By Dr. James M. Dahle, WCI Founder
Estate planning is a chore that most of us put off whenever possible. We usually find it uninteresting and expensive, and even worse, it can force us to face our own mortality. However, it is an important aspect of financial planning and, when done poorly (or not at all), can really cause a mess for heirs.
Table of Contents
- What Is an Estate?
- What Is Probate?
- What Is Estate Planning?
- How to Avoid Probate
- How to Minimize Estate, Inheritance, and Income Taxes at Death
- How to Prepare an Estate Plan
What Is an Estate?
An estate is what you leave behind when you die. It includes all your money and all of your stuff.
What Is Probate?
Probate, meaning the official proving of a will, is a legal process whereby the estate (property of the deceased) pays off its creditors and distributes the assets of the estate as specified in the validated will. It can be expensive and time-consuming, often consuming a significant portion of the estate in legal and administrative fees and lasting months or even years. Much of estate planning is geared toward avoiding this process as much as possible.
What Is Estate Planning?
Estate planning is the process whereby you ensure that:
- Assets go where you want them to after your death
- Your desires are carried out even after you are no longer capable of making decisions
- You minimize the required estate taxes paid to the government
- You avoid the costly and time-consuming probate process
It can be a simple and inexpensive task, or it can require the assistance of costly specialists to complete properly—all depending on your individual situation and desires.
Who Needs to Do Estate Planning?
Just about everyone needs to do at least a little estate planning. Certainly, if you have acquired significant assets ($20,000+) and care about who they go to when you die, you need estate planning. Likewise, if you have even one child, you need to do at least some estate planning.
What Documents Make Up Your Estate Plan?
There are a number of tasks required for estate planning, but the main one is the preparation of various legal documents that come into play at the time of your death or incapacitation.
A will, officially known as a last will and testament, is usually the first estate planning tool that most people need. If people die “intestate” (without a will), their assets are distributed in accordance with state law, usually to the spouse, or, if not applicable, to the children. If you want your assets to be distributed in some other manner besides to the next of kin, you need a will. Another important function of a will is to name someone to care for your children in the event of your death. Even a medical student with a hugely negative net worth needs a will if they have children.
#2 Living Will/Advanced Medical Directive/Medical Power of Attorney
There is one type of will that most doctors are familiar with, and that is a living will. This generally dictates your wishes in the event you become unable to make your own decisions about your healthcare. It also generally names a healthcare proxy who will make medical decisions for you when you cannot. Even a “Do Not Resuscitate Order” is one form of a living will.
I see living wills on a daily basis and find them generally useless because they are so vague. They never seem to mention the real decisions I need made: Would the patient want antibiotics? IV fluids? Pressors? Intubation/Ventilation? CPR? I don't see a huge need for a living will unless you don't want your next of kin making your healthcare decisions. Perhaps the most important aspect of a living will is to simply have a discussion with your family about what you would want to have done in the event that you are no longer capable of making your own healthcare decisions. “Don't you dare leave me on a ventilator longer than a week,” etc.
Nevertheless, when you go to an attorney or even when you use an online estate planning service, they will generally include this document. It's relatively cheap and easy so you might as well do it. But be sure to talk about it with your loved ones. If you don't, they might not even know it exists when it comes time to use it.
#3 Durable Power of Attorney
Even if you skip the living will and a medical power of attorney, it probably is worth naming a trusted family member, friend, or advisor to manage your finances when you can't. This is called a durable financial power of attorney. Studies show our ability to manage our own finances peaks in our 50s. We've all known elderly folks who have done stupid things with their money that they would have never done 10 or 20 years earlier. Power of attorney documents can be general (covers everything) and life-long (durable), or they can be limited in both time and scope. For example, when traveling and leaving our kids with grandparents, we have at times provided them a limited power of attorney to take care of them. Remember your financial and medical power of attorneys do not have to be the same person.
#4 Letter of Intent
This is a great thing to leave at your death, but it is not actually a legal document. It is simply a letter from the deceased to loved ones or the executor explaining any information you want them to know. They can include personal messages or just be simple instructions. They often include information like:
- Personal effects and their location
- Passwords for financial accounts, email, social media, etc. (Best to use a service like LastPass and then this letter need only contain the LastPass password, but should obviously be kept very securely)
- Funeral wishes
- Financial accounts
- Insurance policies
- Beneficiary contact information (not generally in the will)
The most important aspect of this letter is keeping it up to date.
#5 List of Important Documents
This can be part of your letter of intent or a separate document. Consider including the following documents on the list and be sure to note their location.
