Estate planning is about transfer of assets after one’s death and the taxes and fees related to the transfer, including gift taxes, if gifts were used while one is alive.
Methods to transfer assets at death are by contract (Revocable Trusts or Irrevocable Trusts, insurance proceeds or Qualified Retirement Account beneficiary designation) or by a Will. Also, if none of the above applies then assets pass by court proceedings.
Taxes and fees are: Probate fees charged by the court for assets passing by probate. In California this can be $48,000 for a $1,000,000 asset like a house, even if the asset has been “hollowed out” with a cash-out refinance and has no equity. IRD tax is “Income in Respect of the Decedent” which is income on the income earned in final year of life. Finally estate tax is a tax based on net worth, not on assets. So an estate may pay state and federal estate tax, a court probate fee and IRD state and federal income tax. Also expensive real estate city and county transfer taxes may apply if the deceased person’s home is sold.
Using a Revocable Living Trust is a way to make assets transfer by contract and thus avoid probate, saving probate fees, time and privacy. It does not save on estate tax or income tax. When someone dies the revocable trust splits into an A Trust and a B trust with the deceased exemption amount in one trust and the excess in the other trust. That way the exemption amount (scheduled to be $1,000,000 in 2011, but subject to legislative change) is preserved free of tax to be sent downstream to the children. However, while the surviving spouse is alive, the spouse gets to draw on the income generated by the exemption trust.
Doing Charitable Gifting is a way to reduce estate tax and income tax. This would need integrated financial planning to determine how much tax would be saved and whether one would be able to afford to give the gifts.
Qualified Retirement Accounts such as 401k, 403b, IRA, etc. pass by contract based on the beneficiary designation statement, which can not be overruled by court order or by a Will. This is why it is vital to do a full financial plan and examine estate planning issues. As a rule of thumb it is far more flexible and more reliable for estate planning purposes to have assets in an IRA than in an employer sponsored retirement plan like a 401k because of the benefits of “stretch IRA” and the freedom and control that an IRA gives to the owner to have a sophisticated beneficiary designation.