Your “estate” generally consists of all the assets you own at the time of your death. This can include any real estate, investment and bank accounts, a business, or personal possessions such as jewelry or a car. It may also include items such as life insurance proceeds. As such, “estate planning” deals with how your estate will be managed and ultimately distributed to your beneficiaries after your death.
Estate Planning is Not Just About Minimizing Estate Taxes
Many associate estate planning only with wealth or the estate tax aspect of the discipline. So individuals often think that if they do not have a substantial net worth, that they do not need to do anything.
But estate planning also involves many other issues as well. The main aspect of estate planning which applies to most of us is specifying to which individuals or organizations we want our property to go to upon our death.
Also important is maximizing the amount our beneficiaries will receive, by minimizing expenses. These expenses can include probate fees, attorney and accountant fees, financial management fees, estate taxes, other administrative costs, etc. Also, transferring the property and settling the estate in a timely and efficient manner is another important goal for many.
If you have children or others who require supervision, you also may need to designate a guardian as necessary. Finally, you want to have documents in place which will allow your affairs to be handled efficiently and properly if you become incapacitated.
Comprehensive and effective estate planning can sometimes be complicated. Recommendations will vary according to each individual’s specific circumstances. However, below are some basics to consider which can apply to most people.
Last Will and Testament
The most basic and common document of an estate plan is your last will and testament (your “will”). This is the legal document which states where you want your property to go after your demise. The will also names an executor or executrix. This is the individual who will be oversee the management and settlement of your estate. This includes tasks such as identifying all assets of the estate, paying debts and expenses, filing any required tax returns, and ultimately distributing the remaining property to your beneficiaries.
The executor is typically a spouse or child, but it can also be an attorney or anyone else whom you trust. The executor will typically hire other estate planning professionals such as attorneys, accountants, and financial advisors to help administer and settle the estate. Experts also generally recommend that you name an alternate or co-executor as well.
The will is also usually the document in which to name any guardians. For example, if you have minor children, your will should appoint a guardian who will help raise them until they reach adulthood. The guardian can be a spouse, another relative, or anyone else that you trust and who would be willing to serve in this capacity.
If you have a valid will upon death, you are said to have died “testate.” If you die without a valid will, you are said to have died “intestate.”
Probate is the legal process through which the property of a deceased individual is transferred to his or her beneficiaries. Under the oversight of a probate court, the executor is tasked with distributing the property according to the decedent’s will. If the decedent died intestate (without a will), the court will appoint an administrator to distribute the property according to state law.
The length of the probate process can vary. Required estate tax returns, contesting of a will, size and complexity of the estate all have a bearing. But it usually ranges from about six months to a couple of years. Although it can take longer depending on the specific circumstances.
Probate proceedings are a matter of public record, so privacy can be an issue. It can also be a costly process the more assets the estate has. Expenses include court, lawyer, and executor/administrator fees.
Note that if the executor is a relative or is otherwise going to be receiving an inheritance from the estate, they typically waive their own fee. Also, many states offer a simplified and less expensive probate process for smaller estates.
Avoiding probate can help reduce the expenses of your estate while maximizing the inheritance received by your beneficiaries. Added benefits include privacy and a smoother and quicker estate settlement.
If you own property in different states, there may be multiple probate proceedings required for your estate to be settled. But not all assets that you own upon your death are controlled by your will or otherwise subject to the probate process.
Estate Planning for Jointly Held Assets
Assets held jointly with right of survivorship pass automatically by law to the surviving joint owner when one dies. For example, if you have joint ownership with right of survivorship (JOWROS) of a bank account (or a home, etc.) with your child, the child would receive complete ownership upon your death.
So this type of joint ownership of property with a spouse, child, or anyone else will allow that particular asset to bypass probate. As such, your will does not control these assets. The JOWROS form of ownership will override anything you might state in your will about that particular asset.
Note, however, that co-ownership via a “tenancy in common” (TIC) does not contain a right of survivorship. As such, your share of such property would not avoid the probate process solely due to the TIC form of ownership.
Property With Designated Beneficiaries
Property that passes automatically to properly designated beneficiaries also is not subject to probate and would not be controlled by a will. For example, you may have a retirement account such as an IRA or 401(k), or a life insurance policy, with appointed beneficiaries.
Some non-retirement cash and investment accounts now also offer a payable on death (POD) or transfer on death (TOD) designation option, respectively. These options allow the account owner(s) to designate beneficiaries for their accounts.
With 529 college savings plans you have the option of appointing a “successor owner” in order to transfer ownership at death and avoid probate.
To avoid complications, you may wish to avoid naming a minor as a beneficiary for any such type of account or property. If you are allowed to name a minor as a beneficiary, you should also designate a custodian. This will reduce the chance the matter will end up in probate court with a court appointed guardianship of the account.
If you want to leave property to minors, it is best to do it through a trust. This way you name your trustee and you have more control as to how and when the minor can access the property.
Revocable Living Trust
A trust is a fiduciary arrangement whereby you (the “grantor”) place property with someone else (a “trustee”). The trustee holds and manages the property for the benefit of your named beneficiaries. As such, any assets contained within a trust avoid probate. There are many types of trusts which can serve many different purposes.
