taking a look at how to qualify at least part of the gain for the 0% rate is worth doing.

When deciding which assets to sell, one strategy is to sell stocks or other assets with the least amount of capital gains. Normally, with a tax-advantaged strategy one wants to maximize the gains taxed at the low rate. But there is a ceiling on the amount of gain that qualifies for the 0% rate each year. The goal should be to generate the maximum amount of cash at the lowest tax cost. By selling assets with the least appreciation, it is possible to free up more after-tax cash than if assets with higher appreciation were sold. This is a good strategy for retirees who are deciding which assets to sell to pay for their expenses the next few years.

The main problem now for most people will be to find assets that have capital gains in them. But those who have held assets for a long time likely have gains they have not recognized.

The 0% tax rate is tricky. But there are many retirees who qualify for it, and they should review asset sale strategies.

Bob Carlson is editor of the monthly newsletter Retirement Watch and the web site www.RetirementWatch.com.

The Neglected Step: Preparing Your Heirs

Bob Carlson — Fri, 23 Jan 2009 19:17:00 GMT

Many estate plans ultimately fail. The problems are not with the plans. The owners spent a fair amount of time and money preparing and executing the plans. They are sound plans that, if properly executed, would meet the goals.

The problems with many estate plans tend to occur in the final stage. One final stage problem is the heirs are not prepared to receive the wealth. They mishandle it. Or they did not know what was intended, so they do the wrong things. The results are squandered wealth, overpaid taxes, and lost opportunities. Inheritance mismanagement usually falls into one of three categories. Each of these types of mistakes could be avoided if estate owners understand their heirs and take the time to prepare them for the inheritances—or prepare the inheritance for them.

§ Not knowing the rules. Sometimes heirs can reap the full intended benefits of an inheritance only if they know to take certain actions, or to avoid other actions. This often is the case when the tax law is involved, as when an IRA is inherited.

For example, heirs must know not to allow the IRA custodian to retitle the IRA in their names. The deceased owner's name must remain as part of the account name if the heirs want to maximize tax deferral. Heirs also must know when to begin required minimum distributions, how to compute them, and which paperwork to complete. Otherwise, they lose the benefit of the tax deferral. They have to distribute the entire IRA within a short time and pay income taxes on the distribution.

IRAs are not the only area where heirs need to know what to do. They are one major example. Unique assets—businesses, real estate, collectibles—often require special treatment. Or the original owner has unique knowledge about how to maximize the follow of these assets.

An estate plan should ensure that heirs have the advice and information they need to make the right decisions and make them on time. I have long recommended that part of an estate plan include a letter to the executor and perhaps heirs with the basic instructions and supplemented by a notebook containing the appropriate documents, contact information, and any detailed instructions. The executor should know your intentions so these can be explained to the other heirs.

The heirs might not want to follow your advice. They might want to take all the money out of the IRA and spend the after-tax amount, for example. But they should do so knowing the alternatives and fully considering them.

§ Inheritance as a shrine. Some heirs will not use, change, or spend an inheritance. They view it as a legacy their loved one intended or as a memorial of the loved one. They come to believe that any change of the inheritance is a sign of disrespect or a loss of the final connection with their loved one.

Heirs in his mindset might be unwilling to make any changes in an investment portfolio. If they inherited a portfolio overloaded with a particular stock, they feel obligated to hold all the shares of that stock regardless of what is happening with the company. The company might be well past its growth phase and in decline. But the stock is considered the family legacy and not to be sold. Or they believe that the entire portfolio was never supposed to be changed. As the markets and the securities in the portfolio experience changes, the heirs will not allow any changes.

The truth is that many people do not sell long-term holdings during their lives because they do not want to pay the capital gains taxes. They know when heirs inherit they get to increase the tax basis to the current fair market value and can sell without paying taxes. But they do not communicate this to their heirs, so the heirs think the asset had some special value or meaning.

The same attitude might be taken towards assets such as real estate or collectibles. The heir might inherit the family vacation home. Perhaps the heir cannot afford to own and maintain it or does not have the time or money to visit it very often. But he or she believes it would be improper to sell the home. So instead of being a valuable asset it is a cash drain that produces neither financial nor personal benefits.

