Learn About Estate Planning Basics

Understanding What Estate Planning Is and Why It Matters

Estate planning is the process of organizing your money, property, and possessions so that your wishes are followed after you pass away. It involves creating legal documents that tell people what should happen to your assets and who should make decisions on your behalf if you become unable to do so. According to a 2023 Gallup survey, only about 32% of American adults have a will or other estate plan in place, which means the majority of people haven't taken these steps yet.

Estate planning isn't just for wealthy people. Anyone who owns property, has a bank account, or has children should think about creating an estate plan. Without one, your state's laws will determine who gets your money and property, which may not reflect what you would have wanted. Additionally, if you have minor children, your estate plan is where you can name a guardian to care for them.

The main reasons people create estate plans include reducing family conflict after death, minimizing taxes owed on their estate, ensuring their children are cared for properly, and making sure their medical and financial wishes are carried out. Estate planning also allows you to leave instructions about your digital assets, such as social media accounts and online banking access.

Estate planning documents typically include a will, which is a legal document stating who receives your property; powers of attorney, which allow someone to make decisions for you; and advance medical directives, which explain your healthcare preferences. The cost and complexity of your estate plan depends on how much property you own and how complicated your family situation is.

Practical Takeaway: Consider creating an estate plan if you own any significant property, have children, or want to ensure your wishes are followed after you pass away. Start by making a list of your assets, including real estate, vehicles, bank accounts, and valuable items, and think about who you want to receive each item.

The Key Documents That Make Up an Estate Plan

A basic estate plan typically includes several important documents, each serving a different purpose. The will is the foundation of most estate plans. It's a legal document where you state who should receive your property, who should manage your estate (called an executor or personal representative), and who should care for your minor children. A will only takes effect after you die, so it doesn't control what happens to your property while you're still alive.

Another critical document is the power of attorney for finances, sometimes called a durable power of attorney. This document names someone (called an agent or attorney-in-fact) who can make financial decisions on your behalf if you become unable to do so due to illness or injury. This person can pay your bills, manage your investments, and handle other financial matters. You can decide whether this power begins immediately or only if you become incapacitated.

A healthcare power of attorney, also called a healthcare proxy or medical power of attorney, names someone to make medical decisions for you if you cannot make them yourself. This is different from a living will or advance directive, which states your preferences about medical treatment in specific situations, such as whether you want life support if you're in a coma.

Some people also create living trusts, which are legal arrangements where you transfer property into a trust during your lifetime. A living trust can help avoid probate (the court process that distributes property after death) and may provide privacy, since trusts don't become public records like wills do. However, setting up a trust involves more work and expense than a simple will.

Your estate plan might also include a document called a HIPAA authorization, which allows healthcare providers to discuss your medical information with specific people you name. Without this authorization, your family members may not be able to talk to doctors about your condition.

Practical Takeaway: Make a checklist of the documents you need: a will, a power of attorney for finances, a healthcare power of attorney, and an advance directive. Research the specific requirements in your state, as laws vary regarding what documents are needed and how they must be signed and witnessed.

How Probate Works and Why Some People Try to Avoid It

Probate is the legal process that happens after someone dies. A court supervises the distribution of the person's property according to their will or, if there's no will, according to state law. Probate serves important purposes: it authenticates the will, identifies and values the estate's assets, pays debts and taxes, and distributes remaining property to the rightful heirs. However, probate can be time-consuming and expensive.

The probate process typically begins when someone files the deceased person's will with the court. The court then appoints an executor (the person named in the will to manage the estate) or an administrator (if there's no will or no executor named). The executor must identify all the person's property, notify creditors and beneficiaries, and gather assets. This inventory and accounting process can take several months or longer, especially if the estate is complicated.

Probate costs money. Executor fees, attorney fees, and court costs can add up to 3% to 7% of the estate's value, depending on the state and complexity of the estate. For a $500,000 estate, probate costs could range from $15,000 to $35,000. These costs come out of the estate before beneficiaries receive their inheritance.

Some people want to avoid probate because it's public (anyone can view probate documents), because it takes time (often 6 months to 2 years), or because of the costs involved. Common strategies to avoid probate include putting property in a living trust, naming beneficiaries on bank accounts and retirement accounts, holding property as "joint tenants with rights of survivorship" (meaning the property passes automatically to the other owner when one owner dies), or creating a payable-on-death account.

However, probate isn't necessarily bad. It protects beneficiaries by ensuring debts are paid and provides a structured process for distributing property fairly. For small estates with little property or few people inheriting, probate may be straightforward and affordable. Many states offer simplified probate procedures for small estates.

Practical Takeaway: Learn about your state's probate process and costs. If you own property in multiple states, understand that probate may need to happen in each state where you own real estate. Consider whether the benefits of avoiding probate (if any) are worth the cost and complexity of setting up trusts or other arrangements.

Understanding Taxes and Your Estate

Estate taxes and inheritance taxes are concerns for some people doing estate planning, though most people don't owe these taxes. The federal government has an estate tax, but it only applies to very large estates. As of 2024, the federal estate tax exemption is $13.61 million per person, meaning only estates worth more than this amount owe federal estate tax. The American College of Financial Services reports that fewer than 1% of estates owe federal estate tax.

However, some states have their own estate taxes or inheritance taxes with much lower thresholds. For example, Oregon's estate tax exemption is $1 million, meaning Oregon estates larger than $1 million may owe state estate tax. A dozen or so states have inheritance taxes, which are taxes beneficiaries pay on money they inherit. These state-level taxes can significantly affect your estate planning decisions if you live in one of these states.

In addition to estate taxes, your estate may owe income taxes. If your estate earns income during the probate process (for example, interest on bank accounts or rent from property), the estate must file a tax return and pay income taxes on this income. Beneficiaries may also owe taxes on certain inherited assets, depending on what they inherit and how they use those assets.

Some strategies people use to manage taxes in their estates include making annual gifts to reduce the size of their taxable estate (you can give up to $18,000 per person per year without tax consequences in 2024), creating charitable trusts if they want to leave money to charities, or using irrevocable life insurance trusts to keep life insurance proceeds out of their taxable estate. However, these strategies are typically only useful for people with large estates.

For most people, tax planning is a smaller part of estate planning. Simpler concerns like naming beneficiaries, making sure your will is valid, and explaining your wishes are more important. If you have a substantial estate or complicated financial situation, consulting with a tax professional or estate planning attorney about tax implications makes sense.

Practical Takeaway: Calculate the approximate value of your estate by adding up your property, bank accounts, vehicles,