Estate Deep Dive

What is an estate plan?

If avoiding chaos is a priority, a core estate plan can help ensure your affairs are addressed on your terms. A well drafted estate plan identifies what happens in the event of your death but also addresses what you want in the event you are still alive but unable to make decisions for yourself.

Here is a deep dive into the components of a core estate plan:

• ‍ Last Will and Testament – Everyone should have a Will unless they really like their state’s laws of intestacy. If you are not concerned about probate, the Will could be your primary estate transfer instructions. If you are working with a lawyer and creating a trust-based plan, you will still have a Will. With a trust, the Will will likely be integrated into the plan to direct any wayward assets into the trust.‍
• Durable Power of Attorney – A durable power of attorney allows someone else to make legal and financial decisions on your behalf in the event you can’t. It will hopefully be unnecessary but is very beneficial in the event it becomes needed. A lot of estate planning is making unforeseen situations less unpleasant if they happen, which is exactly what this does.‍
• Health Care Power of Attorney – The health care power of attorney is the same idea as the power of attorney above, but specifically for health care decisions. This can be the same person as your legal power of attorney or someone different. The standard legal power of attorney appointment does not cover health care decisions, so it is important to make sure you have POA for both legal and health care decisions.‍
• Living Will – A set of instructions on your preferences for medical care, specifically around circumstances when you have a terminal condition or are in a persistent vegetative state. Combined with the health care power of attorney, this is sometimes called an “Advance Medical Directive.” Again, unlikely to actually be used, but if it is needed, it helps make a bad situation a little less distressing.‍
• Beneficiary Designations – These are the special pre-set instructions that allow assets like IRAs and life insurance to bypass probate. They are not new documents to be created, but already exist if you have this type of account. It is important to make sure that the beneficiary information the administrator has on file reflects your current estate planning wishes.‍
• Revocable Living Trust – If you want to avoid probate, the revocable living trust will likely be the primary set of estate transfer instructions. The main question is when not to  set up a revocable living trust. If you don’t have many assets, it may make sense to wait and upgrade to a revocable trust later. If you have a lot of assets, it may make sense to put them into a revocable trust now and begin to evaluate irrevocable trusts. If you are unsure if you need a living trust or a Will, gauging your reaction to your heirs having to go to court after your death to get their inheritance can be helpful. If your reaction is along the lines of, “Well, I don’t plan to die, so even if I did, my heirs having to go to court to get their windfall money doesn’t seem that bad,” you can probably stick with a Will-only plan. If your reaction is along the lines of, “That would be really bad. I don’t want them to have to spend time in court just to get the money that I want them to have,” then you should probably create the revocable trust now. Framed slightly differently, a revocable living trust is some work now, a little work for the rest of your life, and then it saves your heirs a ton of work. A Will is a little work now, no work for the rest of your life, and then a ton of work for your heirs. If you don’t mind potentially leaving unpleasant work to your heirs, a Will is the more efficient choice. However, if putting in some effort today to save future efforts by your heirs strikes you as a smart thing to do, a revocable living trust is the way to go. And remember, once you’ve made your revocable living trust, you aren’t done estate planning. You will need to adjust your plan as your life circumstances change. Eventually irrevocable trusts may make sense, and depending on your age, assets and goals, they may make sense immediately.

A lot of estate planning is staged on the premise that “if an unexpected bad thing happens, it can be a little less bad”. If you end up on life support after an accident, your loved ones don’t have to struggle about what you would want because you’ve already told them in a legally recognized way. If you die unexpectedly, your loved ones don’t have to pay out of pocket for your funeral and then struggle in court for years to become the beneficiaries of your assets. Most of these insurance-type preparations never actually come to use, at the end of the day that’s a good thing as it means you're still with us!

You have a core estate plan - what’s next?

For some, estate planning may need to evolve to a more “active” side of planning for legal structures you put in place ahead of your death. We define these active planning structures as advanced estate planning techniques. Advanced estate planning techniques are generally best for those who benefit from planned giving, gifting, asset protection, or those seeking to minimize their estate tax obligations. Advanced estate planning techniques assume your eventual death and estate tax planners identify solutions to shift assets out of your estate into most commonly an irrevocable trust or legal business formation with the intent of minimizing your projected estate tax liability. 

