Module 1 — Probate & Taxes

One major purpose of wealth transfer planning is the distribution of the estateholder’s property to intended beneficiaries. Property can be distributed after death in one of several ways, and the estateholder also has the option of giving property away during his or her lifetime. The four basic methods of property transfer are:

Each method has certain advantages over the others, and each poses certain drawbacks. Estate planners attempt to find the method or combination of methods that best suits the estateholder’s needs and objectives. Module 2 covers these tools in greater detail.

1. Transfer By Will — Wills & Probate

The Will

Perhaps the most basic estate planning device is the will or last testament. A person creating a will is called a testator. A will is totally inoperative during the testator’s lifetime and may be changed at any time. It becomes effective only upon the testator’s death.

Each state sets forth the conditions necessary to create a valid will. All states require the testator to be legally competent (“of sound mind”), declare the document as the “last will,” and revoke all prior wills. Most states require the will to be written, signed in the presence of witnesses, with an attestation clause signed by the witnesses.

A testator should review and possibly update a will whenever major life events occur: marriage; birth, adoption, or death of children; divorce or death of a spouse; creation or dissolution of a business; retirement; change of domicile; or significant changes in the tax code.

In a will, the testator can express wishes regarding:

• Who is to administer affairs after death (executor/personal representative)
• The powers of the executor and whether a bond is required
• Who is to provide care for minor children (guardian or custodian)
• How, when, and to whom property is to be distributed (heirs or beneficiaries)
• Creation of trusts under the will (testamentary trusts)
• Conditions imposed on heirs

However, a will cannot:

• Disinherit a spouse (without the spouse’s agreement)
• Disinherit a child by mistake (pretermitted heir laws apply)
• Distribute property outside the probate estate (property transferred by law or contract passes independently)
• Create perpetual trusts (subject to state rule-against-perpetuities laws)
• Contribute “excessively” to charities (in some states)
• Violate law or place immoral conditions on heirs

The Probate Process

Each state has established a process to settle the affairs of deceased residents — ensuring creditors’ claims are satisfied and the decedent’s intentions are fulfilled. The court that enforces a will is generally the probate court (some states use names such as “Orphans’ Court”).

The general steps of the probate process are:

• Filing the will — filed with the probate court in the county where the testator resided at death. If no valid will is found, the decedent is intestate.
• Petition — any interested person may petition the court to admit the will. The court appoints a personal representative (executor), sends notices to interested parties, and publishes legal notice to creditors.
• Proving the will — the court holds a hearing to determine that the document filed is the testator’s valid last will. Witnesses must testify, or a self-proving affidavit signed at the time of execution may substitute.
• Letters testamentary — if the will is found valid, the court issues letters testamentary granting the executor authority to collect assets, pay debts, file taxes, locate heirs, and distribute property.
• Final accounting and discharge — after the executor fulfills the terms of the will, a final accounting is filed with the court. When satisfied, the court discharges the executor and closes the estate.

Intestacy

If an estateholder dies without a valid will, state law creates a will for the estateholder — the intestacy law. Any property in the probate estate of an intestate individual is distributed according to state statute. The probate court appoints an administrator rather than an executor. If minor children survive, the court also appoints a guardian.

Under intestacy, only family members inherit — no property passes to friends, domestic partners (unless recognized by state law), or charities. If no relatives can be found, the estate escheats to the state.

Even persons with valid wills may encounter partial intestacy if the will fails to distribute the entire probate estate. A residual clause designating a remainderman to inherit any property not otherwise distributed prevents this problem.

Other Probate Protections

Most states protect certain persons from disinheritance. Florida provides:

• Elective share (forced share) — a surviving spouse may choose to take the elective share of the estate rather than accept the will’s terms, preventing a testator from disinheriting a spouse without consent
• Homestead provisions — protect a surviving spouse and minor children from being dispossessed from their primary residence
• Family allowance/exemptions — certain personal property (home furnishings, vehicle, etc.) is set aside for the surviving spouse and minor children regardless of the will’s terms

2. Transfer By Law

Some property automatically passes to others upon the estateholder’s death without going through probate. Whether property transfers automatically “by law” depends on how title is held.

Tenants in Common (TIC)

Tenants in common hold undivided ownership interests proportionate to their respective shares. During their lifetimes, each co-owner shares proportionately in income from the property and may transfer his or her share independently. Upon death, a co-owner’s interest passes to the deceased’s estate — subject to probate under the will. Tenancy in common does not provide automatic survivorship.

