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  • Rick Kozlowski

Top 5 Estate Planning Mistakes

In 35+ years of legal practice, I have seen a lot of mistakes, especially in the area of estate planning.


In the interest of helping the reader, I have compiled a list of five estate planning mistakes that are relatively common and easy to avoid.


Mistake #1 – Bad Implementation

This is the most common mistake made by planners, even those with years of experience. After incurring the expense and hassle of creating an estate plan, the client is sent on his or her way with a shiny set of new estate documents (trusts, wills, etc.). But no review is made of the client’s assets and the manner in which they flow through the plan – which can lead to unintended consequences. For example, suppose a client sets up a trust to benefit a second spouse and then, after the spouse’s death, to benefit his/her children from a prior marriage. The client’s retirement plans designate the spouse as the primary beneficiary. All other assets are jointly owned. The retirement plans and other assets all pass to the surviving spouse with no strings attached. What if the spouse remarries and decides that the client’s assets should pass to the new spouse – bypassing the client’s children altogether?


Every estate plan should include a review of the client’s major assets and an analysis of how those assets flow through the plan. That exercise often reveals that changes, in how assets are owned and/or designated, are needed to ensure the plan works properly.


Mistake #2 – Too Much Too Soon

Clients often approach estate planning without thinking about immediate consequences. With respect to children, they envision them inheriting wealth when they are older, established and secure. Many clients do not contemplate their untimely deaths and the effect that immediate inherited wealth can have on young people.


Money is like a drug. When applied properly it can provide tremendous benefit; when misused, it can be disastrous. I have seen dozens of situations where a child has inherited a significant amount of wealth at the wrong time in his/her life. It often leads to serious problems.


Where young heirs are involved, and the client expresses concern that they are not ready to handle an inheritance, I normally recommend the use of a trust that permits the trustee to assist a beneficiary financially, but delays the beneficiary’s right to outright distributions until older ages (usually in fractions over time). I also routinely include “super powers” that permit the trustee to delay a distribution to a trust beneficiary where the beneficiary has a known problem (such as drug or alcohol addiction, marital discord, etc.). All of these protections permit the beneficiary to enjoy the benefits money can bring while avoiding the pitfalls of inherited wealth.


Bottom line: be judicious when setting up a plan to transfer wealth to younger generations.


Mistake #3 – Lifetime Gifts of Assets With Low Tax Basis

If you die owning an asset that has appreciated, and that asset is part of your taxable estate, your heirs receive a “step-up” in that asset’s tax basis. This means that if your heirs sell the asset, the gain is determined by subtracting the appreciated (date of death) value from the sales price. Your heirs are thereby able to escape income taxation on all of the appreciation accumulated during your life – often a huge tax benefit.


In contrast, if you gift an appreciated asset to your heirs during your lifetime, they receive a “carryover” tax basis. If they sell the asset, they pay income (capital gain) tax on the appreciation that built up during life.


When making a lifetime gift you should look at the income tax impacts of making that gift – you may be better off retaining the property until death and then passing it to your heirs with a stepped-up tax basis.


Mistake #4 – Failing to Give It All Away

There are two different ways in which clients sometimes fail to dispose of their entire estate. The first occurs when fractions are used, such as: “I leave 20% of the remainder of my estate to John, 30% to Sue, and 50% to Mary.” If John predeceases the client, and the plan does not contain survivorship provisions for John’s issue (or John has no surviving issue), then the 20% that was earmarked for John is left in limbo. Who takes the 25%? Is it allocated to Sue and Mary, pro-rata? Does it pass by way of intestacy?


Lesson learned: do not use percentages, use “equal shares.” Using a similar example, give John 20 shares, Sue 30 shares and Mary 50 shares. If John predeceases the client, his shares pass to his heirs (if that’s the plan) or provide that no shares are created for John. This means that Sue receives 30 out of 80 shares, and Mary 50 out of 80. This solves the problem caused by using percentages.


A second way in which clients fail to fully dispose of their estate is to leave out a “residuary clause” – one that states who receives the remainder of the estate after all expenses and specifics gifts are complete. If a client simply list all of his/her assets in the plan, and those assets change (or the client fails to list them all), then the plan has a hole in it. All estate plans should have a residuary clause to protect against this potential problem.


Mistake #5 – Bad Latin

Two of the most common phrases used by planners when describing the division of assets are “per stirpes” and “per capita.”


“Per stirpes” is a shorthand way of saying that assets are divided among the next generation in equal shares but, if someone in that generation predeceases the client, then the deceased person’s children divide that person’s share equally (with similar divisions for predeceased grandchildren, great-grandchildren, etc.). Used properly, “per stirpes” is a great way to describe a somewhat complicated scheme for dividing assets without having to provide all of the details.


“Per capita” leads to a quite different result. It means that the assets are divided among the class of surviving people described in equal shares. For example, “I leave my estate to my siblings who survive me, per capita” means exactly what it says – all of the siblings alive when the client dies get an equal share of the client’s estate.


Problem arise when the concepts are mixed. A common phrase I have seen in estate plans is: “I leave my estate in equal shares to my children who survive me, per stirpes.” Does this mean that the heirs of a predeceased child receive nothing? How can the shares be equal if a predeceased child has three children living at the client’s death? Or, “I leave my estate to my heirs per capita, share and share alike.” What if the client’s child predeceases the client – do that child’s “heirs” receive an equal share – “share and share alike?”


If your attorney insists on using Latin, make sure he or she understands the nuances and avoids the improper combining of such phrases.