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Estate planning: the red-headed stepchild of financial planning

Man, I can't tell you how many times someone has come to me and said, "yes, I'd love for you to run an analysis on retirement, investing, insurance, and all that, but what I'm really worried about is my estate plan!"

Actually, yes, I can. It's zero.

Estate planning is far from the thoughts of many of us Gen-X/Gen-Y folks; we're only just now getting over the idea that we're immortal. But in the words of my estate planning professor: "There are two things that absolutely must work the first time: your estate plan...and your parachute." You get exactly one chance to get it perfect. There are no do-overs.

So when a client comes to me asking for comprehensive financial planning, you can bet we're going to talk about estate planning. Of course, I'm going to tell you the same thing I tell them: I am not a lawyer. This is not legal advice. However, there are some facts you should be aware of. Estate planning is a core part of financial planning, so let's talk about where the two intersect.

Now, be aware: estate law varies quite a bit from state to state. (That's part of the reason why it's so important to consult with an estate lawyer.) For example, depending on who colonized a state, it may lean more towards community property (Spanish) or common law (English), which will significantly affect ownership of assets in a marriage. Since the vast majority of our audience currently resides in Texas, this post is going to slant towards Texas estate law. Apologies to you silly English common law types.

Be aware of this, too: your estate plan is more than just your will. It's your plan for everything that will happen if you die or get incapacitated, which also includes your insurance and retirement plan beneficiaries, advance medical directives, powers of attorney, etc. So while your will is a lynchpin, don't think that just because it's in place that your estate plan is settled!

Ancillary estate documents: "I'm not dead yet!"

(OK, maybe that's a little morbid, whether you're a Monty Python fan or not. But while estate planning is a serious matter, it's important that you don't let the gravity keep you from getting it done. For me, that means inserting a little levity now and then!)

What the heck are "ancillary estate documents?" Simply put, while your last will and testament covers what you want to have happen to when you die, your ancillary estate documents cover how you want things to go while you're still alive, but incapacitated.

These vary from state to state: different states call different documents by different names, and have different "statutory" (codified into law) versions of those documents. However, states generally recognize some form of advance medical directives, medical power of attorney, and durable power of attorney.

Advance medical directives, or "living wills", determine want you want medical staff to do or not do if you become incapacitated. Do you want your life to be extended if you get a terminal illness? What if you're in a coma that you're not likely to come out of? Since you can't tell the doctors what you want (after all, you're incapacitated), this document does that for you.

Of course, livings wills don't cover every possible thing that might happen -- and bear in mind, the more you alter an ancillary estate document from its statutory form, the less likely it is to be recognized by a hospital's legal team! Medical powers of attorney, sometimes called "healthcare proxies", come in where advance directives leave off. The person you designate as your MPOA is empowered to make medical decisions on your behalf, so they can handle the gray areas not covered by your advance directives.

A durable power of attorney is to your finances what an MPOA is to healthcare: it gives someone the power to act on your behalf with respect to the various assets you indicate in the document, even if you're disabled (hence the "durable" part). The DPOA can be made "immediate" or "springing": for the former, it goes into effect immediately, and for the latter, it only kicks in if you become disabled.

Beneficiary designations: the end-run around your will

If you're an employee of a medium- to large-sized company, you probably have a vague recollection of having to designate a beneficiary for your employer-provided insurance and retirement accounts. And if you have a will, you may have wondered what the fuss was. "Doesn't my will determine where my stuff goes anyway?"

Sure, it does...for assets that transfer by "probate" (the standard legal process after a person dies). However, insurance and retirement accounts transfer by contract, rather than by probate, which means that they go directly to the beneficiary. Do not pass probate, do not collect $200!

As you might imagine, this is a double-edged sword. On the one edge, the beneficiary can get benefits as quickly as they can file a claim and get it processed. On the other, if you establish or update your will and forget to update your insurance and retirement plan beneficiaries, you may find that your estate doesn't at all go where you planned!

