This post will review key tax concepts that are important to understand for estate planning purposes.
Federal Estate Tax Exclusion: Generally speaking, a person's estate is subject to an estate tax. However, the amount that is excluded from federal estate tax is $5.49 million in 2017. That means a decedent's estate can be valued at $5.49 million before the highest tax rate is applied. The federal estate tax exclusion amount is inflation adjusted, so it will presumably increase every year at the rate of inflation. However, if a person's estate is above $5.49 million, the excess will be taxed at a rate of 40%.
Portability: This option allows the surviving spouse to take the deceased spouse's unused exclusion amount, if any, and add it to the surviving spouse's estate tax exclusion. Therefore, a couple can theoretically shield close to $11 million dollars in assets from estate tax. Portability used in conjunction with the unlimited martial deduction is a powerful wealth transfer tool.
Federal Gift Tax Exclusion: Generally speaking, gifts are taxable. However, as discussed before in a prior post, an individual may give up to $14,000 (in 2017) per person without paying a federal gift tax. Anything above that will require filing a gift tax return. The federal gift tax exclusion and the federal estate tax exclusion is a unified credit, so if you gift away a certain amount during your lifetime, you estate and gift tax exclusion will decrease by the amount gifted. For example, Mary gifts $1 million to her son during her lifetime. Her estate and gift tax exclusion is then reduced from $5.49 million to $4.49 million.
Unlimited marital deduction: This deduction allows spouses to pass an unlimited amount of property between themselves without paying any estate or gift taxes (if the spouse is a U.S. citizen). The unlimited marital deduction can be used to defer paying federal estate and gift taxes upon the first spouse's death.
Generation-Skipping Transfer Tax: If a person transfers assets to a "skip person", which is someone who is at least two generations below the transferor, then the federal government will impose a tax called a generation-skipping tax. The federal generation-skipping tax exclusion amount is currently $5.49 million and the federal generation-skipping tax rate is currently 40%. The federal generation-skipping tax exclusion is also unified with the federal estate and gift tax exclusion amount.
When creating a retirement account such as a IRA, 401(k) or other defined benefit plan, an individual is usually (and hopefully) instructed to name at least one beneficiary to the account. Upon the individual's death, the beneficiary (if still alive) will then inherit the account balance without having to go through the probate process.
Sometimes, though, an individual forgets to review and update the beneficiary designations on their retirements accounts. If the primary and contingent beneficiaries predecease the individual or if there is no primary and/or contingent beneficiary listed, then usually the account will revert to the estate and be subject to probate.
But, what happens to the retirement account if 1) no beneficiaries are named or have predeceased and 2) no personal representative is appointed to administer the decedent's estate?
Hawaii Revised Statutes Section 523A-3(14) provides that any property in an individual retirement account, defined benefit plan, or other account or plan that is qualified for tax deferral under the Internal Revenue Code is presumed to be abandoned three years after the earlier of:
(1) the distribution or attempted distribution of the property OR
(2) the date of the required distribution as stated in the plan or trust agreement governing the plan, or as specified in the Interal Revenue Code by distribution shall be nade to avoid a tax penalty.
This means the retirement account will be considered abandoned property and will eventually escheat to the State of Hawaii.
As a general rule of thumb, one should review their estate plan every three to five years to determine whether life changes or new laws merit making revisions to their plan. As part of the estate plan review, one should also examine the beneficiary designations on their retirement accounts to ensure that their primary and contingent beneficiaries are updated and current.
When a person dies, who has priority to be appointed the personal representative (also known as the executor) of the decedent's estate? Hawaii Revised Statutes Section 560:3-203 provides a list of interested persons who may be appointed as the personal representative to administer the estate. They are as follows from highest to lowest priority:
(1) The person with priority as determined by a probated will including a person nominated by a power conferred in a will;
(2) The surviving spouse or reciprocal beneficiary of the decedent who is a devisee of the decedent;
(3) Other devisees of the decedent;
(4) The surviving spouse or reciprocal beneficiary of the decedent
(5) Other heirs of the decedent; and
(6) Forty-five days after the death of the decedent, any creditor.
