Your estate consists of all of your wealth and assets, including your bank accounts, money market funds, stocks, bonds, precious metals, life insurance policies, real estate and all your personal property, such as automobiles, jewelry, artwork, etc. The value of your estate is equal to the sum of all your assets, minus the sum of all your debts and liabilities. Estate planning is the process of making whatever legal arrangements you consider necessary to protect and manage your estate while you are alive, plus whatever ways you wish your assets to be transferred, and to whom, in the event of your incapacity or death.
There are many ways to transfer wealth. Each person will have different needs depending on the size and value of the estate, the composition of one’s family, the number of potential heirs or beneficiaries chosen to receive the estate’s assets, and the type of legacy one wishes to leave behind. In many cases, the object of a sound estate plan will include the minimizing of any federal and/or state estate taxes and the avoidance of probate, as well as the successful accomplishment of personal, family and charitable objectives. Some typical ways of transferring wealth include: the drafting of a will, the allocation of gifts, and the creation of trusts.
A will is a legal document that specifies who will get your property when you die. A properly drafted will is a basic component of any estate plan. If you die intestate, i.e. without a will, you lose control over your estate and the transfer of your wealth will be decided by a court in the state where you last lived, based on that state’s inheritance laws and statutes. However, even a well-crafted will may be subject to challenges by potential heirs, and/or creditors, as all property passing through a will is subject to probate, which is the legal process by which a will is proved to be valid or invalid.
One of the most important estate planning decisions involved in drawing up your will is choosing the executor of your estate, sometimes known as an estate administrator or personal representative. The executor may be a family member, a friend, an attorney, or a corporate administrator, such as a bank trust department. The executor will be named by you in your will and then authorized by the probate court to carry out your wishes as closely as possible. However, in some instances, an executor may have wide latitude in determining exactly how your assets will be distributed, regardless of certain stipulations in your will. Or, conversely, that person might not be responsible enough to handle the duties of the job and will resign and/or be replaced by the court. In those situations, the transfer of your wealth might not go precisely as you had planned.
Also, probate ensures that all your estate taxes and liabilities will be paid before any of your assets can be distributed to your heirs or beneficiaries. Your estate will also have to pay probate court expenses which can range from one or two percent to four or five percent of your estate’s value. So, although you will definitely benefit by having a will, you will invariably also want to have a more extensive estate plan that combines other strategies for transferring your wealth – especially if your estate is large enough. The following two strategies will save you money, while also giving you more control over your assets, both while you are alive and after you die.
You can save on estate and gift taxes, thus preserving more of your assets for your family and other beneficiaries, by making gifts while you are still alive. Individuals may give any number of people up to $14,000 a year in cash or assets without the recipient having to pay gift taxes. If you are married, you and your spouse can both gift up to $14,000 per individual, per year, tax-free, for a total of $28,000. Naturally, since you are giving away money before you die, the value of your estate will be minimized when you die, thus lowering its potential estate tax burden.
In addition to the annual tax-free exemption of $14,000 per person, per year, you have a lifetime gift exclusion of $5.34 million (or $10.68 million for a married couple) for taxable gifts. That means that you can gift up to that amount while you are alive and thus save up to the 40 percent federal estate tax rate your heirs would have had to pay on it when you die. (Any used portion of the lifetime gift tax exclusion will reduce the standard $5.34 million estate tax exclusion. This is known as the “unified credit.” Essentially it means that the first $5.34 million of your estate, expressed either as gifts you made while alive, or assets you have left behind, is exempt from federal estate taxes.)
Finally, there is an unlimited amount that you can gift for certain tuition and medical payments made on the behalf of others, as long as those gifts go directly to the providers, i.e. the medical or educational institutions. This transfer of wealth while you are still living further reduces the value of your estate upon your death. Charitable gifts can also be given at any time while you are still alive and can provide even more extensive income, gift and estate tax savings, as well.
Transferring Wealth Using Trusts
There are many types of trusts that can help you transfer your wealth to chosen heirs and beneficiaries. In most cases, trusts will help you circumvent probate while also reducing your estate taxes. For example, a life insurance trust lets you keep the death benefit of your policy “outside” of your estate, thus lowering your estate tax liability and avoiding probate.
Irrevocable Gift Trusts, sometimes known as “Crummey Trusts,” and Grantor Retained Annuity Trusts (GRATs), are two types of wealth transfers that can help a beneficiary escape gift taxes. A Revocable Living Trust with a “Pour-Over” will allows assets to be transferred outside of probate while also directing that any assets not held in the trust can be “poured over” into the trust at the time of death. A Marital Trust can reduce federal and state estate taxes since any married person may leave an unlimited amount of assets to a spouse who is a U.S. citizen. Charitable Trusts allow an individual to eliminate part of the donor’s assets from his or her estate both during the donor’s life and afterwards.
Setting up the right type of trust is a complex process, best left to knowledgeable professionals. In fact, when considering any portion of your estate planning process, including the drafting of a will, the allocation of gifts, the creation of trusts, and the estimation of taxes, you should work with a competent financial advisor who will help you determine the best strategies to protect your assets while you’re alive and direct the transfer of your wealth to your heirs and beneficiaries after your death.