How to Stop Estate Planning From Spooking You

Estate planning isn't a fun topic, but it's a vital one to tackle in order to take care of your loved ones.

On this Halloween edition of Industry Focus: Financials, Fool analyst Gaby Lapera and Dan Caplinger, the Fool's director of investment planning, talk about this scary subject, breaking it down into manageable bits you can plan for. You'll learn what documents you need, whether a will or a trust is better for you, various types of trusts, the taxes some estates have to pay, and how you can tell your loved ones what they'll need to know after your death. Make it your Halloween resolution (that's a thing, right?) to tackle your estate planning and put a plan in place that will protect your family from financial harm.

A full transcript follows the video.

This podcast was recorded on Sept. 22, 2016.

Gaby Lapera: Hello, everyone! Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. You're listening to the Financials edition, taped on Thursday, September 22nd, 2016, but you're listening to this on Monday, October 31st, at the earliest. I am in Hong Kong or San Francisco, hence the pre-tape, but I should be back in two days. My name is Gaby Lapera, and joining me on Skype is Dan Caplinger, personal finance guru extraordinaire at The Motley Fool. How's it going, Dan?

Dan Caplinger: I'm doing good, Gaby. You ready for vacation?

Lapera: I'm so ready! Today, we're going to channel the spirit of Halloween, so I'm going to tell you happy Halloween, Dan! Pretend it's Halloween.

Caplinger: [SPOOKY GHOST NOISES]

Lapera: That's a great spooky voice. I love Halloween. I don't know if you know what you're going to be for Halloween this year, but I totally do.

Caplinger: I don't. I haven't figured it out. It's not today in my world right now, I still have a month to figure it out.

Lapera: Fair enough. I was Ruth Bader Ginsburg last year.

Caplinger: Sweet.

Lapera: But I accidentally got mixed up and realized I had another great costume idea for this year, which is Ruth Gator Ginsburg. Next year, I'm going to be Ruth Darth Vader Ginsburg. [laughs]

Caplinger: Awesome!

Lapera: I'm just going to iterate on my theme for the next two years. Plus, she's a lovely lady. Since today is Halloween in a month, we decided that what we we're going to do was talk about something that is a little ghoulish, but very important, and that is estate planning. Estate planning is things you need to do before you die. I think most people have in their heads, "I really need to get a will." I don't think they even think about other stuff that could be attached to that. So, to get us started, Dan, what documents do you need to prepare before death?

Caplinger: There are a bunch of documents that are really helpful to have in a number of situations, not just in preparation for death, but also in case you actually manage to keep living. Having a full set of these estate planning documents can help you and your family in a wide range of situations.

First, you mentioned the will. Very basic, it's definitely a good idea to have, because it's the primary instrument for figuring out where your stuff goes after you die. But it's not the only document that does that. A lot of people get confused about this. One thing you have to be absolutely sure that you do is complete what are known as the beneficiary designations. These forms are used for accounts that you have at financial institutions that require them -- it's like an IRA, for instance. If you have a retirement account, whether it's an IRA or 401(k), they will have you fill out a beneficiary designation. On that, you'll say, "Who's going to take this account after I pass away?" A lot of people mistakenly think that their will says where their IRA or 401(k) or other types of these accounts, where these will go after they die. Your will does not control that; it's your beneficiary designation that controls that. It's important on not only retirement accounts, but also life insurance policies. Check with your financial institution -- a number of places will have these forms available on other types of accounts as well on what's called "payable on death" accounts. So, make sure, if you have one of those, you've filled out that necessary paperwork.

The other major class of documents you should have are what's known as powers of attorney. Those fall into two categories. One covers financial elements, so it lets you name someone else who can take care of things like writing checks on your bank account, paying your bills, making trades in your investment account. This happens if you're incapacitated -- so, you're still living, but something's happened to you, you've had a major accident or a major illness, and you're unable to take care of those affairs on your own, this person can step in and handle that. So, that's the financial side.

Then, you have another power of attorney on the healthcare side. That's the person who can make medical decisions on your behalf. Going with that power of attorney also what is sometimes known as an advanced medical directive -- some people call it a living will. That's where you set out what your wishes are for whether you want life-saving techniques used, life support systems, or other measures taken to extend your life, or whether you don't want those -- it's an opportunity to express that. It's a wide range of documents, but they cover a bunch of different situations.

Lapera: And suffice to say that for all of these things, you should choose, for your power of attorney, both medical and financial, you should choose people that you really trust. And you can change that over time, that's not a problem. But you also want to make sure that this is legally binding, so you want to find a lawyer to help you do these things. There's lawyers that specialize in this.