Once again, the solution is to make clear your thoughts about an asset and your advice. There are few assets that you should expect heirs to hold indefinitely and pass to their heirs. Assets that fall into that category should be clearly identified. You should explain why the asset is unique and should be held, so heirs can tell when circumstances have changed. You also should leave enough other assets so the heirs have sufficient income to pay any costs of ownership. If the heirs do not have the knowledge to properly manage inherited assets, such as an investment portfolio, recommend one or more sources of advice to guide them. Do not let your inheritance to them become a burden.

§ The windfall mentality. There are some people who, after receiving a windfall, do not feel the need to manage it for the long term. They view it as found money that should be used to justify taking higher risks, satisfying short-term desires, or purchasing items they would not buy with their own income or assets. Heirs with these attitudes usually go through an inheritance fairly quickly and spend it in ways that provide little for the future other than memories.

If you do not mind your loved ones treating their inheritance this way, there are no steps you need to take. Leave them what you have and let them do as they please.

You might know your loved ones well enough to realize that they will not take a windfall mentality with their inheritance. Some people are reassured after discussing the issue with loved ones and reiterating their hopes in a letter to heirs.

If you do not want the inheritance treated as a windfall and do not feel assured that your heirs will manage it properly, consider a trust. The trust can limit the spending of the heirs and preserve the assets for the future.

The bottom line is if you have intentions or preferences concerning an inheritance, you should say so. Either discuss it with your heirs now or state it in a letter to them as part of your estate plan.

Some good advice to give heirs is that they first should use an inheritance to eliminate their debts. Next, the assets should become part of their retirement fund or their children’s college funds. If they are well-funded for retirement, they can consider spending it in other ways. But providing a comfortable retirement should be their first use. If the inheritance is spent, the preference should be on items that increase wealth instead of on depreciating items that temporarily enhance life style. If you are leaving IRAs or either tricky assets, be sure the heirs are properly advised on the tax implications and other decisions.

Finally, whatever assets you leave try to ensure they are managed properly. If your heirs do not have enough knowledge, recommend some trusted advisors who can steer them toward good decisions.

Bob Carlson is editor of Retirement Watch and www.RetirementWatch.com where this article originally appeared. He also is the author of The New Rules of Retirement and Invest Like a Fox…Not Like a Hedgehog.

Trustee Strategies for the 21st Century

Bob Carlson — Fri, 16 Jan 2009 17:04:00 GMT

Trusts are part of more and more estate plans. Often trusts are used to hold and manage assets for younger generations.

Sometimes the beneficiaries are too young or inexperienced to manage the assets. Other times the older generation is afraid the younger generation might not resist temptations to spend direct gifts.

The success of an estate planning strategy involving a trust often hinges on the choice of trustee and the structure of the trustee’s job. The intentions of many estate plans have been stymied when the wrong trustees were appointed. A trustee can ignore or misunderstand a trust grantor's intentions. Or after a professional trustee or trust company is appointed, the original professional trustee might disappear in a series of promotions, job shifts, or corporate mergers. The new trustees are not as well-versed in the trustor’s intentions. Changing trustees is an increasingly common problem with all the havoc in the financial services industry.

Trust grantors need to give as much consideration to the choice of trustee as they do to the other details of the estate plan.

One strategy becoming more and more popular is to appoint more than one trustee or to divide the trustee duties among two or more trustees. There are different ways to use this specialization approach.

The original way to divide duties among trustees was simple. An institutional trustee would be appointed to handle the administration and "back office" duties. This trustee would retain custody of the assets, implement the investment transactions, prepare tax returns, and perform other duties of this type. The other trustee often would be a family member or trusted advisor to the family. This trustee would decide on the amount of distributions and make investment decisions or hire investment advisors.

A variation is to appoint co-trustees, usually one family member and an institutional trustee. The trustees have equal power. No action can occur unless each trustee agrees to it. In practice, the institutional trustee defers to the family member on issues of distributions and sometimes on investment strategy. The family member reviews the tax returns and other documents but defers to the institution on their preparation.

Still another variation is to appoint a committee of at least three trustees, usually selected from family members, friends or advisors, and an institution. The trustee agreement might require unanimity for any decision or allow an action to proceed after at least two trustees agree.

More recently, trust creators have been carving the trustee duties into separate compartments or roles and appointing a separate trustee for each role. Each trustee has sole authority over his or her sphere of responsibility.

