For the most effective study of this lesson, complete the assignments in the sequence listed below.
1. Read the Preview and the Learning Objectives for this lesson. Use the Learning Objectives to guide your study.
2. Read Chapter 19 (pages 621 - 650) in the Personal Finance textbook, Seventh Edition.
3. Read the Lecture Notes for this lesson.
4. Review all reading assignments for this lesson, especially Chapter 19 of the textbook .
Although almost no one likes to talk about it, everyone is going to die—whether you are prepared for it or not. The topic of this lesson is how to prepare for the transfer of your assets at death. Often it takes the death of someone close to us to make us consider the impact death will have on the ones we leave behind. Although death is inevitable, many people put off making the proper arrangements and preparing their family members to handle this reality. Estate planning is not nearly as complicated as it often seems. This lesson will cover some basic principles of estate planning, such as the difference between a will and a trust. It will show you how probate and estate taxes are calculated. You will get some guidelines on how to pick the right person to be your executor or your children’s guardian. Power of attorney will be defined and explained and its purposes and limitations are described. You will also learn about preparing a letter of last instruction. This lesson will give you the information and steps you need to stop procrastinating and begin planning your estate.
The first—and ongoing—step in estate planning is the building of your estate. The final step is transferring the estate at your death according to your wishes. The goal of estate planning is to assure that your assets go to your chosen beneficiaries rather than to Uncle Sam. Your marital status will be an important aspect of your estate planning. If you are married, estate planning will involve your interests and those of your spouse, and your children, if any. A single individual may want to provide for other family members or friends or make bequests to charitable organizations. A will is the legal vehicle for transferring estate assets. This lesson will present tips on writing a will, such as selecting an executor and altering or rewriting a will. Various types of wills will be discussed, including a simple will, a traditional marital share will, an exemption trust will, and a stated dollar amount will. Finally, this lesson will present information on the various types of trusts that can be used for estate planning. Trusts discussed will include living trusts (also called inter vivos trusts), testamentary trusts, life insurance trusts, charitable remainder trusts, and self-declaration trusts.
The final part of this lesson will present information on various tax issues affecting your estate. The four major types of taxes that will be discussed are estate taxes, estate income taxes, inheritance taxes, and gift taxes. Several methods of minimizing or eliminating all of these taxes will be discussed. Making this very difficult time for your family as painless and as uncomplicated as possible are important reasons for proper estate planning. Preserving as much of your wealth as possible for your heirs is one of the most loving things you can do for them. This lesson will deal with some sensitive issues in a way that should provide peace of mind for you and be very helpful for the ones you love.
When you have completed all assignments for this lesson, you should be able to:
1. List at least two dangers of failing to establish an estate plan.
2. Define probate and explain the probate process.
3. Distinguish among holographic, formal, and statutory wills.
4. List the duties of an executor.
5. Describe the unified estate and gift tax credit.
6. Define net taxable estate.
7. Evaluate the effects of federal and state taxes on estate planning.
8. Explain the legal distinctions among joint tenancy, community property, and tenants in common.
9. Describe intestate rule of succession.
10. Describe the issues of conservatorship.
11. Describe living wills and non-resuscitation clauses.
12. Describe medical and financial powers of attorney.
Estate planning is a strategy to handle the administration and disposition of your property according to your wishes, both during your lifetime and at the time of your death. Your estate consists of everything you own. During your working years, your objective is to accumulate funds for your future and the future of your dependents. As you near the end of your life, the emphasis in your financial planning will shift from accumulating assets to distributing them wisely. Most people would like to see their hard-earned wealth go to family, friends, or charities they wish to support rather than to government taxing agencies. That is the purpose of estate planning, which, contrary to what many people think, is useful to more people than just the rich and the elderly. Estate planning primarily consists of strategies using wills and trusts to facilitate the transfer of your assets and to ease the tax burden on the estate and on those who receive the distributions.
The cost of not doing any estate planning may be exorbitant. Under present law, with estate planning and a properly drawn will, you may leave all your property to your surviving spouse free of federal estate taxes. However, the surviving spouse’s estate in excess of $1 million (in 2002 and after) will face estate taxes up to 50 percent. (See the "Unified Estate and Gift Tax Schedule" on page 645 of the textbook.) Those rates go well above the current highest federal income tax bracket (39.6 percent). In addition to estate taxes, estates and certain trusts must file federal income tax returns and pay income taxes at the prevailing tax rate. A state inheritance tax may also be levied on the right of an heir to receive all or part of the estate and life insurance proceeds of a deceased person. This tax depends on the net value of the property and/or insurance received and also on the relationship of the heir to the deceased. Finally, a gift tax on the privilege of making gifts to others may be an estate planning cost consideration. Because a property owner can avoid estate and inheritance taxes by giving away property during his or her lifetime, federal tax laws were changed to collect gift taxes at the estate tax rates. The federal gift tax does allow you to give up to $10,000 per year to any number of persons without incurring any gift tax liability, or without having to report the gift to the IRS. A husband and wife may give up to $20,000 to any one individual. You might be penalizing your heirs with significant tax liabilities on their inheritance by not doing any estate planning or gift giving. It is important that you understand the consequences of doing nothing.
