Where there's a will...

More than half of all Americans don’t have a will* (in legalese this is called dying “intestate”).  When I heard this I wondered why.  After an informal survey of my own I learned that many people don’t think they need a will because they’re “not rich.”  Well, I practice Estates & Trusts law specifically for the “average family”, so I thought about the reasons those people (i.e., you and me) really do need to have a will.  Here are the top 5 reasons why everyone needs a will…

1. Who gets your stuff?  If you die without a will the State decides who gets your stuff.  In Maryland, if you have a spouse and children the assets are split between them and that can mean substantial assets going straight to your minor children – yikes!.  (See Md. Code. Ann. Estates & Trusts 3-102). If you have a spouse, but don't have kids yet, your spouse has to share your assets with your parents.  Even more frightening is the fact that if you are unmarried without children the State may take your assets for itself.  That’s right.  Take my cousin for example.  She is an only child, is not married, and has no kids of her own yet.  If she outlives her close relatives (parents, grandparents, me), her assets go to the Board of Education or Department of Health and Human Services.  Her car, her bank account….everything.  (See Md. Code Ann. Estates & Trusts 3-105)She is a teacher so maybe she doesn’t mind supporting the Board of Education in that way, but I think most of us would like a choice in the matter.
2. Do you have any special gifts in mind?  Your will allows you to determine exactly how you would like to distribute your assets.  Perhaps you want to leave money to charity.  Or, maybe you do not wish to divide your assets evenly among your children because you already gave significant financial support to one during your life.  And, if you want to be sure that treasured family heirloom makes it way to a good home, your will is the place to do that.
3. Who gets your kids?  If you have young kids, your will is the document you use to determine who should care for your kids if you die.  If you die without a will and you have a spouse who survives you (assuming for now that your spouse is also a parent to your children), he or she will be automatically made the guardian of the children’s person, but not necessarily their property (and they may have significant property because you died without a will).  A court will need to step in to appoint someone (hopefully your surviving spouse) as guardian of the property.  Having a properly drafted will with guardianship provisions can avoid this hassle and expense.
4. Who should manage your estate?  Your will assigns a person to serve as your “personal representative”.  This person will have a lot of responsibility in administering your estate.  He or she will divide and distribute your assets, pay necessary estate taxes and debts out of your estate, file regular papers with the court and Registrar of Wills, and respond to inquiries from creditors.  Without a will nearly anyone can petition the court to be appointed as your representative and fights can often brew over who should hold such a position.
5. Who gets the house?  If you own real estate, things can get a little tricky after you die.  Without a will, the State attempts to divide up your assets (as it sees fit) and that may mean that a lot of people get a “share” of your home.  This can include your minor children, your parents, etc.  And, this can happen even if you have a surviving spouse because the State splits your assets between your spouse and your children or your parents.

Don’t let the default rules of the State determine what’s in your family’s best interests (and even worse, don’t let the State take your stuff!).

You can’t prevent dying, but you can prevent dying intestate.

*This statistic comes from a Harris Interactive (nasdaq: HPOL) survey of the general population, done for lawyers.com.

Per Stirpes v. Per Capita: What's fair is fair; or is it?

The other day I was talking to a fellow attorney about estate planning.  As a litigator, he doesn’t generally work with wills or other estate documents.  He told me that he would love to have me draft his will and would refer all his friends to me if I could just explain one thing that has plagued him since law school – "what does per stirpes mean?”

If you’ve ever read a will or listened to a bunch of estate planning lawyers talk over coffee, you’ve probably seen or heard the terms per stirpes and per capita.  They are both used in explaining how you would like to divide your estate among your children and other descendents after you pass.  

Per Capita is a Latin term that literally means “by the head”.  When you die, all of the living members of the group you identified (e.g., “my children” or “my descendants”) will receive an equal share.  If one is deceased, he will not receive a share.

Per Stirpes is another Latin term that means “by the roots”, or more usefully “by representation”.  When you die, all of the original members of the group you identified (e.g., “my children”) will receive an equal share.  If one is deceased, his children stand in his shoes and split his share.

Most people think dividing their estate among their children is easy….”I have 3 children, and they each get a third.”  While that may work fine most of the time, what if something unfortunate happens and one of your children predeceases you?  And, what if that child had children of her own?  Should your grandchildren by that child receive her third in her place?  Let’s look at some examples:

Basic Assumptions:
--You are widowed or unmarried (just to keep it simple for today)
--You have 3 daughters
--Daughter 1 has 1 child; Daughter 2 has 2 children; and Daughter 3 has 3 children

Example 1:
When you pass away all three daughters are alive.  If your will left your property “to my children, per capita” each child receives 1/3 of your property.  The same is true if your will left your property “to my children, per stirpes”.  Because all 3 daughters are alive, both methods achieve the same result.

