Estate planning can be a neglected part of financial planning. It’s easy to delay answering uncomfortable questions such as “What happens to my assets and my loved ones when I die?” So, it’s no surprise that roughly half of Americans don’t have a will, and even fewer have an estate plan.
How many of us could benefit from an estate plan? For that matter, what is an estate plan, and how does it differ from a will?
A will is a relatively simple legal document that sets forth your wishes regarding the distribution of property; it may also include instructions regarding the care of minor children. An estate plan goes much further than a will. Not only does it deal with the distribution of assets and legacy wishes, but it may help you and your heirs pay substantially less in taxes, fees, and court costs.
Most people with assets or a family should execute a will. However, not everyone needs an estate plan. The decision is a personal one, and depends on more than the potential size of an estate. Consider the following eight key questions:
- Are there children involved?
- How large is the estate, and which state is it in?
- If the decedent has a 401(k) account or an individual retirement account (IRA), can it be “stretched?”
- Is privacy important?
- Would you like some money to go to charities?
- If you own a business, have you thought about succession planning?
- What life stage are you in? Is estate planning becoming more important?
- Are there special circumstances to consider (e.g., split families or disabilities)?
Let's go through these eight considerations one by one.
1. The arrival of children
A number of major life events help shape the need for and scope of an estate plan. Especially significant is the birth of a child. Consider a young married couple having their first child. How will the child be provided for if either or both parents were to die?
“Drafting a will provides the opportunity for a parent to name a guardian to take care of a child in the event that something were to happen to the parent,” says Christin Haley, director of estate planning at Fidelity Investments. “But while naming a guardian is important, it’s just one step.” In addition to a guardian, who assumes responsibility for the care and custody of the minor child, a conservator (or “guardian of the estate”) may also be necessary to manage any assets the minor child may inherit. The age of majority in a given state is set by state laws; generally, with respect to most states, the age is 18 or 21.
Some assets can be distributed by the institutions, such as a bank or brokerage firm, that hold them, as long as the owner has provided the proper instructions to the financial institution and named the beneficiaries who will receive those assets. But if the owner also has a will, the directions in the will should be consistent with the directives provided to the financial institutions. For example, if a beneficiary is named in a transfer on death (TOD) account, the account can usually pass directly to the beneficiary without going through probate, and thus will trump a will. For assets that do not allow for the naming of beneficiaries (such as some bank accounts and real estate), the will is the instrument through which to designate who will receive them, and it can detail any related special instructions.
Nonetheless, although a will is a cornerstone of estate planning, some people need more than that, and for this, a trust can be beneficial. “Trusts can make sense for most assets, including financial assets, retirement assets, real estate, or life insurance,” Haley says. “Those assets could be handled within a trust for the benefit of the minor, and a professionally managed trust could theoretically produce better results than an account entrusted to a nonexpert guardian, who might mean well, but might lack the experience or knowledge to properly invest and protect assets.”
2. The size of an estate and the state of residence
Another important factor is the size of an estate. Does the value of the estate exceed the estate tax exclusion? For a legally married couple, generally each spouse would have the $5.25 million federal estate tax exclusion. At the death of the first spouse, his or her exclusion could be taken on by the surviving spouse, allowing the survivor to exclude $10.5 million (or more, since the surviving spouse’s exclusion will be indexed for inflation) from federal estate taxes. A thorough estate plan would also include provisions addressing what would happen in the event of a simultaneous death.
Estate planning strategies have been made more complicated by the introduction of state-level estate taxation in recent years. Nineteen states have either an estate tax or an inheritance tax, and two states—Maryland and New Jersey—have both. Many states have estate tax exemptions of $1 million or less.1 See the map to the right to find out whether your state imposes estate taxes of some type.
The impact of a state-level tax can be substantial. As an example, consider a New York state resident with a $5.25 million estate. Despite being fully exempt from federal estate taxes, the estate could potentially owe more than $420,000 in New York state estate taxes.2 Also, real assets held in other states can cause complications in terms of dealing with multiple states’ laws.
“For the states that have estate taxes, it’s easy to cross the threshold of estate tax liability in many states,” Haley acknowledges, “just by adding the value of a person’s real estate, retirement assets, and life insurance policy.”
Also consider other issues around how best to manage the intergenerational transfer of assets. For example, if children aren't old enough or mature enough to handle a large inheritance, an estate plan can provide for that through a trust.
An estate plan is also about creating a customized plan that addresses your needs and desires, such as maintaining privacy, providing for multiple generations, or accomplishing charitable goals.
