Estate planning can be a dark, convoluted maze, and it's what you don't know that can get you in trouble. Here are six of the most common estate-planning traps waiting to ensnare you, and how to avoid them:
1. Leaving everything to your spouseIs your estate, counting life insurance, worth less than $1 million? If so, you can skip this one. If you expect to die with more than that, pay attention.
Under current law, anything you leave to your spouse escapes the federal estate tax. In addition, $2 million can be bequeathed tax-free to anybody. That number will jump to $3.5 million in 2009 and is scheduled to be unlimited in 2010 before dropping to $1 million in 2011.
Probably in 2009, Congress will change the law. The size of the exclusion will depend on November's election results. I expect a permanent exclusion of at least $3.5 million -- "permanent," that is, until Congress changes the law again.
Focused on that marital exclusion, many people make the mistake of leaving all of their estates to their spouses. There's no tax at the first death, but there's a potential hit when the second spouse dies.
Say, for example, that my wife and I each have an estate of $2 million. If I leave her everything at my death, she'll pay no tax. Now she has an estate of $4 million. When she dies, she still has only a $2 million exclusion, subjecting the remaining money to tax, to be paid by our children.
Congress is debating a provision that would allow people to claim any exclusions that weren't used when their spouses died. But that's not law yet.
That's why an appropriately drafted will should contain what lawyers call a bypass trust.
In my case, I'd leave the amount of the exclusion -- $2 million, if I died this year -- to a trust for the benefit of my surviving spouse. She could get all the income -- whatever she needed for health, education and maintaining her standard of living -- without the trust assets being included in her estate. She would even be allowed to tap the principal of the trust, each year, for the greater of 5% or $5,000.
When she died, the trust would go to our children, estate-tax-free. It was never in my spouse's estate.
By filtering the assets through the trust, I save our children the tax. Structured this way, $4 million escapes tax rather than only $2 million. With an exclusion to $3.5 million, only people with estates of more than $7 million should face a federal estate-tax bill.
2. Naming one-half of a couple as guardianForget about the money. The most important clause in your will is the one selecting who will raise your minor kids if both you and your spouse are gone.
The mistake I see most often is the naming of only one individual in a marriage. Say you select your brother as guardian of your 5-year-old daughter and you and your spouse are killed in an accident. Your brother and his wife raise your daughter until she's age 12. Then your brother dies. But your contingent guardian was your spouse's sister, not your brother's wife.
Now your adolescent daughter is pulled out of the home she's been in for the past seven years, possibly to a new town, if not a new state. It's not going to be pretty.
If it's possible, name both potential parents as guardians of your minor children. Kids suffer enough trauma coping with death, and they don't need the added stress of relocation. If you're uncomfortable with naming both spouses, perhaps neither should be your choice.
3. Not setting age limits on an inheritanceUpon the death of the second spouse, most couples' estates are left to their children. Once your kids hit age 18, unless it's otherwise specified, they would get control of those assets.
Big mistake. If I had inherited $1 million on my 18th birthday, I would have had a great year. But I wouldn't have had anything near $1 million when I hit 19.