11.4: Estate Planning

Learning Objectives

1. Identify the purposes, types, and components of a will.
2. Relate the value of Advance Directive tools.
3. Describe the roles and types of trusts and gifts.

When people hear “estate planning,” they often think of mansions, yachts, or million-dollar assets. But an "estate" simply refers to everything you own—your bank accounts, car, home, belongings, and even digital assets. Estate planning is about making sure your wishes are known and your loved ones are supported, no matter your income level. Whether you rent or own, have a little or a lot, planning ahead helps protect what matters most.

Estate planning is a process for managing your assets after your death. Age is not a factor, because death can occur at any time, at any age, by any cause. Arranging for the disposition of your estate is not a morbid concern but a kindness to those you leave behind. Death is a legal and financial event - and in some cases a taxable event - as well as an emotional one. Your loved ones will have to deal with the emotional aftermath of your loss and will appreciate your care in planning for the legal and financial outcomes of your death.

Wills

Since you won't be here, you will need to leave a written document outlining your instructions regarding your estate. That is your will, your legal request for the distribution of your estate, that is, assets that remain after your debts have been satisfied. If you die intestate, or without a will, the laws of your state of legal residence will dictate the distribution of your estate.

You can write your own will so long as you are a legal adult and mentally competent. The document must be witnessed by two or three people who are not inheriting anything under the terms of the will, and it must be dated, signed, and, in some states, notarized. A holographic will is handwritten; it may be more challenging to validate. A statutory will is a preprinted will that you can download online. Consider, however, that a will is a legal document. Having yours drawn up by a lawyer may better ensure its completeness and validity in court.

Probate is the legal process of validating a will and then administering the payment of debts and distribution of assets by a court. Probate courts also distribute property in the absence of a will. Probate is not required in every case, however. Probate will not be required if the deceased:

• owned assets of little value, allowing for transfer without court supervision
• owned assets jointly with or "payable on death" to another person
• owned assets that named another person as the beneficiary
• held all assets in a living trust (a legal entity for managing assets on behalf of beneficiaries)

Besides the details of "who gets what," a will should name an executor, the person or persons who will administer the payment of your debts and the distribution of your remaining assets, according to your wishes as expressed in your will. If you have legal dependents, your will should name a guardian for them. You may also include a "letter of last instruction" stating the location of important documents, safe deposit keys, and bank accounts. Also, this should specify your funeral arrangements.

There are several types of wills. A simple will leaves everything to a spouse. For comparatively small estates, a simple will may be the most appropriate. A traditional marital share will leaves one-half of the estate to a spouse and the other half to others, usually children.

A stated dollar amount will allows you to leave specific amounts to beneficiaries. A drawback of this type of will is that the stated amounts may be reasonable when your will is drawn up, but may not reflect your intentions at the time of your death, perhaps many years later. For that reason, rather than specifying specific amounts, it may be better to specify percentages of your asset values you would like each beneficiary to have.

You may change or rewrite your will at any time; however, it is essential to update it as your life circumstances change, particularly with significant events such as marriage, divorce, the birth of a child, or the acquisition of substantial assets, like a house. If the changes in your circumstances are significant, you should create a new will.

Advance Directives

It is possible that you will become mentally or physically disabled before you die and unable to direct the management of your assets. To prepare for this possibility, consider creating a living will or advance directive with instructions for your care in the event of an emergency. You may appoint someone - usually a spouse, child, or sibling - who would have power of attorney, that is, the right to act on your behalf, especially as regards financial and legal decisions. That power may be limited or unlimited (such as a "durable power of attorney") and is restricted to certain acts or dependent on certain circumstances.

Along with granting power of attorney, your living will may include a health care proxy, requesting that medical personnel follow the instructions of a designated family member who expresses your wishes concerning your end-of-life treatment. For example, many people request that they not be revived or sustained if they cannot experience some quality of life. Be sure to update your advance directive, as your views may change, and medical and technological advances may change our notions of "quality of life."

