Organizing your affairs in preparation for the end of your life is an important task, and estate planning is an ongoing process that includes much more than writing a will. This type of planning helps determine who can make decisions on your behalf, who takes care of your dependents, and how to avoid unnecessary taxes and waiting periods.
Estate planning covers any decisions regarding money, property, medical care, dependent care, and other matters that can arise when a person dies.
The biggest benefit of estate planning is peace of mind—you’ll know your wishes will be fulfilled for the benefit of your loved ones. At the very least, everyone should have a simple estate plan in place.
Elements of estate planning
Most of this process consists of creating and finalizing estate planning documents, such as wills, trusts, powers of attorney, and living wills. You can be as detailed as you want. Some people even include a letter of instruction with their estate to walk their family members through the documents.
A will, formally called a “last will and testament,” is a legal document stating how you want your executor (the person legally obligated to administer your estate) to distribute your assets when you die.
Dying without a will is known as dying “intestate,” which means state law will dictate what happens with your estate.
Probate refers to the process of distributing your estate after you’ve died. Your estate will go through the probate process whether you die with or without a will, but having a will ensures your executor honors your wishes. Going through probate court without a will is more time consuming and expensive, with the money coming out of your estate first.
If you already know where you want your assets to go, it’s easy to make a will without a lawyer. Online will services offer interactive questionnaires to help you create a legally binding will specific to your state.
A trust is a legal contract that allows another person (the “trustee”) to hold property for you (the “grantor”). This is typically so the beneficiaries (individuals or institutions who stand to inherit something) can use the property at some point in the future. You can place money, physical assets, or anything else of value in a trust.
Trusts are also helpful to hold property when beneficiaries are minor children who are not yet fit to handle their full inheritance. In that situation, the property will stay in the trust until the beneficiaries reach a certain age.
Property is also distributed faster in a trust because you avoid a lengthy probate court process, so it’s sometimes preferred for that reason.
Living trust vs. testamentary trust
You can create a living trust, also called an inter vivos trust, to hold property both before and after your death.
A testamentary trust is a type of trust that a will creates, so it only becomes effective after the grantor’s death.
The difference between these two kinds of trusts is that a living trust is effective while the grantor is alive, and a testamentary trust only becomes effective after the grantor’s death.
Revocable vs. irrevocable living trusts
A revocable living trust is one where the grantor retains the right to modify, amend, revoke, or terminate the trust. In an irrevocable living trust, the grantor is not allowed to make changes to the trust, but some states may allow the trustee to transfer property in and out of an irrevocable trust with permission from the trust’s beneficiaries.
A revocable trust becomes irrevocable when the grantor dies, since they can no longer make changes to it. Some people choose to place their assets in a revocable trust rather than only using a will. Upon the grantor’s death, the executor distributes assets in a trust faster because they don’t have to go through probate.
||Helpful hint: Trusts are not just for wealthy people. Anyone who wants their property to go to their relatives in a quick and easy manner can create a trust. For example, parents of young children may put property in a trust specifically designated to fund a child’s education.
Power of attorney
Power of attorney (POA) refers to the authority you give someone else to make legal, financial, or medical decisions on your behalf. These documents are commonly included in online estate planning service packages.
The person to whom you grant power of attorney is called your “agent.” You identify this person in a document that only takes effect when you are considered unable to act on your own behalf, or you can grant someone POA for a specific purpose, such as purchasing a vehicle for you.
If you become unable to manage your own legal or financial affairs and you have not designated an agent to act on your behalf, a court may appoint one for you. Each state has its own laws on POAs, but the general types to be aware of include (but are not limited to) durable, limited, and financial.
A durable power of attorney means your agent can continue to act on your behalf even when your situation changes, such as if you become ill and are unable to make decisions. It can grant broad authority or be restricted to a specific purpose.
||Helpful hint: Some states allow “springing” durable POAs, which means the POA only takes effect when you are deemed incapacitated. This is useful if you don’t want to give someone else decision-making authority right away, but want protection if you ever need someone to advocate on your behalf.
A limited power of attorney gives the agent authority to make decisions for a specific purpose, or for a limited period of time. In contrast, a general POA gives the agent broad authority to act.
A financial power of attorney gives the agent authority to manage your financial affairs. You can make this effective immediately or at the time of an event, like a sudden incapacitating illness or death.
Health care decisions
Health care is one of the most common aspects of estate planning. You want someone you trust to help ensure your wishes are respected if you become unable to advocate for yourself. Living wills, health care proxies, and advance health care directives are tools you can use to protect yourself in the future.
A living will states your preferences regarding health care planning, such as whether you want life-extending treatment, how you want to manage long-term care, what procedures you do or do not want, and other end-of-life matters.
Health care proxies
A health care proxy is a durable POA specifically for medical treatment—you appoint someone to make decisions on your behalf when you are deemed unable to do so by a medical professional.
Advance health care directives
Advance directives is an umbrella term that can refer to any document regarding future medical decision-making. It can refer to a living will, health care proxy, or other legal document.
One document to include with your advance directive is a HIPAA authorization. HIPAA stands for Health Insurance Portability and Accountability Act (1996).1 This federal law protects your medical records by requiring a signed authorization form before you grant access to someone other than yourself. Having a signed authorization for your agent ensures they can access your medical records when the directive takes effect.
Tax planning documents
Taxes can take an alarming percentage of what you leave to your beneficiaries, but you can limit what taxes your estate pays in a few ways. Each state has its own tax laws, so your obligation will depend on where you live. While financial and tax planners are best equipped to advise you on these matters, you should consider a few types of taxes when organizing your affairs: estate, inheritance, and gift taxes.
According to the IRS, an estate tax applies to estates valued more than a certain threshold at the time of death.2 You calculate the tax by:
- Adding the fair market value of everything a person owns
- Taking out deductions
- Adding the value of gifts made during the person’s lifetime
- Taking out any credits
If the estate value is above $12.92 million (as of 2023), the estate pays a tax to the federal government.
Only six states impose inheritance taxes:
- New Jersey
While estate taxes are owed to the federal government, inheritance taxes are owed to the state government. Additionally, while estate taxes are paid directly from the estate itself, inheritance taxes are paid by the heir or beneficiaries based on what they received in probate.
These taxes do not apply to surviving spouses or to payouts from life insurance policies. Instead, inheritance taxes usually only apply to more distant relatives and heirs. It’s unlikely this tax affects you, but it’s good to be aware of if you live in one of the six states that applies it.
Many people choose to make gifts during their lifetime to reduce the value of their estate when they die. According to the IRS, gifting can take different forms: selling something for less than its full value, transferring the right to use income from property, or transferring money or property without expecting to receive the full value in return.3 Usually the person giving the gift owes the tax, but other arrangements are possible with the advice of a tax professional.