The most logical division of duties is: investments, distributions, and administration and recordkeeping. The administration and recordkeeping (which includes custody of the assets) normally is assigned to an institutional trustee. Sometimes an account is opened with a broker or mutual fund, and the family CPA handles the taxes and recordkeeping. The other two functions can be assigned to either individuals or to committees of trustees. A committee of family members, perhaps with a third party such as a family advisor, might determine distributions. Another committee or perhaps a trusted financial advisor can make the investment decisions or hire investment managers.

The functions also could be split among institutions. A money management firm could be the trustee that oversees investments, while a bank or trust company could be in charge of custody, administration, and recordkeeping.

A variation is to appoint one or more persons as trustee with oversight of one of the functions, but the trustee is allowed to hire or delegate to others the actual performance of the functions. For example, a person or committee could be the trustees who oversee the trust's investments. Instead of making the individual investment decisions, they could hire money managers or consultants or otherwise delegate the details of the portfolio. Delegation does not relieve the trustees of their fiduciary responsibility for the results. They have to hire carefully, monitor the performance, and make changes if performance is unsatisfactory.

The advantage of splitting the trustee duties is specialists oversee each function. An institution likely is best at administration, custody, and tax preparation. Family members and friends probably best know the grantor's intentions regarding distributions. Specialization of investment management should reduce risk and increase returns.

There also are disadvantages with splitting trustee duties.

Costs are likely to increase with multiple trustees. Friends and family members might serve without compensation. Institutional trustees, however, often offer lower fees for a package deal that includes all trustee duties. They won't proportionately reduce costs to perform only the administration, custody, and recordkeeping, for example. An investment specialist firm also might or might not charge more than an institution would to manage the portfolio.

If something goes wrong with the trust the legal ramifications of dividing trustee duties are not settled. It is important to delineate each trustee's duties and responsibilities in the trust agreement. This could increase the cost of creating the trust. Part of the agreement should include a dispute resolution procedure that eliminates or reduces the risk of court action or of actions not being taken because trustees cannot agree.

Several states have changed their laws to encourage split trustee duties. Delaware, South Dakota, and a few others have laws establishing what they call "directed trusts" that allow a split in trustee duties. Under these laws, trustees in one area are not liable for improper actions of trustees in the other areas.

Income taxes also might rise with multiple trustees. A trust is considered resident in the state where the trustee resides. If there are multiple trustees and they reside in more than one state, each state might claim the trust as a resident and impose income taxes. Research on the issue is needed before trustees are selected.

An increasingly popular tool is to appoint a trust protector. This function is common in foreign trusts and recently made its way to the U.S. A trust protector is not a trustee but is a third party who oversees the trust and trustees and has broad power to protect the trust. The protector may remove and replace a trustee, change the trust's home or situs, resolve disputes between co-trustees, veto investment decisions, change trust distributions, change trust terms under unforeseen circumstances, resolve disputes between trustees and beneficiaries, or even terminate the trust.

Not all states have laws recognizing or defining the protector role. There are unresolved issues such as: What are the trustees' roles when the protector has such broad powers? Who, if anyone, oversees the protector? There also needs to be a mechanism by which a successor protector is appointed.

Trustees can mean the difference between the success and failure of an estate plan. Today, trust grantors have far more options than they did only a few years ago. They must carefully consider not only the choice of trustees but also the structure of the job.

Four Estate Planning Mistakes to Avoid

Bob Carlson — Fri, 19 Dec 2008 20:03:00 GMT

Estate planning and tax reduction will be returning to the front burner for many people. Congress was unable to pass a permanent estate tax reduction in recent years, but a permanent law is likely in 2009 or 2010.Changes in Washington made permanent repeal of the estate tax unlikely, but something similar to the law as of 2009 is likely to be permanent.

As readers re-focus on their estate plans, they should take care to avoid the four main types of errors committed by estate owners. These errors do not concern taxes or probate. The most common mistakes involve family dynamics. These mistakes either create harmful relationships within the family or lead to mismanagement of wealth. Even an estate plan that eliminates taxes can fail if it does not avoid these mistakes.