Caplinger: It's not just that you should pick people you trust, but you should pick people who know the gravity of the situation, who are prepared to deal with the hard decisions they might be asked to make. It's important that you be able to trust them, but they also have to have a comfort level that if they're called upon to act, they feel comfortable, they know what you want, they know what you would do. It's so much easier to do that when everything is great, upfront, well before any of those documents are needed, so that if that crisis happens, the person you name will be ready to handle it.

Lapera: Yeah, you definitely want to be prepared. I do have a question for you, though. We talked about wills, but I also know that trusts are something that is commonly recommended to people who are doing estate planning. Can you go over what the difference is between a will and a trust?

Caplinger: Basically, what a will does is, it's a document that sits there, but it doesn't really take effect until the time of your death. Then, at that point, that's when the will kicks in and you follow the instructions that are given in it. A trust, on the other hand, is something that you can set up during your lifetime, it has the same instructions that you would find in a will to handle what happens to your assets after your death, but it can also make provisions for what happens to your assets during your lifetime.

For instance, a lot of the time, the way that a trust gets drafted, the person who's the trustee after the person who's created the trust essentially takes on the same role in managing that trust asset as someone who's given the power of attorney over your financial matters would be given to the assets that aren't in a trust setup. It's that same level of trust that you are establishing with the person that you name to take over if you're unable to do so. Now, the big advantage of having a trust over a will is, having a trust generally prevents you from having to go to a probate court to have your matters dealt with after your death. A trust doesn't have to be a public document. A trustee has the power after your death to take action as specified in its instructions. So, it doesn't generally need to have any court oversight to follow those instructions.

On the other hand, a will, in general, needs to be adjudicated before a court judge, and your will becomes a public document. In those situations, it's something that a lot of people are less comfortable with, having those documents be out there in the public eye. It's not like everybody's looking at them, necessarily, but they are available in case anyone is curious. For many people who are interested in maintaining their privacy, that's really not something that they need to have in everybody's business. They prefer the confidentiality that a trust setup allows you to maintain.

Lapera: So, with the wills, do they all have to be sent to probate?

Caplinger: The processes for dealing with wills differ from state to state. Some states have what are known as simplified proceedings in order to handle the vast majority of situations where there aren't that many assets, where you're only talking about transfers of a minimal amount of money, or a minimum number of pieces of property. But, a lot of time, the thresholds for those simplified procedures are pretty low. If you have more than just a minimal amount of assets that you're trying to pass on to your heirs, those simplified processes aren't available, and you do have to do a full-blown probate proceeding that involves hiring an attorney, getting the necessary court documents written up, and figuring out how to navigate that probate process, which could take months, or even years, and be extremely costly, especially if there are any complicated situations that arise.

Lapera: Can people challenge your will, if it ends up in probate court?

Caplinger: Yes.

Lapera: So, that would be another advantage of having a trust -- no one is going to be able to go to court, or, they're a lot less likely to be able to go to court and challenge it in court, right?

Caplinger: Yeah. Again, that becomes one of the elements of the confidentiality aspect of it. A trust document doesn't have to be public. That doesn't mean that it's invisible. For instance, in order for a trust to work, you have to actually put your property into the trust. For instance, if you own a house, you're going to want to do a deed transfer out of your own individual name into the name of the trust. So, anybody who looks up real estate property records, which are public documents, will know that your house is owned in the name of a trust. So, they'll know it exists. That opens the door to potential challenges. But it's not quite as simple of a process as it is when you have a will that's just out in the open.

Lapera: OK. So, what I'm hearing is that trusts are potentially a better vehicle for a lot of people. And I know there's different types of trusts. The ones that we've been talking about have been living trusts, and of those living trusts, there's both revocable and irrevocable trusts.

Caplinger: Yeah, a living trust, when you hear somebody talking about a living trust, they're generally talking about revocable living trusts, because that's the kind of trust that you can make changes to during your lifetime. As you pointed out, irrevocable trusts are things that, once you create that trust, you can't change the aspects of it, you can't change the instructions. For the most part, there are more specific, specialized reasons to use irrevocable trusts during your lifetime, but in the vast majority of cases, when you're talking about basic estate planning, you're talking about setting up a revocable trust.

Lapera: I know -- or, I think I know, because I'm not 100% clear on trusts -- the irrevocable trust, while you can't make changes to it, I was under the impression that the appreciated assets aren't going to be subject to estate trust, which might be one of the reasons why you might be interested in opening an irrevocable one versus a revocable living trust. Of course, you can have multiple trusts set up, right?

