What's missing from your will?

Four things that parents can neglect when estate planning

Four things that parents can neglect when estate planning

If you’re a parent, you probably have a will to make sure your family is taken care of if something happens to you. What you might not know is that a simple will won’t protect your children from some common problems which can plague families when tragedy strikes.

Standby Guardianship Document

Many parents believe that naming a guardian in their will is enough to make sure someone is available to take care of their children. However, a guardian designation in a will has no effect if a parent is alive but unconscious in the hospital. 

Even in the case of death, a guardian named in a will has no legal authority until a Petition for Guardianship is submitted and approved by a court — a process that could take months. In the meantime, no one would have the ability to authorize medical treatment for your child or to enroll your child in school or health insurance.

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To make sure your child is always under the care of a legally responsible adult, you must execute a Standby Guardianship Designation, which triggers temporary legal guardianship until a permanent legal guardian can be appointed by a court.

A Testamentary Trust

While many people think trusts are for only the very wealthy, trusts should be a staple of every estate plan for families with young children. There are several different kinds of trusts, but all of them serve to hold and administer assets for a named beneficiary. 

A trust is generally created by a parent to hold and administer assets for their child until the child reaches a certain age. The parent names a trustee, who is responsible for administering the trust, and establishes conditions under which distributions should be made to the child.

Trusts provide protection for your family in many ways.

Trusts prevent your child from having unfettered access to his or her inheritance at a young age. In the absence of a trust, your child could be given control of large sums of money at the age of 18 or 21 (depending on the type of asset).

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Trusts relieve your your child’s guardian of costly and burdensome legal obligations that would otherwise be imposed until the assets are transferred to the child at the age of maturity.

If you have more than one child, a trust ensures that your assets are fully available in the event that one child incurs unexpected medical or therapeutic expenses. Otherwise, one sibling’s share of the inheritance could not be used for another sibling, even in extraordinary circumstances.

The most common type of trust is a testamentary trust. This is a trust that is created pursuant to a Will and receives assets in the event of a person’s death. For example, many parents have Wills directing that all of their assets be transferred to a trust for their children in the event of the parent’s death. The document specifies the conditions under which distributions can be made from the trust and the age at which the children should be given complete access to their inheritance.

Other trusts can be created during a person’s lifetime. Such trusts can receive assets during the life of the trust maker. 

A Separate Trust for Your Retirement Accounts

While a regular testamentary trust is sufficient to hold most assets, funds that are held in a tax-deferred retirement account require special planning. If funds in a retirement account are transferred to a trust or estate pursuant to a beneficiary designation, income tax on the entire account balance will be triggered upon transfer. When this happens, all tax-deferral benefits are lost and the large amount of income pushes the taxpayer into the highest tax bracket. 

There are two ways to avoid this situation. The best way is to name a special retirement trust as beneficiary of the accounts. Such a trust has certain provisions that allow for continuation of the account’s tax-deferral benefits.

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The other way is to name your children as the direct beneficiaries of the accounts. In this case, the children would be given full access to the funds at the age of 18 and the account would be subject to court supervision and reporting requirements until that time. Moreover, funds left to one child could not be used for the benefit of a sibling, if necessary.

Estate Tax Planning with an Irrevocable Trust

If your net worth plus your life insurance (your “taxable estate”) exceeds, or is likely to exceed, $5.5 million in the next 10 years, your family could end up with a tax bill for hundreds of thousands of dollars in state and federal estate taxes at the very worst time.  

Fortunately, this tax can often be completely avoided by transferring your life insurance policies to an Irrevocable Life Insurance Trust (ILIT). Unlike a testamentary trust, an ILIT is created during your lifetime but survives after you’re gone. If your net worth plus your life insurance exceeds or is likely to exceed $5 million within the next ten years, you should talk to an estate planning lawyer about setting up an ILIT for your family. Please note that certain information above applies specifically to residents of New York State.

Shannon P. McNulty is an attorney at The Village Law Firm, Law Office of Shannon P. McNulty LLC specializing in estate planning for families.