Giving too soon. Many estate owners allow heirs full access to their inheritances when they become adults or shortly thereafter. Some parents or grandparents reason that the heirs are adults. They can drive, vote, and join the military, so they should be trusted with their inheritances. Others believe the heirs have shown themselves to be responsible and will be able to handle the inheritance.

Being mature and responsible is not the same thing as being able to handle a relatively large sum of money. Young adults, even mature ones, rarely think about the long term, or they might treat something given to them differently from the way they treat something they earned.

Some parents and grandparents say they aren't concerned about what happens to their wealth. They are going to give the money to the people they want to have it. Whatever happens to the wealth is not their concern.

Yet, giving an inheritance too soon can be bad for a young person. The heir might believe that the money will last forever and neglect career opportunities or engage in some personally destructive behavior.

The damage from giving money too soon is most likely when the young person has not been involved in discussions about money with the older generations and has not learned how to handle money. Parents and grandparents should realize that managing an allowance is not similar to investing an inheritance and establishing a long-term spending policy. Estate owners need to take care before giving a young person unrestricted access to wealth.

Giving too late. Some estate owners will not make lifetime gifts, no matter how financially comfortable they are. This can create several problems. One problem is that children or grandchildren might not receive anything until they are nearing their own retirement. Receiving the wealth earlier, or at least being certain of receiving it, might have changed life decisions. The wealth could have helped enhance their lives and those of their children. More importantly, giving only through the will leaves the children to manage the estate at the same time they are coping with their grief.

At a minimum, parents and grandparents should discuss their plans with the heirs. The heirs should be given some idea of what they will inherit, when they will receive it, and suggestions about how to handle it. Ideally, children receive portions of their inheritance over time so they get used to it and learn how to manage it.

Too many controls. Some people like to give and retain control at the same time. The classic way is to leave wealth to a trust with controls and incentives. These trusts can be beneficial. They encourage young people to stay in school or hold jobs in order to benefit from the wealth. They also spread out distributions, so people become comfortable with the wealth and learn how to manage it. But the trusts also can go too far.

An incentive trust might penalize someone whose passions do not include higher education or a high-paying job. Or the trust might be written so narrowly that it does not take into account a number of situations that could arise. Some trusts actually are written so that beneficiaries feel encouraged to have additional children. Restrictive trusts also can breed hostility and frustration among the heirs as they get older and realize their parents or grandparents did not trust them to act responsibly.

Incentive trusts can be useful in some situations. But their creators must carefully consider the incentives and how the trust will be administered. An incentive trust generally should be a way of safeguarding assets until the heirs are likely to be mature enough to manage the money. It should not be a way to control people for life or be a substitute for imparting values during life.

Giving too much. Warren Buffett used to say that his goal was to give his children enough money that they can do anything but not so much that they can do nothing. In some estates, the children receive the entire estate without real consideration of other options, including other family members or entities outside the family, such as charities.

If the children have done well on their own, it might be better not to give them everything. Or if the children simply are not responsible, they might be better off with a relatively small inheritance.

There can be benefits to both the family and the estate owner from considering several generations and beneficiaries outside the family when there is enough wealth involved. For example, the charitable contributions can be structured in ways that get the heirs involved in the giving and teach them about philanthropy.

Giving unequal amounts. There is another problem in some estate plans that is not really a mistake but needs to be carefully managed. Estate owners need to be careful when giving unequal amounts to children.

There can be good reasons to give unequally. Perhaps a child has done very well financially and does not need the wealth. Or one child might have demonstrated that he or she cannot be trusted with an inheritance. But unequal inheritances can create hard feelings toward the parents. They also can create animosity and jealously among the siblings. The situation can be more inflamed when there is a family business. Often, one or more siblings are not qualified to have a significant role in the business, or the parents believe that one person needs to be in control.

Most of these problems can be minimized through communication. Parents and grandparents need to make their plans known ahead of time. This gives everyone a chance to become familiar with the plan and allows for questions and discussion. It also gives a child or grandchild the opportunity to demonstrate that the plan is wrong.

Some estate planners recommend having social workers or psychologists help with the discussion, having the discussion moderated by the estate planner, and even videotaping the discussions.

One goal of estate planning is to get assets to the intended beneficiaries in an efficient way. But this should be done in ways that do not harm family members or make family relationships worse. It can be done in ways that improve family dynamics.