Joint Tenants with Right of Survivorship (WROS)

Like tenants in common, WROS co-owners hold undivided interests and share income proportionately during their lifetimes. However, upon the death of a co-owner, the property automatically passes to the surviving owner(s) by operation of law — bypassing the will and probate entirely. Because the property is not in the probate estate, the spouse’s elective share does not apply to WROS property. If all co-owners die simultaneously, the property splits between their estates and becomes subject to probate.

Tenants by the Entirety

Available only to married couples and only in certain states, tenancy by the entirety operates like WROS but with an added protection: neither spouse may transfer ownership without the other’s consent. Upon a spouse’s death, the property passes automatically to the surviving spouse. Florida recognizes tenancy by the entirety.

Community Property

Nine states treat assets acquired during marriage as community property, with each spouse holding one-half ownership. Property owned before marriage, or inherited or received as a gift during marriage, remains separate property. Upon death, one-half of the community property plus all of the deceased spouse’s separate property is subject to probate. The surviving spouse retains their one-half of the community property outright.

Important: Community property laws follow the couple — property acquired while residing in a community property state remains community property even if the couple later moves to a non-community property state. Florida is not a community property state, but Florida agents must be aware of these rules when clients have lived in or acquired property in community property states.

3. Transfer By Contract

Various contractual arrangements provide for payments to designated beneficiaries upon the contract holder’s death. The most common examples are:

• Life insurance death benefits — paid directly to named beneficiaries
• Annuity survivorship benefits — paid to designated beneficiaries or joint annuitants
• Retirement plan benefits (401(k), IRA, pension) — paid to named beneficiaries

Unless the contract holder named the estate as beneficiary, these payments pass directly to the named beneficiary, outside of probate, and are not subject to the terms of the will. Transfers by contract are discussed in greater detail in Module 2.

4. Lifetime Gifts

If property is disposed of during one’s lifetime, there is no need to transfer it at death — that is the simple premise behind lifetime gifts as an estate planning tool. The advantages of making gifts during life include:

• Reducing the size of the estate before death makes administration easier and less costly
• Reducing estate size may reduce estate tax liability
• Transferring assets early also transfers any future appreciation out of the taxable estate
• The donor receives the satisfaction of seeing the benefits of the gift during his or her lifetime
• The donor knows the current tax consequences of the gift — unlike a bequest subject to possible future changes in the tax code

The most obvious drawback of lifetime gifting is that the donor permanently loses control over the property and any income it generates. The federal gift tax must also be considered — discussed in detail on the following pages.

5. Trusts

While technically not a separate form of property transfer, trust arrangements are a powerful and versatile estate planning tool that often works in combination with the four transfer methods above. A trust is a legal arrangement that splits the title to property (legal or nominal ownership) from the benefits derived from the property (beneficial or equitable ownership).

The key parties to a trust are:

• Grantor (or settlor) — the person who creates the trust and transfers property into it
• Trustee — holds legal title to the trust property and manages it according to the trust document; may be the grantor, a third party, or a corporate trustee
• Beneficiary(ies) — the person(s) who enjoy the benefits generated by the trust property

The grantor may also serve as the trustee or beneficiary, allowing continued control or enjoyment of the property even after it has been technically transferred into the trust. This inherent flexibility makes trusts among the most powerful estate planning instruments available.

Revocable vs. Irrevocable Trusts

Under a revocable trust, the grantor retains the right to alter or cancel the trust arrangement at any time. Because the grantor retains control, revocable trusts are common estate planning instruments — but they do not provide estate tax protection, since the assets remain in the grantor’s taxable estate.

Irrevocable trusts, if properly drafted, can remove assets from the grantor’s taxable estate and provide protection from federal and state death tax liability. The tradeoff is a permanent loss of control: once established, an irrevocable trust cannot be altered or revoked by the grantor.

Living (Inter Vivos) Trusts vs. Testamentary Trusts

Trusts established while the grantor is alive are called living trusts or inter vivos trusts. They may be either revocable or irrevocable. Upon the grantor’s death, property in a living trust continues to be administered by the trustee for the benefit of the beneficiaries — avoiding probate entirely. The transfer is immediate, private, and relatively cost-free, making the living trust one of the most effective will substitutes available.

Testamentary trusts are created after the grantor’s death through a provision in the grantor’s will. They are always irrevocable. Because a will is required to establish them, property passing into a testamentary trust must first go through probate — they are not a probate-avoidance tool. However, testamentary trusts are useful when estate property needs to be administered over long periods (for example, for minor children or beneficiaries with special needs). Property held in a testamentary trust does not receive favorable estate tax treatment.

Trusts are discussed in much greater detail in Module 2 — Trusts.