Why You Need An Estate Plan

Why you need an estate plan

No one wants to think about their own death. Yet none of us will live forever. Creating an estate plan is an unpleasant but necessary part of being a responsible adult. We can’t know when our time is done, but we can control whether we help our loved ones in their time of mourning or leave them with a financial mess to clean up.

This month, I’m taking a break from Moatiful’s usual stock market commentary to sit down with Kent Phelps, attorney and CEO of Trajan Estate, to learn more about this important subject.

Matt Coffina: Hi Kent, thanks for joining me today. Let’s jump right to it. My wife and I created our first estate plan when my son was born eight years ago. There was an added sense of urgency, since we wanted to make sure he would be protected if anything happened to us. My understanding is that if you don’t have some kind of written document, it’s possible your kid could end up in foster care—even if it’s only for a few days—while the state clears a relative or friend to take custody. Let’s start there: What happens to a minor child if both parents die in a car crash or something, and they don’t have a will?

Kent Phelps
Kent Phelps, CEO of Trajan Estate

Kent Phelps: There are two sides to this: guardianship and financial. On the guardianship side, if you don’t have a will, then you have not properly named the legal guardian for your children should something happen to both parents. That means the state becomes the guardian, the child becomes a ward of the state, and it’s up to the courts now. Without having received any guidance from you, it is 100% within the court’s discretion as to who should be appointed to finish raising your children. The state is completely in control of that decision, again without any input from you. And while the state is figuring that out, of course it doesn’t happen overnight, there will have to be intermediate measures taken. Would a child end up in foster care? If there were relatives that indicated they were willing and able to care for the child, then it’s likely the child would end up with a family member, even in the short term. But that’s not necessarily so. It’s at the discretion of the court, or really the judge. Let’s say the judge has a concern about somebody who you would have had no problem with, but for whatever reason there’s something about them that the judge isn’t comfortable with. At that point, sure, your child could end up in foster care.

So that’s the guardianship side. Now the financial side. A lot of young parents don’t think about this—they’re still trying to get established, the money seems to come in and go right out. Even if you live a comfortable lifestyle, you may not feel like you have enough to justify an estate plan that involves a living trust, for example. But what they’re not thinking about is the life insurance that young couples often have, sometimes over a million dollars’ worth. In that scenario, if both parents pass away without a will or especially a trust—and I’ll get into that later, why a trust would be better in this situation—but that means we now have a large life insurance payout that the estate must appoint a conservator to manage on behalf of the children. The conservator has to file a report with the court every year, but the worst part about this is the child is going to get all of that money at age 18 without any strings attached.

Matt: Interesting, let’s discuss that. Can you help us briefly understand what’s the difference between a will and a trust?

Kent: Sure. The difference between a will and a trust is very fundamental. A will is what we call a testamentary instrument. That means it’s not effective until you die. Whereas the type of trust most people need, which is a living trust, is effective when you sign it. It continues to be effective throughout your lifetime, including during times when you may be incapacitated.

Why does it matter? I’ll return to the example of the million dollars of life insurance proceeds going to the child. Most people have a will that says who gets what. If you have two children, say 50% goes to each. We’ll name legal guardians in the will, which is wonderful. We can specify who’s in charge of managing the estate—in some states, that’s called an executor, in some states it’s a personal representative. But a will doesn’t go much further than that.

If you have a will, the will must be submitted to the state probate court. There are many things about probate that the average person wants to avoid, such as cost and delay, loss of privacy, and loss of control since we’re involving the state in our personal and financial affairs. Problems like family conflict, where now we are in a forum that by its very nature is adversarial. If we’re trying to avoid family conflict when we pass away, being in a court of law is typically not the best place to do that.

And then on top of all that, we have a lack of direction and guidance about the transfer of value to the children. Let’s say we have a child who has turned 18, and they are inheriting a million dollars. I have raised six children to the age of 18 or older. As wonderful as I think my children are, there isn’t a single one of them that I would want to get that kind of money at age 18. I have sat in courtrooms and watched judges very nervously end a conservatorship. They effectively are handing the checkbook to the 18-year-old, who can use those funds for any purpose that they want, whether that purpose is going to bless their life or destroy their life. And all the judge can do—I’ve literally seen this—is slide an article across the bench about how to manage finances. That’s it. That’s as much direction as the judge can give that 18-year-old. Very scary situation there.

So how does a trust help in that situation? We can design the trust to do anything we want. And I’m talking about a trust that is drafted by a competent estate planning attorney, who focuses just on estate planning. You typically won’t be able to get this kind of structure and control in place with a generalist attorney.

