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Common Estate Planning Terms and Acronyms

Many clients are overwhelmed by the complex documents and acronyms (i.e., ILITS, GRATS and QPRTs) associated with estate planning.  We have created this guide to provide a brief description of the various documents used in estate planning and the circumstances in which those documents may be used.

Basic Estate Planning Documents

For many clients, the documents comprising a basic estate plan are a last will and testament or a revocable living trust in combination with a pour over will, an advance health care directive or health care power of attorney and living will, a durable power of attorney for financial matters and a Health Insurance Portability and Accountability Act authorization.

Traditional Last Will and Testament

A will is a formally executed, written instrument that directs your personal representative to dispose of your "probate assets."  In general, your probate assets are those assets that are owned by you at death that are held in your name and not set up to be transferred on death.  A will usually names guardians for your minor children, trustees for any trust you create and your personal representative.  A will can also create trusts to minimize or eliminate the federal estate tax that might otherwise be levied upon your estate.  A will does not transfer non-probate assets which may include among other things: (i) Individual Retirement Accounts; (ii) other Qualified Retirement Plans; or (iii) life insurance.  A will can transfer real property but your personal representative will need to open a probate case to accomplish the transfer.

Many times, even though you have a will, your descendants or surviving family members will still need to open a probate case in the county in which you last resided.  Probate is the legal court-supervised process designed to facilitate the transfer of a deceased person's probate property.  The most common reason to open a probate case is to obtain to the proper paper work from the court to transfer real property of the descendant into the name of the beneficiaries designated in the will.

Revocable living Trust and “Pour Over” Will

A revocable living trust is used to avoid probate, for tax planning, and to control the manner and timing of distribution to beneficiaries.  Unlike a will, which is a public document filed with the court, the trust is private.  Property held in the name of the trust is not subject to probate proceedings.

After creating the trust, you will need to transfer your assets (e.g., real estate, cars) into the trust, generally with the assistance of an attorney.  You will have the same control over the assets as you did before they were transferred to the trust; however, but upon your incapacity, your named successor trustee manages the trust assets on your behalf without a court having to appoint a conservator.

Upon your death, your successor trustee distributes the assets to your beneficiaries according to the terms of the trust.  To the extent you have not properly transfer certain of your assets into the trust, you may still need to go through the probate process.  Therefore, proper maintenance of the trust is essential to produce the intended result.

A "pour over" will is typically used in conjunction with a revocable living trust, to catch any assets that may not have been transferred to the trust, so they can be distributed according to the trust's terms. You also nominate guardians for your minor children in the will.

Durable Power of Attorney

A durable power of attorney is a document in which you name another person to act on your behalf for legal and financial matters; except for property that is held by a trust (the trustee will control that property). Typically, this power of attorney becomes effective upon execution.  By appointing an agent, you can avoid a court procedure to appoint a conservator in the event you become disabled or unable to make your own decisions. 

Medical Power of Attorney

A medical or health care power of attorney is a formal document that names another person to act on your behalf for medical decisions when you lack the capacity to make them for yourself. A medical power of attorney can be designed to be used only if you are unable to make decisions for yourself. It can be a simple appointment for a person to make all decisions or it can be customized, i.e., itemizing the specific procedures to be provided or withheld and it can be for a short term or for a long term.

A “springing” durable power, grants an agent authority only after you become unable to function.  Alternatively, a “standing” durable power grants an agent authority on the date the document is executed, rather than at some future time or upon the happening of some future event.  A “standing” durable power is preferable in the nursing home context and for isolated or rural clients who lack immediate access to physicians who can quickly determine incapacity.

Health Insurance Portability and Accountability Act Authorization

A Health Insurance Portability and Accountability Act ("HIPAA”) authorization permits your designated agent to obtain protected medical information about you in order to handle your medical affairs.

Advanced Estate Planning Documents

While there is currently no estate tax (as of January 1, 2010) larger estates should consider one of more of the following advanced techniques to reduce your taxable estate as many professionals believe the estate tax will be applied retroactively sometime during 2010:

Irrevocable life Insurance Trust

Life insurance proceeds are included in your estate.  To avoid inclusion in your estate, you can transfer ownership of a policy, along with all incidents of ownership, to either an irrevocable trust or to another person.  If the life insurance policy was not originally issued to your insurance trust, you must survive the transfer by three years or the value of the policy will be considered part of your estate.  One advantage of having life insurance proceeds pass outside of your estate is that the funds are then readily available.

Although there are numerous ways to create and fund these trusts, usually you make annual gifts to the trust. Based upon current withdrawal rights given to beneficiaries, called Crummey powers, these gifts are designed to qualify for the gift tax annual exclusion.

The trust purchases life insurance on your life using the gifts to pay the premiums. The gifts will help to reduce your taxable estate. At your death, the life insurance proceeds are paid to the trust as beneficiary.  The irrevocable life insurance trust generally receives the policy proceeds free of income taxes, and with proper planning, the proceeds may be excluded from your estate for estate tax purposes.

Qualified Personal Residence Trust

A Qualified Personal Residence Trust (QPRT) allows you to give away your house or vacation home at a discount, freeze its value for estate tax purposes, and still continue to live in it.

Family Limited Partnerships and Limited Liability Companies

Family Limited Partnerships (FLPs) and Limited Liability Companies (LLCs) are entities involving members of your family. The main advantages of forming and funding FLPs and LLCs involve estate and gift tax savings and asset protection.

Grantor Retained Trusts

A Grantor Retained Annuity Trust (GRAT) is an irrevocable trust to which you contribute assets. You retain the right to receive annuity payments for a specified period of time based on an assumed discount rate determined by the IRS.  At the end of the term, assets in the trust pass to other beneficiaries. The GRAT provides gift and estate tax savings if the return on the assets placed in the GRAT exceeds the assumed discount rate.  Grantor Retained Unitrusts (GRUTs), where distributions are based on a percentage of assets instead of an annuity, and Grantor Retained Interest Trusts (GRITs), where you retain an income interest, are similar techniques.

Intentionally Defective Grantor Trusts

Alternatively, you may want to sell assets to an Intentionally Defective Grantor Trust (IDGT), an irrevocable trust you establish that is excluded from your estate for federal estate tax purposes, yet owned by you for income tax purposes. The sale can be in exchange for a promissory note. Similar to a GRAT; the sale of the promissory note provides gift and estate tax savings if the return on the IDGT exceeds the interest rate on the note.

Charitable Planning Documents

If you are charitably inclined and seek to minimize taxes while enhancing the amounts going to your loved ones, you may want to consider charitable planning.  Documents associated with charitable planning include Charitable Remainder Trusts (CRATs and CRVTs), Charitable Lead Trusts (CLATs and CLUTs), and Private Foundations.

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