Simple Strategies for Effective Estate Planning

Estate planning can be much easier than people realize, and simpler than many estate planners make it.

Too often, people delay creating or updating their estate plans to avoid confusion about a potentially steep learning curve for novel terms and strategies.

Fortunately, few of us need to learn about grantor-retained annuity trusts, intentionally defective trusts, estate freezing and other strategies.

Most estates need only fairly straightforward plans that use simple tools and strategies.

Start a plan by determining whether the bulk of the estate should pass to the next owners through the will and probate estate or through a revocable living trust.

Everyone should have a will. The key question is whether the will or a living trust should control most of the assets.

The key advantages of the living trust are that the assets in it avoid the cost and delay of probate and the trust maximizes privacy. For more details about differences between the two, see the April 2023 issue of Retirement Watch.

You also probably own some assets that will pass to the next owners independent of the will and living trust, such as qualified retirement accounts such as 401(k)s and IRAs, annuities and life insurance. Title to a jointly owned home usually passes automatically to the surviving owner as do financial accounts with transfer-on-death provisions.

Passage of the ownership of these assets is determined by contracts or law, not the terms of your will or trust. Identify any of these assets you own and review the beneficiary designations or other documents to be sure they still say what you want.

Your estate plan should include a financial power of attorney (POA). It can be more urgent than a will because the POA ensures your finances are managed if you temporarily are unable to while you’re alive. Without a POA, your family might have to ask a court to designate someone to pay bills, manage investments and take other actions. See our June 2023 issue for details about the POA.

Likewise, you need a medical care document, often called a medical directive, advance medical directive or health care proxy. This document appoints one or more people to make medical decisions for you when you aren’t able to do so. I discussed this in our July 2023 issue.

After completing these steps, consider some simple lifetime actions that might increase the value of the estate to your heirs or enable them to enjoy some benefits now.

One simple strategy is to make outright lifetime gifts to some or all your heirs. The main reason to do this used to be to reduce estate and gift taxes.

Now, fewer than 1% of us have to worry about avoiding estate and gift taxes. But there are good reasons other than taxes to consider making some lifetime transfers.

The simplest strategy is to make cash gifts to heirs. They use the money to enhance their current standards of living. They might pay off debt or use it to help buy a home or pay for their children’s education. Some will take vacations or buy some luxuries they otherwise couldn’t afford.

You also receive some benefits. First, you see the advantages your heirs receive from your lifetime of saving and investing. You don’t wonder how they might benefit in the future.

Second, you see how the heirs handle the gifts and give them experience learning to manage and spend extra wealth. This might make you more confident they will be good stewards of the estate when they inherit.

Or it might teach you that they need help. You might decide to leave the bulk of the estate in trusts for their benefit instead of making direct bequests. Or you could decide that you or a financial professional should provide some guidance and coaching now to prepare them to inherit the estate and receive future gifts.

Lifetime gifts of property instead of cash might reduce income taxes. When an investment is generating taxable income or gains that you don’t need to support your standard of living, it might make sense to give some of that investment to family members who are in lower tax brackets.

They’ll benefit from the income now instead of some indefinite time in the future, and you’ll get to see how they benefit from it. The family will have more after-tax income, because their taxes on the income will be less yours.

Gifts of property should be considered for any investments you have in taxable accounts that have appreciated a lot.

If you’re inclined to sell the investment, you might want to make gifts of it instead. If you sell, part of the gain will be depleted by capital gains taxes. If you give the asset to heirs in lower tax brackets, they can sell and pay lower taxes on the gains. Again, there’s more after-tax wealth in the family.

An alternative is to avoid selling highly appreciated investments and hold them for the rest of your life. Then, the heirs increase the tax basis to the current fair market value. They can sell right away without owing capital gains taxes. The appreciation during your lifetime never would be taxed.

A potential disadvantage of that strategy is there might be good investment reasons to sell now. Another disadvantage is the heirs don’t benefit from the asset until some unknown point in the future.

Loans to family members are an additional simple strategy. You can make low-interest loans without tax consequences.

The loans provide assistance to the heirs when they need it. The loans also can teach financial responsibility when you require them to be paid back.

If you can afford it, down the road, you can forgive the loans, converting them into gifts. Family loans are discussed in more detail in the August 2019 and June 2021 issues of Retirement Watch.

There are a couple of other strategies to consider that are a little more sophisticated but still not very complicated or expensive to implement.

One that we’ve discussed in the past is to reposition your traditional IRA or 401(k).

You can convert the traditional retirement account to a Roth IRA. Or you can reposition it as a taxable account or permanent life insurance policy.

Another strategy is to create an irrevocable life insurance trust and give it money to buy a permanent life insurance policy. This eventually provides a substantial tax-free inheritance for the heirs.

You can set the terms of the trust so that it is a dynasty trust, benefitting multiple generations of the family. Or you can use the trust and the trustee to professionally manage the money and distribute it gradually.

See our April 2023 and May 2023 issues for more details on repositioning your retirement accounts.