Estate Planning Essentials

Wills and trusts are two different types of estate planning devices that allow you to look into the future and determine how you can protect your children and your assets if something were to happen to you.

Dan Danford, CFP® and Founder/Chief Executive Officer of Family Investment Center, says that many people use the terms wills and trusts interchangeably even though there are major differences between the two.

In the video below, Danford explains the disparity and in what situations people are more likely to need a will or a trust. He also suggests that any asset protection estate planning document should be handled by an attorney. According to Danford, a small fee can ensure a lifetime of peace of mind.

Estate planning: reconsider in 2011

We receive questions from readers and our followers on Twitter (@family_finances) often, and we're happy to answer any inquiries. Let us know if you have a question for us. You can post it in the comments section or e-mail robynsekula@sbcglobal.net.

QUESTION: As I understand it, the estate tax doesn’t exist right now. So does someone who is wealthy need to reconsider their estate plan? Should someone change their estate plan, even though we all know Congress will be likely to change the estate tax sometime soon?

ANSWER FROM DAN DANFORD: At the very simplest, estate planning is just figuring out what to do with what you have after you are gone. Each family is different, but most distributions take place after the last spouse dies. Since everyone eventually dies, everyone needs an estate plan of some sort. If nothing is done (no formal will or documentation), each different state has statutes detailing how property is distributed.

As your question suggests, much of high-end estate planning is tax-related. Former tax laws demanded tax on any estates over a certain size, so elaborate schemes (perfectly legal) were created to reduce or avoid those high taxes. As you also note, estate taxes were eliminated beginning in 2010 because Congress let the estate tax lapse, and the waiver is set to expire late this year. So, wealthy families, lawyers, accountants, and all their advisors are waiting to see how Congress changes the rules.

As an editorial aside, estate taxes are essentially a penalty against financial success, and I don't favor them. Any family that accumulates sizable wealth, does so after decades of paying annual income and other taxes. Charging them an "extra" tax because they were successful is ridiculous! But I digress.

The thing is, we don't know what is going to happen, yet. And, even when we do, those laws are subject to future change (as we've just been discussing). Most families with larger estates will need to visit with their attorney early next year. Depending on the actual laws enacted, they may need to adjust their plans to fit the new rules. Also, the entire topic needs to be revisited every few years because Congress makes tax changes - especially estate tax changes - frequently.

Choose your executor wisely

We've been posting tips this week on Twitter @family_finances about creating a will, which is absolutely essential. We got a question from a follower about how to choose an executor. This is critical for your estate plan.

Question: I am planning to have a will written soon. How do I choose an executor? Should it be one of my adult children? An attorney? Are there professional executors?

Answer from Dan Danford: There are a number of things to consider. How complex is your situation? Are there a lot of things to sell? Is the estate large enough to file an estate tax return, and pay estate taxes? How about a final income tax return? How clean are the titles to your various assets?

Basically, the executor (called a personal representative in our state) is charged with tying up loose ends. They liquidate accounts, pay bills, collect debts, sell property, files reports, and finalize all financial aspects of your life. If you own most things jointly with your spouse, and your financial life isn't too complex, then a child or other relative can probably handle it. There's still one more test: would they want to? Paperwork can be burdensome, and some folks aren't tuned to that kind of chore. So, even if they can do it, is it something they'd welcome?

If that's not the case, a professional approach makes more sense. Some states have special fiduciary provisions that allow qualified people to work professionally as executors. In most places, your choices are going to be a bank trust department or attorney. The major complaint about this approach is cost; that is, professionals get paid for doing what a family member might do for free. But - and this is important - you're hiring someone with genuine expertise. In a complex estate, that can actually save money. They know taxes. They know investments. They know real estate markets. They probably know the Probate Judge! Truthfully, in many cases, it's money well-spent.

Of course, they don't know your family as well as you do, and that could be a challenge. On the other hand, it could be a good thing. Bottom line? You know your situation better than anyone else, and you need to decide who will settle your estate. It can save a lot of heartache later.

How trusts work

By Dan Danford

News broke today of Michael Jackson's will, which was filed in court. Mr. Jackson left his estate to a trust. This prompted the question, "What is a trust? How does it work?" and we're happy to answer that here.

The concept of trust originated in the Middle Ages when crusaders left someone behind to care for their family and property. The trustee watched over their stuff and made financial or other decisions on their behalf. If necessary, they bought and sold property, reached investment decisions, or spent money for necessary items. Legally, they "stood in" for the missing person.

Today's trust is similar. It's a legal form of ownership with several key parts. The Grantor is the person creating the trust. The Trustee is the person (or institution) who stands in the grantor's place. The Beneficiary is the person for whom the trust exists. In a so-called living trust, the same person can serve in all three capacities. However, a Successor Trustee is named to take over when the trustee is unable or unwilling to serve. Trustees can be a bank, trust company, or friend.

In estate planning, the trust is an important vehicle because it allows a trustee to care for and invest for a beneficiary, often long after the grantor is dead. It's a way of assuring that a spouse, children, or grandchildren get professional guidance for taxes and investments. It's also a way to establish some guidelines about how money should be invested or spent.

Importantly, a trustee has a fiduciary duty to beneficiaries. That means a legal duty to serve in their best interests. Decisions must be made according to the best interest of each beneficiary, without conflict. For this reason, a trust can be a good way to care for important friends or relatives after we are gone. Especially if they are young, inexperienced, or have special needs.