Does Your Estate Plan Flunk The Real-Life Test?

While thumbing through the pages of a trade journal, I came across this quote, “We install 90 percent of what we sell. That’s one big advantage we have over [the competition].”

Occasionally, products we purchase may not work after installation. The manufacturer may blame the installer or the installer may blame the manufacturer. The customer, however, is put in the middle and endures customer service purgatory until the product is correctly installed and working.

That is a blame game you don’t want to play with your estate plan. Let’s look at a real-life tax blame game and how the problem was solved.

Joe died and was survived by his wife, Mary, and three grown kids. One managed Joe’s family business, Success Co. Success Co. was a C corporation. Prior to Joe’s death, he and Mary owned a residence worth about $800,000 and Success Co., which was valued at $10.3 million at the time of Joe’s death. Aside from these assets, they enjoyed a spendable income of about $350,000 after-tax, owned various personal properties and a summer home worth more than $1 million.

About 5 years before he died, Joe gathered a team of professionals to handle his estate plan: his CPA, a lawyer who specialized in estate planning and his long-time friend, an insurance agent.

The professionals crafted a good traditional estate plan: no tax due at Joe’s death (the marital deduction) and enough insurance (second-to-die) to pay the projected estate tax at the time of Mary’s death. An irrevocable life insurance trust owned the second-to-die policy on Joe’s and Mary’s lives.

Unfortunately, the team missed one important detail: Mary, a healthy age 64, did not have enough cash flow to maintain her lifestyle. Joe’s $550,000 salary, plus generous perks from Success Co., stopped when he died. Aside from the usual lifestyle cash needs, Mary also needed $46,000 per year to pay the second-to-die insurance premium.

None of the professionals accepted responsibility for Mary’s lack of necessary spendable income. Worse yet, they had no suggestions about how to solve the problem.

First, Mary’s immediate problem—finding the cash flow to maintain her lifestyle—needed to be addressed. The marital trust (created in Joe’s revocable trust as part of his estate) owned 90 percent of Success Co. while Mary owned the other 10 percent. The solution was for the stockholders (the marital trust and Mary) to elect S Corporation status for Success Co. The large corporate profit could therefore provide the income stream that Mary needs, as the beneficiary of the marital trust (90 percent) and as a direct owner (10 percent).

What can be learned from this nearly tragic tale? Rather than rehash what should have been done for Joe and Mary, let’s emphasize the lesson. Whether you refer to it as estate planning, lifetime planning, wealth transfer planning or whatever, your master plan must include three separate plans: 1) a lifetime plan to transfer your wealth while you are alive (and you can control your wealth for as long as you live); 2) a retirement plan that provides the after-tax cash flow needed to maintain you and your spouse’s lifestyle for as long as you (or your spouse) live; and 3) a transfer/succession plan for your business that gets the value of the business out of your estate tax-free to your kids (or other successor) who are responsible for the business.

You should always—and I mean ALWAYS—seek an independent second opinion. Finally, you need to make sure that the professionals who create your plan know in advance that they are responsible for all aspects of the plan.