A key distinction for understanding trusts is the difference between revocable and irrevocable trusts. The names are fairly useful here, but don’t give a complete picture. A revocable trust can be “revoked” by the trust’s grantor alone; an irrevocable trust cannot be “revoked” by the grantor alone. “Revoke” meaning cancelled or annulled. A grantor is the person that puts the money/assets into the trust. This person is also sometimes referred to as the settlor. They are the person that initiates the trust to happen in the first place. One way to think of it is that revocable trusts are two-way doors, and as the grantor, you can go back and forth, cancelling or changing the terms. An irrevocable trust is more of a one-way door for the grantor; once you go through, you cannot easily go back. If you set up an irrevocable trust to benefit your brother, you can’t alone go back later and change the beneficiary to your partner. With an irrevocable trust, the transfer has already happened. Your brother would have to agree to be removed as beneficiary to unwind things from this point. Because it was an irrevocable trust, you as grantor no longer can unilaterally change things. 

What benefit do irrevocable trusts offer? Why give up control and flexibility to make alterations to your estate transfer design? The main reason is estate taxes. Asset protection can be another. In general, when working with assets that may appreciate significantly over a short period of time, the sooner the estate planning work begins, the greater the taxes that could potentially be saved. 

Currently in the United States, estate taxes are levied at up to 40% on the assets in an estate above a threshold known as the Lifetime Estate & Gift Tax Exemption amount. The exemption amount in 2025 and 2026 is $13.99M and $15M respectively ($27.98M and $30M for a couple). In essence the federal government says, if you die with under $13.99M no estate tax applies, however if you die with more wealth, estate tax will apply to amounts greater than that threshold. 

Within advanced estate planning, an alphabet soup of strategies exists, some common and not made-up examples include: SCIN, CST, QTIP, ILIT, FLLC, FLP, IDGT, QPRT, GRAT, PIF, CRT, CLT, SLAT. The alphabet soup has been further delineated below:

• Self Cancelling Installment Notes (SCIN)
• Credit Shelter Trust (CST)
• Qualified Terminable Property Trust (QTIP)
• Irrevocable Life Insurance Trust (ILIT)
• Family Limited Liability Company (FLLC)
• Family Limited Partnership (FLP)
• Intentionally Defective Grantor Trust (IDGT)
• Qualified Personal Residence Trust (QPRT)
• Grantor Retained Annuity Trust (GRAT)
• Pooled Income Fund (PIF)
• Charitable Remainder Trust (CRT)
• Charitable Lead Trust (CLT)
• Spousal Lifetime Access Trust (SLAT)

There are a few other notable advanced strategies that don’t fit into the alphabet soup above but are valuable mentions for consideration:

• Outright gifts up to the annual exclusion amount (2025 limits are $19k per individual / $38k when electing gift splitting between spouses)
• Paying education and healthcare expenses directly to institution
• 529 Superfunding
• Intrafamily loans
• Income in respect of decedent (IRD is relevant for beneficiaries of an IRA when the original estate paid federal estate tax on the assets held in an IRA or other retirement account)

Readers must not only contend with Federal estate tax law but also evaluate their State level estate and inheritance tax laws. 

• States with an estate tax: WA, OR, MN, IL, NY, ME, VT, MA, RI, CT, DC, HI
• States with an inheritance tax: NE, NJ, KY, PA
• States with estate tax and inheritance tax: MD

★ Note only HI and MD allow for portability. Portability is a federal estate tax concept that allows a surviving spouse who files an estate tax return following the first to pass spouse's death to retain the deceased spouse's unused exemption amount “DSUE” for future use. 

As an end user of estate planning, you probably care less about the specific tools and how they work and more about the outcomes and results. Very few people think to themselves, “I want to structure my affairs so that I can make effective use of an irrevocable life insurance trust.” Very many people think to themselves, “I want to structure my affairs so that I can leave money to my kids and charities after my death.” With that in mind, rather than define each acronym of the alphabet soup we have provided several case studies to illustrate the value of these concepts.

Case Study 1: High net worth with high growth potential asset ownership

Early Employee Evan has shares of his fast-growing pre-IPO company that are currently worth $10M. Evan and his wife Emma have three young children. Evan and Emma know that they ultimately want to leave most of their estate to their children and maybe grandchildren. They estimate the company shares may grow 10x over the next 10-15 years.

Evan and Emma may be good candidates for an irrevocable trust set up to benefit their children. In our example Scenario 1, they can place $3M of the $10M of pre-IPO shares, $1M for each child, into an irrevocable trust, keeping $7M for themselves in their revocable trust. The $3M counts against Evan and Emma’s lifetime exclusion in the year that they fund the trust, but only at the current $3M value, and after that it is out of their estate. If, 15 years from now, the shares of the company have gone up 10x, and the irrevocable trust is worth $30M, Evan and Emma will have passed $30M to their children without incurring any estate or gift taxes. 

