When choosing how to approach your estate plan, it’s important to realize that the different types of assets that you own have different legal and tax treatments. The way that I most often explain it is to consider them grouped into separate baskets, and then deciding how you want your estate plan to distribute each type of basket.
The first basket consists of your Florida homestead. Florida law limits what you can do with your homestead in your estate plan. My recently published book The Florida Residency & Estate Planning Guide details the complex issues surrounding the devise of your Florida homestead through your will or trust.
If you are married, for example, and do not have a nuptial agreement with your spouse, then you must bequeath your homestead in fee simple to your spouse. You cannot bequeath a life estate interest or put your homestead in some kind of a trust that benefits your spouse for life and then distributes it to others. If you do, then you have an invalid devise. I’ve written other columns on this topic before. If your plan involves bequeathing your homestead other than outright to your spouse, then this basket needs attention – and likely will need at least a limited nuptial agreement dealing with this issue.
The second basket consists of your IRA, 401(k), pension and profit sharing plans (“Qualified Retirement Accounts”). Here, whomever you leave these accounts to will have income tax liability associated with any withdrawals, just as you presently recognize taxable income (unless you have Roth accounts) when you take distributions. While a spouse is the only beneficiary who can “rollover” the account into his or her own account, non-spouse beneficiaries will have Required Minimum Distributions (RMDs) upon receiving an inherited IRA, regardless of their age. If a minor is named as a beneficiary, a court process will also be required without proper planning. Moreover, if you name a trust as the beneficiary of this kind of account, income taxes may be accelerated without proper planning.
The third basket consists of stocks, bonds, mutual funds, cash and bank accounts that are not Qualified Retirement Accounts. These assets receive a step-up in tax cost basis at the death of the account owner, meaning that unrealized capital gains are usually eliminated. These types of accounts have the fewest restrictions on how you can bequeath them in your estate plan.
The fourth basket consists of closely held business interests. These assets aren’t easily disposed of, as they are not traded on any stock exchange. Moreover, you may have other family members or third parties involved in the business or entity. There may be a shareholder, partnership or membership agreement that either restricts the disposition, or requires that the interest first be offered to the other shareholders at death. In the case of “S” Corporation stock, there are important elections that must be made within a certain time period after the death of the owner, and the type of beneficiary is restricted under federal tax law.
The fifth basket consists of annuities and life insurance policies, which have beneficiary designations. Annuities are similar to Qualified Retirement Accounts because the beneficiary will usually recognize taxable income when receiving distributions. Wills and trusts generally do not govern the disposition of these assets unless they are named in the beneficiary designation. Trusts named as beneficiaries of annuities may incur higher income taxes than direct beneficiaries due to their compressed federal income tax rate structure.
The sixth basket consists of real estate that is not your Florida homestead. There may be inheritance taxes associated with this asset if it is owned in a state that imposes such taxes. In my book I detail all 50 states’ income, estate and gift tax consequences of owning property in each state. Commercial real estate may be held in the form of a corporation, partnership or LLC discussed above. The ongoing management of this asset should be considered in your estate plan.
Yet another basket might be a trust in which you are a beneficiary and possess a “power of appointment” that would allow you to alter its disposition from the default provision in the governing document, which might be a parent’s will or trust. Your attorney should determine whether you have a power of appointment, whether it is limited in any way, and whether the value of the trust will be considered taxable in your estate for federal estate tax purposes.
There may be other baskets in any individual plan. So as you can see, when planning your estate, all of the different baskets should be considered, along with their unique legal and tax consequences. Failure to consider the intricacies of each type of asset might result in missing planning opportunities or in unintended adverse results.