Learn whether you need a trust, power of attorney, or health care directive in addition to a will.
Most Americans don’t have a will, to say nothing of a more comprehensive plan to avoid probate or save on estate taxes. Do you need to start planning what happens to your estate when you die? It depends on your age, health, wealth, and innate level of caution.
We’ve sorted our tips into broad categories of family situation and age. But keep in mind that age is an imprecise proxy for life expectancy, which is affected by all sorts of other factors — smoking, extreme sports, and driving a motorcycle, for example. It’s up to you to add or subtract a few years based on your health and lifestyle.
You’re in Your Twenties or Thirties and Single
At your age, there’s not much point in putting a lot of energy into estate planning. Unless your lifestyle is unusually risky or you have a serious illness, you’re unlikely to die for a long, long time.
If you’re an uncommonly rich twenty- or thirty-something though, write a will. (Bricks can fall on anyone.) That way you can leave your possessions to any recipient you choose — your boyfriend, your favorite cause, the nephew who thinks you’re cool. If you don’t write a will, whatever you leave behind will probably go to your parents.
You’re Paired Up, But Not Married
If you’ve got a life partner but no marriage certificate, a will is a must-have document. Without a will, state law will dictate where your property goes after your death, and your closest relatives will inherit everything. Unmarried partners generally get nothing unless you have registered as domestic partners or entered into a civil union (allowed only in some states), in which case surviving partners can inherit just like surviving spouses.
Another option to make sure that your partner isn’t left out in the cold after your death is to own big-ticket items, such as houses and cars, together in "joint tenancy" with right of survivorship. Then, when one of you dies, the survivor will automatically own 100% of the property.
You Have Young Children
First and foremost, get yourself a will. A will allows you to leave your property to whomever you choose and, more importantly, names a guardian to care for your children. The guardian will take over if both you and the other parent are unavailable. If you fail to name a guardian, a court will appoint someone, possibly one of your parents.
Note that if you don’t have a will, some of your property may go not to your spouse, but directly to your children. The problem with the children inheriting directly is that the surviving parent may need to get court permission to spend or invest the money — a waste of time and money in most families.
Second, think about buying life insurance to replace your earnings, just in case. Term life insurance is relatively cheap, especially if you’re young and don’t smoke. You can shop for the best bargain online, by consulting free services that compare the rates of lots of companies.
You’re in Your Forties
This is the time when most people consider estate planning in earnest. Keep in mind that your assets and what you want to do with them may change in 10 or 20 years — be prepared to revisit and change your estate plan accordingly. First, create a will, and then consider some of these other planning options:
Revocable Living Trusts
To save your family the cost (and hassles) of probate court proceedings after your death, think about creating a revocable living trust. It’s hardly more trouble than writing a will, and lets everything go directly to your heirs after your death without taking a circuitous and expensive detour through probate court.
While you’re alive, the trust has no effect, and you can revoke it or change its terms at any time. But after your death, trust property can be transferred quickly, according to the directions you left in the trust document.
There are other, even easier ways to avoid probate for some types of accounts: You can turn any bank account into a "payable-on-death" account simply by signing a form (the bank will supply it) and naming someone to inherit whatever funds are in the account at your death. You can do the same thing, in almost every state, with securities and retirement accounts.
Reducing Estate Taxes
If you have enough property to worry about federal estate taxes, think about tax avoidance as well. In 2008, only estates worth more than $2 million are taxed. That amount is scheduled to increase to $3.5 million in 2009. (The estate tax is being phased out, but its future is uncertain.) If estate tax does take a bite, it can be a big one: 45% of everything over the exempt amount. Here are some ways to reduce estate tax:
Give your property away before death. One way to reduce these taxes is to give away property before your death. After all, if you don’t own it, it can’t be taxed. Gifts larger than $12,000 per year per recipient are subject to gift tax, at the same rate as estate tax. Still, an annual gift-giving plan can reduce the size of even a big estate, especially if you have a covey of kids and grandkids. Gifts to your spouse (as long as he or she is a U.S. citizen), direct payment of tuition or medical bills, and gifts to a tax-exempt organization are exempt from gift tax.
Create an AB trust (also called a bypass trust). Another way to cut estate taxes is with trusts. Many older couples use an AB trust to leave property to each other for life, and then to their children. The surviving spouse can spend trust income and, in some circumstances, principal. An AB trust can shield up to twice the exempt amount from estate tax.