A will is a legal declaration of a person’s mind as to the disposition of his or her property after death. A will is used to transfer your property according to your wishes after you die. Even if you don’t prepare a will yourself, you still have one. If you fail to prepare your own will, your state of legal residence will control the distribution of your estate without regard for your wishes. Thus, if you die intestate—without a valid will—the state’s law of descent and distribution becomes your will. Probate is the legal process of establishing the validity of a will (or using intestate laws if necessary) and distributing the estate to heirs after debts have been paid. If you have a will and are about to be married or divorced, you should review your will with an attorney for necessary changes. If you have had a divorce since writing your will, provisions favoring a former spouse are usually automatically revoked. However, provisions favoring family members of your former spouse, such as stepchildren, nieces, nephews, or in-laws, will not be affected. If you marry after you have made a will, the will is revoked automatically unless certain conditions are met. One such condition would be if the will specifically indicated an intent not to be revoked by a subsequent marriage.
Since your will may affect the tax on your estate, you should be familiar with the various types of wills. A simple will, or an I love you will, leaves everything to the spouse. Such a will is sufficient for smaller estates, but it may create later tax problems if the estate is large. A traditional marital interest will leaves one-half of the adjusted gross estate (that is the gross estate minus debts and costs) to the spouse outright as a marital share. The other half passes to the children or other heirs or will be held in trust for the family. A properly executed trust can provide the spouse with a lifelong income and will not be taxed at the spouse’s death. The exemption trust will has been gaining in popularity due to its increased exemption. Under this type of will, everything passes to your spouse with the exception of an amount equal to the exemption, which is put into trust. The amount passed to your spouse can be by will, trust, or other means. The exemption trust can provide your spouse with a lifelong income also. The stated dollar amount will allows you to pass on to your spouse any amount that satisfies your family objectives, which may or may not include tax considerations. Amounts over the current exemption would, of course, be subject to estate taxes. Which will is best for you? There is no one ideal will, and everyone’s situation is unique, so you should choose the type of will that best fits your circumstances. The will may be holographic (handwritten), formal (written by an attorney) or statutory (a purchased fill-in-the-blanks form).
The job of having your estate distributed according to the dictates of your will is carried out by an executor or executrix. You should select someone who is both willing and able to execute the complicated tasks associated with estate transfer. These tasks are preparing an inventory of assets, collecting any money due, paying off any debts, preparing and filing all income and estate tax returns, and liquidating and reinvesting other assets to pay off debts and provide income for your family while the estate is being administered. In addition to disposing of your estate, your will should name a guardian and/or trustee to care for minor children if both parents die at the same time. Obviously, you want a guardian who is willing to accept the responsibility and whose philosophy on raising children is similar to yours. A trustee, on the other hand, is a person or an institution that holds or manages property for the benefit of someone else under a trust agreement. If you need to make minor changes to your will, this is usually done with a codicil, which is a document that explains, adds, or deletes provisions in your existing will. If major changes need to be made, the will should be rewritten. In addition to your will, many estate planners recommended that you prepare a letter of last instruction. This document, though not legally enforceable, can provide your heirs with details of your funeral arrangements, names of people to be notified, locations of your will and financial accounts, and other personal information.
An alternative to the use of a will to distribute your estate is to place your assets in a trust. Basically, a trust is a legal arrangement through which a trustee (who can be you) holds your assets for your benefit or that of your beneficiaries. Trusts can either be revocable, meaning you can make changes to the trust, or irrevocable, meaning no changes can be made after the trust is set up. The primary reasons for establishing a trust are to reduce or provide for payment of estate taxes, to avoid probate and transfer your assets more quickly than with a will, or to establish regular income. One of the fastest growing estate planning tools is a living, or inter vivos, trust. This is a property management arrangement that you establish while you are alive. Well-structured estate plans often start with a living trust that becomes irrevocable at death, dividing itself into several other types of trusts. A living trust ensures privacy, since it is not a public record as a will is. It avoids probate and probate costs, but it may not avoid estate taxes. It is less subject to dispute by disappointed heirs than a will is. It can be designed to guide your family and doctors if you become terminally ill or incompetent. A testamentary trust is established by your will and becomes effective upon your death. A life insurance trust is established while you are living to receive your life insurance benefits after your death and administer them in an agreed-upon manner. A credit-shelter trust is designed to allow married couples, who can leave everything to each other tax free, to take full advantage of the exemption that is allowed to pass free of federal estate taxes. Finally, with a charitable remainder trust, you retain the right to an income (perhaps from securities or property), but transfer that right to a charity upon death. If you have highly appreciated assets, it is a great way to improve your cash flow during retirement and pursue a charitable interest at the same time. You must give away these assets irrevocably.
The final topic in this lesson will cover the legal aspects of various titles in which property can be held. If you live in a community property state and designate your estate that way, half of the marital assets will be included in each spouse’s estate. Any property that has been acquired by either spouse during the marriage (except by gift or inheritance) can be included as community property. Other types of ownership are joint tenants with rights of survivorship, tenants in common, or tenants by the entirety. Each of these designations will have different tax implications.
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