Face it: It's tough to own up to your mortality. Most of us haven't done so. Only 41% of all Americans have a will, and only a third of those with children have bothered to draw one up, according to a survey last year by FindLaw, a legal Web site. Even fewer have taken the time to do a full-fledged estate plan aimed at shielding heirs from the court costs, executors' fees, and estate taxes that death almost always triggers.
Of course, you already have a default estate plan, of sorts. It's a one-size-fits-all mishmash that varies according to where you live--and almost certainly won't result in what you intended. Think all of your property will be transferred naturally to your spouse when you die? In some states, only 30% to 50% goes to your spouse, and the rest is divvied up among other relatives. Some may go to your kids--yes, even the financially irresponsible one. Some may go to your siblings, or even your parents, whether they need it or want it, or whether you want them to have it.
If you don't have a plan, now's a good time to get started. Last year, Congress overhauled the estate tax law, with an eye toward repealing it, so you can at least reasonably predict that liability for the next few years (table). The new law gradually increases the estate tax exemption--the amount that can be passed along without paying estate tax--to $2 million in 2006 and $3.5 million in 2009. The law repeals the tax in 2010 but snaps it back to this year's $1 million exemption in 2011--inviting a future Congress to make the repeal permanent.
The tax law also raises the gift-tax exemption to $1 million. Gift and estate taxes are linked: It doesn't matter whether you give away your wealth before or after you die; it's going to be taxed at the same rate. Every year, however, you can give, tax-free, up to $11,000 apiece to as many people as you like.
Let's say you don't have a will. If you've prepared your latest income-tax return, you've probably gathered up most of the paperwork that you'll need to figure out how much of an estate plan you should have. Add up the value of your house, investments, and retirement accounts, and throw in the face value of your insurance policies and pension plans. You may be surprised at what you're worth. If you're getting close to or topping the $1 million mark ($2 million for a couple), where estate taxes kick in this year, it's time to hire a lawyer.
Avoiding taxes isn't the main reason for estate plans, just a nice bonus. In fact, if you're in your 30s or 40s and in good health, you may want to stick with the basics: a will for your possessions, and a living will and health-care power of attorney to specify how medical decisions, such as ending life support, are to be made if you become incapacitated. It should cost $500 to $1,000.
The most pressing reason to write a will is to take care of minor children in case you and your spouse die simultaneously, or if you're a single parent. You'll want to name a guardian to bring them up--the probate court will do so if you don't--and perhaps someone else to oversee the finances this will require. You'll have to name an executor, too, to handle the estate's distribution. And your will must spell out as specifically as possible how you want your property divided.
If you know you'll keep putting it off, you can draw up a simple will in an evening using Quicken Lawyer 2002. This includes the software formerly known as WillMaker from Nolo ($42 at nolo.com). It also includes forms for living wills and medical powers of attorney. Or you can download the right forms for your state at partnershipforcaring.org.
That will cover the basics, at least, as long as you sign everything and have your signature properly witnessed and notarized. (Witnesses should not be family members or beneficiaries, and you'll need two or three, depending on state law.) Even if you know you should see a lawyer--you have a substantial estate, say, or children from more than one marriage--Quicken's question-and-answer technique can help you sort through the options. That way, when you finally make an appointment with your attorney, you'll have the important decisions already resolved and can save a bundle in fees.
In the past several years, many people have opted for a living trust instead of a will, or in addition to one. But bare-bones living trusts, which start at $1,000, are overhyped and often misunderstood. They do not, for example, bypass estate taxes or protect you from creditors. What they do is avoid probate--which, in states such as Florida and California, can drag on for a couple of years and eat up as much as 5% or 10% of the estate's assets in administrative fees. With a living trust, you can change the terms while you're living, and your successor trustee, usually a family member, distributes the property without court interference when you die.
Living trusts are a must if you own property in more than one state, since your heirs will not be subjected to multiple probate proceedings. Unlike wills, which become public as soon as they are filed with the probate court, living trusts are private documents. They can be handy for other situations as well, such as disinheriting estranged family members. The biggest mistake made in estate planning? You sign the documents setting up the trust, but don't follow through with the tedious task of retitling all of your property, such as real estate, stocks and bonds, and bank accounts, in the specific name of the trust.
If you simply want to avoid the time and costs of probate, other ways work just as well, and they're virtually free. Life-insurance policies pay the beneficiaries directly, often within a few weeks. You should name beneficiaries for your retirement accounts, such as IRAs and 401(k) plans, as well. For brokerage and bank accounts, you can turn them into pay-on-death accounts that transfer the assets to your beneficiaries outside of probate. A few states will let you title your car this way, too.
The most common probate-avoidance technique is joint ownership. You and your spouse probably own your house as joint tenants, and you may own cars jointly with your children. But there can be pitfalls. A joint owner can legally wipe out your savings account, for example. Or joint ownership can deprive your heirs of a valuable tax break. If they want to sell any appreciated assets that they inherit, such as stocks or real estate, they'll pay capital-gains taxes based on the value when you died rather than on the price you originally paid. If they are co-owners with you, they won't receive that step-up in basis on their part of the assets.
Only two percent of Americans pay any estate tax at all. But don't be fooled into thinking that estate planning is only a rich-person's concern or that the new laws make it unnecessary for you to address the important issues in advance. Without the basics in place, your even-modest estate could easily become a big problem for your family and heirs.
By Larry Armstrong