In a situation where an individual dies, is incapacitated, or is no longer able to make financial decisions on their own, what happens to their assets? Estate planning can ensure an individual’s assets are managed and distributed in accordance with a plan they set out. When an estate plan isn’t established, it can create a domino effect of issues for an individual’s estate when they die, which can comprise long, complicated court cases or family disputes. In the case that a plan is established but not well thought through or up to date, it can cause similar issues and have detrimental tax implications for beneficiaries.
What is Estate Planning?
Estate planning can be complex and entails multiple moving parts. However, in summary, it’s a way to plan for the management of an individual’s assets or estate if they’re incapacitated or die. Some examples of assets included in the estate planning process are:
- Real estate
- Life insurance
- Automobiles
- Retirement accounts (401(k), IRA, 401(b))
- Investing accounts (traditional brokerage, HSA)
- Savings accounts
- Checking accounts
- Any other valuables (Jewelry, collectibles, furniture etc.)
- Businesses
In addition to making decisions about assets, estate planning also has a healthcare element called a living will. This outlines your wishes for medical care if you can no longer make those decisions on your own.
Steps In the Estate Planning Process
Estate planning includes multiple steps, which will vary for every person. It’s also essential to mention that estate planning isn’t a “set it and forget it” process. Individuals will likely need to revisit their plan periodically, especially when they undergo life changes. Some examples include getting married, having more kids, or death of loved ones.
On that note, here are some key elements the estate planning process entails.
Estate Inventory
This is usually the first step in the estate planning process as it’s a snapshot of an individual’s assets and lists out everything they own. During this step, an individual may include some of the items mentioned above, such as securities and property. The goal is to take note of every single asset they have. It may be helpful to include liabilities or debts too so it’s easy for the estate executor to manage those when an individual can’t or dies.
Estate Planning Documents
An estate plan contains several legal documents and each one serves a different purpose. Estate planning documents can be drafted by a lawyer and should be notarized. Here is a brief explanation of what each document is.
- Guardianship: Outlines who will care for dependents and how.
- Will: Legal document detailing last wishes as it pertains to assets. A will can also include guardianship for any surviving minors.
- Trust: A legal agreement that allows the trustor to give the trustee rights to hold or distribute assets on their behalf. Keep in mind that trusts must be funded, which means the assets that go in the trust should be in the trust’s name, not the individual’s name.
- Financial power of attorney: A legal document that enables a selected person to make financial decisions on an individual’s behalf when they’re medically unable to do so.
- Advance healthcare directive: This legal document often includes both a living will and a medical power of attorney. A living will details an individual’s medical care wishes in the event that they aren’t able to make them on their own. A medical power of attorney is a document that gives an individual power to make medical decisions on another individual’s behalf.
Beneficiaries
This is a crucial step in the estate planning process as it forces people to think about who they want to inherit their assets. The good news is that people can choose multiple beneficiaries and distribute their assets in any way they see fit. In addition to choosing a main beneficiary, they can also choose multiple contingent or secondary beneficiaries. This way, there is someone else in line to inherit their estate if the primary person can’t or doesn’t want to.
Tax Planning
It’s important to plan for taxes when estate planning. If this crucial piece isn’t planned for, a significant chunk of an individual’s assets could end up going to the IRS, leaving their loved ones with less than they anticipated. Common taxes associated with estates include estate tax, inheritance tax, and gift tax. All three can impact the value of an individual’s estate and the amount the beneficiary pays in taxes when they inherit the assets.
Working with a tax professional or estate planner can help an individual ensure their assets are housed in the most tax efficient vehicles.
If you need help drafting your estate plan it may be ideal to work with an estate planning professional and financial advisor to ensure all of your needs are addressed.