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If you want to pass your estate along to your survivors, you need to take the right steps. Otherwise you could leave behind a legal nightmare or inadvertently donate a huge chunk of your estate to the government.
Last year, for example, the real-estate developer and Holocaust survivor Roman Blum died at age 97. He was a fabulously wealthy fellow with an estate valued at around $40 million. He did not, however, leave behind a Will and he had no living family members. Right now the $40 million is in the custody of the State of New York and New York may wind up legally keeping all of it.
When you die (and unfortunately we all will) your estate’s assets will be processed with supervision from the court system – or more specifically, the probate court. If you leave behind a Last Will and Testament, the court will abide by the wishes you expressed in that document. Courts move slowly, though, and probate can take up to two years or more, even when nobody contests the Will. The assets remain held up in legal proceedings and your heirs may need to hire attorneys to help along the way.
Gifts Now vs. Gifts in Your Will
Taking that into consideration, it’s not surprising that the practice of leaving assets behind in a Will has become less popular, as people figure out ways to circumvent the time-consuming and sometimes aggravating process of going through probate court. These days much of the wealth left behind transfers to heirs through other more direct legal structures or vehicles.
If you want to leave a lot of money to your family, for example, one way is to go ahead and spend it now to buy a valuable insurance policy that names them as the beneficiaries. You may also set up a Living Trust, which is a legal structure for holding your assets. When you die, the assets in the Living Trust will be distributed by the designated manager of the Trust (the Trustee) according to your explicit instructions. The probate court has no jurisdiction over that Living Will and the distribution of assets, so you sidestep that whole procedure.
Another thing you can do if you are married and have a joint bank account is to set it up so that if one of you dies, the surviving spouse is automatically entitled to full ownership of all the money in that account. The legal terminology for this arrangement is “right of survivorship” and means that the surviving person is protected from any claims brought by other heirs. The right to that money also passes directly, without going through probate. Money in the account simply changes ownership and the surviving spouse can write a check, sign it, and withdraw all the cash without any hassles.
Gift Taxes and Cost Basis
- The IRS allows you to give away up to $14,000 a year to anyone you want, without incurring a gift tax. That’s a really convenient way to transfer wealth before you die. If you are married with a child, each of you can give that child $14,000 a year – for a total of $28,000 a year.
- Gifts in the form of stocks are really popular for this purpose. Let’s say that you want to transfer $14,000 worth of stock and you have 50 shares of a company that are now worth $280 per share. Sign over those 50 shares and that’s a gift to your kid worth a total of $14,000. If and when your child sells those shares, however, they will have to pay income tax.
- In order to calculate the profit from selling stocks, you subtract what it cost to buy them from what you gained when you sold them (assuming you sold them for a profit). Your child will be required to base those calculations on the original cost of those shares, which is referred to as the “cost basis.”
- The error that people often make is that they assume the gift recipient’s cost basis is what the stocks were worth on the day that they received them as a gift, but that’s not accurate. Since the stocks were a gift they must assume the original cost basis of the person who bestowed the gift. For example, say you buy shares at the bargain price of $5 and years later – when they are worth $100 – you give them to your child. They need the cash so they sell them right away for $100 a share. If their cost basis was $100 – the price of the stock when you gave it to them – then they would have no profit to pay tax on, which would be great. In actuality, however, their cost basis is what you paid for them, which was $5 per share. That creates a $95 per share profit on which they do have to pay taxes on.
To learn more about how gift taxes work, visit the IRS website.
Percentages vs. Fixed Dollar Amounts
If you do leave assets via a Last Will, be sure that you are careful when it comes to specifying dollar amounts. If you want to leave your estate to four children and ensure that they each receive an equal share, leave each one 25% of your estate. Don’t try to assign a dollar value because asset values change all the time – while percentage values do not. In other words, the size of the pie will change, but the slice that each child receives will be equal – as long as you convey the asset as a percentage value.
Here’s an example:
Someone worth $100 million writes their Last Will. They love their grandkids and want to leave them nearly all of their money. They say in the Last Will that after the other terms of the Last Will have been met, the grandkids are entitled to everything that is left over. That should be a huge fortune.
They also want to leave behind $500,000 to their faithful dog Fido for Fido’s ongoing maintenance and welfare – so they clearly mention that in the Will. Sure, that’s a lot of cash, but it’s small potatoes if your estate is worth $100 million. Later the person with the rich estate falls on hard times; they lose a lot of money in the stock market and what’s left goes towards nursing home bills. By the time they die their estate is only worth $500,000, and if they didn’t revise their Last Will, Fido gets $500,000. The dog inherits their entire estate. The deceased really only intended to leave a small percentage of their estate to Fido and the majority to the grandkids, but they made the common mistake of writing in a fixed dollar amount.
Instead, they should have used a percentage, not a dollar figure. In the end, regardless of how much the estate was worth, Fido would have inherited the same portion of that estate – which would ensure that the wishes of the deceased were followed in a fair and equitable manner. Had they said “I leave Fido one half of one percent of my estate, Fido would have gotten only $5,000 ($1 million X .50% = $5,000) and the grandkids would have received the rest.