What is Estate Planning and Why is It Important?

“In this world, nothing is certain except death and taxes.” These famous words attributed to Benjamin Franklin over 200 years ago still ring true today. Minimizing the amount of taxes you have to pay when you pass away is just one of the reasons why estate planning is important. No matter the wealth you’ve accumulated in life or the income you earn, knowing what estate planning is and the services available from financial and legal professionals can help you prepare yourself and your family for the inevitable.

In this article, you will learn what estate planning is and why it’s important with expert insights shared by a diverse mix of financial advisors experienced in helping their clients in this complicated area of planning.

What is Estate Planning?

Estate planning is the process of establishing and maintaining a plan that outlines who will receive your assets after you pass away. There are many important documents required, some legal and some that are simply for the benefit of your loved ones. It’s a stressful time when a family member dies—having a solid estate plan can go a long way toward easing burdens.

An estate plan also helps when an individual is incapacitated, too. Moreover, estate planning includes not only your financial assets but also other items and general last wishes.

Due to the financial complexities and legal implications involved, many people choose to work with financial advisors and attorneys knowledgeable in estate planning.

Why Is Estate Planning Important?

Estate planning is important because it puts in writing how your assets will transfer after your death. Common documents and products include a will, trust, insurance policies, and healthcare-related forms. Estate planning is simple for those with relatively few assets, but it quickly turns complex for high-net-worth individuals and families. Creating an estate plan with an experienced financial planner is thus important to avoid headaches after you pass away. New laws, regulations, and financial products make estate planning a complex area of long-term planning.

Assets Considered Part of an Estate

You might wonder what is included under the term “estate.” Just about everything you own. Writing down a list of all your assets is a good first step toward crafting a basic estate plan. Note everything, including retirement and investment accounts, properties, cars, jewelry, collectibles, cash, and insurance policies. The list goes on! Knowing what you own along with the total value of your assets helps a financial planner strategize the optimal estate plan for you.

What’s ideal about financial accounts, though, is that you can simply name a beneficiary to whom a specific account will go upon your passing. That makes executing an estate plan easy. Other non-financial assets pass through to your heirs based on how your will is constructed.

Working with Financial Advisors and Estate Planning Attorneys

The next step is to sit down with a fiduciary advisor well-versed in estate planning. The advisor must understand both the laws and regulations as well as your desires. You want to ensure that your wishes are carried out efficiently while minimizing tax liability and following all state and federal rules. A financial advisor who deals with estate plans each day helps individuals and families spot potential landmines in the process. Going about estate planning alone might work for some people, but those with significant assets should seek the counsel of an advisor.

Another option is teaming up with a lawyer who specializes in estate planning. Attorneys help create complex legal documents and contracts for those with large estates. Chances are most people don’t need to go that far, but wealthy families and business owners should consider the guidance of a respected lawyer or estate planning attorney.

Common Estate Planning Documents

The best way to develop an estate plan is to first understand what documents you need to complete. Simply putting in writing what you want to happen if you become incapacitated or if you pass away can take care of much of the estate planning process. A financial advisor helps guide individuals in the process, too.

1. Last Will and Testament: This is the most well-known document in estate planning. Most people know they should have a will, but the majority of Americans do not have one. According to a 2020 Gallup survey, just 45% of U.S. adults reported they had a will. A will is the foundation of an estate plan. The document outlines to whom your assets will go upon your death. Assets mentioned in a will still must go through the probate process, however. A will can be inexpensive and simple to make online, but they are often costly and elaborate for high-net-worth families. Moreover, a will is not a ‘set it and forget it’ estate planning document – it must be maintained just as a financial plan is updated as life events happen. Naming an executor of an estate is a critical component of your last will and testament, too. Finally, individuals should be aware that the will is made public through the probate process, so be thoughtful about what is included in the document.

2. Power of Attorney Form (POA): There are two types of POAs: Financial and Durable. A Financial POA allows someone to control your financial accounts when you are unable to do so. A Durable POA goes into effect when someone becomes disabled in some way and cannot act personally.
3. Advanced Healthcare Directive (AHCD): An AHCD, or Medical POA, outlines what healthcare-related actions should be taken if you are unable to make decisions.
4. HIPAA Authorization: This document can save a lot of time and anxiety since it gives consent to share your medical records with third parties.
5. Trust documents: Trusts allow you (the Grantor) to give someone else (a Trustee) control over how assets are invested and held for the benefit of a third party (a Beneficiary). When constructed properly, assets in a trust avoid both probate and estate tax liability.
6. Beneficiary forms: You might be overwhelmed by all that goes into making and maintaining an estate plan. One thing you can do today that is quick and easy is complete beneficiary designation forms on all your financial accounts. IRAs, 401(k)s, and brokerage accounts often offer short forms to accomplish this estate-planning task. Financial accounts with a named beneficiary efficiently transfer upon your passing. Checking accounts have a “transfer on death” option as well.
7. Guardianship: More important than money is what happens with your children and other dependents. No estate plan is complete without a directive on who will care for your loved ones when you pass away. Guardianship is commonly outlined in a will.

Estate Taxes

Avoiding estate tax is among the primary goals of crafting and strategizing an estate plan. After all, for individuals with a net worth above the federal estate tax exemption, the so-called “death tax” can run into the millions of dollars. Ultimately, you want to ensure your heirs receive as much of your assets as possible. A savvy financial advisor helps individuals and couples create an optimal estate plan—that includes taking tax minimization actions years in advance of retirement.

The top federal estate tax rate is 40% for 2022. The estate tax exemption amount, also called the exclusion, is
$12.06 million per individual and $24.16 million per couple. That means if the cumulative value of your assets exceeds those amounts, you could face substantial estate tax liability. The good news is that there are strategies you can act enact to reduce what you might owe. In general, the higher your net worth, the more value a financial advisor knowledgeable in estate planning brings.

Another key amount is the annual gift tax exclusion, which is $16,000 per donor, per donee ($32,000 per couple). A popular strategy is to gift assets to children and grandchildren during, say, retirement years to bring down the value of an estate. An upshot is you get to see your loved ones enjoy the money while you are alive. Roth conversions can effectively bring down the taxable value of an estate, too.

Get Started Today

Everyone needs an estate plan, but maybe the value of your assets is significantly below the federal estate tax exemption. If so, you can simply visit any number of online sites to draft and formalize your estate plan document. Many employers offer estate planning services in their benefits packages—check with your Human Resources department at work to see if that’s the case for you.

But here’s the thing: While your net worth might be well under the exclusion amount today, decades from now that might not be the case. Consider that compounding investment returns, business growth, and even tweaks to the federal tax code might change your situation. Getting started today with certain estate minimization techniques can prepare you for an easier tomorrow.

Once you decide to take control of your financial future, begin your estate planning journey by taking inventory of all items you own. Then consider who you want to take care of your children if you pass prematurely. Next, fill out beneficiary forms and create the estate planning documents mentioned earlier—that likely means you will need to sit down with a financial planner.

Also, reach out to someone you trust who can serve as executor of your estate. Be sure to keep your estate planning documents in a safe place and store them electronically for easy access. Finally, no financial plan is complete without active monitoring and review—when life events happen, be sure to make time to update your plan.

Conclusion

Taking time today to craft an estate plan helps ease your loved ones’ burdens after you pass away. A solid estate plan outlines who will receive what after you die and this important piece of financial planning includes directives on what actions to take if you become unable to act on your own. Working with an experienced financial advisor on an estate plan is a valuable and prudent move in the financial planning process.