A revocable living trust is a common type of trust. It is “revocable” because you can change or revoke it while you are alive. It’s a “living” trust because you create it before your death. Upon death, a revocable trust becomes irrevocable. With a revocable living trust, you can be the grantor as well as the trustee initially. But you must name at least one trustee (and preferably an alternate) who will take over upon your death.
A Revocable Trust Gives You Control and Allows You To Avoid Probate
The revocable living trust allows you to retain control during your lifetime of any assets that it holds. Assets within the trust will also avoid the public and potentially lengthy and expensive process of probate upon your death. A revocable living trust is especially helpful if you have assets in different states. It can help you avoid multiple probate proceedings.
Further, it allows you more control as to what will happen to your assets after death. For example, once minor beneficiaries reach 18 or 21, they will gain control of any property in a custodial account. With a trust document, you can dictate when the trustee will distribute assets to your children. Not to mention that you will be able to select who will manage the trust assets. So it is best to leave property to minors via a trust.
A key point to remember is that unless you title assets to the trust, it will be ineffective. The trust only controls assets re-titled to it by you as the grantor.
Any assets or accounts owned outright (i.e., not in a trust or JOWROS) and without valid designated beneficiaries will generally have to go through the probate process.
Estate Planning By Minimizing Taxes
Federal estate taxes can take a substantial bite out of your estate if it is relatively sizable. Fortunately, there is an exemption of $5.49 (2017) million per individual. This means that you can have a net taxable estate up to this amount without incurring any federal estate tax.
Net estate equals the gross estate minus liabilities and certain expenses. So most individuals will not have to worry about federal estate taxes. However, some states also have an estate tax. So make sure to check your state’s estate tax laws as well.
If you believe your estate may be subject to estate taxes, there are various gifting and other strategies that can help.
If your estate generates income, the executor may be required to file fiduciary income tax returns.
Basis and Capital Gains
One thing to keep in mind regardless of estate size is that there is a “step up” (or “step down”) in basis on assets transferred at death. You use basis to determine realized gain or loss on your income tax return when you sell an asset.
The cost basis of property inherited at death generally becomes its fair market value at the date of the previous owner’s death. When gifting property while you are alive, your cost basis will carry over to the recipient of the gift.
So highly appreciated assets with large unrealized capital gains that are transferred at death can be sold by the beneficiaries shortly afterwards with minimal income tax impact. Likewise, an asset which has depreciated over time may be sold prior to death. This will lead to capital losses which can offset any capital gains and a small amount of ordinary income.
Capital losses do carry over from year to year. However, they do expire at death. So if you will not be able to use up the losses, gift the property so that the recipient may potentially benefit.
Life insurance can be used to pay off liabilities and any estate taxes or other expenses of your estate upon your death. It may also be another way to give more to your beneficiaries or heirs.
Although life insurance proceeds are income tax free, they are subject to estate tax. If the insurance proceeds will otherwise create a taxable estate, it may be wise to have an insurance trust own the policy. This way the proceeds will not be a part of your taxable estate.
This is a legal document which will appoint someone to make healthcare decisions on your behalf if you are unable to do so due to incapacity. This person should be someone you trust, and should share your views about medical choices. Especially end of life decisions. Others, including family members, will generally not be able to interfere or overrule any decision of the healthcare proxy.
Living Will (aka Healthcare Directive)
A living will is a document which provides instructions from you, as to what type of care you want in the event you become incapacitated and cannot communicate your wishes. One potential issue with a living will is that it may be ambiguous or difficult to interpret under certain circumstances.
It also cannot anticipate all possible scenarios you may face from a medical or healthcare perspective. On the plus side, you decide what goes into your living will. Further, the health care agent chosen in a healthcare proxy cannot overrule any provisions included in your living will.
Laws vary somewhat within each state. So make sure to check your state’s laws for specifics. Make sure trusted family members and your doctor are aware of this document and can access a copy if needed.
Durable Power of Attorney
A power of attorney is a legal document which authorizes someone else (an attorney-in-fact) to handle all or specified financial matters on your behalf. You can modify or revoke the document at any time. It terminates automatically upon death or disability. A durable power of attorney is one which remains in effect even if you become incapacitated.
The attorney-in-fact can be your spouse, a close relative, or someone else you trust. This individual should also be willing and able to undertake the responsibility of acting in this capacity.
To prevent misplacement or premature use of the document, keep it in a safe place such as a home safe. But make sure trusted individuals know about it and can access it if needed. It can be provided to the named attorney-in-fact for his/her use upon your incapacity.
For more information on document storage and retention, see Recordkeeping for Individuals.
Alternatively, you can have a “springing” clause in the document, which states that it is to take effect upon disability. However, make sure the document clearly defines incapacity or disability.
Basic estate planning is something that applies to just about everyone. It is important to have a plan in place as soon as possible since no one knows exactly when you will need it.
Keep in mind, however, that as your situation changes over time, you will likely need to update your estate plan periodically. Events such as births, deaths, marriage, divorce, accumulation of assets, minors reaching adulthood, or the changing of circumstances of an executor, trustee, or guardian, relevant changes in tax laws, etc. can all require an update to your estate plan.
Finally, don’t forget that the documents discussed above generally must be signed in front of witnesses and/or a notary public. Each state may have different requirements in this regard. So be sure to check with your specific state’s laws and/or consult with an estate planning professional.