- Life insurance policies
- Disability insurance policies
- Health insurance policies
- Pension or retirement accounts
- Bank accounts
- Divorce records
- Birth and adoption certificates
- Automobile, boat, plane titles
- Real estate deeds
- Stocks, bonds, and mutual funds
#6 Revocable Living Trusts
Revocable living trusts are basically designed to avoid probate, not to avoid taxes or to protect assets from creditors. The money and assets are placed into the trust, and at the time of your death, the trustee distributes the assets to your heirs in accordance with the trust document, no probate required. Of course, the assets in the trust are still subject to estate tax. The main benefit of a revocable over an irrevocable trust is that you can control and use the assets if you want to and you can “revoke” them at any time. Assets are “put into” a trust by retitling them in the name of the trust. Revocable trusts provide privacy at the time of death (since probate is a public process) and can save substantial time and money for a large estate. Most doctors should have most of their assets that do not have beneficiary designations (and perhaps even some of those should list the trust as the beneficiary) in a revocable trust by the time of their death. The taxes due on income in a revocable trust are generally passed through to your personal return.
#7 Irrevocable Living Trusts
These trusts have the main advantage of a revocable living trust, in that they avoid probate. They also have the advantage of avoiding estate taxes, and they often avoid income taxes. This is because when you place assets into an irrevocable living trust, you are essentially giving them away. You can no longer use the assets or the income they produce. Taxes on the income must be paid by the trust or by the heirs (which may be advantageous if they are in a lower tax bracket).
Only money you know you will never need should be placed into a trust like this. Irrevocable means just that. Keep in mind that gift tax laws apply to the money you put into the trust. Consult with an experienced attorney in your state to determine just how much you can put in the trust each year without triggering gift/estate taxes. Keep in mind that irrevocable trusts are also excellent asset protection tools. The asset no longer belongs to you, so your creditors cannot seize it. Revocable trusts do not have this advantage.
#8 Other Trust Documents
If you do not want your minor children to get their entire inheritance right when they become an adult or if you have a disabled adult child, you may need some sort of a spendthrift trust to ensure the assets are used appropriately. There is a ton of flexibility in these documents and you can do almost anything you want here. Just be aware that the more you try to rule their lives from the grave, the more complications are likely to arise. You may also need trusts to take care of family cabins, cemeteries, or similar multi-generational properties. You may also want to protect assets from your children's ex-spouses. Without a prenuptial agreement, a trust may be the only way to do so.
#9 Guardianship Designations
This is an important aspect of the will, not a separate document. It dictates who will take care of your minor children after your death (guardian) AND who will manage the assets left for them on their behalf until they become adults (conservator). These do not (and perhaps should not) be the same person. I recognize that this is a difficult decision, but the most important thing is to make a decision. You can always change it later. Be sure to consider both how the potential guardian feels about the child and how the child feels about the potential guardian. Ideally, they will love each other and raise the child exactly how you would. Consider economic circumstances, occupation, physical and emotional capacity, religion, and other aspects of their lives that could affect your child's future life. Generally just list a single person, not a couple. If you wish to put restrictions on how money is spent either before or after they reach adulthood, you will need a trust, not just a will naming a conservator. Lastly, be sure to tell whoever you designate of your decision, and make sure they agree to do it.
#10 Beneficiary Designations
Another important aspect of estate planning besides document preparation is to make sure all retirement accounts, annuities, and life insurance policy beneficiary designations are correct. All of those assets pass outside of probate even without the use of a trust. Go over these regularly and update them for major life events like births, deaths, marriages, and divorces. You probably don't want your life insurance and retirement accounts to go to an ex-spouse!
#11 Payable on Death Designations
You can designate a bank account of just about any type as “payable on death” to whoever you want. This way, when you die, your designated person simply goes to the bank with proof of your death (generally a death certificate) and collects the money, no probate involved. You can also register securities such as stocks, bonds, mutual funds, or even entire brokerage accounts as “transfer-on-death.” The best part about that is the basis of these securities is updated as of the day of your death, so that if your heir sells them immediately, no capital gains tax is due. You can even do this with your automobiles in two states, California and Missouri.
What Is the Goal of Estate Planning?
The point of estate planning is to make sure that your minor children, your money, and your stuff go to the people or organizations you want them to go to with a minimum of hassle, expense, and tax due and a maximum of speed and privacy. Implementing the documents discussed above will generally ensure proper guardianship and proper inheritance of assets. However, you also want to avoid probate as much as possible and pay as little tax as possible. We'll discuss both of these topics next.
How to Avoid Probate
Probate can be expensive, open to the public, and time-consuming. It may cost tens of thousands of dollars, and your heirs may not get what is coming to them for more than a year. A little planning now can save a lot of hassle later. Probate is a state-specific process governed by state law, so expect variation from state to state. But in general, there are many ways to avoid probate, some of which have been discussed above already. These include:
#1 Beneficiary Designations
Works great for retirement accounts, pensions, annuities, and life insurance policies.
