Step 5 of Retirement Success Plan: Estate Planning
Troy Sharpe: Step Five of the Retirement Success Plan is Estate Planning. Estate planning is much more than just having your basic will, living will, maybe a trust. It’s the optimization of taxes, of structuring of assets, it’s your charitable and gifting strategy. It’s all of these different pieces working together according to your stated objectives. It’s very important to understand that estate planning really is part of the overall financial planning process.
Yes, you need attorneys to draft trusts or wills, and you need CPAs to file taxes, but estate planning, at its very core, is a plan that optimizes the disposition of your assets to your children, to your grandchildren, to your charities, to your church, and we need a plan for that.
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Everyone needs an estate plan, no matter how much money you have. Of course, the more money you have, the more complex estate planning could possibly be, but the more things you also have to plan for. There are two types of designations in the industry that you should be aware of. The first one is the Certified Financial Planner professional, which I think most of you are familiar with, the CFP. The CFP, it’s a 10-month course, and part of that does cover estate planning.
The Difference Between a CFP® and a CPWA®
What the CFP does is, they don’t go tremendously deep in all of these different areas. The second one, which is for higher net worth people, typically estates of $5 million and above, is the CPWA, the Certified Private Wealth Advisor designation. That’s the designation that goes very deep into estate planning. If you have a net worth above $5 million, you probably want to seek out a CPWA professional. If you’re under $5 million, a CFP pro should be able to get that done for you.
As I stated at the beginning of the video, an estate plan is one part of an overall financial plan. There are different areas that we’re going to go through today. We’re going to talk a little bit about documents, the ones that you need to have, titling of assets, trusts, the difference between something being in your estate and out of your estate, gifting, charitable strategies, and also, the importance of consolidating assets. The goal is to have all of these different pieces moving together to bring your goals to fruition.
Now, not all of you are going to need to have every single one of these pieces as part of your overall estate plan, but it is important that you understand the different aspects of an estate plan. Okay, very basic. This is what most of you think about when you think of an estate plan. You think of your will, possibly a living will, power of attorney, so you have a durable power of attorney which is for your financial affairs, and you have a medical power of attorney. The living will, this is your end-of-life care instructions.
The medical power of attorney, it’s a more broad, more comprehensive document. Those two pieces work together to really bring that medical piece together in your estate plan. Then, a revocable living trust is typically part of an estate plan, as well. Most attorneys are going to charge somewhere from about $2,000 to $5,000 to put these documents in place. Now, I don’t want you to be cheap and try to do this yourself, because it does require specialized skill. You want to see a board-certified estate planning attorney.
We had a client a long time ago that tried to skirt out on costs and do his own trust. Well, he named a beneficiary of that trust, his retirement account, but when you name retirement accounts as a trust beneficiary, you have to have very, very specific language inside there, and he did not. When his daughters went to have the IRA payout into the trust, they thought it would maintain its tax-deferred status, that was his intention, because the language was not correct, the financial institution would not honor it.
They distributed the full retirement account, creating hundreds of thousands of dollars in taxes. When you pass away, your assets go through probate. This is where the revocable living trust comes in, because anything that you have in your will, will go through that probate process. It goes through the courts. The judge uses your will as essentially a set of instructions, but it’s public record, it can be time-consuming, and costly in some states.
Every state has their own process. The revocable living trust here is essentially like a will, it creates more privacy, and assets bypass probate. Same thing with your retirement accounts. If you have a 401(k), an IRA, life insurance policy, or an annuity, anything that has a beneficiary designation, they will bypass probate and go directly to whomever you’ve named as those beneficiaries.
The Importance of Titling of Accounts
On to titling of accounts, because this is a very important, and also very simple part of the tax code that we can use to your advantage, but I see it all the time not being used properly, or accounts mistitled because there is no respect given to the estate planning side of things. We see this most often with our clients that are in different states, states that are not community property states.
First thing I want to go through is what we call basis. Basis is what you have purchased something for, and then there can be some adjustments to basis. Let’s say you have an investment account, a non-retirement account, and you bought those stocks for $300,000 10 years ago, and today, they’re worth $700,000. If you pass away, and let’s say you name your spouse the sole beneficiary of that account, it’s going to get a step up in basis.
