Estate planning may sound like it's only for the ultra-rich, but it’s a basic part of financial planning that applies to most of us. At its simplest, estate planning is about putting into place the structures that will let us pass on what we have to our desired heirs.
Your estate consists of everything you own and want to give to specific people. Estate planning also includes issues such as naming a guardian for minor children in the event of your premature death, and settling potential family strife without costly legal battles. Proper estate planning can also help reduce any taxes that might arise in connection with settling your estate as well, leaving more for your loved ones.
Here are some things to consider as you get started.
What do you hope to accomplish?
Estate planning is no different than any other kind of financial planning; the first thing you should do is to define your goals and review how things currently stand.
There are many possible estate planning goals that you may be trying to achieve. These will vary by person, but some common estate planning goals include:
- Ensuring that your assets go to your desired heirs/beneficiaries
- Avoiding probate
- Minimizing taxes
- Establishing guardianship for minor children
- Protecting assets from creditors
- Benefiting a charity
- Providing for children and grandchildren
- Maintain control over the distribution of your assets
Once you’ve defined your goals, you can look at your assets and think about how you’d like to distribute them upon your death. Assets to be passed on might include:
- Bank accounts
- Taxable investment accounts
- Retirement accounts
- Annuities
- Real estate
- Cars
- Art and collectibles
- Interest in a business
The people you might want to receive your assets might include:
- A spouse
- Adult children
- Minor children
- Other family or friends
- A charity
Enacting your wishes
Once you know what you want to do, three things will help ensure your plans become reality.
A will
Your will and last testament is a legal document in which you lay out how you want your assets and property to be distributed upon your death. In addition, a will covers things such as who is responsible for distributing your assets to the beneficiaries named in the will, and who you want to be guardians of minor children or dependents.
Assets covered under a will can include a home, cars, bank accounts, brokerage accounts, and other assets that you own by yourself. Assets not covered by a will include assets that are owned jointly with your spouse or others, retirement plan accounts such as an IRA or 401(k), life insurance policies, and annuities among others. (We’ll cover how you direct the latter assets in the next section.)
Wills generally go through probate, a public process where the courts certify the will and ensure there are no debts or other obligations that need to be settled before the estate can be distributed. While this process can be a bit lengthy and complex, if the will has been properly prepared, the executor (the person responsible for ensuring the assets are properly distributed, often a family member) shouldn’t have too much trouble with the probate process.
If the will is not properly completed, or there are other issues, the probate process can be lengthy, complex, and costly. Additionally, if the public nature of probate is an issue for you, then you’ll need to consider a route other than a will.
Beneficiary designations
Several types of assets pass via beneficiary designations and not through a will. These include:
- IRAs and employer-sponsored retirement plans like 401(k)s, 403(b)s, pension plans, and others.
- Life insurance policies
- Annuities
- Health savings accounts (HSAs)
- Stock options
- Employee stock purchase plans
- Deferred compensation plans
- Survivor’s benefits for a pension
For assets like these, the money will pass to whomever is named as your beneficiary in the plan documents. Assets passed by a beneficiary designation will generally not be subject to probate and will go directly to the beneficiary.
It's critical to make sure your beneficiary designations are current and, if possible, you have contingent beneficiaries in case a primary beneficiary dies. For example, if you get divorced, you may want to remove your ex-spouse as the beneficiary on your life insurance. Further, if you remarry, you’ll likely want your new spouse as the primary beneficiary. If you were to die before changing the beneficiary, your ex-spouse would be the one receiving the money, even if this was not your intent.
In addition to naming a person or persons as your beneficiary, you can also name your estate as the beneficiary. In this case, however, these assets may be subject to probate.
Gifting
Part of your estate planning might include gifting assets to family members during your lifetime, which would reduce the estate that would need to be distributed upon your death. Under the Tax Cut and Jobs Act, the lifetime exemption from gifting and estate taxes now stands at $13.61 million per person. Note that unless there are legislative changes, this limit will be “sunsetting” after 2025 and reverting to lower levels in line with what was in place prior to the Tax Cut and Jobs Act.1
Other things to consider
Although it's extremely important to make sure your wishes are clearly documented, there are other considerations covered under estate planning as well.
Proper ownership of assets and accounts
An important part of estate planning is ensuring that all assets and accounts are properly titled.
For example, if you’re married, you might own your home, cars and other assets jointly. A jointly owned house would revert to the surviving spouse, as would any mortgage on the property, as long as the mortgage was taken out in both names.
Additionally, your bank accounts and taxable investment accounts might be titled in both spouse’s names. In this case, these assets would pass directly to the surviving spouse upon the death of the other spouse.
Joint ownership with a non-spouse can work the same way in some cases, but it could also lead to complications. In states with community property rules, this process can be very complex, and we recommend you always consult with a lawyer versed in the laws of your residence.
Life insurance
Life insurance can serve a number of purposes in your estate planning.
For those who are younger and have not yet built significant assets to pass on to their family in the event of their untimely death, life insurance can be a way to build an estate and take care of loved ones.
In a situation where your estate is large enough to trigger estate taxes, the death benefit can be used to cover these taxes. This can be helpful in cases where much of the estate consists of illiquid assets like art, collectibles, and real estate.
Life insurance can be used to “even out” the estate assets among beneficiaries. If a business or real estate is left to one or two beneficiaries, life insurance can be used to provide a death benefit to any heirs who do not receive a benefit from those assets.
Life insurance can also be used to fund a trust to provide benefits to a beneficiary with special needs.
Do you need a trust?
A trust is a legal entity that can hold assets for later distribution to the specified beneficiaries. A trustee manages and administers the trust.
A trust is not always needed in estate planning, but there are a number of situations where one can be useful.
Trusts generally avoid probate, which can save time, and certain types of trusts can remove the assets in the trust from your estate, reducing taxes.
Trusts also provide greater control over your legacy, as you can specify when and to which beneficiaries distributions are made. Trusts can provide creditor protection from your heirs’ creditors, and provide a vehicle to help protect the assets from beneficiaries who are not skilled in money management.
A trust can also protect your estate from the public disclosure that comes with probate, if this is an issue.
Conclusion
Estate planning is important for all of us, not just the ultra-wealthy.
Your estate plan needs to be reviewed periodically to ensure that it fits your current desires, and to ensure that it takes into account any changes in your life, or changes in the laws and rules.
Estate planning can get very complex very quickly. Working with knowledgeable financial and legal advisors can help ensure that your estate plan is accomplishing your goals the most tax-efficient way.
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