The Basics of Estate Planning

If you have already done a bit of estate planning, congratulations! You're ahead of the general public and even some celebrities who died without a will, fracturing families and enriching their attorneys. Let's hope you have a will and have named a power of attorney for finances and health care. But unless you regularly update these documents and beneficiary designations, your heirs could still find themselves in a legal morass after you die or pay more than they had to in taxes (we’ll cover that, too). Worse, some of your assets could end up going to a wrongful heir. 

There are ways to save money on estate planning, so even if you're not a millionaire, an estate plan should be within reach.

Essential estate planning documents

The basic components of an estate plan include wills, trusts, powers of attorney (POAs), and living wills. Here's a breakdown of these elements.

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A will. Every estate plan should have a will listing your assets and how you want them distributed to your heirs after your death. Although a will may sound straightforward, it's essential to know what you should include and what you should leave out of a will. 

A living trust. A living trust, also known as a revocable trust, ensures that the assets you put into the trust (like stocks, bonds, CDs and other investments, jewelry and real estate) are distributed according to your wishes after your death. These trusts are themselves a gift to your heirs, as your beneficiaries will not have to go through often lengthy and onerous court probate to receive the assets.

A living will. This document type may have a different name depending on the state where you live, sometimes with slightly different meanings. A living will may also be called an "advance health care directive" or "medical directive." These documents ensure that your health care choices are followed if you are incapacitated or for end-of-life care.

A power of attorney (POA) for finances and health care (also known as a health care proxy). POA designations give an individual you trust the authority to manage your finances or make health care decisions if you become incapacitated. 

A digital POA. You can also use a power of attorney to designate an individual to manage your digital assets, such as your online and social media accounts. 

Some individuals use living trusts to avoid probate and designate a trustee to manage their assets after they die (see When Do Living Trusts Make Sense?). But whether your estate is simple or multi-layered, you should review all of your documents every three to five years, or more often if you experience a major life change, says Marcos Segrera, a financial adviser with Evensky & Katz, in Miami. We’ve provided a checklist that you can use to determine whether you may need to update your estate plan.

Your beneficiaries are key

Certain assets, such as your retirement accounts and insurance policies, require you to name a beneficiary who will inherit the account when you die. That ensures those assets will go directly to your beneficiaries after you die, outside of probate. 

Beneficiary designations usually supersede instructions in your will or living trust, so it’s critical to get them right, says Letha McDowell, an attorney with the Hook Law Center and former president of the National Academy of Elder Law Attorneys. You should also name contingent beneficiaries in case you and the primary beneficiary — usually your spouse — die simultaneously or within a short period of time, McDowell says. Although 401(k) plans routinely remind participants to review their beneficiaries, they rarely advise them to name a contingent beneficiary, she says. 

If you don’t name a beneficiary — or the primary beneficiary predeceases you and you don’t designate a new beneficiary — the proceeds will be paid to the estate, which means they’ll go through probate. This could significantly delay the process of distributing assets in your estate, creating headaches and costs for your heirs. 

Spousal beneficiary rules for qualified retirement plans

Federal law requires that qualified plans, such as 401(k) plans, go to the surviving spouse unless the spouse agrees to give up that protection. If you want those funds to go to someone other than your spouse — you’ve remarried, for example, and want your adult children to inherit the money — your spouse must sign a waiver giving up the right to receive funds. 

This spousal protection doesn’t apply to IRAs. In most states, you can name anyone you want as a beneficiary of your IRA (a spousal waiver may be required if you don’t name your spouse and live in a community-property state). So, while a spouse may be the default beneficiary of a 401(k), that protection disappears once the funds are rolled over to an IRA.

Consider your non-retirement accounts

While not required, you can — and should — arrange for bank and brokerage accounts to pass directly to your heirs, outside of probate. This process is typically known as a transfer-on-death (TOD) or payable-on-death account, and the forms should be available at your financial institution. You may prefer this option to a joint account, which will also bypass probate but gives the co-owner equal right to the assets in the account. With a TOD or payable-on-death account, you maintain control of the account until you die. The beneficiaries can claim the account outside of probate by producing proof of identity and a death certificate. 