3. The value of “stretching”
When reviewing assets, it’s not just the sum total that matters in designing an effective estate plan. Review where your retirement investments are located, in what type of account they’re held, and what the beneficiary options are for each account type. For instance, IRA assets can be “stretched” so that they may last for the entire lifetime of the beneficiary, provided the recipient qualifies for that option, and elects to receive it. If you’re leaving money to a child or grandchild who is significantly younger than you, this benefit could be substantial, allowing tax-deferred or tax-free growth to continue for many years—even decades.
Let’s say the owner of the IRA is 70 and his daughter, Sue, is 35. If the owner of the IRA were to die next year and had designated Sue as the beneficiary, she would inherit the IRA at age 36. Based on the Internal Revenue Code table, Sue’s life expectancy would be 47.5 years. By opting to take stretch distributions over her entire life expectancy, and by taking her first distribution by December 31, 2014, Sue would receive the account balance, divided by 47.5, in the first year. For each subsequent year, she would subtract roughly one year from her previous year’s life expectancy and divide that new life-expectancy factor into her previous year-end account balance. The account could potentially last for 48 more years, as long as Sue remains alive.
4. Probate and privacy concerns
Another good reason to have an estate plan is to minimize the probate process and its expenses, delays, and loss of privacy. These are among the concerns with probate:
- Loss of privacy: Anyone can access information from the probate court. For example, real estate agents might offer to help a beneficiary sell a piece of property for someone who has passed. “A beneficiary could be offered an inheritance loan at a high interest rate to help with cash flow while assets are frozen in probate,” Haley says. “Without a will, creditors and anyone who might object to the settlement of your estate could come forward. Creditors can still come forward if they question the will, but having the directives spelled out in a will and an estate plan make it much less likely.”
- Expense: Probate fees can be quite substantial, even for the most basic case not involving any conflict. A probate attorney’s fees and court fees could take up to 5% of an estate's value, with fees on a more or less routine estate with a gross value of $400,000 amounting to $20,000+.3
- Delays: The average uncontested probate could take longer than a year. With proper planning, these delays, costs, and loss of privacy can often be avoided.
5. Philanthropic goals
If an estate consists of sizeable assets and the owner has a desire to give to charity, there are a number of ways to incorporate those philanthropic goals into an estate plan. Charities can be named as recipients in a will.
“You could name your favorite charity as a primary or a contingent beneficiary. For example, a charity can be designated to receive a certain percentage of retirement plan assets,” Haley notes. “Or if you were seeking to establish an income stream for a charity throughout your lifetime, one possible option would be to establish a charitable lead trust (CLT).” Upon your death, if the CLT were properly established, the remaining balance would then go to the grantor’s beneficiaries.
A properly established charitable remainder trust (CRT) would do the reverse, giving beneficiaries an income stream while the grantor is alive, and then the remainder would go to the grantor’s favorite charity. Either option—CLT or CRT—can have multiple benefits, among which are:
- Reducing or eliminating capital gains tax on assets that have appreciated
- Claiming income tax deductions for charitable giving
- Reducing estate taxes
- Giving to your favorite charity
- Giving to your designated beneficiaries.
A lawyer or tax adviser can help you sort through the options that might be right for you.
6. Business succession
If you own a business, have you considered how best to plan for the business once you have passed away? If you plan to keep it in the family, consider creating a structure that makes it easier to transfer the business’s assets to other family members, such as a family limited partnership or a family limited liability company.
There are many options; your attorney or tax adviser can help you select one that is appropriate for you in light of your specific situation.
7. Life stage
Estate planning can be an important activity to engage in at various points throughout your lifetime; there is no one ideal age to begin the process. Certainly, when becoming a parent, the parent will want to consider the child’s welfare and plan appropriately. As children grow, as your financial life becomes more complex, and as assets and needs grow and change, an existing estate plan should be reviewed to make sure that it still meets current needs, and that future needs are anticipated.
8. Special circumstances
Two of the most common special circumstances that may affect estate planning decisions are blended families and concerns about disabilities. Of course, there may be other needs that affect a particular situation.
Blended families can make estate planning more complicated. For example, a parent may want to leave a different inheritance to biological children than to stepchildren, or the parent may want to protect his or her biological family's inheritance in the event a spouse remarries. A solid estate plan can help prepare for these or other scenarios. (Read Viewpoints: Estate planning for blended families). Also, consult an attorney to discuss your particular circumstances.
Regarding disabilities, there are specific trusts that are set up for the benefit of a disabled beneficiary, and that are structured in a way that allows the beneficiary to continue to qualify for public assistance such as Social Security Disability Insurance. Again, an attorney or financial adviser can help establish a trust that will meet your specific situation.
Before you meet with an estate planning specialist to create your plan, make sure you do your homework and organize your thoughts and plans so that you can make the most of the time when you meet with an expert. Estate planning is complicated, and we encourage everyone to seek help from an attorney and tax adviser.