William J. Davis, DDS, MS;
Joseph Massad, DDS; and
Gary L. Rathbun, CLU, ChFC
Once dentists have achieved some degree of financial independence, they need to have an estate plan. Without a crystal ball, no one really knows when the need for an estate plan will become a reality. Although professional advisers aid the estate-planning process, mistakes still can occur. Some of the most common mistakes made by dentists and their advisers include the following:
Mistake #1
Underestimating exposure to estate taxes
Some dentists simply don`t think they will have any estate taxes to pay when they die. Perhaps you believe you are not worth enough money to be subjected to estate taxes.
Exposure to estate taxes begins with the very first dollar of a dentist`s or spouse`s estate. Granted, there is an exemption of $650,000 as of January 1999. This amount is only the federal exemption and does not include any state exemption. Many states have a lower state exemption. Usually, the state estate taxes are levied sooner than the federal tax on smaller estates.
If your estate is larger than $650,000, the federal estate tax starts at a beginning rate of 37 percent and can increase to as much as 55 percent at $3 million level. This amount of taxation can be significant to your heirs.
Mistake #2
Not balancing ownership of assets
Many dentists own most of their assets jointly with spouses. At the death of the first spouse, all assets flow directly to the surviving spouse. This situation causes problems for couples who have a combined estate larger than the $650,000 exemption (known as the unified credit). The unified credit allows both the husband and wife to have a $625,000 deduction for each estate.
Therefore, if all the assets are together, one unified credit could be wasted if one spouse leaves everything to the surviving spouse. At the second death, everything over the exemption amount of $650,000 will be taxed. Not using the unified credit exemption at the first spouse`s death may cause you or your remaining spouse to pay an additional $202,050 in federal estate tax. By balancing your assets, each spouse having $625,000 in assets will be allowed to effectively pass $1.25 million to the next generation with no federal estate tax due.
Mistake #3
Choosing the wrong executor or trustees
It is very common for a dentist to choose a friend or family member as an executor or trustee. Being an executor or trustee is a very critical job. This responsibility should not be taken lightly. Many times, the person for one or both of these jobs is not aware that they have been named. It is always a good idea to ask the potential executor or trustee before you appoint them.
When it comes to choosing an executor, remember to consider all of the duties they must perform. Numerous legal obligations need to be completed correctly and in a timely manner. Is the person you have chosen capable and willing to take on this serious responsibility?
As for the position of trustee, it is very important for the person appointed to be qualified. It is also important to consider the length of time you will need this person to be your trustee. You might want to consider a bank trust department. The bank is not only capable of performing all of the duties required by the trust document, but it is also perpetual. If one of your children or grandchildren is named in a trust, the bank will more than likely still be in business many years into the future to administer the trust.
Mistake #4
Incorrect beneficiary and distribution elections of retirement plans
Retirement plans usually are part of an individual`s estate and can be taxed at a higher rate than normal federal estate tax rates. Your retirement plans are subject to estate taxes first when the unified credit is met, then the remaining money is subject to regular income tax. Depending upon the size of your estate and the income bracket of the beneficiary, the combined rate can go as high as 75 percent or more!
In most cases, dentists elect their spouse to be the beneficiary of their retirement plans. In fact, it is the law, unless your spouse signs a form indicating that it is OK to designate someone else as the beneficiary. The IRS makes us think this is an added benefit - naming your spouse as the beneficiary and allowing the surviving spouse to keep the money qualified or tax-deferred until the spouse receives the money as income. However, this only delays the tax problem and raises the ultimate cost associated with the death of the second spouse.
A solution to this situation is to arrange for the beneficiary designation be given to a trust, so the surviving spouse has access to all of the money he or she needs. This will also keep the retirement plan money out of the estate of the second spouse who dies.
Mistake #5
Owning life insurance
Many dentists purchase life insurance so that the death benefits can be used to pay estate taxes. What they fail to realize is that the death benefit becomes part of their estate and, consequently, increases the overall size of the estate. Therefore, the liability of estate taxes is increased.
Insurance salesmen try to solve this problem by having the spouse own the insurance. This keeps the money out of the estate of the first spouse at his or her death. However, this solution only delays the estate tax for the spouse who own the insurance policy, since it will be included in his or her estate.
