Personal Finance SIXTH EDITION Chapter 20 Estate Planning

Chapter Objectives 20.1 Explain the use of a will 20.2 Describe estate taxes 20.3 Explain the use of trusts, gifts, and contributions 20.4 Introduce other aspects of estate planning 20.5 Explain how estate planning fits within your financial plan

Purpose of a Will (1 of 8) Estate: the assets of a deceased person after all debts are paid Estate planning: the act of planning for how your wealth will be allocated on or before your death Will: a legal request for how your estate should be distributed upon your death. It can also identify a preferred guardian for any surviving children

Purpose of a Will (2 of 8) Reasons for having a will Ensures that your estate is distributed as you desire Beneficiaries (heirs): the persons specified in a will to receive a part of an estate Intestate: the condition of dying without a will Court appoints an administrator who may not make the decisions you preferred

Purpose of a Will (3 of 8) Creating a valid will Minimum age—18 or 21 Mentally competent Not under undue influence of others Must be signed and dated 2 or 3 witnesses who are not beneficiaries Use of an attorney recommended

Purpose of a Will (4 of 8) Common types of wills Simple will: a will suitable for smaller estates that specifies that the entire estate be distributed to the person’s spouse Traditional marital share will: a will suitable for larger estates that distributes half of the estate to the spouse and the other half to any children or to a trust

Purpose of a Will (5 of 8) Key components of a will Distribution of the estate Details the distribution to the heirs, usually by percentage Executor (personal representative): the person designated in a will to execute your instructions regarding the distribution of your assets Collects debts owed to the estate, pays debts owed by estate, and distributes proceeds of the estate

Purpose of a Will (6 of 8) Guardian Signature Parents should name a person to be responsible for caring for any dependent children Signature Validates will Letter of last instruction: Supplement to the will that describes your wishes regarding funeral arrangements and tells the location of any key financial documents

Purpose of a Will (7 of 8) Changing your will May be necessary if you move to a state with different laws or if you marry or divorce Major changes may require a new will Codicil: a document that specifies changes in an existing will Appropriate for minor revisions

Purpose of a Will (8 of 8) Executing the will during probate Probate: a legal process that declares a will valid and ensures the orderly distribution of assets Executor files forms in probate court, provides a copy of the will, a list of assets and liabilities of deceased, pays debts and sells necessary assets Typically opens a bank account for this purpose

Exhibit 20.1 A Sample Will (1 of 2) WILL of James T. Smith I, James T. Smith of the City of Denver, Colorado, declare this to be my will. ARTICLE 1 My wife, Karen A. Smith, and I have one child, Cheryl D. Smith. ARTICLE 2 Payment of Debt and Taxes I direct my Executor to pay my funeral expenses, my medical expenses, the costs of administration, and my debts. ARTICLE 3 Distribution of the Estate I direct that my estate be distributed to my wife, Karen A. Smith. If my wife predeceases me, my estate shall be distributed to my Trustee, to be managed as explained in Article 4. ARTICLE 4 Trust for Children 4A. Purpose. This trust provides for the support of my daughter, Cheryl D. Smith, and any other children born to me. 4B. Use of Funds. The Trustee shall use as much of the trust income and principal as necessary to care for my child (or children). When the youngest of my children reaches the age of 25, the assets of this trust shall be split equally among the children. 4C. No Survivors. If no child of mine survives until age 25, assets of the trust shall be liquidated and 100% of the proceeds shall be donated to the San Diego Humane Society. 4D. Nomination of Trustee. I appoint my brother, Edward J. Smith, to serve as Trustee. If he is unable or unwilling to serve, I appoint my sister, Marie S. Smith, to serve as Trustee. ARTICLE 5 Executor I appoint my wife, Karen A. Smith, to serve as Executor. If she is unable or unwilling to serve, I appoint my brother, Edward J. Smith, to serve as Executor.

Exhibit 20.1 A Sample Will (2 of 2) ARTICLE 6 Guardian If my spouse does not survive me, I appoint my brother, Edward J. Smith, to serve as Guardian of my children. If he is unable to serve as Guardian, I appoint my sister, Marie S. Smith, to serve as Guardian. ARTICLE 7 Power of Executor My Executor has the right to receive payments, reinvest payments received, pay debts owed, pay taxes owed, and liquidate assets. ARTICLE 8 Power of Trustee My Trustee has the right to receive income generated by the trust, reinvest income received by the trust, sell assets in the trust, and use the proceeds to invest in other assets. IN WITNESS WHEREOF, I hereby sign and declare this document to be my Will. _________________________________________ James T. Smith __________________________________________ Date The above-named person signed in our presence, and in our opinion is mentally competent. Signatures of Witnesses Addresses of Witnesses Kenneth Tagan 44241 Lemon Street Denver, Colorado 80208 Barbara Russell 101 Courtney Street