This list would apply in situations where a decedent died with a Will (testate) or without a Will (intestate).
In addition to directing where and how a person's property is distributed upon their death, a Will allows a person to nominate an individual or corporation (such as a bank) to serve as the personal representative. Such a nomination would help avoid a situation where multiple parties may fight to be appointed the personal representative since they have equal priority to serve under Hawaii Revised Statutes Section 560:3-203.
In a prior blog post, I reviewed what a power of attorney is and the types of power of attorney that are available depending on the situation. In April 2014, the Hawaii legislature passed the Hawaii Uniform Power of Attorney Act, which was codified in Hawaii Revised Statutes Chapter 551E. This new section replaces Hawaii Revised Statutes Chapter 551D, the Hawaii Uniform Durable Power of Attorney Act. Here are some highlights from the Hawaii Uniform Power of Attorney Act:
1. A power of attorney is now considered "durable" unless otherwise specified. In other words, it is effective even after the principal may be incapacitated.
2. An issue under the Hawaii Uniform Durable Power of Attorney Act was that a person who was presented with a power of attorney did not have to accept the power of attorney. Under the Hawaii Uniform Power of Attorney Act, a person who is presented with a power of attorney may ask that the agent certify "any factual matter concerning the principal, agent, or power of attorney". If an agent refuses a request for a certification, the person presented with the power of attorney may decline to accept the document. However, if a power of attorney presented with a certification is still refused, the agent may seek a court order mandating acceptance of the power of attorney. This change provides another layer of protection for the person being presented with the power of attorney while also giving the agent recourse if a certified power of attorney is still not accepted.
3. Chapter 551D does not govern power of attorney for healthcare decisions. Those fall under Advance Health Care Directives. They also do not cover power of attorney for parents or legal guardians of a minor or disabled adult under another person.
Your friends and/or relatives may have mentioned that they have set up a revocable trust and urged you to look into creating one as well. While a revocable trust is a powerful and flexible estate planning tool, it is not a one-size-fits-all solution. I would caution engaging with an attorney who insists that creating a trust no matter what. Revocable trusts are more expensive to create than a simple Will, so an attorney may be motivated more by their pocketbook than looking out for your best interests.
That being said, generally speaking, a revocable trust is a wonderful estate planning tool that everyone should be educated about, even if it may not be currently suitable for them. Below are some of the benefits of having a revocable trust.
Avoiding Probate. All property transferred to a revocable trust will avoid the probate process upon the decedent's death. This means property may be held or distributed pursuant to the trust terms to beneficiaries without having to go through the court-supervised process known as probate. This is especially important for people who own real property since Hawaii probate law mandates that real property interests are subject to probate.
Control. One can draft the terms of the revocable trust to distribute trust assets to beneficiary in stages. This may be useful for those who have minor children who cannot legally own property or adult beneficiaries who may lack financial management skills. If a minor is a beneficiary of an estate or other property (e.g. life insurance proceeds), then a conservator will need to be appointed to manage the property until the minor reaches the age of majority, which is 18 in Hawaii. A trust can provide asset management until the minor child is an appropriate age. For an adult beneficiary who may be at risk of frittering away their inheritance, a trust can provide asset management by placing a third-party trustee in control of the assets and distributing income and principal to the beneficiary at regular intervals and/or at the trustee's discretion.
Asset Management. A revocable trust can also provide asset management for the person who created the revocable trust if the person becomes incapacitated for some reason. A successor trustee can step into the shoes of the incapacitated person and have the authority to access accounts to pay bills and manage financial affairs until the person gains capacity or, if the person remains incapacitated, provide ongoing asset management.
