As published in the Houston Chronicle, Legacy Section, April 2000

Passing On Wealth

Proper planning key to passing wealth to beneficiaries

“If there is a logical beginning place, it would be with estate planning, which, in turn, will cause you to ask: “Do I really need a will?” If you own the chair you are sitting in as you read this, the answer is ‘yes.’”

By Professor Stanley M. Johanson and Wesley E. Wright

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The purpose of this article is to expose you to a general overview of estates, trusts, and probate. These are concepts used in the process of passing wealth to a person's intended beneficiaries.

An estate is generally everything a person owns, whether it be large or modest. Simple estates versus complicated estates can be distinguished by posing questions, such as: “What is the value of the estate?” “What kind of property does it contain?” “Who are the intended beneficiaries?” “What are the debts?” “What are the family dynamics?” “How will the estate be distributed at death?”

If there is a logical beginning place, it would be with estate planning, which, in turn, will cause you to ask: “Do I really need a will?” If you own the chair you are sitting in as you read this, the answer is “yes.” Any adult who owns property should have a will.

“Can I write my own will?” Yes, you can. Texas law permits handwritten, signed, unwitnessed wills (called “holographic” wills). But pay no attention to this information. Texas law also permits you to take out your own appendix. This area of the law is rather technical, and is no place for amateurs.

“But I am young and in good health. Wills are for old people. I'll get a will when I need one.” Unfortunately, when you need a will, it's always too late to get one! Especially if you are married and have children, you are doing a great disservice to your family if you don't have a will.

If you don't leave a will, upon your dearth one will be provided for you by the state. Here's a scary thought: Do you really want a will written for you by the Texas legislature? The one-size-fits-all “intestate succession” laws are like a size 8 shoe. Unless you have a size 8 foot, it's a bad fit.

“I wrote my will 15 years ago. Is it still valid?” Probably. However, you should reread it to make sure that it still satisfies your objectives, and that it fits your current situation. Marriages, divorces, births, deaths of family members - all of these may have affected your will and your planning objectives. Also, Congress has changed the estate tax laws almost every year since 1976. If your estate is in the range where taxes are a concern (see below), your will may have to be revised to take advantage of (or to avoid problems created by) the new laws.

The same is true if your will was written in another state, before you moved to Texas. The will itself is valid, but it may not have some useful provisions that are available only under wills written by a Texas lawyer. Have a Texas attorney review, and perhaps, revise your will.

Probate is a word that defines not only the process used to pass estates on to beneficiaries after the death of a decedent, but also for the admittance of a will in a court proceeding once the will is determined to be valid. The general purpose of the process is to identify and collect assets belonging to a decedent's estate, pay debts and expenses of administration, and distribute the remaining estate to the lawful beneficiaries.

“But, shouldn't one of my objectives be to avoid probate?” If you lived in California, Ohio, or one of the other states that have complicated and expensive probate procedures, the answer would be a firm “yes”. But this is not a concern in Texas. Thanks to our Mexican heritage (at least in this area of the law), we have a procedure called “independent administration” that greatly simplifies winding up a deceased person's affairs. The results are far less legal fees, court costs and complications.

“Do I have to worry about estate taxes?” Not if your net worth is less than $675,000. This is the “credit shelter” or exemption equivalent amount for estates of decedents dying in 2000 or 2001. Until 1977, the federal estate tax exemption was a paltry $60,000. It was increased to $175,000 in 1981, and to $600,000 in 1996. In 1997, Congress increased the credit shelter once again. The increase will reach $1 million by 2006. If your estate is in this range, the best estate planning advice we can give you is: Hang in there until 2006!

Many people look at that $675,000 number and quickly conclude that “Bob and I don't have to worry; our estate is well below $675,000.” But that may be the wrong conclusion. The federal estate tax base, called the “gross estate,” is aptly named. It is really gross! Any form of property passing at death is included. Not just the property you own that will pass under your will (house, cars, mutual funds, etc.), but also what attorneys call “non-probate assets”.

Non-probate assets are interests in property that pass at death, but not under a will because title passes outside the probate process. The most common examples are joint bank accounts with rights of survivorship, life insurance proceeds, death benefits under employee retirement plans, 401k plans, and IRAs (individual retirement accounts), where the beneficiary designation controls. Every one of these is subject to the estate tax at its date-of-death value.