Bob Carlson is editor of Bob Carlson's Retirement Watch and author of The New Rules of Retirement and Invest Like a Fox...Not Like a Hedgehog. This posting is adapted from materially previous published in Retirement Watch. www.RetirementWatch.com

A Fresh Look at Family Limited Partnerships

Bob Carlson — Fri, 26 Sep 2008 18:29:00 GMT

Family limited partnerships have been a key element in many estate plans for decades. The FLP provides an array of benefits to the estate owner, not the least of which are tax reduction plus continuing control of the assets. Those benefits and the popularity of FLPs are why the IRS has been fighting FLPs. Taxpayers won some cases and lost some others, making the status of FLPs uncertain for a number of years.

The tax law regarding FLPs has fluctuated, but there now are enough court cases decided to develop a road map for securing the benefits of an FLP.

An FLP is flexible and the details of the structure can vary with the needs of each estate owner and family. In the standard FLP, the estate owner creates the FLP and transfers assets to it in return for the limited partnership shares. In the past it was common for the estate owner also to be the general partner and run the partnership.

All or a portion of the limited partnership interests then are transferred to others, usually the estate owner's children and grandchildren. The transfers can be by gift or sale. There are many ways to make the transfers, so the transfers can be structured to fit the family’s situation.

The tax advantage to the FLP is known as the minority or control discount. Under partnership law, the general partner controls most actions of the FLP; limited partners have few rights. As a result, the value of a minority interest is less than its proportionate share of the value of all the assets held by the FLP. Discounts range from 30% to over 50%, depending on the types of assets held by the FLP.

The discount means that the estate owner can transfer assets to the children at a much lower gift tax cost. Instead of giving assets directly to the children (or to a trust for their benefit), the owner transfers the assets to the FLP. Then, the owner transfers the limited partnership interests to the children. The minority discount applies to the FLP interests but would not apply to straight gifts of the assets.

The minority discount also means that any limited partnership interests held by the estate owner at death receive a discount when the estate tax is computed.

By holding the general partnership interest, which usually has only 1% ownership in the FLP, the estate owner also is able to retain control over the assets.

It is easy to see why the FLP is a popular estate planning tool and why the IRS is opposed to it. The IRS has had some success in the courts, but it also has lost some cases. The recent court cases give us a checklist of how to secure the benefits of the FLP. Ensure that your FLP meets these requirements, and it likely will pass muster with the IRS and the courts.

Economic purpose. The key requirement is that there must be one or more substantive nontax reasons for creating the FLP. If the only reason for creating the FLP is to use the minority or control discount to reduce taxes, all the assets in the FLP will be included in the owner’s estate.

Most of the cases the IRS won involved very elderly people who were either terminally ill or mentally impaired when they created or transferred assets to their FLPs. The FLPs were established within months or less of their demise, and often the actions to create the FLP were taken by an adult child exercising a power of attorney. The only reason the courts saw for the creation of these FLPs was to reduce taxes.

There are nontax reasons for creating an FLP the courts will recognize. Providing asset protection from either creditors or potential divorces of the children is a good reason. An FLP also can be an efficient way to shift ownership and management of assets to the next generation. Putting family assets in one entity also can result in more efficient and lower cost management.

These all are nontax reasons that are accepted by the courts. Some estate planners now recommend stating the nontax reasons in either the documents creating the FLP or in the minutes of the initial partners meeting.

Proportionate contributions. Some FLPs were established by simply creating limited partnership interests for the children. The children contributed little or nothing for their interests. A partner should contribute property roughly equal in value to the ownership interest received. That is why the standard arrangement is for the parents to contribute property in return for all the limited partnership interests. Then, the parents give or sell limited partnership interests to the children. Estate planners now prefer to have the children contribute assets in return for partnership interests. This also bolsters the case that a nontax reason for creating the FLP was to consolidate management of family assets.

Respect the entity. Some FLP creators had the paperwork setting up the FLP completed but afterwards did not follow the legal formalities. They continued to treat the assets as their own, did not hold partnership meetings, and did not establish ownership of assets in the FLP's name. Some used the FLP checkbook to pay their personal expenses. If you do not follow the formalities of the FLP, the IRS and the courts will not recognize it either.