Although sometimes going through probate is better than the hassle and expense of avoiding it, one goal of estate planning, as a general rule, is to avoid probate. There are many ways to do this. One of the main ones is to designate beneficiaries of your retirement accounts. For instance, if the beneficiary of your IRA is your son, upon your death he gets the proceeds without them ever passing through probate (they are, of course, still subject to estate and inheritance taxes, and, if a traditional IRA, eventually to income taxes).
As you recall, when you opened up a 401(k) or IRA, you were asked for beneficiaries. If you choose someone besides your spouse, you'll need your spouse's written approval. Don't forget, if you get divorced or become estranged from a beneficiary—or you simply change your mind—don't forget to go back and change the beneficiaries to the account. It often happens that an ex-spouse after a bitter divorce ends up with retirement accounts that the decedent would have never left to them knowingly.
Be aware, that if you live in a community property state (Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, Wisconsin, and sometimes Alaska) you cannot give more than half your retirement account money away to someone besides your spouse, because half of the account is considered to belong to your spouse.
Life insurance proceeds pass to the beneficiaries outside of probate. It is generally one of the quickest ways for your heirs to get money after your death. An insurance company may pay out the money within a week of getting the death certificate, but it is almost always less than two months after death.
#2 Pay on Death or Transfer on Death Designations
Works great for bank accounts, investment accounts, and even automobiles in some states.
#3 Revocable (Living) Trust
Have the trust own the asset, and it no longer goes through probate. This is a great solution for homes, automobiles, boats, planes, motorized toys, bank accounts, and even investment accounts.
#4 Irrevocable Trust
Works just like a revocable trust after death, but it has some additional limitations and benefits prior to death.
#5 Joint Ownership
Some forms of joint ownership avoid probate as well, such as joint tenancy. If the title of real estate, for instance, is done properly, the person with whom you own it can easily transfer the entire property into their own name without going through probate.
One should be careful using this as an estate planning tool. For instance, adding your child to your bank account as a joint owner involves several issues:
- First of all, you've given away property—which the joint owner now has the ability to use even before your death.
- The money is also now exposed to the joint owner's creditors, not exactly a good idea from an asset protection point of view.
- It may also spawn disputes after death, especially if an older person does it for convenience, while not actually intending to give the asset to the joint owner.
The manner in which an asset is titled can make a difference, so when titling assets such as real estate and cars, realize that there are estate planning implications to the process.
In community property states, sometimes community property goes through probate, and sometimes it doesn't. In the states in which it does (Arizona, Nevada, Texas, and Wisconsin), you can add the phrase “with rights of survivorship” to ensure that asset doesn't go through probate.
There is an additional income tax issue when it comes to joint ownership of assets that appreciate, such as investments or property like your home. At your death, your heirs normally get a step-up in basis to the value of the asset on the day of your death. However, if the inheritor is a joint owner, they do not get that step-up in basis. That could potentially result in a very large, but completely unnecessary, income tax bill when that asset is eventually sold. So as a general rule, it might be OK to have joint ownership with your heir of bank accounts and cars, but it is almost never a good idea to have joint ownership of investments or your home.
#6 Small Estates
Sometimes, if the value of the estate is below a certain amount, probate can simply be avoided by having the heirs fill out affidavits that the property they are inheriting is specified in a will. Most physician estates will be above these limits at the time of their death.
How to Minimize Estate, Inheritance, and Income Taxes at Death
Besides avoiding probate, estate planning is focused on avoiding the estate tax, aka gift taxes, inheritance taxes, and “the death tax.” Minimizing income tax paid by the deceased, the estate, and the heirs are also a common goal.
Federal Estate Taxes
Unfortunately, estate tax laws can be a moving target. They have changed a half-dozen times in the last decade, ensuring a good income for estate planning attorneys and much confusion for everyone. As of 2023, the federal exemption amount before the estate tax applies is $12.92 million for an individual (in 2022, it was $12.06 million). As long as the total value of your estate is below that amount at your death, you will not owe any federal estate tax. The exemption amount is doubled to $25.84 million if you are married, and this amount is actually portable, meaning all of the assets of the first spouse to die go to the second spouse without any tax due, and then the second spouse can pass on nearly $26 million federal estate tax-free. The exemption amount is also indexed to inflation under current law, so it should double every 20 years or so. However, be aware that under current law, the exemption will actually be halved on January 1, 2026, unless Congress acts to extend it.
State Estate Tax
The states also like to get into the estate tax game, and even worse, some of them don't use the federal exemption amount. These include the District of Columbia, Rhode Island, Connecticut, Illinois, Hawaii, Vermont, Oregon, Maine, Washington, Minnesota, New York, Maryland, and Massachusetts. For example, if you live in New York, the state tax exemption is at $6.11 million in 2022 with a top rate of 16%. You can look up each of these state's estate tax exemptions and rates here.