Create a charitable or other trust. Charitable trusts, which involve making a gift to a charity and getting some payments back, can also save on both estate and income tax. There are many other complex trusts; learn about them on your own and then have an experienced estate planning lawyer draw up the documents you want.
You’re Over Fifty or Ill
Now is the time to take concrete steps to establish an estate plan. First, the basics: Consider a probate-avoidance living trust and, if you’re concerned about estate taxes, a tax-saving trust. (These devices are discussed just above.) Write a will, or update an old one.
Then take a minute to think about the possibility that at some time, you might become unable to handle day-to-day financial matters or make healthcare decisions. If you don’t do anything to prepare for this unpleasant possibility, a judge may have to appoint someone to make these decisions for you. No one wants a court’s intervention in such personal matters, but someone must have legal authority to act on your behalf.
You can choose that person yourself, and give him or her legal authority to act for you, by creating documents called durable powers of attorney. You’ll need one for your financial matters and one for health care. You choose someone to act for you (called your agent or attorney-in-fact) and spell out his or her authority. You can even state that the document won’t have any effect unless and until you become incapacitated. Once signed and notarized, it’s legally valid, and your mind can be at ease.
Giving gifts to family and charity while you’re alive can be a boon to them – and your estate.
Estate planning isn’t just about how you want your assets distributed after you die. It’s about deciding how much you want to give away while you’re still alive. If you plan carefully – so you don’t outlive your assets – giving allows you to reduce your taxable estate and provide advance help to your beneficiaries.
There are two easy ways to give gifts without incurring the gift tax:
- You may pay an unlimited amount in medical or educational expenses for another person, if you give the money directly to the institutions where the expenses were incurred.
- You may give up to $12,000 a year in cash or assets to as many people as you like.
Anytime you give more than $12,000 annually to any one person you must file a gift-tax return and the excess amount will be applied toward your lifetime gift-tax exclusion of $1 million.
If at any point your gifts exceed that exclusion, you will have to pay gift tax on the excess amount. There is some good news in that regard. The top tax rate on gifts is gradually declining. In 2006 it is 46 percent, and it will fall to 35 percent by 2010.
Keep in mind, too, that gifts you give within three years of your death that exceed the lifetime gift-tax exclusion will reduce the amount of money you may leave to your heirs free of federal estate taxes, according to certified public accountant P. Jeffrey Christakos of First Union Securities in Westfield, N.J. For example, if you give away $100,000 more than your lifetime exclusion within three years of your death, your estate tax exemption will be reduced by $100,000.
If you want to invest in a 529 college savings plan for a beneficiary, contributions are treated as gifts. You may put in as much as $60,000 in one year, but that contribution will be treated as if it were being made in $12,000 installments over five years.
That means you can’t give any more money to that beneficiary tax-free during that five-year period. Should you die before the five years are up, part of the money you gave will be included in your taxable estate, specifically the $60,000 minus $12,000 for each year you were alive.
The tax consequence of making large gifts can get complicated. So if you have a large estate, consult with your financial or tax planner to see how much giving you can do without triggering a big tax bill.
Charitable donations are another way to reduce your estate. By investing in charitable gift funds and community foundations, those donations can stretch beyond your death.
Charitable gift funds, which are offered by Fidelity, Vanguard, and others, permit you to make a tax-deductible donation, grow your investment tax-free, and then direct a contribution – in your name – to nonprofits of your choosing whenever you like.
Community foundations are regionally based charities that take donations of as little as $5,000 in cash, stock, or property. The foundations invest that money, pool the gains, and allocate grants, usually to local nonprofits. In most cases, you may either have the foundation give money to organizations you choose or ask the foundation to locate a worthy recipient for a cause you like.
You also can set up what’s known as a charitable lead trust, from which a charity receives the income and your heirs the principal; or a charitable remainder trust, in which your heirs get the income and the charity gets the principal.
These tools aren’t just for Rockefellers.
The notion of a legal trust may conjure up images of country clubbers cradling gin-and-tonics.
The truth is a trust may be a useful estate-planning tool for your family if you have a net worth of at least $100,000 and meet one of the following conditions, says Mike Janko, executive director of the National Association of Financial and Estate Planning (NAFEP):
- A sizeable amount of your assets is in real estate, a business, or an art collection;
- You want to leave your estate to your heirs in a way that is not directly and immediately payable to them upon your death. For example, you may want to stipulate that they receive their inheritance in three parts, or upon certain conditions being met, such as graduating from college;
- You want to support your surviving spouse, but also want to ensure that the principal or remainder of your estate goes to your chosen heirs (e.g., your children from a first marriage) after your spouse dies;
- You and your spouse want to maximize your estate-tax exemptions;
- You have a disabled relative whom you would like to provide for without disqualifying him or her from Medicaid or other government assistance.