Bank and investment accounts can similarly avoid probate and thus bypass your will. If you title an account as JTWROS (joint tenants with rights of survivorship) or TOD (transfer on death), the assets therein will "transfer by operation of law" upon your death.

"I, Marvin Acme, of sound mind and body..."

At this point, you may be wondering if there's anything left for your will to actually cover. Oh, there's plenty!

Executor, trustee, and guardian designations. Who's going to be in charge of handling your estate? If there are trusts (see below), who's going to be in charge of them? If you have minor children, who's going to take care of them?

Personal and real estate property. If you have any heirlooms or items of sentimental value (perhaps including your home!), your will can head off any squabbling among your inheritors.

Specific bequests. Similarly, you can designate in your will that a specific entity -- for example, a charitable organization -- gets a specific sum.

"Distribution of residue." Any estate asset that doesn't bypass probate and isn't handled elsewhere in the will is called "residue". (Kind of an odd mental picture, isn't it?) A will generally has a specific section to handle this catchall category.

Testamentary trusts. Do you want your children to have their entire share of the inheritance when they hit the age of majority? If not, you can establish a trust in your will, allowing you some control over how their assets will get spent.

Et cetera, et cetera. What powers does your executor have? What about the trustee? Can they charge a customary fee? How should your be handled if both you and your spouse die within a short time of each other? These and other details -- minor and major -- are spelled out in the will.

Don't forget taxes

I'll be honest: for many people, the estate tax is a non-issue. The threshold at which it will affect you is currently $11.4 million per individual, and it rises each year with inflation. (The phrase "death tax" irritates the heck out of me. The bar is eleven million dollars per person. That's an estate tax, not a death tax.) This is especially a non-issue if you're of the "die broke" mindset!

However, it's still worth going through the planning exercise. For one thing, there are actions you can take now to reduce the likelihood of you paying estate tax, like taking advantage of the annual gift tax exclusion. And just because you're below the estate tax threshold doesn't mean that you don't have to think about taxes as they relate to your estate. Some examples:

  • The fact that your assets receive a "basis step-up" on death may be cause for you to rethink your investment strategy.

  • Conversely, assets do not receive said step-up if they're gifted to individuals while you're still alive!

  • That Traditional IRA you have is going to be taxed as ordinary income someday, whether that tax paid by you or your inheritors.

Et cetera. The only certainties are death and taxes; it's worthwhile to think through what happens when the two combine!

Get 'er done

"OK -- I'm motivated to set up my estate plan, and I've got some ideas of what I want to have happen. What do I do next?" Well, as I said, I'm not a lawyer, so I can't give you legal advice. However, I can say the following:

Ancillary estate documents are often available for free. Because the language is statutory, many states (like Texas) have templates available online. You'll have to get the documents notarized and/or witnessed, but you don't need a lawyer to put them into effect.

Check your beneficiary designations and titling. Make sure your insurance and retirement account beneficiaries are what you want them to be, and make sure your bank and investment accounts are titled the way you want.

Don't put off establishing your will. Make it a priority to get it done, or it won't happen. If you're worried about the hourly rate, you can often find estate lawyers who will establish your will for a flat fee. Also, many employers offer basic legal benefits for a small monthly fee, which can be extremely useful for e.g. establishing a simple will.

Talk to the people involved. Once you've figured out your powers of attorney, healthcare proxies, executor, trustees, inheritors, etc. -- talk to them! Let them know what's going to happen. "Side letters" can be useful here; they're documents that have no legal power, but simply lay out your thoughts and wishes.

Like money, estate planning is one of those things we just don't talk about. Sure, it's a serious and sobering matter...which makes talking about it that much more important! So: if you have any estate planning thoughts or stories to share, please leave a comment! Let's get the conversation going.

Britton is an engineer-turned-financial-planner in Austin, Texas. As such, he shies away from suits and commissions, and instead tends towards blue jeans, data-driven analysis, and a fee-only approach to financial planning.

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