For community property owned by spouses, only one-half is includible in the gross estate. But if the first spouse to die leaves it all to her husband (or his wife), the entire value will be subject to tax in the surviving spouse's estate. It is also important that beneficiary designations on life insurance policies, IRAs, etc., meet your current objectives. These may be more important than your will! In recent years, many people who have directed investments in their 401k plans or IRAs have seen remarkable growth, carried along by the astonishing rise in the Dow Jones average.

Qualified retirement plans and IRAs are very volatile assets. Because they are subject (in most cases) to both the income tax and the estate tax, they can be all but wiped out by taxes (up to 70 percent, in some cases). On the other hand, with careful planning that takes full advantage of the opportunity to defer income taxes, they can provide extraordinary economic security, not only for retirees, but also for their surviving family members. The difference between “misfortune” and “good fortune” turns on the beneficiary designation you have selected.

Space considerations preclude us from discussing this very technical topic any further. But here is one bit of advice: Do not, under any circumstances, designate your “estate” as beneficiary of your qualified plan, 401k plan, or IRA. You always want to name an individual (your spouse or a family member). If this is important to you, find out why this is so, and do so immediately.

Trusts play an extremely important function in estate planning. These mechanisms can be in simplest terms viewed as a bank account filled with money held for the use and benefit of another or others and guided by a list of “do's and don'ts”. Although the purposes are many, some of the most popular trusts are used for educating your children, distributing assets to your children and spouses over many years to avoid early dissipation, avoiding taxes, limiting your assets from ending up in the hands of your surviving spouse's next love interest, charitable giving, and the list goes on.

“Shouldn't I have a revocable ‘living’ trust?” Maybe yes, but probably no. Only an attorney can tell you for sure. Living trusts can be effective when used appropriately and in certain limited circumstances.

These arrangements are being vastly oversold to people who have no business creating trusts. They are being used as marketing devices to sell financial products and financial services to people who don't need them. You have probably seen ads for “free” seminars at some hotel, touting the advantage of living trusts. Let us hasten to add that some of these are highly reputable and professional, and can provide helpful information. But others are simply trying to get their hands on your money. We can tell the difference, but can you?

A living trust (more precisely, a revocable management trust) that is funded with assets during the owner's lifetime is not some panacea or legal wonder drug. It is a very specific, mildly technical planning arrangement that makes a lot of sense in certain situations, and no sense at all in most situations. A living trust is just one item on a vast menu that includes a number of planning techniques to choose from. You want to stay away from anyone who says that a revocable trust is the one answer to your legal or property management problems.

There is one situation in which a living trust is particularly useful, and the trust doesn't have to be funded at the time it is established. It is called a “standby” revocable trust, and it is used to cover the possibility of incapacity. If you become disabled and do not have a durable power of attorney, a guardianship administration in the probate courts will be necessary. A guardianship is an expensive and time-consuming method for handling the affairs of an incapacitated person. A standby revocable trust, which is left on the shelf unless and until it is needed (at which time it is funded under the authority of a power of attorney), provides a more efficient, flexible, and less costly means of handling an incapacitated person's property.

“With our IRA, the inflated value of our house, and other assets, my husband and I have an estate in the range where we have to worry about estate taxes. What are some of the planning arrangements we can use to reduce taxes?” We cannot do justice to this important subject in a short article. Let us point out, though, that for estates above $1 million, the estate tax is, to a surprising degree, a voluntary tax. If you want to pay it, you (more precisely, your heirs) can do so. However, estate planning specialists have in their toolboxes a broad array of planning techniques (some appropriate for your circumstances, others inappropriate), that can sharply reduce and even eliminate projected estate taxes in estates as high as $2 to $3 million. If your estate is in this range, you need help, and you should get it right away.

So get going! Get your affairs in order as they say, and remember this: proper planning is your best shot at passing your wealth to your loved ones in an orderly and efficient manner.

Stanley M. Johanson holds the Distinguished Teaching Professor and Fannie Coplin Regents Chair in Law at The University of Texas at Austin and is of Counsel to Vinson & Elkins. Wesley E. Wright is an attorney with Wright & Associates, in Houston, Texas, and is Board Certified in Estate Planning & Probate Law by the Texas Board of Legal Specialization.

This article is presented as a public service by the HBA's Probate, Trusts and Estates Section. Nothing in this article should be taken as rendering of legal advice to any person's specific case, but should be considered only general information.