It is common for people to confuse writing a will with estate planning. After all, a will is a legal document that dictates how to distribute possessions that make up your estate after you die. However, a will is only one of the many documents in a comprehensive estate plan.
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What Does an Estate Plan Do?
A will covers what will happen to your family and property after you die. An estate plan has a will but also includes other documents protecting your family and property while you are alive but incapacitated.
An estate plan guides your loved ones in handling your financial affairs and medical care. If you have a spouse, minor children, or family members with special needs, your estate plan should provide for their care and financial support if you are incapacitated or after you have gone. Finally, an estate plan minimizes estate taxes and provides a fast, orderly distribution of your assets.
The following sections will explain the difference between a will and estate planning, the role a will plays in estate planning, and what other documents make up a well-crafted estate plan. Those documents include wills, living wills and healthcare powers of attorney, financial powers of attorney, and trusts.
What Is an Estate?
Most people know they leave behind an “estate” when they die, but what is part of your estate? At its most basic, your estate consists of everything you own. That includes the following:
- Checking and savings accounts
- Your home and other real estate
- Your car
- Life insurance
- Your personal possessions
Depending on the state law, your estate satisfies your outstanding debts after you die, significantly reducing your estate’s value. That means that if your debts are greater than the size of your estate, there will be no assets to distribute in your estate plan. Fortunately, if there is not enough in the estate to repay your debts, your family members usually aren’t responsible for your unpaid bills.
Last Will and Testament
Most estate planning attorneys will tell you that a last will and testament is the foundation of any good estate plan. The document sets out your wishes for distributing your property after you die and who will care for your minor children. The individuals or organizations receiving your assets under the terms of the will are your “beneficiaries.”
Essentially, a will is a set of instructions the estate’s executor or the personal representative responsible follows to administer your estate. The executor should be someone you trust to carry out the will’s instructions and manage your assets until they can distribute them to your beneficiaries. A state probate court usually supervises the executor to ensure they carry out your wishes.
Each state has its own rules, but a court will usually find a will is valid if signed by someone who is at least 18 years old and understands its contents. Most states require at least two witnesses over the age of 18.
Living Will and Healthcare Power of Attorney
A living will sets out your wishes for your medical care should you become incapacitated or unable to make your own decisions due to illness. These are sometimes called “advanced medical directives” and usually state your wishes concerning life support or other life-sustaining interventions if you cannot decide for yourself.
A healthcare power of attorney lets you give another person legal authority to make crucial decisions regarding your medical care. In most cases, the named individual has a durable medical power of attorney so that person can continue making medical decisions if you have become incapacitated. Most states assume that healthcare power of attorney is durable, but the estate plan should clarify this issue.
Financial Power of Attorney
A financial power of attorney allows you to name someone to manage your assets and finances on your behalf. In most cases, the named individual receives durable financial power of attorney that lets them continue making financial decisions if you are incapacitated or too ill to manage your financial affairs. If you cannot make decisions for yourself and have yet to give someone durable financial power of attorney, a probate court will appoint someone to act on your behalf if you are unable to do so.
Whoever you grant financial power of attorney is legally required to act in your best interests; this includes:
- Managing your finances and assets in an honest and reasonable manner
- Avoiding situations where their interests will conflict with yours
- Keeping detailed records of their actions on your behalf
Married couples often assume they don’t need to grant their spouse financial power of attorney because they hold many of their assets in joint names. However, it is not uncommon for a medical emergency to quickly exhaust the money in the couple’s joint bank account, where each spouse has the right to draw funds. Without a financial power of attorney, your spouse can’t access 401(k) accounts held in your name or accounts that require both spouses’ signatures. Additionally, some state agencies require power of attorney to seek benefits on behalf of an incapacitated spouse.
Using Trusts for Estate Planning
While you can establish a trust to hold your assets on behalf of your beneficiaries in your will, many people choose to establish trusts through separate documents. Among other things, creating separate trusts allows its assets to transfer outside of probate and may reduce the inheritance taxes due.
What Is a Trust?
A trust is a fiduciary relationship where one party gives another party (called a “trustee”) the right to hold title to assets or property for the benefit of a third party. The person or organization establishing the trust is known as the “grantor.” The purpose of the trust is to protect the grantor’s assets by moving them to an independent trust entity and provide for distribution to the trust’s beneficiaries. The trustee is responsible for acting in the best interests of the beneficiaries and operating the trust in a manner consistent with the trust agreement.
Trusts are often used in estate planning because they reduce estate taxes, avoid the time and expense of probate proceedings, and govern the distribution of assets to beneficiaries. Because the federal estate tax levied is based on the size of a person’s estate when they die, moving your assets to a trust reduces the size of your estate and tax burden. Additionally, the trust does not become a part of the public record when submitted to a court during the probate process.
The two types of trust most often used for estate planning are revocable and irrevocable.
Revocable Trusts (Living Trusts)
Revocable trusts are often referred to as living trusts because they can be modified or revoked during the grantor’s lifetime. The grantor also serves as the revocable trust’s initial trustee and can add or remove beneficiaries and change how to manage the assets.
While a revocable trust offers maximum flexibility in estate planning, it does not provide much asset protection. Since the grantor still has the power to add or remove assets from the trust, their creditors can ask a court to have them remove assets from the trust and pass it along to them. When creating a revocable trust, you may want to contact your financial advisor to set beneficiary designations for assets such as:
- Bank Accounts
- Retirement Accounts
- Insurance Policies
Once the grantor dies, the revocable trust becomes an irrevocable trust.
When you create an irrevocable trust the terms are set. The terms of an irrevocable trust can’t be changed after that point, even if the grantor wants to. The grantor’s assets move to the trust, and the assets are no longer considered their property. That means creditors of the grantor and the beneficiaries cannot access any assets held in an irrevocable trust.
When a revocable trust becomes irrevocable upon the grantor’s death, the grantor can no longer serve as a trustee. A successor trustee takes over responsibility for managing the trust. If there is no successor trustee, or the named individual is unable or unwilling to serve, a probate court can appoint someone as trustee. That makes it essential to name a successor trustee when you create a revocable trust if you don’t want a stranger administering your assets.
How To Get Started On Your Estate Planning
Estate planning is easy with state-specific estate planning forms and services. You can save time and money by completing your will and other estate planning forms in the comfort of your home. However, if you have any questions about your will or estate plan, you should contact a local estate planning lawyer for legal advice.