With a trust, we can name a trustee—someone you can count on to manage your assets on behalf of your children until they’re old enough to do it themselves. The trustee can utilize the funds for the benefit of the child, without writing a check to the child. For example, the funds can be used for education, getting married, buying a car, buying a house, starting a business, paying medical expenses, whatever it might be. The funds can be used for purposes that will bless the lives of our children. And then the trust can identify an age when the baton can be passed to the child to manage their own share. We’ll have to make our best guess based on what we know about the child when we create the trust, about if they’ll be ready when they’re 25, 30, or 35 years old.

In our trusts, we also include a safety net, we call it the “trustee blocking power.” It means that even though the trust says that Junior can take over the trust at age 27, if the trustee believes (in their sole and absolute discretion) that the child is not in a good place, they can delay handing off the baton. Maybe the child is struggling with personal problems like addiction, or they’re a spendthrift, they’re engaged in criminal conduct, whatever the problem might be. And in those cases, the trustee can work with the child to maybe get them into rehab or whatever is needed to hopefully get them to a better place where they can be trusted with the money.

Matt: Do you ever see that result in a dispute between the trustee and the beneficiary?

Kent: No, I haven’t personally seen that. Sometimes it does happen, typically when a corporate trustee has been named, and a trust has been written without specific directions about when the trustee is to step down. These would be trusts drafted by other attorneys, not from my office. Corporate trustees have a fiduciary duty to the beneficiary, but they also have a self-interest in keeping the funds under management and being paid to be trustee. So, I have seen situations like that, which have to be resolved in court.

Matt: And Trajan Estate avoids those kinds of situations, if there’s a corporate trustee, by setting a deadline?

Kent: Yes, as long as the client is comfortable with it, we would always specify an age at which time the baton would be passed. And beyond that—in case the corporate trustee, or really any trustee, is being unreasonable—we include a “trust protector provision” that allows an independent attorney to do due diligence and investigate the situation. And if the trustee is misbehaving, the trust protector can remove the trustee, without even going to court.

Matt: Let’s circle back to the downsides of the probate process for a minute. Can you elaborate on that?

Kent: Sure. There are basically five reasons why most people want to avoid probate. The first, as I mentioned, is delay. AARP did a study that showed the typical probate, across the country, takes about 18 months to resolve. It could be less, it could be more. I’ve been involved in probates that have taken as long as five years. When you have more complicated situations, such as a blended family or a family business, people who are not getting along, then it can really drag out.

The second reason to avoid probate is cost. The studies say that if you take the value of your estate, and multiply that by about 5%, that will give you an estimate of what the average probate might cost. So if you have an estate  worth half a million dollars, count on about $25,000 in court costs, attorneys’ fees, and other professional fees.

Matt: The cost alone seems like a good enough reason to create an estate plan—it pays for itself many times over!

Kent: Third, loss of privacy is really interesting. Think about the great lengths we go to while we’re alive to protect our most valuable and sensitive information, especially our family and financial information. Yet that is the very information that is open to public view through the probate process. Anyone can go down to the courthouse, or in some counties go online, and pull all of the pleadings, all of the filings, find out who’s involved, what the assets are—and use that information for commercial or even nefarious purposes.

The fourth reason is losing control. Through probate, we’re taking control out of the hands of the people we love and trust and putting control ultimately in the hands of the state. And lastly, as I mentioned before, family conflict. You don’t want to be in a courthouse if you’re trying to do everything you can to maintain peace in the family.

Matt: Is there an asset level at which a trust becomes necessary, or is a trust appropriate for anyone?

Kent: The answer to this question is the classic attorney answer: It depends! Most states have a probate exemption, meaning that if your net worth is below a certain level, probate court isn’t required to transfer assets to their rightful heirs. Depending on the state, it might be $100,000 for real property and, say, $75,000 for personal property, which would include any checking and savings accounts, the contents of your home, your vehicle, and so on. Some states have higher exemptions and some are lower. But if you’re in a state where those are the numbers involved, we might say you need a trust if your net worth is above $200,000, depending on the character of your assets.

But there are other factors to consider, as well. Let’s say we have a client with a net worth below the probate exemption. Maybe they own a home with $50,000 in equity and have total checking and savings accounts worth $50,000. But they also have a minor child. Any time a minor is entitled to property, the probate court has to be involved—they’ll create a conservatorship, and the court will manage and oversee the assets until the child is 18 years old. There’s no exemption in that situation. Another scenario might involve a grown child who is struggling with substance abuse problems. If they inherit $25,000 or $50,000 in cash, not only will they use it inappropriately, but they could literally kill themselves with that kind of money. Sadly, I’ve seen that happen. So it really depends on the situation.