Further suppose the $7M they kept for themselves grew into $40M (lower returns from taxes, diversification, and spending). Based on the current estate tax exemptions and rates ($30M for couples), less the $3M of exemption used to fund the trust, they would be subject to estate tax on $13M of assets and owe about $5.2M in estate taxes, transferring an additional $34.8M to their heirs. Combined with the earlier $30M from the irrevocable trusts, that totals $64.8M.

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Had Evan and Emma instead held all their investments within their revocable trust (and thus within their estate) and not implemented the irrevocable trust plan, yet still received the same $70M outcome from a base of $10M pre-IPO shares, their estate tax would be about $16M, and they would only transfer $54M to their heirs. 

The effective estate tax rate on $70M of wealth transferred is reduced from 22.9% to 7.4% or $10.8M less of federal estate tax. It is worth noting that irrevocable trusts are not exempt from capital gains and income taxes. The basis of the shares carries over (in this example, they would be near zero), so upon sale, significant capital gains are realized and capital gains tax applies. This compares to keeping the assets in their estate, paying estate tax, and taking the stepped-up cost basis before liquidating.

Case Study 2: Leave all assets to surviving spouse

A quite common and fairly effective system of estate planning to transfer assets after death is as follows: a married couple holds their assets jointly and has beneficiary designations and a Will directing all assets transfer to the surviving spouse. After the second spouse passes, the assets are then directed to their secondary beneficiaries. The ‘leave all assets to surviving spouse transfer plan’ may create unanticipated state level inheritance/estate taxes. 

In our example we assume Illinois residents Joe and Bonnie are a married couple with a $7 million net worth. The couple has a Will, owns assets jointly, and has active beneficiary designations to leave assets to the survivor. The couple does not believe estate taxes are applicable because they fall below the federal threshold and below the $4M per taxpayer State of Illinois estate tax exemption amount. Sadly this approach may result in unnecessary Land of Lincoln estate taxes due to the concept of ‘portability’ not existing within the state's statute. Under the ‘leave all outright to surviving spouse scenario, $565k of Illinois estate tax is due following the second spouse's passing. 

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A way to circumvent this is to establish a credit shelter trust under which a portion of assets are segregated following the first to pass spouse’s death, that when funded uses the first to pass spouse’s $4M state level estate tax exemption amount. Because both $4M exemptions are preserved the couple estate tax liability is reduced to $0. The credit shelter trust, also known as a family trust, can allow the surviving spouse to use the assets during their lifetime for health, education, and support - and for income from the assets to be distributed to the surviving spouse - due to retaining access to income and as an ascertainable standard, the use of trust based planning may a valuable tool for those residing in states with estate tax policies of their own. 

Case Study 3: Family Business

Ryan and Jess established a highly successful and lucrative consulting business while raising their only child Maeve. Ryan and Jess now spend more of their time traveling between their primary residence and vacation home. Maeve graduated from school and has been working for the family business for a handful of years, establishing herself as a leader within the company. 

Ryan and Jess find themselves less interested in the business yet enjoy seeing its success and Maeve’s interest in continuing this component of their family legacy. 

The business was recently valued at $10M. Ryan and Jess have accumulated assets outside of the business in their personal estate totaling $25M - bringing their total net worth to $35M. After much deliberation and thought, the couple establishes a family limited partnership in which Ryan and Jess own 2% interest as general partners and own 98% limited partnership interests.

The couple has identified Maeve as the successor owner. As general partners, Ryan and Jess, retain their management authority and control of business operations. Furthermore, due to the partnership documents restrictive language within, Ryan and Jess are able to discount the value of the interests for purposes of federal gift and transfer taxes by 30%. In essence the $10M business is now valued as a $7M asset for estate tax purposes. 

To take things a step further - Ryan and Jess now begin an annual gifting plan in which they each gift $19,000 worth of limited partnership interest ($38,000 in value total) to Maeve. By going through this additional exercise, the benefit of the FLP is compounded as it reduces the value today for estate tax purposes but also facilitates a transfer of ownership that fully removes the gifted interests from the parents’ taxable estate. 

Conclusion

Estate planning can be complicated - protecting your loved ones and wealth while understanding the nuances of tax consequences and wealth transfer. Working with advisors who understand your goals, like those at Compound Planning, can help you navigate the process, collaborate effectively with an estate planning attorney and ultimately provide the peace of mind that comes from having a thoughtful, well-structured plan in place.

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