Caplinger: That's true. You can have multiple trusts set up. And you're right that, when you're talking about gift and estate tax, by setting up an irrevocable trust that vested the time of the initial formation of the trust, the valuation of that trust at its formation is the value that will be used for determining the gift and estate tax value that is charged against your unified gift and state tax credit at your death. That's very complicated.

Lapera: It's so complicated. [laughs]

Caplinger: But as you say, the net result of that is, if you give property that's worth $10,000, you put that into an irrevocable trust now, over the next 30 or 40 years, it climbs up to $100,000, the value that will be treated as the appropriate value for gift and estate tax purposes will be that $10,000 value at the time that you made the gift, not the $100,000 that's the appreciated in value at the time of your death. That's assuming you made an irrevocable trust that's not subject to being clawed back into your estate. Those rules are probably more technical than we want to get into at this point. In general, you can -- with the help of your attorney -- set up an irrevocable trust to achieve those ends and get the estate tax relief that you want. 

Lapera: I have a series of questions for you about trusts, and then I want to get into the estate tax. Rapid-fire. Where can I get a trust?

Caplinger: An estate planning attorney is probably the best way to structure a trust. An estate planning attorney will know what questions to ask in order to figure out exactly what you want to have under what circumstances, and to get the document set up the way that you want.

Lapera: How much does it cost to set up a trust?

Caplinger: It usually costs...legal fees from place to place vary greatly, but what I will say is this: It usually costs more up-front to set up a trust than it does to draft a simple will. But, when you consider the additional cost later on of a will, the cost of hiring an attorney to go through the probate process, the total costs that you'll spend on estate planning throughout your lifetime and after your death in the case of a will and the probate proceeding are often roughly comparable. So, it's more a matter of timing than it is a matter of how much you'll spend. You might save more up-front on a will, but if it's costly to administer in probate after your death, then that's when the costs will catch up to the total amount you would have paid to the trust.

Lapera: So, it's kind of whether or not you want your kids to have to deal with it, or you.

Caplinger: Yeah.

Lapera: Should you update a trust? If so, how often should you update a trust?

Caplinger: Whether you have a will or a trust, it makes sense to have it taken a look at regularly in a number of situations. In general, every three to five years is a good idea just to make sure that there aren't any major legal changes that would affect the situation. However, you should have it looked at more frequently than that if there are major changes either to your financial situation or to your family situation.

For instance, if you get married, if you get divorced, if you have a child, these things are generally going to change the way that you want your assets to pass after you die. So, it makes sense to have your estate planning documents taken a look at to make sure that they still do what you want to do. And that goes not just for the will and for the trust, but it also goes for those beneficiary designations that we were talking about earlier. You definitely don't want an account that you set up when you were married to go to your ex-spouse after you get divorced. And yet, there are a huge number of beneficiary designations out there that do that, just because the person forgets that that beneficiary designation was out there in the first place.

Lapera: And I want to listeners know that your estate attorney will probably charge you a fee to update your trust and/or will, but it's a lot less than it was to set it up in the first place.

Caplinger: Often, yes. More importantly, it avoids some major problems that can occur if you have an out-of-date document that might not actually meet the needs and wishes that you have because of these changes that can occur.

Lapera: Definitely. Let's move on to estate taxes. This is something that happens after you die, obviously, and your estate gets passed on to someone. I think most people have this conception that everyone gets charged an estate tax, and you're going to lose half the value of whatever gets passed on to you. That's not true at the federal level. Estate taxes only apply on the part of the estate that exceeds $5.45 million, which is, for most people, a lot of money.

Caplinger: That's right. A lot of people pay a lot of attention to the 40% rate, which is very high. It's higher than any of the income tax brackets that are out there. But you're right, you have what's known as the lifetime exemption amount that covers not just what's in your state when you pass away but also taxable gifts that you make during your lifetime. You can give up to a total of $5.45 million to heirs, either during your lifetime or in your estate when you pass away, without having to pay any estate taxes at all. And that doesn't even include a lot of the exemptions that are available for estate tax. For instance, you can give an unlimited amount to your spouse, and you won't have to pay any estate taxes on that. There are other exemptions. If you make a gift of money that goes toward someone's educational expenses, as long as that gift is made directly to the educational institution, that qualifies for an exemption. There are all kinds of these exemptions that can add up. Even if you do have a large enough estate that you have to worry about that amount, there are still techniques that you can use either to reduce your estate tax or eliminate it entirely at the federal level.

