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  • Writer's pictureMalissa Marshall, CFP®, MS Tax, EA

How To Build A Strong Estate Plan

Updated: Aug 24, 2023

Estate planning can present many challenges. It asks you to confront uncomfortable truths, all while navigating complex legal technicalities and deciding on what you want your final legacy to be. But when done right, constructing a proper estate plan works to ensure your wishes are followed and your loved ones continue to be well-cared-for in your final absence.

I want to take this time to walk you through some fundamental elements of a cohesive estate plan that you should consider to both make the estate planning process less stressful and also more tax-efficient, such that you retain more of your assets to pass to your heirs.

Why make an estate plan?

The main purpose of an estate plan is to spell out exactly how your assets should be distributed upon your passing. In the absence of a plan that you design, your assets will be distributed according to your state’s intestate laws, which may bear no resemblance to your final wishes.

A properly constructed estate plan dictates which assets go to which beneficiaries, in what manner, and at what time. It answers the who, what, when, and how so that your heirs are not left to sort through those tactical elements while also grieving.

However, there is one key question underpinning all the others: why? While the other questions bring order and structure to your plan, your why helps build the structure in the first place. Think about what you want your legacy to be within your family, community, and favorite charities. When you frame it in this way, an estate plan becomes so much more than a collection of financial documents but becomes transformed into a testament of your life and legacy.

Tax planning is part of this process, certainly, but it is secondary to the ends you hope to accomplish. Once you have your initial outline of the goals and wishes for your estate, then you can bring tax-efficient tools and strategies to help bring those goals to fruition. Your estate plan, then, is a way to accomplish your legacy goals in the most tax-efficient manner. How can you accomplish this? It stems from utilizing the best resources for your situation. Below are some of the essential steps of most estate plans which you should consider.

Establish a trust

Trusts are an excellent vehicle for passing down wealth. Most trusts avoid probate, which brings added privacy and simplicity to the process. But not all trusts are the same. Depending on your needs, different types of trusts may be more appropriate.

A bypass trust, or an A/B trust, is a valuable planning tool for married couples. This type of trust splits assets into an A (or marital) trust and a B (or family) trust when the first spouse dies and shields the assets in the B trust from federal estate tax. It is best funded up to the maximum annual estate tax exemption; in 2021, this is currently $11,700,000. The remaining assets then flow into the A or marital trust, benefitting from the unlimited marital deduction until the second spouse passes.

If you have a non-citizen spouse, however, then a Qualified Domestic Trust could help your surviving spouse take advantage of the unlimited marital deduction and avoid paying any estate taxes on assets transferred at your death. Citizen spouses are already able to claim the unlimited marital deduction, so this type of trust wouldn’t benefit them.

If you intend to leave assets to a charity, but also want to receive the income generated from those assets during your lifetime, then a Charitable Remainder Trust is something to consider. Conversely, a Charitable Lead Trust will allow the income from those assets to go to a charity for a pre-determined number of years but will distribute the underlying assets to your heirs once the term has ended. Either type of trust enhances the tax-efficiency of your charitable gift.

If your heirs are faced with the possibility of paying estate taxes, a different type of trust may be called for. Unless your estate has sufficient cash to pay the taxes, your heirs may be forced to sell assets to cover the tax bill, which could significantly impact the amount they would receive. In such a case, you could set up an Irrevocable Life Insurance Trust (ILIT) to receive the tax-free proceeds of a life insurance policy and ensure there will be sufficient cash available to pay the estate taxes.

Create a will

A will outlines your wishes for your assets, names guardians for your minor children and trustees for their assets, and generally directs how you want to pass down your possessions. It provides a roadmap of your final wishes for your family.

While wills are a necessary and key component of any estate plan, they are public documents that undergo probate, which is a legal process completed under the purview of the county court. Probate can be a time-intensive and costly process, and the fact that it is public also means that your family's business may become public. Depending on your family dynamic and what you outline in your will, this may not be ideal, which is why trusts are often recommended.

Determine your beneficiaries

A beneficiary is anyone who will inherit something from you upon your passing. To simplify the transmission of your financial assets, you will typically name a beneficiary or beneficiaries on any account that you have, such as a checking account or retirement account (401k, IRA, etc.), and any life insurance policies you may hold.

It may seem simple, but naming beneficiaries on your account paperwork is often overlooked. Moreover, such named beneficiary designations will override a will, so they should be reviewed periodically, and certainly any time you have a major family shift such as a marriage, birth, or divorce. In addition, consider naming contingent beneficiaries in case the first beneficiary or beneficiaries predecease you; otherwise, your accounts will have to pass through probate.

On the other hand, if you are using a trust to govern the distribution of your assets after death, you should instead either title the accounts in the name of the trust or make the trust the primary beneficiary.

When thinking about your beneficiaries and how your assets should be distributed, it may not be practical to divide each asset into equal percentages, for example, 25% of every asset to each of four children. Instead, considering each child’s age and tax bracket, some assets may better be passed to one child or another, and as part of the decision, you should consider the after-tax value of each type of asset.

For example, retirement accounts (IRAs and 401ks) are taxed as ordinary income, whereas brokerage accounts may have a high basis and eligibility for taxation at more preferential capital gains tax rates. Furthermore, it might not make sense to split a business or rental property among all your heirs, but instead, leave such assets to those involved in the day-to-day operations and leave the remaining assets to the other heirs.

It’s vital to consider these nuances and decide what is best for both you, the beneficiaries, and the longevity of the assets.

Select a power of attorney

A core component of estate planning should involve a durable power of attorney, or someone else who is legally allowed to make decisions on your behalf while you are still alive but physically or mentally incapacitated. Usually, this is either a spouse or a trusted friend, and having such a document in place before you need it can make the transition much smoother for everyone, and allow someone to keep up with routine activities like paying bills and taxes or settling debts on your behalf.

A medical directive, on the other hand, allows someone to make health-related decisions for you. The document not only provides them the authority to make such decisions for you but also provides your loved ones with some guidance about your wishes and also limits some of their choices.

Be sure you talk with each of the people you elect for these roles before appointing them. You may think that your closest loved one is the best choice, but that may be a tough burden for someone who is already upset if something has happened to you. While this discussion will be difficult, it is necessary to ensure that they feel comfortable taking on such a role, and you need to feel comfortable that they will abide by your wishes.

As you can see, estate planning is a comprehensive process that should be considered one step at a time. Those with significant assets need to think carefully about the tax-efficiency of their choices to ensure more of their assets are passed to their heirs or donated to charity.

As I tell my clients, any tax planning we do during our life could be dwarfed by the estate tax consequences of failing to plan for the proper transition of their assets after death. Should you need to discuss how to put together a cohesive, tax-efficient estate plan as part of your overall financial plan, set up an appointment today.


Image by bady abbas

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