Estate Planning Basics: 4 Crucial Steps to Protect Your Assets
We don't like to think about it, but the truth is that we are all going to move on from this world someday. Instead of leaving decisions up to our loved ones and the courts after we pass on, it's essential to do some estate planning. Estate planning outlines the critical medical, financial, and personal decisions you would like made on your behalf in the event of your death or if you become incapacitated.
This article will go over what estate planning is, how it differs from creating a will, and why you should have a plan for your estate, regardless of how much money you have.
The Short Version
- Estate planning lets convey your wishes regarding the division of assets, the care of your children, medical and financial decisions, and more.
- Legally binding estate plan documents can help mitigate conflict.
- Everyone should have an estate plan, regardless of whether or not they have an inheritance to pass down.
What Is Estate Planning?
Estate planning is the process of legally establishing your wishes for what happens to your assets, possessions and dependants after you die. Part of the process involves drafting legal documents that name who receives assets after you die and outline whether or not you have appointed someone to make decisions on your behalf if you are incapacitated.
If you have children or are a caretaker for a family member, the documents drafted as part of your estate also define how your family’s needs should be handled if you can no longer care for them. This can include life insurance policies designated to provide for your loved ones and whether or not you’ve appointed a guardian to look after your children.
Why Is Estate Planning Important?
Estate planning can help avoid conflict and confusion once you pass and ensure you have a trusted advocate making medical and financial decisions on your behalf if you cannot.
Without an estate plan, the courts may intervene and mediate conflict should disagreements arise. Or your family may be left to make decisions without your guidance as they mourn your loss. Having an estate plan makes a stressful time go more smoothly for everyone involved.
What Are the Basics of Estate Planning?
Estate planning includes several steps, including drafting legal documents, identifying your assets, outlining your family's needs, and planning for the financials surrounding your estate when you pass. Creating a plan for your estate now is important to avoid legal headaches in the future.
Step #1: Compile Essential Estate Planning Documents
As you begin the estate planning process, there are several documents you will want to draw up. These documents clearly state your wishes and can be helpful should a court become involved.
These are some of the core documents and designations you’ll want to draft:
- Will or trust: this determines who gets what after you die.
- Beneficiary designations: when you set up an account like a 401(k) plan or a life insurance policy, you usually need a beneficiary designation. An important thing to note is that beneficiary designations override asset distributions laid out in a will. Update these regularly to align with the wishes of your will.
- Power of Attorney: this allows you to appoint another person to act on your behalf should you become incapacitated or unable to make important financial, medical, or other life decisions.
- Healthcare Power of Attorney: this appoints another person to make medical decisions on your behalf. Depending on your preferences, you can have a general power of attorney who is empowered to make all decisions for you or divide responsibilities between different individuals to act on your behalf for medical and financial decisions.
- Guardianship designations: this allows you to appoint someone to care for your children should you be unable to. Without this document, the court may intervene and place your children in foster care.
- Letter of Intent: this is an informal document communicating other personal requests. It could include your burial preferences and login information to your digital accounts.
Step #2: Take Inventory of All Your Assets and Possessions
To draft a will and designate beneficiaries, you’ll want to take stock of what you have. While you may not think you have much to pass down, it’s essential to itemize everything.
Create a list of all the assets you plan to include in your will, including your investment and retirement accounts. Take note of the beneficiary designation of your accounts and update them if needed.
Take an inventory of personal possessions that you plan to pass down too. Include these in your letter of intent so your loved ones know how to to divide your items. This can mitigate conflict between family members once you’re gone.
Step #3: Determine Your Family’s Needs
A guardianship designation is one of the core documents you want to include in your estate plan. This is important if you have children and why you should create an estate plan sooner rather than later.
Name a guardian to care for your children and outline your financial wishes in a legal document to ensure they are adequately cared for should you pass away unexpectedly or be unable to care for them. While it might be convenient to assume a friend or family member will take care of your children, there's no guarantee and it may not be in your child’s best interests.
To mitigate court intervention you need to define who will take care of your children in the event of your death. Without this document and a designated guardian, the court can intervene and remove your children from a family member’s care altogether.
You may also want to set up a trust to provide for your family's needs that can come into affect after your death. Trusts can help you manage your assets, distribute your wealth, and even reduce your taxes. Trusts can also protect your assets from creditors or lawsuits.
Step #4 Plan for Taxes
Even if you don’t have a large sum of money or significant assets to pass down, planning for taxes is an integral part of the estate planning process. Otherwise, your beneficiaries might receive the surprise of a significant tax burden after you’re gone.
You likely won’t have to worry about estate tax at the federal level. In 2022, estates below $12.06 million are exempt from taxes.
The state level is where things can get tricky. Some states levy taxes on estates under the federal government’s exemption amount. Other states may levy inheritance taxes on what your beneficiaries receive. And one state, Maryland, imposes both an estate and inheritance tax.
If you anticipate passing down a large estate, consider working with a tax professional as part of your estate planning process. They can help you plan for taxes, determine whether or not you will incur taxes based on where you live, and mitigate the taxes your beneficiaries pay.
Estate Planning vs. Will: What Are the Differences?
A will is one of several documents you should have in your estate plan. Your will typically defines who will receive your assets after you die and is an important document pertaining to your finances.
Your estate plan might also include supplemental documents like a living will. This document and a healthcare power of attorney can outline your medical wishes and name the person appointed to act on your behalf. This is distinct from a traditional will which typically only outlines who will get your property after you die.
How To Find Estate Planning Services
Estate planning services vary. You can go the DIY route and get templates of basic legal documents from a site like LegalZoom or work with a legal clinic to help you get your affairs in order.
Consider working with a trained professional if you expect to pass down a large estate or have complex requests, such as planning to pass down a business. Look for a lawyer certified in estate planning to ensure they prepare your documents correctly. Ask for recommendations from friends or family members who have gone through the estate planning process and whose advice you trust.
Are Estate Planning Fees Tax Deductible?
Estate planning fees used to be an itemized deduction, but that changed with the Tax Cuts and Jobs Act of 2017. This could change again in 2025, when most of the law's provisions expire.
Depending on your needs and whether or not you work with an estate planning attorney, estate planning can cost anywhere from a few hundred to several thousand dollars to get everything in order.
How To Choose an Estate Planning Attorney
An estate planning attorney can help you ensure you are setting your estate up the right way and can help you understand how laws at the state and federal levels may impact your estate. They can be particularly helpful if you have a large estate or complexities that might require legal expertise.
Make sure the attorney you work with specializes in trusts and is certified in estate planning. This will help ensure your documents stand up to legal scrutiny. Finding an attorney or tax professional who can help you navigate estate or inheritance taxes might also be helpful.
The Bottom Line
Don't delay estate planning until you're old. Your estate plan outlines your wishes and ensures your family members are adequately cared for when you can no longer care for them.
You don't have to be a millionaire to craft an estate plan. Even if you don't have any assets to pass down, it is important to identify your wishes regarding other matters, such as how family members should divide up your personal possessions and how you would like to be buried. You can get started with an online template but you should work directly with a trained estate planning attorney to make sure you do everything correctly.
More on planning ahead:
- Top Long-Term Investment Strategies to Use in 2022
- Best Retirement Planning Tools & Calculators for 2022
- Using an Inheritance or Windfall for Retirement Planning
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