Proportionate distributions. Related to respecting the entity is to treat all owners equally. Some FLP general partners distribute assets and cash to themselves as they need the wealth. The limited partners receive little or nothing during the general partner's lifetime. The court cases make clear that any distributions should be proportionate to the ownership interests of the partners.

Retain personal assets. In the court cases lost by the taxpayers, the parents contributed everything to the FLPs, including their personal residences and checking accounts. Thus, they used partnership assets to pay for their day to day living expenses. For the FLP to be respected, the creators must retain their personal residences and enough assets to pay living expenses. Partnership assets must be used to benefit all partners.

Limit control. The early FLPs allowed the parents to be general partners and to exercise complete discretion in management of the assets. While most state laws allow that, the courts considering the tax results of FLPs now frown on that arrangement. Some estate planners believe the parents should have no control or at least no greater voting rights than the other partners. Alternatives to the parents as general partners include a sibling, adult child, business colleague, or a trustee of the family trust. Another option is to have one spouse transfer most of the assets to the FLP while the other is the general partner. Because of the new rules on control, FLPs now are more appealing to retiring business owners than those who still plan to be active in the business.

FLPs still are very viable estate planning tools. But estate owners must respect the limits developed in the court cases and cannot continue treating the partnership’s assets as their personal property.

Avoiding IRA Inheritance Disasters

Bob Carlson — Fri, 19 Sep 2008 17:31:00 GMT

IRAs are supposed to be simple, but when it comes to inheritance IRAs are more complicated than most people realize. It is not unusual for IRA heirs to misunderstand some key rules. A wrong move or two triggers high taxes, often causing most of the IRA to end up with the IRS. Income taxes can take 35% or more of the IRA. Estate taxes can take another chunk.

Part of your estate planning should ensure that your heirs know what to do — and what not to do — with the IRA. Don't expect that they will get good advice from the IRA custodian, or just any accountant, or financial professional. We are in the early stages of the first generation to inherit IRAs, and many advisors are not up to speed on the rules. IRA custodians are not in the business of advising beneficiaries or their best moves. You need to get good advice and pass it on to your heirs.

Here are the key inherited IRA mistakes and how to avoid them.

Disappearing documents. Your will or living trust has no effect on an IRA. Only the beneficiary designation on the form held by the IRA custodian determines who inherits the IRA. IRA owners often make the mistake of not designating a beneficiary or not updating the form after a beneficiary passes away. Another common mistake is the heirs’ misplacing or not being able to find the designation form. They have to depend on the custodian to have a current copy. Custodians don’t always have a copy, especially if it was filed many years ago or the original firm has merged one or more times.

In any of those cases, the custodian's rules (if it has any) determine the beneficiary. It might be your estate, which is the worst result from a tax standpoint. Or it might be a spouse when you intended the IRA to go to your children.

Keep copies of your beneficiary designation forms in a file that is easy to find, and keep the designations up to date. Let your executor and heirs know where the forms are.

Ignoring spousal benefits. When a surviving spouse inherits an IRA, a special option is allowed.

One option is for the inheriting spouse to treat the IRA the same as any other beneficiary can. Or the spouse can roll over the inherited IRA into a new IRA in his or her own name. The rollover allows the surviving spouse to start a new required minimum distribution schedule based on his or her own age. It also allows the spouse to name new beneficiaries.

The rollover often allows the IRA to last longer both during the spouse's lifetime and when his or her beneficiaries inherit the IRA. Without the rollover, required distributions must begin soon after the IRA is inherited and might use a shorter distribution schedule than the spouse could establish under a rollover.

If the inheriting spouse is under age 59½, however, and needs to begin taking withdrawals from the IRA, then a rollover would not be a good idea. Distributions before age 59½ would be subject to a 10% penalty in addition to income taxes. But the 10% penalty does not apply when the RMDs come from an inherited IRA that is not rolled over.

Your spouse should know that he or she has options, and the consequences can be very different. Ensure that a good advisor is available to your spouse or leave some suggestions and guidelines for the spouse to follow.

Rolling over an IRA or changing the title. Non-spouse beneficiaries don't have the same options as surviving spouses. For example, if your children inherit the IRA and roll it over into their own IRAs, then the entire inherited IRA would be fully taxable. The children would be treated as though the inherited IRA were distributed directly to them in cash. They might also owe a 6% excess contribution penalty for each year the money sits in their IRAs. If they roll over the inherited IRA to new, separate IRAs in their own names, they will owe only the income taxes.