Example 2:
Daughter 3 predeceases you.  She had 3 children of her own.
“Per Capita to my children”: Only 2 shares are created because you now only have 2 children, so Daughter 1 gets ½ and Daughter 2 gets ½.  The children of Daughter 3 get nothing.
“Per Stirpes to my children”: 3 shares are created because you originally had 3 children.  Daughters 1 and 2 each get 1/3 and the children of Daughter 3 share her 1/3.

Example 3:
Daughter 3 predeceases you.  She had 3 children of her own.
“Per Capita to my descendents who survive me”: The group we are concerned with in this example is your descendents (so, your children and grandchildren).  There are 8 descendents living when you pass away (your 2 remaining children, and your 6 total grandchildren), so there are 8 shares created.  Each gets 1/8.  By using “my descendents” as the defining language, your grandchildren all share equally with your remaining children.
“Per Stirpes to my descendents who survive me”: 3 shares are created because you originally had 3 children and at least one of those children still lives.  Daughters 1 and 2 each get 1/3 and the children of Daughter 3 share her 1/3.

Neither per stirpes nor per capita fit every situation.  For example, in Example 3 when dividing your estate per capita to your descendants the family line led by your third daughter (the one with 3 children of her own) gets more than the other 2 family lines because there are more people in that line.  She and her 3 children get a total of 4 shares whereas the line led by Daughter 1 only gets 2 shares (1 for the Daughter and 1 for her only child).  So, it pays more for your children to have more kids! 

But, if you do the split per stirpes and assume that both Daughter 1 and Daughter 3 have predeceased you, then Daughter 1’s child gets Daughter 1’s 1/3 share, but the children of Daughter 3 all have to share her 1/3.   Under that setup, the Daughter 1’s child gets more than her cousins (your other grandkids) because she happens to be an only child.  Which is more fair?  Only you can decide what is right for your family.

Maryland follows the per stirpes approach because even if it doesn’t fit all situations, it comes close for most families.  Careful estate planning can ensure that your wishes with regard to your actual family situation are carried out and not left to Maryland’s default rule.

So, Michael, do you understand per stirpes now?

Insurance: Don't let Uncle Sam get the biggest share

There is a common misconception that life insurance policies are not included in a person’s estate and therefore not subject to estate taxes either in Maryland or through the Federal government.  I’ve even heard this from fellow attorneys -- especially those that practice Maryland Estate Planning.  While it is true that life insurance policies that are paid to a named beneficiary (not the estate) are not included in the probate process in Maryland (meaning the money can be paid directly to the beneficiary without court involvement), those insurance proceeds might still be included in the decedent’s estate for estate tax purposes.  This is different from probate and carries important consequences.

Life insurance policies are incuded in a decedent's estate for estate tax purposes

if the decedent owned the policy at the time of death.

Example:
John purchases a life insurance policy and names his daughter Susan as the beneficiary.  John pays the premiums and can change the beneficiary at any time.  John’s employer ABC Company also purchases a policy on John’s life to protect themselves if John dies because John is a key employee.  ABC Company pays the proceeds and John has no right to modify the policy or change the beneficiary.  When John dies the policy he purchased is part of his estate for estate tax purposes, but the policy purchased by his employer is not because John did not own that policy.

Defining Ownership

“Owning” an insurance policy is more than a question of who pays the bills.  The IRS defines an owner as a person who retains any incidents of ownership.  What that means is that if you have any power over the insurance policy, you own it.   Specifically, if you have the legal right to do any of the following, you own it:
     ·         Change or name a beneficiary
     ·         Borrow against the policy, pledge any cash reserve it has, or cash it in
     ·         Surrender, convert, or cancel the policy
     ·         Select a payment option (i.e., choose whether payment should be in a lump sum)

Ways Around It

Of course you still want to have life insurance policies.  They are an important tool in providing financial security to your family.  But, there are ways you can have your cake and eat it too.  There are two general ways to avoid having your life insurance policy in your taxable estate:
     1.     Transfer ownership of the policy to any other adult (including the beneficiary)
     2.     Create an irrevocable life insurance trust and transfer ownership to it

TIP: Be sure to check the terms of your policy because some policies do not allow you to transfer ownership.