State Inheritance Tax
Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania prefer to use an inheritance tax rather than an estate tax. This means that the tax is levied on those who RECEIVE the inheritance rather than on the estate itself. Spouses are usually exempt from this, and in some states, so are direct descendants. You can see if your state has an inheritance tax here.
Income taxes also come into play when doing estate planning. You have to consider all of the income taxes, whether paid by you prior to death, paid by the estate in the year of your death, or paid by your heirs after your death. You also have to consider the estate tax ramifications of income tax planning and vice versa.
The most significant income tax planning revolves around the step-up in basis at death. Heirs do not inherit your basis (i.e. the amount you paid for an investment); they get a step-up to the value of the asset on the day you died. So if you bought a property for $100,000 and it was worth $1 million at your death and your heirs immediately sold it, there is no income tax due. Without the step-up in basis at death, they would owe taxes on $900,000! As a general rule, it is a bad idea for an elderly person, especially one in poor health, to sell anything with a low basis and pay income tax on it. It is often far better to leave that asset to their children, even if it means they have to borrow money against it to live on until that time. If an asset must be sold prior to death, one should preferentially sell assets with a high basis.
Another important income tax ramification comes from the fact that after one spouse dies, the remaining spouse will be filing taxes as a single person, usually at a higher tax rate. Thus it can make sense to pre-pay some income taxes while both spouses are still alive.
How to Plan Around the Estate Tax Exemption and Gift Tax Limits
Most estate tax planning revolves around maximizing the use of the federal and state estate tax exemptions. Ideally, good planning eliminates estate tax completely, but even if you have a very large estate, it can help to minimize how much is paid.
If like most docs, your estate is worth less than the estate tax exemptions, there will be no estate tax due at all. You can help keep the value of your estate down by spending your money and by giving it away. You can give any amount to charity at any time, and you may even obtain some income tax benefits for doing so. However, you are only allowed to individually give $17,000 (2023 limit) per year away to anyone else before gift tax laws kick in. You can give more than that, but any amount above $17,000 per year requires you to file a gift tax return and starts eating into the estate tax exemption. Once it is gone, you start paying gift taxes, which is essentially the same as paying your estate taxes in advance. Keep in mind that you can give $17,000 to your child and $17,000 to your child's spouse, and your spouse can do the same. So the two of you can give $68,000 away each year to your married children without having to hassle with the gift tax.
If an asset is likely to appreciate, it is better to give it away before it does so. That way all of that appreciation does not end up in your estate and be subject to estate taxes. This can be done directly, by simply giving the asset to the heir, or it can be done indirectly using irrevocable trusts, Family Limited Partnerships (FLP), or Family Limited Liability Companies (FLLC).
Roth conversions can also reduce the size of the estate since the IRS considers a pre-tax dollar and a post-tax dollar to be equivalent when assessing the size of your estate.
Giving Assets as an Inheritance vs. Giving Away to Charity
As a general rule, the assets at the top of the list below are the best to leave to your heirs and those at the bottom of the list are the best to leave to charity. If you do not plan to leave anything to charity, it is best to spend from the bottom up if you wish to maximize what your heirs receive.
The tax benefits of Roth accounts can be stretched for 10 more years after your death by your heirs, and they generally also receive substantial asset protection.
Life insurance is passed to heirs as tax-free cash within just a few weeks of your death.
Taxable investments benefit from the step-up in basis at death and thus can be rapidly converted to tax-free cash by your heirs after your death, although there may be some expenses associated with selling them.
While traditional IRAs and 401(k)s can be stretched for 10 years by heirs and receive asset protection just like Roth IRAs, they are still pre-tax money and any withdrawals will be fully taxable income to your heirs.
If pre-tax assets are given to charity, the charity gets the full amount and nobody pays taxes on that money. Health Savings Accounts (HSAs) are also pre-tax money best left to charity since they cannot even be stretched by your heirs.
What's the Deal with Life Insurance and Estate Planning?
Life insurance proceeds are not subject to income taxes. If you leave $1 million in life insurance proceeds to your wife, your kids, or your dog upon your death, none of them are going to pay a cent of that in income taxes. Thus, life insurance, even a permanent life insurance policy such as whole life, can sometimes be a good estate planning (but almost never a good investment planning) tool. The proceeds can be used to pay estate taxes or provide liquidity for a family-owned business or farm that is difficult to sell. However, if the deceased/the estate is the owner of the insurance policy, the proceeds are still subject to estate taxes.
The only way to avoid this is to have someone or something else own the policy. You could have your children own the policy and simply gift them the premiums each year, though it is far more common to have it owned by an irrevocable trust. In essence, this strategy involves buying a life insurance policy with annual premiums just less than the gift tax amount ($17,000 per person per year in 2023). The amount of the premium is put into the irrevocable living trust each year and used to purchase the life insurance. Upon death, the proceeds pass to the heirs both income and estate tax-free. Since no taxes are due on life insurance cash value/death benefit growth, it is a very tax-efficient way to pass on wealth.