For tax purposes, the new value is $700,000, meaning if your spouse decided to sell all of those stocks, there would be absolutely zero income tax liability. When you own an account jointly, when you have qualified joint interest property, if you are in a community property state and one spouse passes away, you still get the full step-up in basis, generally speaking. The surviving spouse can sell everything, no tax liability.
If you are in a non-community property state, only one-half of the account will typically get a step up in basis if the property’s owned jointly. There’s $400,000 of gain. You’ll get essentially a $200,000 write-off or step-up in basis, but the surviving spouse will still have $200,000 in potential capital gain liability. Now, if you’re unmarried and you own property with a non-spouse, or even if you are married, but you own property with a non-spouse, basis has to do with the amount that you’ve contributed to that particular account or investment property or asset in general.
A simple fix here, and of course, we don’t always know which spouse is going to pass away first, but a simple retitling of the account. If you’re in a non-community property state and one of you is expected to pass away before the other, and you currently have a joint account, putting that account in the name of the spouse that is expected to pass away first, if that happens and the surviving spouse inherits it, that account will get a 100% step up in basis, as opposed to just a 50%.
Estate planning, financial planning, tax planning. You can see how an estate plan isn’t just your documents. Now, we’re starting to plan with respect to your finances, to tax planning. All of this works together. This is why it’s step five in the retirement success plan, estate plan, because all this ties together with the things that we’ve already talked about, the allocation, tax planning, income planning, health care planning, now, estate planning.
Deciding Which Trust Is Right For You
On to trust planning here. This is very important. We’re going to keep it simple because trusts can be complex and there are literally thousands of potential trusts out there. First, we’re just going to talk about a revocable trust versus an irrevocable trust. The trust we talked about a few minutes ago, the one that bypasses probate, that’s typically your revocable living trust, that if you go see an attorney, they are going to put one of those in place for you, most likely.
Revocable trusts have no asset protection. This is one of the things that we hear all the time that, yes, I have money in a trust, it’s protected from creditors, and if it’s a revocable trust, it is not protected from creditors. It essentially is your asset. Irrevocable trusts, these are trusts that are set up outside of your estate, and they’re irrevocable. Once you put money into them, you cannot take it back out, generally speaking.
Then we have grantor trusts versus non-grantor trusts. This just refers to the taxation of the assets inside the trust. With a grantor trust, the taxes flow through to your personal tax return. With a non-grantor trust, it’s going to be either taxed to the beneficiaries or at trust tax rates. We could have a revocable trust that is a grantor trust. Now we have inter-vivos versus testamentary. I wanted to have these in here, because not all the time when people create trusts, do they create a trust while they’re living.
Inside of your will, you could have a trust that springs open whenever you pass away. That’s a testamentary trust. It’s not created until you pass away. Then according to the terms of your will, assets will flow into that trust, typically for the benefit of your children, or possibly a spouse. The inter-vivos trust is just one that’s created while you’re living. Your revocable living trust, it could be an irrevocable trust, or any type of trust that’s created while you’re alive, that is known as the inter-vivos trust. You think of those as categories. Maybe it’s easier for you to think of it that way.
I want to go through purposes of trusts now, because trusts can be used for multiple different purposes. There are really an unlimited number of trusts out there, but it’s important to understand some of the distinct features. For asset protection, if you want a trust for asset protection, typically, you’re going to need an irrevocable trust, but asset protection for you or for your children.
One of the things in the estate planning process that we see all the time, people overlook, is protecting their children’s inheritance from a future potential ex-spouse. We live in a country where we have about a 50% divorce rate. If you just pass your money on to your children without any type of estate plan in place and they get a divorce, it’s quite possible that half of your money could be going to their future ex-spouse. Keep that in mind.
The Different Ways to Accomplish Asset Protection
Asset protection for you during your life, this could be accomplished in many different ways. It can be done with a corporate entity, it can be done with a trust, but typically, that trust is going to be irrevocable. Life insurance and annuities, they also have special asset protection provisions. Now, typically, you don’t need to have a trust as the beneficiary of your retirement account, but some lawyers will like to put this in place because the one benefit that it can provide is asset protection for your inherited IRA.