Estate Taxes (1 of 3) Without a surviving spouse, a large estate is subject to estate taxes Determining estate taxes Value of estate is the value of all assets minus any liabilities minus funeral and administrative expenses

Estate Taxes (2 of 3) In 2015, the first $5.43 million of an estate can be distributed to children or others tax-free Beyond this limit, the federal estate tax rates on the taxable part of the estate can be as high as 40% in 2015 Proper planning can reduce these taxes

Estate Taxes (3 of 3) Other related taxes Some states also impose taxes on estates Valuing your estate to assess potential estate taxes It is important to calculate the value of your estate periodically so that you can plan appropriately if your net worth exceeds the tax-free limit

Trusts, Gifts, and Contributions (1 of 3) These may help avoid estate taxes Trust: a legal document in which one person transfers assets to another who manages them for designated beneficiaries Grantor: the person who creates a trust Trustee: the person or institution named in a trust to manage the trust assets for the beneficiaries

Trusts, Gifts, and Contributions (2 of 3) Living trust: a trust in which you assign the management of your assets to a trustee while you are living Revocable living trust: a living trust that can be dissolved Irrevocable living trust: a living trust that cannot be changed, although it can provide income to the grantor

Trusts, Gifts, and Contributions (3 of 3) Standard family trust (credit-shelter trust): a trust established for children in a family Testamentary trust: a trust created by a will Gifts: a tax-free distribution of up to $14,000 per year (2015 limits) from one person to another Not subject to tax for the giver or the recipient Contributions to charitable organizations Not subject to estate taxes

Other Aspects of Estate Planning (1 of 4) Living will: a legal document in which individuals specify their preferences if they become mentally or physically disabled Power of attorney: a legal document granting a person the power to make specific decisions for you in the event that you are incapable

Other Aspects of Estate Planning (2 of 4) Durable power of attorney for health care: a legal document granting a person the power to make specific health care decisions for you Maintaining estate plan documents Need to be kept in a safe, convenient place Key individuals need to know where they are kept

Other Aspects of Estate Planning (3 of 4) Key Documents to keep in one location Estate planning information Life insurance policies Retirement account information Home ownership and mortgage information Ownership of other real estate Personal property Personal loans Credit card debt information Ownership of businesses Personal legal documents

Other Aspects of Estate Planning (4 of 4) Recent personal tax returns Bank account information Investment information

Financial Planning Online Go to http://www.nolo.com Click “Wills, Trusts & Probate” This Web site provides guidance on creating a will and other functions of estate planning.

How Estate Planning Fits Within Your Financial Plan (1 of 4) Key decisions about estate planning for your financial plan are: Should you create a will? Do you need to establish a trust? Should you create a living will or designate an individual to have power of attorney?

How Estate Planning Fits Within Your Financial Plan (2 of 4) EXHIBIT 20.2 How Estate Planning Fits Within Stephanie Spratt’s Financial Plan GOALS FOR ESTATE PLANNING 1. Create a will. 2. Establish a plan for trusts or gifts if my estate is subject to high taxes. 3. Decide whether I need to create a living will or assign power of attorney. ANALYSIS Estate Planning and Related Issues Issue Status Possible heirs to my estate? My sister and parents. Tax implications for my estate? Small estate at this point; exempt from taxes. Power of attorney necessary? Yes; I want someone to make decisions for me if I am unable. Living will necessary? Yes; I do not want to be placed on life support.

How Estate Planning Fits Within Your Financial Plan (3 of 4) EXHIBIT 20.2 How Estate Planning Fits Within Stephanie Spratt’s Financial Plan DECISIONS Decision Regarding a Will: I will create a will that stipulates a contribution of $5,000 to a charity. I plan to make my parents my heirs if they are alive; otherwise, I will name my sister as the heir. I will designate my sister to be executor. Decision Regarding Trusts and Gifts: My estate is easily under the limit at which taxes are imposed, so it would not be subject to taxes at this point. Therefore, I do not need to consider establishing trusts or gifts at this time.

How Estate Planning Fits Within Your Financial Plan (4 of 4) EXHIBIT 20.2 How Estate Planning Fits Within Stephanie Spratt’s Financial Plan Decision on a Power of Attorney and Durable Power of Attorney: I will assign my mother the power of attorney and the durable power of attorney. I will hire an attorney who can complete these documents along with my will in one or two hours.