However, it can take some serious number crunching to determine if the tax-saving benefits outweigh the additional costs and relatively poor returns of the life insurance “investment.” It probably isn't a good idea if the estate won't be subject to estate taxes anyway. Remember that insurance salesmen are going to emphasize these benefits at every opportunity. Term life insurance is still the best insurance for nearly everyone out there. Just be aware that it is something to consider if you expect to have an estate tax problem. Waiting to buy does increase the risk of not being insurable at that age, but there are other estate planning tools that can be used if you turned out to be uninsurable at that time.
How to Prepare an Estate Plan
There are some specific steps to do when preparing your estate plan.
#1 Inventory — Net Worth and Family Needs
Like with your financial plan, the first step is to figure out where you are at and what you want most.
Determine Your Net Worth
Your net worth is perhaps the most important number to know in personal finance, but when it comes to estate planning, it is what determines whether you have an estate tax problem. If your net worth is less than the federal and any applicable state estate tax exemptions, no estate tax will be due.
Your net worth is everything you own minus everything you owe. Add up all of your assets such as bank accounts, your house, retirement accounts, brokerage accounts, the value of your practice or other businesses, and rental properties. A reasonable estimate is fine for most purposes. To be technically accurate, you should also add up your vehicles, toys, furniture, clothing, and household goods, but from a practical standpoint, most people just include the big stuff. Then add up all of your liabilities or debts. These include mortgages, student loans, credit cards, auto loans, and anything else you owe. Subtract the liabilities from your assets, and that is your net worth.
Document Everything You Have
As you calculate your net worth, compile a list of all of your assets and liabilities. This document will assist you and your attorney in coming up with an appropriate estate plan. Include:
- All of your bank accounts with at least approximate balances
- All investments you have
- Any retirement plans you have, including pensions
- Any real estate or property you own
- Businesses you own, wholly or partially
- Personal property of value, from your grandmother’s wedding ring to your collection of trading cards
- Insurance policies
- Digital assets, like passwords and email accounts where you receive important communications
- All debts you owe
Make a Plan for Minors
In life, the people matter more than the things and the money, especially if you have minor children depending on you. List your plans for them in the event of your untimely death. Include:
- Who will be their guardian?
- Who will be the conservator of the assets and/or trustee of their trust fund?
- What will the terms of the trust be?
- How will you fund the trust? Will it be the beneficiary of retirement accounts and life insurance policies?
#2 Hire an Attorney
Estate law is state-specific, so you need an attorney in your state. While very basic estate planning can be a do-it-yourself project using an online attorney/service, most professionals reading this site will likely eventually want to sit down across from a real, live attorney to get this done. This attorney helps you to understand the process, drafts up your documents, answers your questions, and updates the plan periodically as needed. They can also serve as a trustee and resource for your heirs after your passing.
Online Legal Services
There are dozens of online legal services. The best-known one is Legal Zoom, but others include Rocket Lawyer, LegalShield, and Zen Business. Some specialize in business formation such as LLCs and corporations, but most will at least do a basic will and perhaps even a trust. They can probably handle a basic “I love you” will that names a guardian and conservator for your children, but by the time you start thinking about trusts, it's probably time to find a local attorney.
What Does an Estate Planning Attorney Cost?
Attorneys generally charge by the hour, perhaps $250-$350 per hour. So the cost of your estate planning depends on the complexity of your estate. If your situation is really complex, it will cost you thousands or even tens of thousands to form trusts, family-limited partnerships, and more. But a simple will or power of attorney may cost less than $200. The initial meeting is often free, so feel free to shop around a bit. It can help you keep costs down if you did your research, knew exactly what you want before you arrive, and collected all relevant information and documents. Plus, it'll help if you can make important decisions rapidly and are willing to participate fully in the process. No, the fees are not going to be tax-deductible, even if you own a business. They used to be deductible as an itemized deduction prior to the Tax Cuts and Jobs Act and may again be deductible when those provisions sunset after 2025.
How to Find a Good Estate Planning Attorney
Your goal is to find someone that is competent, experienced, and a good fit. You probably don't want your friend or cousin unless they specialize in estate planning. You can check to make sure they're in good standing with the bar and that estate planning is what they spend the majority of their time doing. Like with a financial advisor or a doctor, there is some value to a few gray hairs. Someone who has already done this hundreds of times is usually going to be more efficient and make fewer mistakes. You also want someone that you can relate to and enjoy working with. Ideally, they have worked with a lot of people in your particular situation. WCI keeps a shortlist of recommended attorneys for your estate planning and asset protection needs.
#3 Establish Estate Plan Directives
You have your documents and the ideas of what you want, and you have hired an attorney. Now, it is time to establish your directives and time to start producing documents.