As is the case with beneficiary designations, these accounts supersede your will or trust, so it’s important to make sure they’re up to date and have contingent beneficiaries.

If you change a beneficiary designation, you should receive a confirmation from the account. Store that confirmation with your other estate-planning documents, McDowell says. 

Marriage or divorce

State laws vary with respect to current and former spouses, but there have been some unfortunate cases in which a life insurance payout went to an ex because the original owner failed to update the policy’s beneficiary. In 2013, the Supreme Court ruled that the proceeds of a $124,500 federal life insurance policy taken out by Warren Hillman, who died of leukemia in 2008, should go to his former wife because she was named as the beneficiary on the policy. Hillman’s widow received none of the money.

Death of a spouse

Because most couples name each other as beneficiaries, surviving spouses need to update their beneficiary designations as soon as possible. This may not be top of mind when you’re grieving, but it will make probate much easier for children and other survivors after you die. (You’ll need to update your will and living trust, too.) If you’ve named contingent beneficiaries, you may not need to take this step, but you should make sure your choice of those beneficiaries hasn’t changed. 

Change in accounts

If you’ve rolled over 401(k) plans to IRAs or opened new bank or brokerage accounts, you should make sure the beneficiary (or TOD) designations are correct. If you transfer a brokerage account to another firm, make sure any beneficiary designations will also transfer. While you’re at it, make sure all accounts with beneficiary designations are up to date, including 401(k)s you’ve left with former employers.

How to lower your heirs’ tax bite 

Although beneficiary designations, along with a living trust, will keep your assets out of probate, those measures won’t shield your heirs from federal or state estate taxes.

In 2024, estates valued at up to $13.61 million ($27.22 million for a married couple) are excluded from federal estate taxes. However, it will drop to about $6 million in 2025 unless Congress extends the estate tax provision of the Tax Cuts and Jobs Act. In addition, 12 states and the District of Columbia have much lower estate tax exemptions. Oregon’s kicks in for estates valued at $1 million or more. 

You can reduce or avoid federal and state estate taxes by giving money away while you’re alive. In 2024, you can give up to $18,000 to as many people as you want without reducing your estate tax exclusion, and your spouse can give up to the same amount.

New rules for inherited IRAs 

While even a $6 million threshold would exclude most estates from federal estate taxes, your adult children (or other nonspouse heirs) could still find themselves on the hook for a big tax bill if they inherit a traditional IRA.

But under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, adult children and other nonspouse heirs who inherit an IRA must either take the lump sum — and pay taxes on the entire amount — or transfer the money to an inherited IRA that must be depleted within 10 years after the death of the original owner. And under guidance issued by the IRS earlier this year, many heirs who choose the latter approach must take annual withdrawals, based on their life expectancy, and deplete the balance of the account in year 10. (If the original owner died before taking required minimum distributions, the heirs can wait until year 10 to deplete the account.)

The 10-year rule doesn’t apply to surviving spouses. They can roll the money into their own IRA and allow the account to grow, tax-deferred, until they must take RMDs, which currently start at age 72. Alternatively, spouses can transfer the money into an inherited IRA and take distributions based on their life expectancy.

The Roth workaround. If you want to minimize the tax bill for your heirs, one option is to convert some or all of your IRA to a Roth. Inherited Roth IRAs are also subject to the 10-year rule for non-spousal heirs, but with a critical difference: Withdrawals are tax-free.

When you convert money in a traditional IRA to a Roth, you must pay taxes on the conversion. But this is an instance in which the bear market could be your ally, because the taxes are based on the value of the IRA when you convert. 

Before converting any funds, compare your tax rate with those of your heirs. If your tax rate is much lower, converting could make sense. The math is less compelling if your heirs’ tax rate is lower than yours, particularly if a conversion could kick you into a higher tax bracket. In addition, a large conversion could trigger higher Medicare premiums and taxes on Social Security benefits.

One of the advantages of converting toward the end of the year is that you should have a pretty good idea of your annual income, which will make it easier to estimate how much the conversion will cost, says Ed Slott, founder of IRAhelp.com.

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