Your retirement account, your 401(k)– Well, the 401(k) has– I believe it’s unlimited protection through ERISA. IRAs, in different states, have different levels of creditor protection. Now, inherited IRAs, they typically don’t have any protection from lawsuits or creditors. If you have a properly worded trust in your retirement account, you name that trust the beneficiary of your retirement account. That is one way where you can create creditor protection for that inherited IRA.
The next reason we often see people put trust into place is to have control, to have some type of control from beyond the grave. You can create any stipulations you want. Typically, what we’ll see is 5% of the trust corpus, along with what we call a HEMS clause, H-E-M-S, stands for health, education, maintenance, and support. A lot of times, there will be some type of age provision, let’s say you have young children and you don’t want them to access the full value of your accounts until they’re 25, 30, or 35.
That HEMS clause will allow the trustee to provide financial support as needed until they’re at an older age, where you feel more comfortable with them having access to a much larger sum of money.
Something like that also will protect against the potential for a future divorce. Okay, special needs. If you do have a child that has special needs, you want to make sure that you have a trust set up for them. You want to make sure you carve it out and set money aside specifically for their needs.
The last one I put in here is asset free. This is more of a sophisticated use of a trust for advanced estate planning. We use something called a GRAT, which will make a gift into the GRAT, G-R-A-T, and it essentially freezes that value for estate tax purposes. Any growth of that asset above and beyond is outside of your estate, will go to your children, and the primary principle will come back to you during your life, usually after a set number of years.
I just wanted to point that out, that for advanced estate planning, we can use these different types of trusts to either freeze the value of something that’s expected to grow a tremendous amount in value. I just want you to be aware of some of these techniques. All the assets that you own currently are most likely inside your estate. When it comes to estate planning, we have to understand that we need to get things outside of our estate. There’s two categories here.
Will You Be Expected To Pay Federal Estate Taxes?
You are either a taxpayer or a non-tax payer. I’m not talking about federal income tax, I’m talking about the federal estate tax. I’m not going to get into state estate tax or inheritance tax. That’s a whole another rabbit hole. High level here, everyone has what’s called a lifetime exemption. This is the amount of money that you’re allowed to pass away with before you have to start paying a state tax. Currently, per person, up to 2025, you can die with $12.92 million and not pay any federal estate tax.
In 2026, it is dropping, the Trump tax cuts go away. The federal exemption is dropping to about $6.5 million. It’s going back to the 2017 levels, which was $5 million, but it’s indexed for inflation. This means anything over $6.5 million will be taxed at 40%. Now, this is in addition to income taxes, potentially if you have an IRA. I’m going to talk about that in a minute, but first, we just need to understand what the exemption is. We have this lifetime exemption amount, currently, it’s $12.92 million.
It’s going down to about $6.5 million, and that is per person. When we’re starting to do the math and looking at how much you’re spending, the total taxes you’re going to pay, everything we do from a financial planning experience, we have to model out into the future to get some type of range of what your future estate value could be, based on how much you’re spending, how your assets are invested, based on the whole picture.
This is part of the reason why estate planning is part of the overall financial planning process. There’s so much going into it. An attorney who’s just drafting agreements, typically, they’re not going to know your financial plan, they’re not going to model out all these different scenarios based on the nuances of that financial plan. All of your assets inside of your estate, cars, homes, retirement accounts, investment accounts, the change in your couch cushions, everything, that is in your estate.
When you pass away, this is a very simple high-level explanation, let’s say this is $6 million, minus your exemption, the exemption’s more, you’re not going to pay any estate tax, but let’s say this, in 25 years, is $12 million, and the estate tax exemption is only 8. Well, you subtract that out, the remaining 4 million is going to be subject to a 40% estate tax. Now, part of the overall plan for someone in that particular situation would be, “How do we start to intelligently get money from your estate to out of your estate?”
There are usually some things we want to do here. One, we want to get it out of the state, of course, but a lot of people want to retain some type of control. There are various techniques that we can use to get the money outside of your estate, either freeze the asset value, or create something where we’re getting an income back from those assets. The income that’s coming back to us, of course, would be part of our estate, if structured properly, it’s an amount that you can spend, but if not, it’s going to add to the estate.