Most policies make it easy to transfer ownership and the insurer probably has a form to do it.  Give them a call and inquire.  But, be sure that you can’t change your mind later and transfer it back to yourself or someone else.  The IRS will view this as retaining ownership in the policy.  This is why irrevocable life insurance trusts were created; and an experienced estates and trusts attorney can help you create one.

Another reason to use an irrevocable life insurance trust is when your chosen beneficiary is not a person that you can trust to maintain the policy and pay the premiums.  You could establish the trust and place a third party (not the beneficiary) as trustee and you could specify in the trust instrument that the policy must be kept in effect while you live, eliminating the risk that a new owner of the policy could decide to cash it in.

Example:
John is the divorced father of two children in their 20s who will be the beneficiaries.  John doesn’t think either child is responsible enough with money to manage the policy.  John has an estate of $700,000 plus a life insurance policy that will pay $500,000 when he dies.  Because John’s estate will be subject to estate taxes if the life insurance policy is included (because it will be higher than the current $1,000,000 limit for Maryland estate taxes), John wants to transfer the policy out of his estate.  John creates an irrevocable life insurance trust with his sister Jean as the trustee and transfers ownership of the policy to the trust.  When John dies, Jean must follow the terms of the trust document and distribute the money to John’s children as he wanted.

The key components to using a trust to avoid your life insurance policy being included in your estate are:
     ·        The trust must be irrevocable.  If you have the right to revoke (i.e., cancel) it, you will be 
               considered the owner of the policy and the proceeds will be subject to estate taxes.    
     ·        You cannot be the trustee.
     ·        The policy must be transferred to the trust at least 3 years prior to your death.

Beware of Gifts
If you choose to transfer your policy to a beneficiary, the IRS is likely to consider the transfer a gift, and therefore impose gift taxes.  Under current rules, you can give up to $13,000 annually to a person without incurring gift taxes.  But, if you transfer a policy with a present value of more than $13,000 gift taxes will be assessed.  However, you should keep in mind that gift taxes will be far less than the amount of estate tax that would be due if your policy remained in your estate because the gift tax value is determined at the time of the transfer.  And, for most policies, the value of the policy while you’re alive is much less than the amount that will be paid upon your death.

TIP: Using something called a “Crummey Notice” in your irrevocable life insurance trust can help you avoid this problem altogether.  We'll go over Crummey Notices in greater detail in a later post.  Stay tuned....

Don’t Die Too Soon
Another possible pitfall when transferring your policy (to a person or to a trust) is that the IRS will disregard any transfer made within 3 years of your death.  So, the IRS acts like the transfer never took place and the full amount of the proceeds are included in your estate for tax purposes.  So, be sure to hang on and survive at least 3 years after you transfer a life insurance policy!

TIP: One way around this is to have the trust purchase the policy.   But, this may require a new application and physical examination and might not be feasible in all circumstances.

Leave it all to your spouse
There is a special exemption that works to protect insurance proceeds from estate taxation when you leave 100% of the proceeds to your spouse.  So, even if you own the policy, if you name your spouse as the sole beneficiary, the value (no matter how high) is exempt from federal estate taxes.  But, you still might benefit from a life insurance trust or other transfer of ownership.

Example:
John purchases a life insurance policy and names his wife Jane as the sole beneficiary and his daughter Susan as the contingent beneficiary.  Unfortunately, Jane dies before John, but John did not change his beneficiary designations.  When John dies the proceeds are paid to Susan, but are included in John’s estate for estate tax purposes.

Income Tax
I’ll wrap this up on a good note.  No matter how you slice it, life insurance proceeds are not considered income for the beneficiary on their annual income taxes. 


For more information about insurance policies and estate taxes, visit http://www.irs.gov/ and review the instructions for filing Form 706 - the Estate Tax Return (http://www.irs.gov/pub/irs-pdf/i706.pdf).  All insurance policies are to be included on Schedule D of Form 706.

Hello and Welcome

I am a Maryland attorney, and after years of practicing as a ligitator for big corporations I decided to devote my time to energy to helping the average family plan for their future and protect their assets through estates and trusts.  I get asked a lot of questions about planning estates from the simple ("What exactly is a will and why do I need one?") to the more complex ("What exactly are QTIPs, QPRTS, ILITS, and GRATS and why would I need one?").  My goal with this Maryland Estate Planning Blog is to answer some of these questions and to talk generally about things that I find interesting in Maryland estate law.  I realize that there are a lot of estate planning blogs out there, but I hope you'll find mine informative and entertaining (at least at times).  Stick around and hopefully I'll teach you something you didn't know.