Make a Will
The will lists a guardian and conservator for minor children. It may also list who is to receive various assets, including real property like your home that is not covered by beneficiary designations. These may be very simple “I love you” wills if you are recently married with young children to incredibly complex legal instruments when there are blended families with married adult children and minor children involved.
How to Sign the Will: The Will-Signing Ceremony
In some states, a “holographic will” is actually valid and requires very little formalities. However, to make sure the will is valid and not contested, it is best to sign it in a formal way, including each of these steps.
- Proofread it. Make sure it actually says what you want.
- Arrange for witnesses. This can just be employees at the law firm.
- Get a notary public. The “self-proving affidavit” is signed in front of a notary public in most states. That way they can testify that you had the mental capacity to know what you were doing.
- Gather everyone and explain what's going on. At a minimum, this includes the attorney, the witnesses, and the notary public. But I would also recommend, if you really want to minimize future drama, that you bring in everyone named in the will too. That way there is no doubt what your intentions were. Surprises in estate planning make for dramatic TV and movies, but they're probably not best practice.
- Initial, sign, and date the will.
- Have witnesses sign.
- Sign the self-proving affidavit.
- Store the will safely. Make sure your executor knows where it is.
What Is a Will Executor?
A will typically names the executor of the will. Sometimes it is simply a trusted family member, especially if there is an attorney in the family. It can also be your estate planning attorney if you prefer to minimize family drama. This person will be responsible for wrapping up your affairs, including selling property and filing tax returns, as well as carrying out the instructions in your will. Named executors are simply acting in your stead, of course, and have no responsibility for or ownership of your debts or assets.
An important part of estate planning is also to go over every account or policy that can name beneficiaries and make sure the appropriate people or entities are named. You may wish to name a trust as the beneficiary. You can also usually name contingent beneficiaries if the beneficiary dies before you or refuses the gift. Beneficiaries are easily and routinely named for retirement accounts, annuities, and life insurance policies. But you also need to think about Health Savings Accounts, 529s, and ABLE accounts. Taxable investing accounts and bank accounts can also be set up to go to a beneficiary at the time of your death with a “Payable on Death” or “Transfer on Death” designation. In some states, you can even do this with houses and cars. This is faster, cheaper, and more private than simply naming beneficiaries for each of these in your will and having the executor take it through probate.
Create a Healthcare Plan
If you want some control over your healthcare decisions after you get too sick to make your own decisions, you probably want to get a living will and name a healthcare proxy. This can even be a formal healthcare power of attorney. You may want to provide a specific HIPAA waiver for your proxy. Perhaps you want to fill out your state's formal Do Not Resuscitate (DNR) form. Whether it's in the will or not, provide as much direction as you wish to your proxy including what you would want in a given situation. I find that most people are fine with an attempted resuscitation or a short period of life support; they just don't want to “be a vegetable” who is “living on a machine the rest of their life.” Consider including specific instructions about CPR, dialysis, intubation/ventilation, pressors, nutrition support (tube feeds), ECMO, and surgery.
A revocable or living trust is very useful if you wish to pass on assets faster, with less expense, with more privacy, and with more control to your heirs. Most white coat investors will want to put one in place as part of their estate planning process and this is likely a large part of the work and cost of the attorney.
A trust is a separate legal entity—like an individual, a corporation, or a limited liability company—and lives on after your death according to its provisions. To pass an asset on to heirs through a trust, the asset must be titled in the name of the trust. With a revocable or “living” trust, you can simply remove the asset from the trust at any time while you're alive. Thus, it passes assets outside of probate but provides no asset protection. With an irrevocable trust, you are giving away the asset. You lose a lot of control that way, but you gain two things:
- Any increase in value from the time the asset is placed into the trust until your death is not part of your estate and thus does not count toward your estate tax exemption.
- It becomes unreachable by your creditors, providing excellent asset protection.
An irrevocable trust does have to file a tax return, however, and it is subject to a more aggressive set of tax brackets. This is why a lot of people put whole life insurance policies inside irrevocable trusts since they do not generate taxable income.
A testamentary trust is created at the time of your death. While this avoids the hassle and expense of maintaining a trust during your life, the assets must go through probate before going into the trust.
Charitable trusts can also be created at this point in the estate planning process. These can save a lot of taxes, but generally do require significant charitable intent to work out well.
Remember to actually retitle assets in the name of the trust, or you will spend all that money on a trust for nothing.
Letter of Intent
This discusses your funeral, burial, and other final wishes. You may also wish to include messages for family or friends. Obviously, you don't need an attorney to do this part, but be sure to include it with your other papers and tell people it exists, or they might not look at it until it is too late. This may be a good place to include the master password for your password manager and directions for what to do with social media accounts, email accounts, Google Drive, and other assets in the cloud.
