Understanding Estate Planning

Estate planning is a financial and legal process that involves arranging for the distribution of a person’s net worth, property, commitments, and other assets after his or her death. Common elements of estate plans include wills, trusts, and power of attorney agreements. Estate planning makes probate issues clear, determining who will serve as the legal executor of the person’s will. In addition, estate planning is often used to mitigate the financial burden on a person’s family or next of kin after death and to minimize expenses and taxes on bequests left to associates and family.

Background

In law, an estate is defined as a person’s net worth at any point in his or her life or after his or her death. A person’s net worth can be defined as the sum of all the person’s assets, both financial and physical, after subtracting for the person’s liabilities in the form of debts and expenses. Estate planning is a legal and financial process that involves determining how a person’s estate is distributed or used after his or her death.

One of the first and most important steps in estate planning is creating a will or testament. In this legal document, a person, called the testator, names one or more individuals to manage his or her estate after death and to handle the distribution of assets. When a person dies without leaving a will, the distribution of any assets left after debts have been met may fall to the courts and will follow the rules regarding inheritance and intestacy, which is the legal term for the dispensation of an estate without a will. Typically, assets not specified in a will get distributed among descendants, if the individual has descendants, or among other members of the immediate family based on degrees of kinship. According to the American Bar Association, approximately 55 percent of Americans die without a will or estate plan, therefore leaving the distribution of their assets, when applicable, entirely to probate courts and laws regarding intestacy.

Probate is a legal proceeding that attempts to determine the validity of a person’s will and appoints an executor, an individual legally designated to distribute an estate according to the terms specified in the will and any other legal provisions that are applicable. A person may name his or her executor in a will, and this individual will typically be selected to serve in this capacity during a probate hearing. Assets left without specified beneficiaries and estates that are not tied to a legal will are subject to division according to probate.

Because probate laws differ in each state, estate planning often involves researching or consulting financial experts to determine local probate regulations. There are ways to limit or avoid the probate process altogether, such as by transferring all assets to a living trust before a person dies. In this case, the distribution of assets has already been determined in the trust, eliminating the need for probate hearings. However, living trust arrangements can be expensive and do not cover assets that are transferred automatically by naming a beneficiary, such as finances contained in a retirement account; these tend to have a beneficiary named within the account. Other methods of reducing probate requirements include setting up "payable on death" bank and savings accounts that have legally identified beneficiaries and so do not figure into probate determinations.

Careful estate planning can begin at any age, and individuals with descendants are advised to start planning early and setting up provisions in case of unexpected death or illness. There are many parts of the estate-planning process that can be conducted as a normal part of a person’s financial management, such as designating beneficiaries on financial accounts and setting up retirement accounts. In many cases, a designated estate-management plan can prevent or reduce conflict between descendants and next of kin after a person’s death.

Overview

Creating a will or testament provides a legal means for individuals to determine how their estate is divided and distributed after their death. To ensure that their will is followed after their death, individuals are advised to seek legal advice before creating a will and to ensure that the will has been witnessed and notarized. Provisions of the will allow the individual to designate an executor. In some states, naming an executor in the will eliminates the need for court intervention to settle an estate. The will also allows the individual to specify bequests, which are gifts of property or financial assets after death.

Through a will, an individual can also designate guardianship of his or her children or minor dependents. Those interested in leaving property or financial assets to individuals or organizations outside of their descendants or immediate family are advised to prepare a will to specify these bequests. Stepchildren, godchildren, charities, and friends will not receive assets through the probate process unless specific bequests are identified in a will.

A person’s will only applies to property or assets that pass to the estate after a person’s death. Certain types of property and assets do not pass to the estate, including any property or assets that are jointly owned. For instance, jointly owned real estate passes to the surviving owner upon the death of the joint owner and is not included in a will. Individuals may also add account holders to bank accounts, known as joint tenants, who can then help manage financial decisions with the primary account holder. After a person’s death, the surviving tenant will inherit sole ownership over the contents of the account—unless the deceased has formally designated a durable financial power of attorney, or an individual legally designated to act on his or her behalf regarding the dispensation of financial assets.

There are other types of assets that do not figure into the estate, including individual retirement accounts (IRAs), that have named beneficiaries. Many retirement programs, including IRAs, which are savings accounts with certain tax benefits, allow the account holder to designate a beneficiary who will directly inherit the contents of the IRA after the primary account holder’s death. IRA accounts can have contribution limits and are therefore typically valuable only when the individual sets up an IRA account for long-term contribution. Many other types of assets, including property and bank accounts, can be changed so as to designate a specific beneficiary. Designating beneficiaries for specific assets eliminates or reduces the need for an executor or probate court to determine the distribution of remaining assets and most beneficiary designations on specific assets supersede the provisions in a will or testament.

For many individuals, estate planning is primarily about leaving an inheritance to family, friends, or institutions. Estate planning is partially about setting up bequests and about limiting taxation and liabilities regarding the dispensation of property and assets. As of 2015, the Internal Revenue Service (IRS) has established the annual tax limits for estates and gifts. An individual’s estate can be subject to federal or state taxation unless the value of the estate falls below certain limits. The 2015 estate tax exemption limit is set at $5.43 million per person, or $10.86 million for a married couple. Estates below this threshold are not subject to estate taxes, which can be as high as 40 percent of the value of the estate beyond the tax exemption limit.

The IRS also determines a limit on gifts that can be given to individuals without being subject to taxation. In 2015, the gift tax limit was $14,000 per recipient. Married individuals can each make $14,000 gifts without being subject to taxation. In addition, as part of the 2012 American Taxpayer Relief Act, an individual has the ability to transfer his or her unused federal estate tax exclusion to a surviving spouse upon his or her death.

Individuals conducting estate planning might also worry about inheritance taxes, which are taxes imposed on assets transferred as part of an inheritance. Only a few states collect inheritance taxes, and the taxes are only applicable when the individual leaving the inheritance lives in one of the states with inheritance tax laws. Individuals concerned about inheritance tax should meet with financial planners to help plan bequests so as to minimize inheritance tax obligations.

In addition to documenting bequests in a will, there are many other ways of leaving gifts, donations, or assets to family and friends after death. A living trust, which is a legal arrangement, designates a successor to take ownership of certain assets after a person’s death. A trust can also be used to organize one’s assets to be given to a descendant at a specific time. For instance, individuals can set up a trust for one or more of their children that determines an age at which the child receives the funds stored in trust. Organizing a trust typically involves paying a legal specialist to draft the appropriate paperwork, adding an additional expense to the estate-planning process.

In most cases, estate-planning choices are unique to a family. Different processes may be needed depending on whether a person is married, whether there are dependent children or minor children involved, and on the relationship between the estate holder and his or her family. Families that have prearranged plans may be better able to work together to take care of obligations and manage the distribution of assets without conflict.

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