Trusts and Gifts

A trust is a legal entity created by a trustor, also known as a grantor, who owns assets managed by a trustee or trustees on behalf of one or more beneficiaries. A testamentary trust may be established in a will, allowing beneficiaries who cannot manage their assets (such as minor children or disabled dependents) to benefit from the assets while having them managed on their behalf. A living trust is established while the grantor is alive. Unlike a will, it does not become a matter of public record upon your death. A revocable living trust can be revoked by the grantor, who remains the owner of the assets, at any time. Such a trust avoids the probate process but may not shield assets from estate taxes. An irrevocable living trust cannot be changed; the grantor relinquishes ownership of their assets, which are transferred to the trust. However, the trust then becomes a separate taxable entity and pays tax on its accumulated income.

Another way to avoid probate and estate taxes is to gift assets to your beneficiaries while you are alive. Ownership of the assets passes to the beneficiaries at the time of the gift, so the assets are no longer included in your estate. The federal government and many state governments levy a gift tax for gifts exceeding certain limits. For tax year 2024, for example, the annual exclusion from federal tax was $18,000 per recipient._^[1] Additionally, the federal government does not tax gifts to spouses or payments for another person's medical bills or tuition.

Most trusts, whether testamentary or living, revocable or irrevocable, are created to avoid either the probate process or estate taxes or both. The probate process can be lengthy and costly, and therefore a burden for your executor, your estate, and your beneficiaries (who may have to wait for their distributions).

Estate Taxes

Estate taxes are sometimes called the “death tax,” and the name alone can make them sound scary. However, in reality, estate taxes only apply to very large estates worth millions of dollars. For most of us, this tax isn’t something we’ll ever have to pay.

In planning your estate, your primary objective is that the distribution of your assets provides for your dependents and that your assets are distributed as you would want, were you still there to distribute them yourself.

Summary

• A will describes your wishes for the distribution of your assets (the estate) after your death.
• Probate courts distribute assets in the absence of a will and administer wills in estates with assets valued above a certain (variable) dollar amount.
• There are many kinds of wills, including
  • the simple will
  • the traditional marital share will
  • the stated dollar amount will
• Living wills, with power of attorney and health care proxy, provide medical directives, empower someone to manage your estate while you are still alive, and authorize someone to make decisions about your health and end-of-life care.
• Trusts are used to provide the benefits of assets to beneficiaries without requiring them to assume responsibility for asset management.
• There are testamentary trusts, living trusts, revocable trusts, and irrevocable trusts. Setting up and administering trusts involves some considerable expense.
• Creating trusts and giving gifts are ways to reduce the taxable value of an estate.

Exercises

1. Draft a will or use a statutory will form recognized in your state. Start by reviewing your balance sheet, showing your assets, liabilities, net worth, and an inventory of personal and household property. Think about how you would want your estate to be distributed upon your death. Identify an executor. Review free advice for writing a will (www.legalzoom.com/articles/how-to-write-a-will) from LegalZoom.com. The same website can help you find out what kind of document your state requires (www.legalzoom.com/articles/state-requirements-for-a-last-will) for a "last will and testament". Finally, investigate if you need to use a lawyer (www.nerdwallet.com/article/investing/estate-planning/do-you-need-lawyer-make-will) to create your will.
2. Review the Investopedia.com information about living trusts (also called life estates in some states) (www.investopedia.com/terms/l/living-trust.asp). When and why might you want to create a revocable or irrevocable living trust (www.investopedia.com/articles/pf/06/revocablelivingtrust.asp) in addition to or as an alternative to a will?
3. Investigate the estate tax laws in your state. Does your state tax income from Social Security payments? Does your state tax pensions and other sources of retirement income? How does your state treat inheritance taxes and estate taxes? What tax breaks does your state offer to retirees? Find answers to these questions by visiting Taxes by State (www.retirementliving.com/taxes-by-state).

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^[1] Internal Revenue Service, “Instructions for Form 709”, www.irs.gov, 2023, www.irs.gov/instructions/i709.