This is also a good time to give some thought as to what you will do with your businesses. These might be a practice, side gig, or full-on free-standing business with multiple employees. Just like people need estate planning, so does your business. What will happen if you die? What do you want to happen? Make sure the business has a plan in place. Forming a business as a Family Limited Partnership (FLP) or Family Limited Liability Company (FLLC) can save a lot of taxes and provide asset protection, and it can facilitate a smooth, private transition at the time of your death.
#4 Estate Taxes & Asset Protection
As your trusts and other documents and plans are being created, this is a good time to consider the estate tax, income tax, and asset protection implications of your plans.
What Is Estate (Death) Tax and How Does the Estate Tax Work?
Estate tax is tax that is paid on any amount over the estate tax exemption. It is often called the “death tax.” The idea behind it is to try to prevent a class society from forming as rich people pass wealth to their kids' generation after generation. The federal estate tax brackets rapidly rise to 40%, meaning 40% of what you leave behind goes to the government and 60% to your heirs. Any money left to charity is not subject to that tax. However, the tax does not begin until your estate is larger than the estate tax exemption. On a federal tax level, that exemption is $12.92 million ($25.84 million married) in 2023, but some states have their own estate tax with a significantly lower exemption amount. Under current law, the married exemption is “portable,” meaning that just because you were married, you get the $23.4 million exemption at the time of your death. Essentially, if you die, your spouse can inherit everything from you without using up any exemption AND they get to use your exemption when they die.
What Is the Inheritance Tax?
Unlike the estate tax, which is paid by the estate (essentially the deceased), some states (Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania) have an inheritance tax instead of an estate tax or in addition to an estate tax. This tax is assessed to the person inheriting assets. It is entirely possible for an asset to be subject to an estate tax in one state where the person died AND be subject to an inheritance tax in another state where the inheritor lived!
What Is the Gift Tax?
The gift tax is rarely paid and is best thought of as part of the estate tax. Basically, if you give anyone more than $17,000 (2023) in a year, the amount above $17,000 is subtracted from the estate tax exemption amount. Once that exemption amount is completely gone, gift taxes must be paid. Until it is gone, you are merely required to file a gift tax return, not pay any actual tax. The gift tax prevents people from giving everything away on their death bed so that it isn't subject to estate taxes.
How to Avoid Estate Taxes?
The main way to avoid estate taxes is to minimize the size of the taxable estate above the exemption amount. There are many ways to do this including:
- Spend your assets
- Give assets away ($17,000 per person per year)
- Place assets into an irrevocable trust before they appreciate
- Give assets to charity now or at death
- Move away from states with estate taxes
- Have heirs move away from states with inheritance taxes
- Give heirs shares of FLPs and FLLCs $17,000 at a time and/or before the value appreciates too much
- Place your home into Qualified Personal Residence Trust
The last two methods use up less of the estate tax exemption than you might think, because the value of the gift is reduced. That's due to the fact that the inheritor will not receive them for some time or because the asset is illiquid.
Income Tax Planning
It is also a good idea to think about how you are going to reduce income taxes for yourself and your heirs. If you plan to split your estate between heirs and charity (or even just heirs in very different tax brackets), carefully decide which assets go where, as per the chart earlier in this post. You also want to take full advantage of the step-up in basis at death. It is often better to borrow against low basis assets rather than sell them and realize even long-term capital gains in the last years of life.
When forming businesses or doing estate planning, there are numerous asset protection implications. It can make sense to combine asset protection and estate planning into one process. Retirement accounts, whole life insurance, irrevocable trusts, family limited partnerships, and family limited liability companies can all have strong asset protection benefits. When forming trusts, be sure to consider the implications of the trust on your children and other heirs. Written properly, you can ensure the assets of the trust only benefit your heir and not their spouse or ex-spouse.
#5 Estate Plan Reevaluation & Document Storage
Now that your estate plan is in place, you need to do a few things to maintain it.
How Often Should You Update Your Estate Plan?
Estate plans should be reviewed for an update in three circumstances:
- After a major life event (birth, death, divorce of you or heirs, sale or acquisition of major asset)
- After a significant tax code change
- Periodically (about every 5 years)
Sometimes, simple addendums can be added to documents or you may need to completely redraft the documents and entities you previously formed.
Beneficiaries may also need to be changed, and additional assets may need to be placed into the name of the trust.
Where Should You Keep Your Estate Plan?
You should have multiple copies of your estate planning documents. You should keep an easily accessible copy of everything at home in one place. Clearly label it so it can be found and tell those who need to know about it where it is. An electronic copy is also a good idea, and you may even want an additional physical copy elsewhere. Your attorney will also likely keep a copy of it. You may also want to provide a copy to the executor of the will, the conservator of your children, the trustee of your trusts, and even major heirs.