Among the chief advantages of trusts, they let you:
- Put conditions on how and when your assets are distributed after you die;
- Reduce estate and gift taxes;
- Distribute assets to heirs efficiently without the cost, delay, and publicity of probate court. Probate can cost between 5 percent to 7 percent of your estate;
- Better protect your assets from creditors and lawsuits;
- Name a successor trustee, who not only manages your trust after you die, but is empowered to manage the trust assets if you become unable to do so.
Trusts are flexible, varied and complex. Each type has advantages and disadvantages, which you should discuss thoroughly with your estate-planning attorney before setting one up.
When it comes to cost, a basic trust plan may run anywhere from $1,600 to $3,000, or possibly more depending on the complexity of the trust. Such a plan should include the trust set-up, a will, a living will, and a healthcare proxy. You will also pay fees to amend the trust if it’s revocable and to administer the trust after you die.
One caveat: Assets you want protected by the trust must be retitled in the name of the trust. Anything that is not so titled when you die will have to be probated and may not go to the heir you intended but to one the probate court chooses.
For a trust in which you want to put the majority of your assets – known as a revocable living trust – you also have to have a "pour-over will" to cover any of your holdings that might be outside of your trust if you die unexpectedly. A pour-over will essentially directs that any assets outside of the trust at the time of your death be put into it so they can go to the heirs you choose.
If you’d like to learn about different kinds of trusts, read on.
5 standard forms of trusts
Credit shelter trust: With a credit-shelter trust (also called a bypass or family trust), you write a will bequeathing an amount to the trust up to but not exceeding the estate-tax exemption. Then you pass the rest of your estate to your spouse tax-free. You also specify how you want the trust to be used – for example, you may stipulate that income from the trust after you die goes to your spouse and that when he or she dies, the principal will be distributed tax-free among your children.
Since your spouse is also entitled to an estate-tax exemption, the two of you can effectively double (or more than double) that portion of your kids’ inheritance that is shielded from estate taxes by using this strategy.
And there’s an added bonus: Once money is placed in a bypass trust it is forever free of estate tax, even if it grows. So if your surviving spouse invests it wisely, he or she may add to your children’s inheritance, says attorney Roger Levine of Levine, Furman & Smeltzer in East Brunswick, N.J.
Of course, you can pass an amount equal to the estate-tax exemption directly to your kids when you die, but the reason for a bypass trust is to protect your spouse financially in the event he or she has need for income from the trust or in the event you think your children will squander their inheritance before the surviving parent dies.
Generation-skipping trust: A generation-skipping trust (also called a dynasty trust) allows you to transfer a substantial amount of money tax-free to beneficiaries who are at least two generations your junior – typically your grandchildren.
The generation-skipping exemption is increasing gradually. The exclusion amount is $2 million for tax years 2006-2008. In 2009, it rises to $3.5 million. You may specify that your children may receive income from the trust and even use its principal for almost anything that would benefit your grandkids, including health care, housing, or tuition bills.
Beware, however. If you leave more than the exemption amount, the bequest will be subject to a generation-skipping transfer tax. This tax is separate from estate taxes, and is designed to stop wealthy seniors from funneling all their money to their grandchildren.
Qualified personal residence trust: A qualified personal residence trust (QPRT) can remove the value of your home or vacation dwelling from your estate and is particularly useful if your home is likely to appreciate in value.
A QPRT lets you give your home as a gift – most commonly to your children – while you keep control of it for a period that you stipulate, say 10 years. You may continue to live in the home and maintain full control of it during that time.
In valuing the gift, the IRS assumes your home is worth less than its present-day value since your kids won’t take possession of it for several years. (The longer the term of the trust, the less the value of the gift.)
Say you put a $675,000 home in a 10-year QPRT. The value of that gift in 10 years will be assumed to be less – say, $400,000 – based on IRS calculations that take into account current interest rates, your life expectancy, and other factors. Even if the house appreciates in 10 years, the gift will still be valued at $400,000.