Matt: You’ve published some intriguing articles where you basically called the estate tax a “voluntary tax.” With careful estate planning, would you say it’s always possible to avoid estate taxes?

Kent: Well, attorneys never give guarantees. But you’re exactly right that the estate tax is a voluntary tax. You pay it only if you don’t plan. On the other hand, if you plan properly, you have the opportunity to eliminate the estate tax – no matter what your net worth is. We’ve had clients with a net worth of $100 million where we completely avoided the estate tax. And if we can’t eliminate it, at least we can minimize the tax as much as possible.

That requires advanced planning. Here’s the landscape as it stands today, in round numbers: Each person has approximately a $13 million estate tax exemption at the federal level. Most states either follow the federal level or don’t have any estate tax, but I’m only going to speak to the federal level for now. So a married couple has a roughly $26 million estate tax exemption. Under current law, the exemption will stay around that level until January 1, 2026, when it will fall to about $6 million per person.

Because of the exemption, most people don’t need to worry about estate taxes—if your net worth is below the threshold, no estate tax will be owed, even without any fancy planning. Where it gets nasty is when you are over those exemptions. Let’s say the last spouse of a married couple with a $15 million net worth passes away after 2026. If they didn’t do any advanced planning, there would be around a 40% estate tax on the $3 million over the $12 million exemption. They could be paying estate taxes of more than a million dollars.

Matt: Can you briefly tell us about some of the strategies you use to avoid that?

Kent: When a client has an estate tax issue, we typically use irrevocable trusts in conjunction with revocable living trusts. Without getting into too much detail, the strategy goes back to something John D. Rockefeller said: “Own nothing. Control everything.” And that’s how families like the Rockefellers have created these multi-generational financial dynasties without it being eaten up by estate taxes. The idea is to move assets out of your name and into a trust that, under the tax code, is exempt from estate taxes.

There are other options as well. For example, a charitably minded client might specify that they want to distribute the portion of their estate that falls below the then-current estate tax exemption equally to their children, and any amount above that threshold should be donated to a charity. We call that a “disinherit the IRS clause”—it’s a simple move that doesn’t require any advanced planning.

Matt: Trajan’s estate plans go beyond just creating trusts and wills. Can you tell us about the other aspects of estate planning, such as creating advanced healthcare directives and powers of attorney? What happens when someone doesn’t have these documents in place when they need them?

Kent: Our living trust estate plans have five core documents. The first is the trust itself. The second is a will. For a married couple, we do a separate will for each spouse. Third is a financial power of attorney for each spouse. This is a document that says, “if I cannot manage my own financial affairs, here’s who has the authority to manage them for me.” Fourth is a medical power of attorney, which is a similar document for medical decisions. And then every person gets a living will, also called an advanced healthcare directive, which says something like “if I meet these criteria—I’m unconscious, living on a breathing machine and a feeding tube, and there’s no hope of recovery—under those circumstances my wishes are to be taken off of life support,” or whatever the client’s preferences are.

Trajan Estate has other offerings as well. We’re a full-service estate planning firm. We handle probate. We do Medicaid planning, which is for clients who likely won’t have the money they need for long-term care, such as assisted living or a nursing home, but who have too much money to qualify for government assistance through Medicaid. We can help those people qualify for Medicaid, if that’s the direction they want to go, even if they have hundreds of thousands of dollars. We also help with trust administration. After someone passes away, there’s work to be done, and we can help a trustee by taking some responsibilities off their plate. We do business formation, such as creating LLCs, partnerships, and corporations. For example, we may create LLCs to own rental properties, which are then held by a trust. And we do charitable planning. Say a client wants to make a charitable contribution, they want to get the tax deduction, but they also want to control the charitable dollars and how they’re invested and ultimately distributed. We can do that with a private family foundation under section 501(c)(3) of the tax code.

Matt: Thanks for your time, Kent. To wrap up, in which states is Trajan Estate currently operating?

Kent: As of now, we have attorneys licensed in Arizona, Texas, Utah, Colorado, Georgia, Oklahoma, Alaska, and Wyoming. We’re growing all the time, but for other states, we can refer clients to a national network of attorneys who are only focused on estate planning.

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Matt Coffina

Matt Coffina, CFA

Matt Coffina, CFA, is the portfolio manager for Trajan Wealth’s Expanding Moat and Defensive Moat strategies. He seeks to invest in companies with strong and improving competitive advantages, above-average revenue and earnings growth, and reasonable valuations. Matt has more than 15 years of experience as a portfolio manager and analyst. Even if it weren’t his job, he would happily spend all day learning about businesses and trying to identify stocks with a favorable risk/reward tradeoff.