Yet, many IRA custodians simply ask the heirs what they want to do with the IRA and don’t explain fully the consequences of the actions.

To prevent immediate taxation, an inherited IRA must be maintained, but it must be retitled by Sept. 30 of the year after the year of the original owner's death. The new title must have the name of the deceased followed by "deceased" or "decedent." Also included must be the beneficiary’s name and statements that the account is "for the benefit of" or "FBO" of the beneficiary and that it still is an IRA. For example: Max Profits, deceased, IRA FBO Hi Profits, beneficiary.

Spending down the IRA. Despite all their parents' planning, an extremely high percentage of nonspouses who inherit IRAs take the balances as lump sums and spend them. That's too bad. The heirs will pay income taxes on the entire balances. The amount they have left to spend depends on their income tax brackets and your estate tax bracket. In most cases, it is a fraction of the IRA’s original value.

Instead of spending the IRA on whatever their current needs are, heirs should let the IRA continue to compound tax deferred. They would end up with significantly more wealth than they would by taking a distribution. It probably even makes sense for the heirs to suspend their own 401(k) and IRA contributions or other savings to free their own cash instead of taking distributions from the IRA.

If your beneficiaries are likely to spend the entire IRA after inheriting, consider leaving them other property if you have it. It would be better to leave the IRA to other beneficiaries or charity. Heirs that plan to spend the inheritance quickly are better off receiving non-IRA assets, if that option is available to you.

Inheritors of IRAs who do not spend the balance right away must begin taking required minimum distributions over their life expectancies. The RMDs have to begin by Dec. 31 of the year following the year of the previous owner's death.

Some heirs fail to begin taking the RMDs, so they pay penalties. Others take the RMDs under the wrong schedule and take larger distributions than they need to. Be sure your heirs who will not spend the IRAs have good information about how to determine the RMDs that will stretch the IRA the most.

Overlooking the tax deduction. Distributions from an inherited IRA are what the tax code calls income in respect of a decedent. This status entitles the recipient to an income tax deduction for the portion of the estate tax attributable to the IRA. Determining the deduction can be complicated. First, determine the amount of the estate tax paid that is attributable to the IRA. Then, the duration of the IRA distributions is estimated. Finally, a pro rata portion of the tax is deducted each year that a distribution is taken. Details are in IRS Publication 3920.

Not splitting the IRA. Until 2001 and 2002 changes, when multiple beneficiaries inherited an IRA most of the time they had to share the IRA. That meant making joint investment decisions and computing required distributions based on the age of the oldest beneficiary.

Now, an inherited IRA can be split into separate IRAs for each of the beneficiaries. Then, each beneficiary makes individual investment decisions and takes required distributions based on his or her own life expectancy.

If splitting an IRA is what your heirs are likely to do, then check with your IRA custodian. Though the tax law allows IRAs to be split, the custodian doesn’t have to allow it. Be sure the custodian will allow a split and will not charge fees or penalties for the split. If it won’t, move the IRA to another custodian now.

Also, be sure your heirs know their options, the consequences, and the deadlines.

IRAs are the prime assets in many estates. They are surprisingly complicated financial accounts — especially when it is time to take distributions. Few people know how to handle them. Be sure your beneficiaries have the information they need to make the right decisions.

Simple Steps to Shield Assets

Bob Carlson — Fri, 25 Jul 2008 14:26:00 GMT

Lawsuits, accidents, and other unexpected events can put personal assets at risk of loss. Protecting assets from these and other potential losses is a prime goal of many people. While expensive asset protection packages are available from various finance professionals, there are much simpler ways to protect most assets that should be implemented before considering the more elaborate plans.

When evaluating asset protection strategies, the differences between federal and state laws are important.

Federal law for the most part covers only federal bankruptcy court actions. In other claims on assets, state law will determine whether or not an asset is protected. The exception is employer pension plans. The Employee Retirement Income Security Act of 1974 provides that most pension plan assets are protected from creditors of the participant regardless of state law.

Each state sets its own laws on asset protection. While there are some general principles and strategies, before implementing a strategy a check of state law is required. For personal assets, the state of the owner's residence usually determines the protection, while the state where real estate is located often controls its destiny.

