Estate planning is an important component of long-term family stability. It can provide guidelines for the prudent management of financial matters and the care and education of children. It is also an important component of overall wealth planning.
The following documents form the basis of an effective estate plan:
- Will (and in some cases a Revocable Living Trust)
- Durable Power of Attorney
- Health Care Power of Attorney / Living Will
A will protects your family by making appropriate provisions for their future financial needs. Your will directs the disposition of assets, including financial assets, real property, collectibles and other personal belongings upon death. Your will also contains provisions for the care and guardianship of any minor children who survive their parents' deaths. For many people, the need to provide for children leads to the execution of a will, while the purely financial aspects are secondary.
A will follows a basic structure. It includes “dispositive provisions” that designate who will receive your assets. If there are individuals and/or charities you wish to receive a specific amount of money, the will lists these “specific legacies.” Often one will also want to provide specifically for personal property, including objects of monetary or sentimental value or artwork. The will then distributes the balance of the financial assets, generally among family members. A will can also establish trusts for minor or incapacitated beneficiaries who will not have the ability or maturity for asset management.
The will appoints an Executor who will handle the administration of the estate. Generally you will also appoint potential successors if the initial person designated is unable or unwilling to serve. The Executor handles numerous tasks, including:
- Collecting and safeguarding the estate assets.
- Notification to creditors and payment of lifetime debts.
- Collection of sums owed to the decedent.
- Filing of claims for retirement benefits, social security benefits and veterans benefits.
- Managing the estate’s assets.
- Sale of assets as required to pay expenses and legacies.
- Maintenance of detailed records of the estate administration.
- Distribution of assets to beneficiaries.
- Filing tax returns, including the decedent’s final income tax return, the estate and/or inheritance tax returns, and the estate’s income tax returns.
Families implementing an estate plan for the first time are often curious about the effect of dying without a will, which the law refers to as “intestacy.” Without a will to establish your intentions:
- State law regarding intestate succession dictates asset distribution. Your assets will be distributed to those persons listed under the state intestacy statutes which may be contrary to your wishes. For example, under the statutory classification, relatives you hardly know or with whom you have no relationship could inherit all or a substantial portion of your estate. In some states (like Pennsylvania) at the death of the first to die of a married couple, the surviving spouse does not necessarily inherit all of the assets. In Pennsylvania, if there are children, the children would inherit a 50% share which can financially disadvantage the surviving spouse. In addition, if the children are minors, the court will appoint an independent guardian to manage the minor’s assets.
- Without a will, the court will appoint a guardian who may not have been your person of choice. There are also added costs and administrative requirements when the court appoints a guardian. In the worst case, which is not uncommon, family members may be in court fighting over the appointment of the guardian.
- Even in the best of cases, the lack of a will makes estate administration longer, and in most cases more expensive and cumbersome for heirs.
- Rather than an individual of your own choice to handle the administration of your estate, the court will appoint an administrator who may not have been your person of choice and who will have to put up a nonrefundable bond (which is paid from estate funds).
Revocable or Living Trust
The revocable trust, sometimes called a “living trust,” is used most often in states that have very burdensome probate procedures. These trusts are designed with two goals in mind: (1) preventing assets from undergoing the probate process; and (2) providing for ongoing management of assets should one become incapacitated prior to death.
Technically, assets held in an individual's name at death are subject to probate, while assets held in a trust are not. By placing assets in a revocable living trust, you can pass assets to heirs without subjecting the estate to the probate process. A husband and wife will generally establish separate trusts. They then transfer assets into their respective trust by re-titling assets, such as bank and brokerage accounts, valuable possessions, and other assets, into the name of their trusts.
During your lifetime, you will deal with any assets titled to your revocable trust in the same way that you deal with your individually owned assets. In the event of incapacity or upon death, the successor Trustee named in the agreement will manage and distribute the trust assets according to the trust provisions. The distributive provisions of the trust that apply following death are similar to the language used in wills, and the overall structure of the estate will be the same. But the trust keeps assets out of probate court, reducing expenses and the public attention that sometimes accompanies probate proceedings.
The revocable trust does not avoid federal estate and state inheritance taxes; the assets are subject to estate and inheritance taxes in the same manner as when you retain them in your own name. Although the revocable living trust is a separate legal entity, for income tax purposes the trust is generally disregarded. Establishing a revocable trust will not affect your income tax liability or change tax filing requirements. The revocable living trust can be thought of as a holding vehicle for assets during your lifetime.
Even with a revocable living trust, you still need a will to designate guardians for minor children, among other things. The will also contains “pour-over” language that ensures assets held in your name at death are transferred to the revocable trust. Once that transfer occurs, the terms of the trust will govern the distribution of assets. Without a will to place assets into the trust, any assets held outside the trust at death would be subject to the laws of intestate succession.
As noted above, another benefit of a revocable trust is the role it plays if you become incapacitated. It is critical to have a trustworthy and competent person named as successor Trustee who can assume responsibility in this event.
Durable Power of Attorney
A durable financial power of attorney will designate an individual as your agent who will assume responsibility for managing your financial affairs if you are unable to do so on your own. The power of attorney authorizes your agent to handle all types of transactions, including banking, securities, real estate and tax-related matters. The power is generally effective as soon as it is signed and is “durable” which means that it remains in effect even if you become incapacitated. In such a circumstance, having a valid durable financial power of attorney in place should avoid the need for a court-appointed guardian. The power of attorney is of no effect after death.
Power of Attorney for Health Care / Living Will
The power of attorney for health care permits you to appoint an individual to make medical decisions for you in accordance with your wishes as stated in the document in the event you are unable to do so on your own.
The living will portion of the document gives you the opportunity to express your wishes and directs the application or nonapplication of extraordinary medical care in the event you become permanently unconscious or have a medical condition that is incurable and irreversible and is either terminal or would cause you to lose significant physical and mental capabilities to the extent that the burdens of continued life would be greater than the benefits to you.
A health care power of attorney generally contains a privacy waiver that authorizes your agent to gain the same access to health information as you would have. The privacy regulations under the Health Insurance Portability and Accountability Act (HIPAA) would otherwise make it difficult for your agent to obtain information from doctors and hospitals. While the HIPAA provisions are generally effective as soon as you sign the document, the balance of the provisions are effective only if you are permanently unconscious or if death is imminent and you are unable to express your wishes.
Creating and updating an estate plan can be a complex process, but it can ensure that your family will be provided for after your death and is a core element of a long-term wealth management strategy. For some families, the basic estate planning documents described in this article are only the first phase of the estate plan, focusing on issues that arise at death. The second stage of planning addresses lifetime wealth transfers and funding family endeavors while reducing eventual transfer taxes and shaping the family legacy. Like any long-term financial planning structure, the estate plan will require a degree of maintenance over time. Changes in tax laws or in personal situations are a standard impetus to review the original plan and ensure that it accords with your family's ongoing goals.