Here’s the catch: If you don’t outlive the trust, the full market value of your house at the time of your death will be counted in your estate. In order for the trust to be valid, you must outlive it, and then either move out of your home or pay your children fair market rent to continue living there, Janko says. While that may not seem ideal, the upside is that the rent you pay will reduce your estate further, Levine notes.
Irrevocable life insurance trust: An irrevocable life insurance trust (ILIT) can remove your life insurance from your taxable estate, help pay estate costs, and provide your heirs with cash for a variety of purposes. To remove the policy from your estate, you surrender ownership rights, which means you may no longer borrow against it or change beneficiaries. In return, the proceeds from the policy may be used to pay any estate costs after you die and provide your beneficiaries with tax-free income.
That can be useful in cases where you leave heirs an illiquid asset such as a business. The business might take a while to sell, and in the meantime your heirs will have to pay operating expenses. If they don’t have cash on hand, they might have to have a fire sale just to meet the bills. But proceeds from an ILIT can help tide them over.
Qualified terminable interest property trust: If you’re part of a family where there have been divorces, remarriages, and stepchildren, you may want to direct your assets to particular relatives through a qualified terminable interest property (QTIP) trust.
Your surviving spouse will receive income from the trust, and the beneficiaries you specify (e.g., your children from a first marriage) will get the principal or remainder after your spouse dies. People typically use QTIP trusts to ensure that a fair portion of their wealth ultimately passes to their own children and not someone else’s.
Money in a QTIP trust, unlike that in a bypass trust, is treated as part of the surviving spouse’s estate and may be subject to estate tax. That’s why you should create a bypass trust first, which shelters assets up to the estate-tax exemption, and then if you have assets left over you can put it in a QTIP, Levine says.
When you can’t control your financial life, make sure someone you trust will.
No one is immune from aging or the loss of mental clarity that may come with it. And you’re never immune to health crises that may leave you unable to handle the business of your life: paying bills, managing investments, or making key financial decisions.
Granting someone you trust the power of attorney allows that person – known as your "agent" or "attorney in fact" – to manage your financial affairs if you are unable to do so.
Your agent is empowered to sign your name and is obligated to be your fiduciary – meaning they must act in your best financial interest at all times and in accordance with your wishes.
There are different kinds of powers of attorney, but in estate planning there are two essential types you should know:
- The first is the "springing power of attorney," which only goes into effect under circumstances that you specify, the most typical being when you become incapacitated.
Often that means your agent cannot act until he or she provides doctors’ letters and sometimes court orders to prove you are incapable of making decisions for yourself.
- There is also the "durable power of attorney." It is effective immediately, and your agent does not need to prove your incapacity in order to sign your name.
An attorney can help you decide which form makes the best sense for your circumstance. In any case, take care in choosing your agent. That person should be competent, trustworthy, willing to take on the burden of your affairs, and financially secure.
If you choose a relative or friend as your agent, you probably won’t have to pay them. But if you name a bank, lawyer, or other outside party, you will have to negotiate compensation, which can range from hourly fees to a percentage of your assets paid annually.
If you do become incapacitated without having assigned power of attorney, the court will step in to appoint a guardian. This process might cost your family well over $1,000, not including the cost of the guardian’s annual visits to court to report on your situation. Plus, the person chosen may not be someone you would have picked.
Making your medical wishes known now can save a lot of heartache later.
A living will (also known as an advance medical directive) is a statement of your wishes for the kind of life-sustaining medical intervention you want, or don’t want, in the event that you become terminally ill and unable to communicate.
Most states have living will statutes that define when a living will goes into effect (for example, when a person has less than six months to live). State law may also restrict the medical interventions to which such directives apply.
Your condition and the terms of your directive also will be subject to interpretation. Different institutions and doctors may come to different conclusions.
As a result, in some instances a living will may not be followed. Nevertheless, a patient’s wishes are taken very seriously, and an advance medical directive is one of the best ways to have a say in your medical care when you can’t express yourself otherwise.
You increase your chances of enforcing your directive when you have a healthcare agent advocating on your behalf.
You can name such an agent by way of a healthcare proxy, or by assigning what’s called a medical power of attorney. You sign a legal document in which you name someone you trust to make medical decisions on your behalf in the event that you can’t do so for yourself.
A healthcare proxy applies to all instances when you’re incapacitated, not just if you’re terminally ill.
Choose your healthcare agent carefully. That person should be able to do three key things: understand important medical information regarding your treatment, handle the stress of making tough decisions, and keep your best interests and wishes in mind when making those decisions.