A common misconception is that a Will is only needed by the wealthy. However, a Will allows a person to control a number of important matters, making it a useful legal document for just about everyone. Without a Will, state law will direct the disposition of a decedent's property and may cause a guardian to be appointed for those who were under a decedent's care. A surviving spouse could also lose the opportunity to save a significant amount of estate taxes.First and foremost, a Will (or a Revocable Living Trust, see the article beginning on page 2) allows an individual to specify the individuals or entities, such as a charity, that will receive his property upon his death. Without a Will, the state law intestacy statute will determine the recipients. These laws may or may not coincide with the individual's wishes.
The effectiveness of a Will, however, also depends upon the manner in which an individual owns his property. Certain property bypasses a Will and passes by operation of law or by the terms of a contract. These assets include jointly titled assets (which generally pass to the survivor upon a joint owner's death) and assets which pass pursuant to a beneficiary contractual designation (for example, individual retirement accounts or life insurance proceeds). Therefore, it is important that the ownership of assets be coordinated with an individual's Will and estate plan.
For those individuals with minor children or incapacitated adults for whom they are responsible, a second important reason for a Will is to name the guardian who will care for these individuals. Without a provision for a guardian in a Will, a court-appointed guardian may be named. This appointee may not be the same person the decedent would have chosen and may not be the person best suited as guardian for the child or disabled person.
For certain married individuals, a third reason for a Will (or Revocable Living Trust) is the availability of an important tax-planning opportunity. A common estate plan for a married couple provides that all assets pass directly to the surviving spouse at the first spouse's death. Unfortunately, this plan may cause the heirs to incur a large amount of unnecessary estate taxes at the surviving spouse's death.
Federal estate and gift tax laws provide that, unless otherwise specifically exempt, all transfers of property are taxable. This general rule is true whether the transfer is made by gift during life or under a Will (or trust) at death.
Current legal exceptions to the general rule provide estate tax-planning opportunities. One exception to this general rule provides that unlimited transfers between spouses (the "marital deduction") are generally gift and estate tax-free. Furthermore, an overriding tax provision provides that each person may transfer (during life and/or at death) up to $625,000 (for 1998) in value without incurring any federal estate and/or gift tax by use of the "applicable exclusion amount." This exclusion provides a direct reduction of all federal transfer taxes imposed on the first $625,000 (for 1998) of taxable lifetime gifts or bequests at death. This $625,000 is frequently referred to as the "exemption amount." Current law provides that this amount will increase gradually over the next several years until it reaches $1,000,000 in the year 2006.
Transfers above and beyond the exemption amount, however, are subject to either federal estate or gift taxes at the time of the transfer, unless those assets pass in another manner that qualifies them for a deduction from the taxable estate (such as the marital deduction). To utilize the exemption amount, either during life or at death, an individual must transfer the property in a "taxable" manner (in other words, a manner that triggers a tax liability). The exemption amount can then be used to offset and reduce this tax liability. However, as mentioned above, leaving property outright to a spouse is not a taxable transaction since the transfer is completely sheltered by the unlimited marital deduction.
To utilize the exemption, a person could transfer property to children or siblings either outright or in trust. Alternatively, a person could transfer the property to a trust created by the Will for the benefit of the person's spouse and/or family. Typically, this trust will provide that income and principal of the trust will liberally benefit the surviving spouse during his or her life, and that upon the surviving spouse's death the property will pass to the children. Additionally, if the trust is properly written, none of the assets in the trust will be included in the surviving spouse's estate at death, and the surviving spouse will still have his or her own exemption amount available to shelter an additional $625,000 (for 1998) of assets from estate taxes.
Thus, a married couple can effectively pass an estate of $1,250,000 ($2,000,000 in 2006) to their family without paying any federal estate taxes. Since federal estate tax rates after the exemption amount start at 37 percent and increase quickly to 55 percent, this strategy can save a married couple who have $1,250,000 in assets close to $250,000 in estate taxes. Nevertheless, every married couple with an expectation of having total assets above the exemption amount (including potential life insurance proceeds) should consult their tax advisor and strongly consider this tax-planning strategy.