Disposition of Assets Upon Death. Like a Will, a revocable trust serves as a testamentary document and can determine how property is distributed upon a person's death. However, unlike a Will a revocable trust has many more features that may be useful depending on an individual's situation.
What happens when a personal representative cannot find any living heirs or devisees of a decedent? Hawaii Revised Statutes Section 531-33 provides a procedure for the disposition of property in this scenario.
First, the personal representative will need to file a petition to have the estate's final accounts approved. Notice will need to be published in the newspaper for a period of not less than three consecutive weeks. All claimants for a distributive share of the estate then have 90 days from the date of first publication to present a claim to their share of the estate.
If no claims are presented within the 90 days or if a portion of the estate remains unclaimed after this period, then after the court approves the settlement and accounts of the estate, the court or registrar may direct the personal representative to transfer the remainder of the property the State Director of Finance.
The State Director of Finance is then instructed to sell any property, if possible, at public auction. The proceeds are then held pursuant to Hawaii Revised Statutes Chapter 523A, which the unclaimed property law.
According to Hawaii Revised Statutes Section 523A(15), generally speaking, property is presumed to be abandoned five years after the owner had a right to demand the property or after the obligation to pay or distribute the property arises.
Administering a decedent's estate can be a confusing and convoluted process. There are the funeral arrangements, various bills that may need to be paid, and the transferring of property to the decedent's heirs or devisees. A critical part of trust and estate administration in Hawaii is knowing the priority of claims. In other words, which bills need to be paid first? How should the decedent's assets be allocated? This post briefly summarizes the priority of claims against a decedent's estate.
In Hawaii, under the Uniform Probate Code, a surviving spouse has a right of election against the decedent spouse's estate. This will be explained in greater detail below, but for historical background, we will briefly discuss the related concepts of Dower and Curtesy.
Up until 1977, a surviving spouse was given an automatic life estate equal to 1/3 interest in any real property owned by the decedent spouse. For men, this was known as Curtesy and for women it was referred to as Dower. Dower affected the husband's real property in that he could not convey his interest in real property without his wife signing off. The wife, on the other hand, could convey her real property without needing her husband's signature.
Dower and Curtesy was replaced in 1977 by the Hawaii Uniform Probate Code. Under the UPC, the surviving spouse has the right to take an "elective share" of the augmented estate, which consists of both the decedent spouse and surviving spouse's estates. The amount of the "elective share" is determined by the length of the marriage and is set out under Hawaii Revised Statutes Section 560:2-202.
Generally speaking, the augmented estate consists of the following:
b. Property in which the decedent retained the right to possession or enjoyment during his
lifetime (i.e. life estates, retained income interest, etc; or
c. Property over which the decedent retained a general power of appointment.
The surviving spouse's elective share is in addition to the homestead allowance, exempt property and family allowance, as were discussed in a previous post.
The probate process in Hawaii can be onerous, time-consuming and costly. However, if the decedent's estate meets certain conditions, initiating a probate with the courts is sometimes not necessary. Hawaii law, namely Haw. Rev. Stat Section 560:3-1201, allows a decedent's next-of-kin to collect the decedent's property by affidavit. The following are the conditions that must be met for a decedent's property to be marshaled by a Collection by Affidavit:
Furthermore, Haw. Rev. Stat. Section 531-20 mandates that "every banking house, fiduciary company, agent, or trustee" must disclose the nature and kind of property being held when presented with the Collection by Affidavit.
A drawback to the Collection by Affidavit method is that any next-of-kin could potentially sign an affidavit and collect the assets unbeknownst to the decedent's other relatives. Obviously, this could lead to discord and friction between the decedent's relatives. If the decedent desired the property to be given to a certain person(s), then leaving the assets to be collected by affidavit is not recommended. The Collection by Affidavit method is simple, but can also be easily abused.
Banks and other financial institutions usually have their own Collection by Affidavit forms or an attorney can draft an affidavit that could encompass the assets generally. Either way, the Collection by Affidavit can be a cost-effective method to marshal a decedent's assets and a simple alternative to having to file for probate.