Retirement plans: As mentioned above, ERISA protects employer-sponsored retirement plans from being reached by creditors. This protection covers traditional defined benefit plans as well as 401(k) plans.

IRAs receive limited protection under ERISA, but have wider protection under federal bankruptcy law. An IRA that consists of a rollover from a 401(k) account has unlimited creditor protection. Otherwise, up to $1 million in an IRA is exempt from creditors. Because contribution limits to IRAs have been fairly low, it is unlikely that a contributory IRA (one that does not contain a retirement plan rollover) will exceed $1 million.

Unfortunately, the IRA protection applies only in federal bankruptcy actions. In any other action involving a creditor and an IRA, state law controls. Some states exempt IRAs completely from the reach of creditors. Others protect IRAs up to a ceiling amount. There also are a few, such as South Carolina, that allow the courts to protect IRAs “to the extent that justice requires.”

Strategy: Maximize the use of 401(k) plans and other employer-sponsored retirement plans. Check state law to learn if IRAs are protected.

Joint ownership. In many states owning property jointly protects all or half the asset from creditors. In states that recognize ownership as tenants in the entirety, the asset is protected from creditors of either spouse. Only real estate owned by a married couple can be owned as tenants in the entirety.

Don't overdo joint ownership. Joint ownership has estate planning disadvantages, especially tax disadvantages. Joint ownership also can invalidate parts of a prenuptial pr postnuptial agreement.

Strategy: Consider joint ownership for select assets, but only in consultation with an estate planner.

Insurance products. In many states, annuities and the cash value of life insurance policies are exempt from creditor claims. Someone concerned about lawsuits or creditors seizing assets can do a portion of his or her investing through these products instead of taxable accounts. Their disadvantages include higher costs, limited investment options, and the possible conversion of capital gains into ordinary income.

Strategy: Move some investments from unprotected taxable accounts to appropriate insurance contracts.

Homesteads. A primary residence receives some degree of exemption from creditors in almost all states. A few states, such as Texas and Florida, provide generous exemptions, while others put a ceiling on the value of protection for homes.

Strategy: Learn your state's homestead exemption. If it is low, consider moving to a state with a higher exemption. If it is high, consider the feasibility of purchasing a more valuable home to exempt more wealth.

Mortgages. A home or other property can be encumbered by debt, reducing its appeal to potential creditors.

Strategy: Borrow against property and give the cash proceeds to family members or use it to buy property with greater asset protection.

Land trusts. These are recognized in the statutes of only six states but provide privacy and asset protection when available. Like other trusts, assets they hold usually are exempt from creditor claims of a beneficiary. In addition, often nothing other than the trust name needs to appear in the public record, providing a level of privacy. Some states allow their land trusts to be used by non-residents if a state resident is trustee.

Strategy: If available, transfer real estate to a land trust.

LLCs. The limited liability company provides strong asset protection in most states. Many asset protection attorneys recommend LLCs as an essential tool. An alternative is the family limited partnership. A creditor, even if it succeeds in gaining an ownership share of the LLC (or limited partnership) usually cannot force distributions, sales, or other transactions. The LLC also can help achieve other goals, such as providing a way to bring family members together to manage assets and create a succession process. A caveat is that all procedural rules and formalities must be followed for the LLC to be recognized as the property owner.

Strategy: Transfer key assets to an LLC. A separate LLC can be created for each asset, a recommended strategy for business assets and real estate.

The umbrella. A basic form of significant protection is insurance. Homeowner's and auto insurance provide some liability protection. A personal umbrella liability policy broadens that coverage, and $5 million of additional coverage usually can be obtained for a relatively low cost. This coverage will protect assets against claims from accidents and some personal acts, and the insurer will pay for the attorney in many cases.

Strategy: Be sure a generous personal umbrella liability policy is in place.

There are basic strategies that provide meaningful asset protection. Someone with assets of $5 million or more at risk might want to consult with an asset protection specialist and consider a series of asset protection vehicles, even offshore trusts and LLCs. Most people, however, can create security with the tools discussed here.

Planning is the key element of any asset protection strategy. Courts often ignore actions that occurred after a creditor's claims already were apparent. For any strategy to be effective, it must be implemented before there is a clear threat of losing assets.