Estate Planning 101
It’s hard enough to manage our finances while we’re alive. So it’s no surprise many of us don’t spend enough time thinking about financial afterlife. But taking some time now to make plans for later can save you and your loved ones a lot of trouble down the road.
This is where estate planning comes in.
What is estate planning?
From creating a will, to naming beneficiaries on your 401(k), estate planning can take a few forms. At the most basic level, it’s about managing the future financial and legal burden of your loved ones. More specifically, estate planning can help you do the following (and more);
• Specify what will happen to your money and personal belongings
• Protect dependent children when you’re gone
• Determine what will happen if you can no longer make decisions for yourself
• Simplify the legal process for your beneficiaries
We should also mention the details of estate planning can get a little complicated depending on your personal situation. So we’re going to stick to the basics and let you fill in the details later.
But isn’t estate planning just for the rich?
Great question, but no! Estate planning is definitely not just for the rich.
We know, the very phrase “estate planning” tends to conjure images of exotic mansions and long lost millionaire relatives. But in a legal sense, your estate simply refers to any property you own. This would include bank accounts, investments, real estate, and your possessions.
And while estate planning does tend to get more complicated for high-net-worth people, it’s about more than setting up trust funds for future generations. So regardless of your level of wealth, some amount of estate planning is important.
Creating a will
One of the main steps in estate planning is to create a will.
A will is a legal document that specifies how you want your assets to be divided up when you die. It may serve some other purposes too, like specifying who should be the legal guardian of any dependent children.
Why is a will so important?
Well, when you die, your property will pass through something called probate. Probate is a legal process for determining the validity of estate documents and for supervising the distribution of your wealth.
So if you don’t have a will (or have a poorly written one), the process can take longer and end up costing more in legal fees. And ultimately, your property may not end up where you intended. Overall, not a great situation. Additionally, if you die without a will and no legal heirs are identified during the probate process, your property will likely be taken by the government. You’re welcome Uncle Sam.
And even if you don’t have children, it can still be a good idea to have a will. You can name other family members or favorite charities as beneficiaries.
Wills can range from very complex to fairly straightforward. Setting one up will typically range in price from a few hundred dollars to a few thousand dollars. It will depend on your specific situation. But, you’ll want to make sure you get it right to avoid messy situations in probate.
Also, once you’ve created a will, don’t forget about it. Be sure to review it every few years and update it whenever there’s a relevant life event that should be factored in, like a birth, death, marriage or divorce.
Living wills
In addition to standard wills, there’s also something called a living will, or more formally, an advanced healthcare directive. It’s a legal document that lays out how to handle your medical treatment in case you can no longer make decisions for yourself, like if you are in a coma or suffering from severe brain damage.
We know it’s not a fun thing to picture. But having a living will can help guide your family members during an already difficult time.
Living wills are often created along with a power of attorney. This is a written authorization allowing another person to make decisions on your behalf in case you no longer can.
Naming Beneficiaries
When you open a bank account or investment account, like a 401(k), you can select beneficiaries. These are the people who will receive your assets if you die. You do the same when you buy life insurance. The goal is to allow your assets to transfer to loved ones as efficiently as possible.
But keep in mind, who you want as a beneficiary can change over time, due to divorce for example. And having outdated beneficiary designations can create serious problems if you die before correcting it. When your named beneficiaries don’t match up with what your will says, the beneficiary designation may even override your will. So just updating your will isn’t enough. You need to keep your beneficiary information up-to-date as well.
Periodically review it and make sure it reflects your current wishes.
What about estate taxes?
When you die, your estate will be subject to an estate tax before your assets can be transferred to your beneficiaries. (Unless it’s passing to a spouse, then it’s not subject to the tax).
However, for most people, estate taxes aren’t currently a factor, at least at the federal level. This is because of the exemption amount. Under current U.S. law, money passing to heirs is exempt from federal estate taxes up to an amount of $12,060,000 per spouse. So a married couple can give twice that amount ($24,120,000) to their children before it’s taxed by the federal government. (Amounts as of 2022).
For high net worth individuals with wealth in excess of this amount, the story is a little different. In that case, estate planning can be used to minimize and plan for future tax bills. You would likely want to work with an estate tax specialist if this applies to you. But feel free to read more about estate taxes on the IRS website.
Side Note: Your home state might have a separate estate tax. And many states have a lower exemption amount than the federal exemption. So you’ll want to be familiar with how yours works.
Setting up trusts
Trusts can take several different forms. But essentially, they’re legal structures that are intended to limit taxes or limit how much financial control you want to give to a beneficiary (i.e. limit how they can spend the money). This can be particularly important for younger beneficiaries.
The trust documents can also stipulate certain requirements that must be met in order for the beneficiary to receive the money. Doing so can help ensure it’s used appropriately.
Typically, a person or organization, known as a trustee, oversees the trust, making sure the terms of the trust are followed.
Trusts can be fairly complicated legal documents and the details are too extensive for us to cover. Generally, you would work with an estate attorney to set one up.
Life insurance proceeds
As we’ve mentioned, life insurance often plays an important role in estate planning and ensuring the financial protection of your loved ones. Insurance proceeds can help pay legal expenses, funeral bills, future education expenses and more.
We cover life insurance in more detail in our core content.
Giving before you’re gone
You also don’t need to wait until you’re gone to help out family and friends financially. Individuals are allowed to give an annual tax-free gift to someone else in an amount up to $16,000 (as of 2022 – this amount tends to increases over time, although not necessarily every year).
Additionally, you can pay for education or health care for someone else. This won’t be tax deductible for you, meaning it won’t reduce your taxable income. But it won’t count towards your annual gift amount, as long as the money is paid directly to the institution (the school or health care provider).
Learn more about saving for college.
And of course you can also give to your favorite charities and organizations. If you give to a qualified tax-exempt charity, your gift will be tax deductible, which may reduce your taxes if you itemize your deductions at tax time.
Working with professionals
The more complicated your estate planning needs are, the more you’ll benefit from working with a professional (or team of professionals) with estate planning expertise.
Even if you think your estate plans are fairly straightforward, you do need to get the details right. So it can be a good idea to work with someone who can set up the necessary paperwork correctly.
There are a few categories of professionals you might consider;
Attorneys
Estate planning attorneys can help you create essential legal documents like wills and trusts that are specific to your situation and needs. Before choosing someone, make sure they are knowledgeable of federal and local laws.
Accountants
A tax professional or accountant might be helpful if you have a significant estate and are concerned about minimizing taxes when your estate passes hands to your beneficiaries.
Planners/Advisors
Financial planners and advisors (covered in Financial Professionals), can help you plan out various aspects of your financial life, including estate planning.
We know it can be tempting to go it alone. And while finding online templates for wills and other documents might save you some money now, you want to make sure you’re doing it right. Any errors may come back to cost you more later. If you’re ever in doubt, it’s generally best to work with a qualified professional.
Keep your information up-to-date
It’s important to keep your estate planning information up-to-date. So you’ll want to review it periodically to make sure it’s still accurate.
This would include beneficiary designations for your bank accounts, investment accounts and life insurance and would also include reviewing your will to make sure it reflects your current wishes.
You’ll also want to keep your financial information secure and organized and to tell someone you trust, like a family member, where they can find it in the event that anything happens to you.
Summary
No matter where you stand financially, estate planning should be part of the equation. And we realize it may not be too pleasant to think about. But you and your loved ones will be better off the sooner you get started. There’s no time like the present to start planning for the future.
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