A lot of different techniques out there, I just want to point out the main thing here, that if you are what we call a taxpayer, someone who has a very high net worth, and that’s expected to grow over time, part of the financial plan is getting money outside of the estate so we don’t have to pay this 40% estate tax. The income tax is based on income that you earn. Think about your retirement accounts, it’s actually known as income in respect of a decedent, but your IRA can be subject to both estate tax and income tax.
Estates need liquidity, because when you pass away, if you are a taxpayer, and the only assets that you have to pass on– Let’s say you have a family farm, some rental homes, be it your primary home, and then 3 million in a retirement account, and you are a taxpayer, so you owe 40% of that total net worth. If everything that you own liquid is inside the retirement account, you’re going to have to make distributions from that retirement account, pay income tax, most likely at 40% or so.
If you’re in an estate, you’re going to have to pay the estate income tax, and then whatever is left, you then have to send to the federal government to pay the federal estate tax. You can quickly dwindle, 70, 80, maybe 90% of that retirement account away, simply for making the IRA distribution, paying income tax, and using what’s leftover to go pay federal estate tax. To get around that, first and foremost, we have to be aware that that dynamic exists within your estate plan, potentially.
We just simply need to create liquidity. A lot of times, people will use life insurance for this, or just make sure that we have assets, possibly selling one of those homes before you pass away, doing something to create some type of liquidity, because the estate tax bill is due pretty quickly after the date of death.
Strategic Gifting In Your Estate
The next part of an estate plan we want to talk about is gifting. A lot of you are aware that you can gift $17,000 per year, per spouse, to a beneficiary. Let’s say you and your spouse have three children.
Then two of those children each have two grandchildren, technically, you could give 34,000 to each child, because each spouse can do 17 and 17, so you could do 34, 34, 34. Then, if you wanted to set up a trust for the minor grandchildren, you could also give them 34, 34, 34, 34. You could gift a lot of money, so $17,000 doesn’t seem like a lot on the surface when you’re trying to reduce the value of your estate, get more money outside of it, or go ahead and start to bequeath it early to your family.
When you start to look at the power of doing split gifts, and having a lot of children or grandchildren, that can really add up pretty quickly. Then you multiply that over a 10, 15, year timeframe, but again, we just have to develop the gifting strategy that makes sense so you’re not gifting too much away so you sacrifice your quality of life, but we also want to match, a lot of times, what the projected value of the estate will be, and have a gifting strategy that is in accordance with that.
We want to try to get to equilibrium there, where you don’t have to pay any estate taxes. Now, let’s say maybe one of your children come to you and they want to buy a home. You want to start to lower the value of your estate because you’re a potential taxpayer, but it’s a million dollars, let’s say. You can only gift $17,000 each year before you have to pay income tax on that gift. By the way, if you do make a gift above that $17,000, it’s not the person that receives the gift that owes income tax, it’s you.
What do we do in this situation, when we need to make or want to make a rather large gift in a year, or at any time? We can go back to our lifetime exemption. Remember the 12.92 million? That is the amount, essentially, that you’re allowed to gift over the course of your entire life, you have to keep track of these gifts, without paying any tax. You have the annual exclusion, which is the $17,000, but then you also have your lifetime exemption of the 12.92 million right now.
Keep in mind, that’s dropping, in 2026, to about six and a half million. We can make that lifetime gift of 1 million, 2 million, or 3 million, now it reduces our lifetime exemption for the estate tax calculation, but we can make that gift during our life. We don’t have to be limited to the 17,000 per year. We do have to file the gift tax return, notify the IRS, of course, but that will be 100% gift tax-free, income tax-free, everything.
Charitable planning. This, of course, can be part of just your overall charitable strategy, your gifting strategy, but it also can be part of your estate tax strategy, or a state plan, if you are a potential taxpayer. If you’re not a taxpayer, a federal estate taxpayer, one of the common errors that I see when people come in to talk to us is, they leave a charity, a church, or some type of 501(c)(3) organization as part of their will, or some type of gift to that charity upon death.
Whereas if you gave that during your life, you could receive an income tax benefit. If you give it upon your death, you do not get an income tax benefit, you would get a deduction against the federal estate tax. If you’re not a taxpayer, you have lost out on that opportunity to take advantage of tax planning. Now, we don’t ever let the tax tail wag the dog. We give to charity because we want to give to charity.
