Prior to the pandemic, only about one in three Americans had a will, let alone another type of estate planning tool. That may be in part because death is an uncomfortable subject – but if you have any assets and any family, it is an important one.
When we die, everything we own is distributed among the living based on our estate plan – and in the absence of one, based on the respective state’s intestate laws. Under most circumstances, this means that everything is divided among the next of kin.
Ultimately, it is about more than just convenience or control. Without an estate plan, you have no influence over how your estate is divided, or what assets go to whom. If you have particularly contentious children, then the lack of guidance and communication may even spark an inheritance war – burning bridges and tearing families apart. If you are unmarried and in love, then there is no way of leaving anything to your partner without making note of it through a legal document.
Regardless of the size of your estate, a commensurate estate plan will yield convenience and peace of mind. Let us go over some of the most common estate planning tools, and what they can do for you.
1. Last Will and Testament
The last will and testament, or just the will, is the most common piece of estate planning people use to control their bequeathments. The last will only refers to the last will written before your death. Dying without a will means dying intestate (without testament), leaving a lot of decisions regarding your belongings up to the state.
Wills can be quite flexible, but they may require state-specific language to be valid. In addition to determining who gets what, a will may name an executor to administrate the distribution of your estate upon death, as well as the candidate guardians for any minor dependents left behind.
A will must be signed, dated, witnessed, and notarized. In some states, a will may forego being witnessed and notarized if it was written entirely by the testator’s hand, provided there is proof that it was their handwriting, and as long as it can be assumed that the testator was of sound mind when they wrote their will. This is referred to as a holographic will.
Without a will, the state will name an executor, usually based on who was closest to the deceased, and is most capable of taking care of the distribution of their estate. With or without a will, this process is called the probate process.
There are limits to what a will can do. The greatest limitation of a will is that it requires probate. Because a will is a testamentary document, meaning it only goes into effect after death, it must be legitimized in a probate court, where it serves as instructions to the executor throughout the supervised probate process. But there are other estate planning tools with similar uses.
2. Revocable Living Trusts
A trust is a legal entity defined and established by a trust document and comprised of assets funded into it. Trusts are a three-way agreement between the grantor or trustor (providing the assets), the trustee (managing the assets), and the beneficiary (receiving the assets). Trusts are incredibly flexible, to the point that all three parties can be one and the same person.
But in the context of estate planning, it makes little sense to leave yourself in charge of assets meant to be distributed to you after your own death. Instead, trusts serve as a way to bypass probate and separate certain assets from your estate before your death. What sets most trusts apart from a will is that trusts go into effect the moment they are signed and notarized, making them living trusts (as opposed to testamentary trusts, which only go into effect after death).
Living trusts have the benefit of helping you organize your wealth to pay out income to your loved ones, for charitable purposes, for estate plans, and even to minimize your tax liability. But because trusts are so flexible, it is important to be specific about what you need a trust to do.
In general, trusts are useful as a way to reduce your probatable estate by managing the largest of your assets through a trust, and distributing them directly to a designated beneficiary upon death. Minimizing the total size and value of what is left of your estate after a successor trustee has finished carrying out your wishes can help expedite the probate process, and even qualify you for a small estate probate.
3. Living Will
Not to be confused with a last will, a living will is an advance directive to healthcare professionals providing them with guidance on your medical wishes, should you be incapacitated. Not all estate planning documents are exclusively used for after you die.
A living will is essentially an official document that explains whether you agree to or forbid specific medical procedures. It is especially important for individuals with progressive or chronic health issues, allowing them to dictate what they do and do not agree to.
4. Power of Attorney
A power of attorney grants someone else the ability to make certain decisions in your name. In general, a power of attorney document greatly limits an agent’s power, such as defining their role simply as your proxy for a deal you cannot be present for.
But durable powers of attorney can be used to establish a more general representation even after incapacity.
In the context of an estate plan, a durable financial power of attorney lets you name someone to take care of your financial responsibilities in the event that you have been in a car accident and are unresponsive. A healthcare power of attorney clearly defines who your doctors should speak to if you are incapacitated, and a medical decision must be made.
5. Irrevocable Trusts
While revocable living trusts grant you great flexibility and the ability to continue managing any assets therein, irrevocable trusts provide greater asset protection and can help minimize your estate taxes, at the cost of burning your bridges with any assets included therein.
It is a bit like taking a property and putting it in a vault, not to be opened until after your death. This degree of separation can be very useful, however, especially if you are incorporating a life insurance policy into your estate planning.
The additional value of a life insurance policy can push your estate into state and federal estate tax territory. Utilizing an irrevocable life insurance trust can help eliminate this concern, while providing a myriad of other benefits.
6. Beneficiary Designations
Wills and trusts are two common methods for distributing assets, but many assets can be distributed upon death without the use of either.
Transfer on death (TOD) deeds and payable on death (POD) clauses are available for certain assets and accounts in certain states, letting you name direct beneficiaries for any given asset or account, bypassing probate, and the need for a trust. Utilizing these designations effectively can help you minimize your estate planning costs and your family’s future probate headaches.
An estate plan can be as simple or complex as you need it to be. A smaller estate can be planned and distributed via an inexpensive estate plan. A larger, more complicated estate with assets in different states and countries will have greater probate costs and tax implications to worry about – and as a consequence, will require a more complicated estate plan.
Working with a professional can give you a much better idea of what you might want to consider given your specific circumstances and requirements. Every estate plan is unique and must be uniquely tailored to the individual’s estate.