In my over two decades of practicing law, I have heard the same estate planning myths repeated time and time again. Here are some of the most common misconceptions:
1. The surviving spouse automatically assumes ownership of the deceased spouse’s assets – many people believe that by the mere existence of a marriage, the surviving spouse inherits the deceased spouse’s individually owned assets upon the spouse’s death. Unfortunately, the law makes no exception for a surviving spouse. If assets are owned only in one spouse’s name, upon that spouse’s death his or her estate will need to be administered via a probate proceeding. If the decedent had a will, the assets will pass as directed under the will (typically to the surviving spouse). If there is no will, then the deceased spouse’s individually owned assets will pass under the state’s intestacy rules. In New York, if a person dies with no will leaving a spouse and children, then the bulk of the deceased spouse’s assets will pass as follows: fifty percent to the surviving spouse, and fifty percent among the deceased spouse’s children –a result that few married couples desire.
2. It is too late to protect your assets if you are in (or about to enter) a nursing home – It is commonly believed that a person already in, or about to enter, a nursing home must “spend down” all their assets before becoming eligible for nursing home Medicaid coverage. In reality, even in such a “crisis” situation fifty percent or more of the Medicaid applicant’s assets can typically be preserved.
3. Gifts to any individual in excess of $13,000 per year will require the payment of gift tax – In addition to the $13,000 “annual exclusion” gifts that any individual may make to any other person (excluding a spouse, to whom unlimited gifts may be made), there is also a $1 million lifetime per person gift tax exemption. So, it is quite rare that anyone making gifts will ever actually have to pay a gift tax. For example, if a parent makes a $23,000 gift to a child, the first $13,000 of the gift would be applied against the annual exclusion amount. The remaining $10,000 portion of that gift would result in a $10,000 reduction of the parent’s $1 million lifetime gift exemption. If the parent had never utilized any portion of their lifetime gift exemption, then they would have $990,000 of that exemption remaining. The $10,000 portion of the gift in excess of the annual exclusion amount would be reported on a form 709 federal gift tax return, but no tax would be owed.
4. Life Insurance is “tax free” – In the vast majority of cases that I review, the insured under a life insurance policy is also the owner of that policy. In such a circumstance, when the insured dies, the death benefit will pass to the named beneficiaries’ income tax free. However, the entire death benefit will be includable in the insured’s estate, thereby rendering the death benefit subject to estate taxes. This rule applies even to term policies. For example, assume a New York resident who owns a $1.5 million term life insurance policy and $1.5 million in other assets were to die in 2011. Under current law, his estate would owe $945,000 in state in federal estate taxes. If instead the $1.5 million life insurance policy were owned in a “life insurance trust,” the total estate tax liability would be reduced to $210,000 – resulting in a tax savings of $735,000!