The only way to prevent life insurance from becoming part of your estate is to not own the insurance when you die. It is also important that your spouse not own it. The best solution is to have a third party own the insurance, namely a trust. An irrevocable life insurance trust can take care of the surviving spouse, pay estate taxes, or take care of other heirs, all without creating any more estate tax.
Mistake #6
Failure to execute basic estate planning documents
Procrastination probably has caused more estate taxes to be paid than any piece of legislation ever passed by Congress. Dentists start the process of creating an estate plan, but do not follow it through to completion. Many trusts are left unfunded, and wills are left undated or unsigned.
Some plans omit basic documents needed to complete the estate plan. Estate planning involves more than just planning for the death of you and your spouse. The other documents needed are:
Y Durable power of attorney
Y Power of attorney for health care
Y Living wills
Y Living trusts
Y Wills
These are only the most basic documents you will need to protect your estate. If your estate is more complicated than normal, then more documentation is needed.
Mistake #7
Lack of liquidity for estate costs
Whether or not your estate is assessed for federal estate taxes, you still have a need for liquidity. Before an estate can be settled, any and all claims against your estate must be paid. The main items in everyone`s estate requiring liquidity are simple debts, attorney fees, and probate costs.
Providing liquidity can be done in a variety of ways. One common method is for the dentist and spouse to purchase a "second-to-die" life insurance policy. The policy will pay a death benefit after the second of the spouses dies. Naturally, you or your spouse do not want to own the insurance, so it should be owned by a trust. The single purpose of the trust is to provide the liquidity needed to settle your estates.
A second possibility is to simply make sure that there is enough cash available in the estate at the time of death to cover estate costs.
No matter how complete the estate plan, there will always be a need for liquidity. If the cash is not planned for in advance, it can become very costly to the estate to liquidate long-held assets to provide the needed cash. Remember, an estate must be settled within nine months from the date of death.
Mistake #8
Not fully using credits and exemptions
Many dentists are aware of the fact that they can make an unlimited amount of gifts in the amount of $10,000 each year to as many people as they wish. However, what many dentists don`t realize is that you can give up to $650,000 during your lifetime. In fact, you and your spouse can each give $650,000 for a total of $1.3 million.
Why wait to use these exemptions until your death? It makes good financial sense to use these exemptions while you are alive if you can afford to do it. All of the "gifts" before your death will be left out of the estate, allowing the appreciation and growth of the assets to go to your beneficiary.
Mistake #9
Not leveraging credits and exemptions
In addition to fully using credits and exemptions, it is necessary to leverage those gifts as much as possible. For example, not only can you give $10,000 to any one of your heirs, but your spouse also can give an additional $10,000. If the heir receiving the gifts is married, you and your spouse can give an additional $10,000 to their spouse so that child`s household can receive $40,000. If you have any grandchildren you can also give each grandchild $20,000 from you and your spouse.
Dentists transfer their assets to the next generation by giving the $10,000 to a life insurance trust to leverage the gifts as much as possible. By giving it to a life insurance trust, the $10,000 gift may compound itself to as much as $250,000 or more, depending on the power of time. It is even possible to create a dynasty trust that will provide funds to your heirs for generations to come.
Mistake #10
Not having a master plan, keeping it up-to-date, and regular reviews with a qualified adviser.
Letting documents get out of date can devastate your survivors and cost untold dollars in additional administration and taxes. A good rule of thumb is to update your plan every two years - more often if there are significant changes in your practice or family situation. If a will is more than three years old, it is significantly easier to contest. This means someone who you do no want to share in your estate could petition the court to be included in it after you are gone. If that person can make a good case and the will is not up-to-date, it is possible some of your assets could be given to the individual by the court.
Another reason to keep your documents up-to- date is that the laws concerning estates, gifts, and taxes change frequently. As the tax laws change, your documents should reflect these changes, so that what you want to happen will happen. It is very important the advisers you use be current on the latest laws and techniques in estate planning and be very familiar with your situation.
Many areas can be overlooked when putting together your estate and financial plans. To avoid making the above mistakes or overlooking opportunities to save money for your estate be sure to use a qualified adviser to assist you.
This article is designed to provide accurate and authoritative information in regard to the subject matter covered. It is presented with the understanding that the authors and the publisher are not engaged in rendering legal, accounting, or other professional services. If legal advice or other expert assistance is required, the services of a competent professional should be sought.