If we are going to give to charity, it behooves us to understand the tax code and how we can strategically gift that money, and also pay less tax today. There are a lot of different charitable strategies that we can use to either lower our estate tax bill, give money to charity, lower our income tax bill. I just want to share one with you now, because this is a retirement planning channel, and most of you need income in retirement. If you’re also charitable, this may be something that’s attractive to you.
It’s called a charitable remainder trust. How it essentially works is– Let’s say we have an investment account, non-IRA, with a basis of $1 million, a fair market value of $2 million. We take the $2 million, we put it into the charitable remainder trust. If we did not do that and we just sold the stock to generate income, we’d have to pay tax on this $1 million. It would be 23.8%, 238 grand, in taxes. By putting it into the charitable remainder trust, we can sell all those stocks and pay no capital gains tax whatsoever.
Now, we can set up an income stream back into our estate, back into our pocket, to help finance our own retirement. There’s a formula that we have to follow here. It has to be at least a 5% distribution. There has to be a present value calculation of the remainder interest has to be at least 10% of the initial gift that is expected to go to charity. There’s some nuances here, but we can sell this tax-free. We receive the annual income stream.
We are going to pay tax on this income stream annually, but instead of paying it all at once, at the 23.8% rate, we are going to the character of the investments that we had. Long-term capital gains, the character of that taxation, will flow through to us annually, but we’ll pay now, most likely, 15%, because that’s a long-term capital gains rate, if your adjusted gross income isn’t in the top brackets, and 100,000 definitely doesn’t get you into the top brackets.
We could receive this income for life, 5% of this, this money can still be invested and growing, and we would receive an income for life. You could do for life or a period of a specific number of years, up to 20. The other really cool part about this, though, is there is– If you remember, I just said there’s a present value calculation of the remainder interest that goes to charity, that remainder interest, you can take an income tax deduction today to offset your income taxes.
Sometimes we’ll couple this with, let’s say, a Roth conversion strategy, where we’re moving money from the IRA to the Roth. If we also are charitably inclined and we want to do the charitable remainder trust, we can create a big income tax deduction today. We can eliminate the capital gains, essentially by selling it inside the trust, create a stream of income for life or for a period of five years, 10 years, 20 years, but also create that income tax deduction today to offset other tax planning techniques that we may be employing.
The Importance of Consolidating
I save the best for last here, because this is so important, and I think maybe it gets overlooked. Consolidate. There’s no reason for you to have 15 or 20 different accounts. I understand we accumulate these different accounts over the years, but part of our job, whenever a client passes away, is– We handle all the paperwork for you or for your spouse, and we make sure that the beneficiaries are correct, then you get retitled, all that stuff takes place. We do this very, very often.
Unfortunately, we have about 15 to 20 clients that pass away each year. We know how difficult this is, but also, because we do it all the time, we are familiar with the institutions, we’re familiar with the paperwork, and if someone passes away, let’s say husband passes away, leaves the wife to take care of all this, and you have all these different accounts during a time where you’re mourning, this could literally take years to unwind.
Something like this would take us probably at least two to three months to get everything consolidated and where it should be. Someone who doesn’t do this all the time, that’s also mourning, all the different institutions, the phone calls, the bad instructions, the wrong information, the different types of paperwork, the tax considerations, retirement accounts, non-retirement accounts, keeping track of basis, this would be a nightmare.
Please, please, please consolidate if you don’t need all those other accounts, because we never do know when we’re going to go. That’s step five of The Retirement Success, Estate Planning. As you can see, there’s a lot more to it than just having your basic living wills, powers of attorney documents. It’s the combination of making sure that your goals are in alignment with how you title your accounts, your charitable strategy, your gifting strategy, everything that we went through in this video.
It’s very, very important. It’s all part of the overall estate plan. The big takeaway, also, here, is that estate planning is part of the financial planning process. We have a whole playlist here, of the retirement success plan. We started with step one, which is the allocation planning. Step two is income planning, step three, tax planning, then healthcare, and now, estate planning. They all work together to create your own personalized retirement success plan.
If you have any questions, feel free to reach out to us. I hope this series of videos was extremely helpful for you in your retirement.