Lapera: And the other thing to think about is that, although this probably won't apply to you from the federal level -- though it might -- some states have not increased their estate tax level in the same way the federal government has. Currently, there are 14 states that have estate taxes, plus D.C., and most have far lower thresholds than the federal estate tax. New Jersey is the lowest, at $675,000. But then, there's other states like Maryland and New York that currently have estate taxes thresholds that are lower than the federal government, but they're working to raise theirs until it's on par with the federal government. So, if you live in one of those 14 states, you might want to take that into account when you're crafting your post-death what-to-do documents. 

This brings us up on the last portion of our show. We talked about all these things that you need to think about before you die. This is also something you need to think about before you die, but it's something that will make whoever you leave behind's life a lot easier. This is something that another podcast voice you might be familiar with wrote, this is Robert Brokamp, "Letter From Your Dead Husband." I can send you guys that PDF if you want. It has all sorts of things. There's frequently -- I know when my parents' relationship, my father handles a lot of the financial stuff, and my mom doesn't really think about it too much, in terms of actually managing accounts and stuff like that. So, I think it would be really helpful for her, when my father passes away, if she had a letter that listed, for example, what all accounts they have, do they have any storage units, who should you call when he dies, what attorney should be called that can be trusted that has all of their information, who their broker is, who their accountant is. These are things that people don't really think about, but when you die, you're not alive to tell people where all this stuff is. So, having it all written down in one central location is really important for the people that you leave behind.

Caplinger: That's absolutely correct. It's something that a lot of people never really think to do. But, at least giving your loved ones some sense of what's out there, what they need to be paying attention to, like you say, even if it's just pointing them in the right direction of, "Do I call our accountant? Do we have an attorney? How do I get in touch with our attorney? Is it just going down to the bank down the street that I know really well?" Just getting a sense of the lay of the land as far as how you manage your financial affairs is important. One aspect that a lot of people don't think about now is just how much of their financial lives are online or on mobile devices. So, having some way of giving people the password access that they'll need is important so that things can run smoothly.

A lot of financial institutions are a little bit behind when it comes to this. I know I've heard stories of people being able to log into deceased people's accounts and even conduct transactions after someone's death. From a family member's perspective, that might be exactly what you want to be able to do. But technically, it's something that financial institutions are going to have very different policies governing. So, it's important to understand that in an after-death situation, family members are going to have to navigate very different situations, even across similar types of things. You have a bank account at one bank, you might end up having to do something completely different from a bank account at another bank just because of the policies and procedures that each institution happens to have in place.

Lapera: So, I think if you take one thing away from this podcast, it should be, you should prepare, before you die, a lot of stuff. I think a lot of people think, "I'll be dead and gone, what does it matter?" It matters to the people you're leaving behind. Even if you're not leaving anyone behind, you should still be prepared, you should still be organized. I know that sometimes it's really hard to think about these things. People don't really want to think about dying. For example, my parents and I had a couple chats about what they want to do with their estate when they die. And I'm like, "That's great, but I have no power to enforce that. I really need you guys to go to a lawyer and write all this stuff down, because otherwise I'm going to have to go to court." And I think mentally, they have accepted that, but emotionally they're not quite ready to do it yet. This is just an ongoing conversation that I think people need to continue to have with their spouses and parents, whoever it is, so you guys can be prepared when that eventuality happens. Death and taxes.

Caplinger: That's a very difficult conversation to have, but it is a very important one to have, just making sure, as a child or grandchild, you don't necessarily need to know the specifics. You just need to know that the people you care for have taken care of things, that they're seeing the right people to get stuff in place to make everything easier down the road.

Lapera: Yeah. So, Mom and Dad, if you're listening, please visit that estate lawyer. I know I keep nagging you about it. Hopefully it will have more weight coming over the airwaves rather than in person.

Caplinger: Do it, Laperas!

Lapera: [laughs] Thank you so much, Dan Caplinger, for joining us. I hope you think of a totally rad Halloween costume between here and October 31st.

Caplinger: I guarantee it.

Lapera: Listeners, if you want to send me pictures of your Halloween costumes, I will think that's hilarious when I'm super sleep deprived when I get back here on November 2nd. 

As usual, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have recommendations for or against, so don't buy or sell stocks based solely on what you hear. Contact us at [email protected], or by tweeting us @MFIndustryFocus. Thank you again to Austin Morgan. I hope that we've made you think about your death a little bit more today [laughs]. And thank you to y'all for joining us. Everyone, have a great week!