Why do I need an Estate Plan?
Estate planning is the preparation of tasks that serve to manage an individual’s assets in the event of incapacitation or death. The planning includes the bequest of assets to heirs and the settlement of estate taxes. Most estate plans are set up with the help of an attorney experienced in estate planning.
- Estate planning involves determining how an individual’s assets will be preserved, managed, and distributed in the event of incapacitation or death.
- Planning tasks include making a will, setting up trusts and/or making charitable donations to limit estate taxes, naming an executor and beneficiaries, and preparing funeral arrangements.
- A will is a legal document that provides instructions on how an individual’s property (both personal and real estate) and custody of minor children, if any, should be handled after death.
- There are various strategies that can be used to limit or reduce taxes on an estate, such as creating trusts to making charitable donations.
Estate Planning Explained
Estate planning involves making decisions on how an individual’s assets will be preserved, managed, and distributed after death. Also taking into account the management of an individual’s properties and financial obligations if they become incapacitated.
Assets that could make up an individual’s estate include but are not limited to houses, properties, automobiles, stocks, artwork, life insurance, pensions, and debt. Each individual will have various reasons for planning an estate, an example of these reasons are preserving family wealth, providing for a surviving spouse and/or children, funding children’s or grandchildren’s education, or creating their legacy through a charitable cause.
The first and most basic step in estate planning usually involves writing a will. Other major estate planning tasks may include the following:
- Reducing estate taxes by setting up trust accounts in the names of beneficiaries
- Choosing a guardian for living dependents
- Naming an executor of the estate to oversee/enforce the terms of the will
- Updating/naming beneficiaries on plans such as life insurance, IRAs, and 401(k)s
- Prepairing funeral arrangements
- Establishing annual gifting to qualified charitable and non-profit organizations to reduce the estate tax
- Creating a durable power of attorney (POA) to direct other assets and investments
Making a Will in Michigan
A will is a legal document created to provide instructions on how an individual’s property and custody of minor children, if any, should be handled after death. The individual expresses their wishes through the document and names a trustee or executor that they trust to fulfill their stated intentions. The will also indicates whether a trust should be created after death. Depending on the estate owner’s intentions, a trust can go into effect during their lifetime (living trust) or after their death (testamentary trust).
The authenticity of a will is determined through a legal process known as probate. Probate is the first step taken in administering the estate of a deceased person and distributing assets to the beneficiaries. When an individual dies, the custodian of the will must take the will to the probate court or to the executor named in the will within 30 days of the death of the testator.
The probate process is a court-supervised procedure in which the authenticity of the will left behind is proved to be valid and accepted as the true last testament of the deceased. The court officially appoints the executor named in the will, which, in turn, gives the executor the legal power to act on behalf of the deceased through Letters of Authority.
Appointing the Right Executor
The legal personal representative or executor approved by the court is responsible for locating and overseeing all the assets of the deceased. The executor has to estimate the value of the estate by using either the date of death value or the alternative valuation date, as provided in the Internal Revenue Code (IRC).
A list of assets that need to be assessed during probate includes retirement accounts, bank accounts, stocks and bonds, real estate property, jewelry, and any/all other items of value. Most assets that are subject to probate administration come under the supervision of the probate court in the place where the decedent lived at death.
The exception is real estate, which must be probated in the county in which it is located.
The executor also has to pay off any taxes and debt owed by the deceased from the estate. Creditors usually have a limited amount of time from the date they were notified of the testator’s death to make claims against the estate for money owed to them. Claims that are rejected by the executor can be taken to court where a probate judge will have the final say as to whether or not the claim is valid.
The executor is also responsible for filing the final personal income tax returns on behalf of the deceased. After the inventory of the estate has been taken, the value of assets calculated, and taxes and debt paid off, the executor will then seek authorization from the court to distribute whatever is left of the estate to the beneficiaries.
Any estate taxes that are pending will come due within nine months of the date of death.
Planning for Estate Taxes
Federal and state taxes applied to an estate can considerably reduce its value before assets are distributed to beneficiaries. Death can result in large liabilities for the family, necessitating generational transfer strategies that can reduce, eliminate, or postpone tax payments.
During the estate-planning process, there are significant steps that individuals and married couples can take to reduce the impact of these taxes.
Education Funding Strategies
A grandfather may encourage his grandchildren to seek college or advanced degrees and thus transfer assets to an entity, such as a 529 plan, for the purpose of current or future education funding. That may be a much more tax-efficient move than having those assets transferred after death to fund college when the beneficiaries are of college age. The latter may trigger multiple tax events that can severely limit the amount of funding available to the kids.
Cutting the Tax Effects of Charitable Contributions
Another strategy an estate planner can take to minimize the estate’s tax liability after death is by giving to charitable organizations while alive. The gifts reduce the financial size of the estate since they are excluded from the taxable estate, thus lowering the estate tax bill.
As a result, the individual has a lower effective cost of giving, which provides additional incentive to make those gifts. And of course, an individual may wish to make charitable contributions to a variety of causes. Estate planners can work with the donor in order to reduce taxable income as a result of those contributions, or formulate strategies that maximize the effect of those donations.3
Using Life Insurance in Estate Planning
Life insurance serves as a source to pay death taxes and expenses, fund business buy-sell agreements, and fund retirement plans. If sufficient insurance proceeds are available and the policies are properly structured, any income tax on the deemed dispositions of assets following the death of an individual can be paid without resorting to the sale of assets. Proceeds from life insurance that are received by the beneficiaries upon the death of the insured are generally income tax-free.
Estate planning is an ongoing process and should be started as soon as an individual has any measurable asset base. As life progresses and goals shift, the estate plan should shift in line with new goals. Lack of adequate estate planning can cause undue financial burdens to loved ones (estate taxes can run as high as 40%), so at the very least a will should be set up even if the taxable estate is not large.