Selecting a Trustee is not a decision that should be taken lightly. However, many people merely select a family friend or their eldest child without a second thought as to whether they are truly qualified and willing to handle the duties. In the context of Revocable Living Trusts, since the Grantor is usually the initial Trustee, the decisions that need to be made are usually in regards to who shall be the Successor Trustee(s). Here are a few factors should be considered when selecting a Trustee or Successor Trustee:
What qualities does the Trustee possess? For people with adult children, selecting the eldest child to act as Trustee is the default. It makes sense to them for the mere fact that the child is the oldest and that the child likely helped care for their younger siblings growing up. However, having seniority is not a prerequisite to being a competent Trustee. For example, the youngest child may be better suited to be the Trustee because of his temperament or perhaps he has an investment or financial background. Instead of merely looking at age of the potential Trustee, think about whether she has the qualities and skills that would allow her to succeed as Trustee. Some of these qualities include being detail-oriented, trustworthy, fair-minded, responsible and having good communication skills,
Will the Trustee have time? An overlooked factor that thwarts Trustees and sometimes gets them into trouble is not having enough free time to administer the Trust. Examine the life situations your potential Trustees are currently in. Is your selection juggling a demanding job and a busy family life? People often equate being Trustee to having a second job. It's not far from the truth. Of course, circumstances change, but it would be wise to consider the Trustee in their current situation and not extrapolate what their lives may be in the future. You can always amend your selections at a later date if a person is no longer suitable to act as Trustee.
Where is the Trustee located? With technological advancements, having a Trustee who is in close proximity to trust assets is not as big of an administrative hurdle as it was in the past, but it certainly makes the Trust easier to administer if your Trustee is nearby. And given our state's isolation, this is especially true for a Trust whose situs is in Hawaii. Consideration should be given to the cost an out-of-state Trustee will incur when employing agents to carry out the administration. This cost will likely be paid for out of trust assets, which will leave less for the beneficiaries. If some of your prospective trustees live on the mainland while others reside in Hawaii, thought should be given to how willing a mainland Trustee may be to administer a Trust located in Hawaii.
How complex and large are the assets in the Trust? If your Trust contains significant assets or is perhaps a legacy Trust that is designed to last multiple generations, you may want to forgo selecting an individual Trustee and opt for a corporate Trustee. While a corporate Trustee's fees will likely exceed those of what an individual may request, a corporate Trustee does have the institutional support and expertise to manage more complex Trusts. However, for Trusts that have assets of less than $100,000, employing a corporate Trustee may not be worthwhile monetarily since a corporate Trustee sometimes charge a minimum fee, which could be a sizable percentage of the trust assets.
How are the relationships between the beneficiaries? If you are aware of conflicts between your beneficiaries, naming one of them as Trustee may not be the wisest move. Other beneficiaries may resent the beneficiary you chose to act as Trustee and those feelings may balloon into costly legal battles. Sometimes beneficiaries will engage in petty bickering, but these distractions will be enough to make cause unnecessary stress for the Trustee, which may lead to additional problems. Therefore, if tension exists between your beneficiaries, whether it is underlying or overt, selecting an impartial, corporate trustee may help reduce the potential for litigation among the beneficiaries. If you're thinking about using a family friend as Trustee, consider the unenviable position he may be placed in when having to act as a mediator or referee to your beneficiaries.
Just ask. Finally, ask your prospective Trustees if they want the responsibility of being Trustee. Explain that administering the Trust and communicating with the beneficiaries will take time away from their own lives and pursuits. Ask if they'd be willing to make that temporary sacrifice for you. Making upfront disclosures to Trustees of their responsibilities will help mentally prepare them for the eventuality of being a Trustee.
Samuel K.L. Suen is an attorney based in Honolulu, Hawaii specializing in estate planning, probate, conservatorship and guardianship matters.
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