As a general rule, your estate planning documents are not a great place to keep secrets. It is far easier for your heirs to plan their own financial lives when they know what is coming. You may also wish to keep a file of your living will, healthcare proxy, and/or healthcare power of attorney at your local hospital and physician's office. Remember if no one can find your documents, it is as though they do not exist. What a shame to put all of that time, effort, and money into the process for nothing. Dying intestate (i.e. without a will) means you have chosen your state's designated estate plan instead of your own.
#6 Understanding What Happens After You Die
The first thing that may be needed after you die is that letter of intent that outlines your funeral wishes. The rest of the process probably won't even start until after that occurs. Once the dust settles from that, the executor of your will goes to work, and the probate process begins.
When Is a Probate Process Required?
Probate law is state-specific, but you usually need an estate of a certain size before it must go through a full probate. Remember, your entire net worth does not contribute to the size of your estate for probate purposes, only the size of the estate that goes through probate. In my state of Utah, an estate must go through probate if:
- The estate includes real property (land, house, condominium, mineral rights) of any value, and/or
- The estate has assets (other than land, and not including cars) whose net worth is more than $100,000.
So if you have your home, cars, boats, bank accounts, and taxable investing accounts owned by a revocable trust and have beneficiaries named for all retirement accounts and life insurance policies, you could potentially avoid this process altogether.
What Happens During the Probate Process?
First, the last will and testament is authenticated and the executor/administrator/personal representative is appointed. Then this person must do the following tasks:
#1 Post a Probate or Fiduciary Bond
While state-specific, this bond is often required and is likely to cost at least a few hundred dollars and possibly thousands. If someone comes to the court and says the executor is not fulfilling their duties, the court can investigate and, if applicable, force them to do so because of this bond.
#2 Locate Decedent's Assets
Hopefully, you've made this easy on your executor.
#3 Determine Date of Death Asset Values
Appraisals may be required for some assets, but most of the time, this is just getting bank and brokerage statements. If you're still living at home at the time of your death, the executor may hire an estate sale company to determine a value for all the stuff left in your house.
#4 Identify and Notify Creditors
A great benefit of living a debt-free life, at least by the end, is your executor has one less task to do. Remember your debts have to be paid off before anyone gets an inheritance, at least an inheritance of the assets that go through probate. Bypassing assets outside of probate, you can potentially stiff a creditor while still providing an inheritance.
#5 Preparing and Filing Tax Returns
An income tax return must still be filed in the year of your death (if you left a spouse, they can still file Married Filing Jointly one more time). The executor will also be responsible to make sure an income tax return for the estate is filed. An estate is technically a different entity than the person who died and needs its own tax number and its own special return (IRS Form 1041). It must file its own return if any beneficiary is a non-resident or if the estate made $600 or more. An estate tax return (IRS Form 706) must be filed if the estate is over the exemption amount OR if any of the exemption is being transferred to the spouse. The executor may also need to ensure state income and estate tax returns are filed.
#6 Distributing the Estate
Finally, the executor is responsible for actually distributing the estate. It would be a very bad idea to make any distributions before all creditors and taxes have been paid, and thus, you can see why it takes a long time for heirs to get their inheritance when it has to go through probate.
If you do not have a will appointing an executor, the state will appoint one. The usual first choice is your spouse or domestic partner, then your children, then any other available family. The executor must follow the state's intestate succession laws. These laws generally pass assets preferentially to a surviving spouse and children, not unmarried partners, friends, or charities. These laws can be complex if your family situation is complex, but it's very simple in a simple situation. For example, if you were only married once and only had children with that person, all of your assets go to your spouse if the spouse is alive and to the kids if the spouse is not alive. Otherwise, it gets very interesting. Per Nolo, this is what happens in my home state of Utah:
Intestate laws in other states are generally similar, but they all vary somewhat, especially as treating domestic partners. If you do not like your state laws, that is a very good reason to get a will in place ASAP.
The trustee of your trust(s) has a fiduciary responsibility to carry out the instructions in the trust, whatever they may be. There are almost limitless options for passing assets to your heirs via a trust. There can be restrictions based on age, knowledge, religion, marital situation, educational achievements, or almost anything else you can think of. Some trust fund kids have it easier than others!
I hope this is helpful in outlining the general strategies of estate planning. There are lots of other tricks and tips involving trusts that I'll discuss in future posts. Remember that having a will, naming beneficiaries properly, and titling assets properly is cheap and probably all that most of us will ever need. If you need more than that, a few thousand dollars spent on an estate planning attorney will be well worth your time and effort. Also remember that the laws governing this process are state-specific and frequently change, so personalized, up-to-date advice is warranted in this important area. Anytime you get wind that Congress or your state legislature has changed the laws regarding probate or regarding estate taxes, you ought to consider whether to visit with your estate planning attorney again.
What have you done as far as estate planning? Do you have a will? A trust? Have you at least checked to make sure your designated beneficiaries were right? Comment below!
[This updated post was originally published in 2011.]