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What Type of Estate and Tax Planning Do I Need to Do?

Susan Johnston

More than half of adults do not have a will, according to a 2011 phone survey conducted by Harris Interactive for online legal service Rocket Lawyer, and 92 percent of adults under age 35 do not have one.

Many people assume their family will automatically inherit any assets they leave behind, but without a will, those assets are usually held in probate court and distributed according to their state's law. "The price that your family pays financially and emotionally to go through the probate court is much higher [than paying for a will], " says Danielle Mayoras, an estate planning and elder law attorney, coauthor of Trial & Heirs: Famous Fortune Fights!, and cofounder of the Center for Probate Litigation.

[See 50 Ways to Improve Your Finances in 2012.]

In addition to the distribution of assets, estate planning should also name the people who should make financial or medical decisions on your behalf should you become incapacitated. Here are the three main documents experts recommend:

-- Will: Experts recommend creating a will as soon as you start acquiring assets or start a family. Assets can be left outright to beneficiaries or through a trust, which is explained below. A will also names executors, who manage the assets until they're distributed to inheritors. A digital executor (who could be the same person managing your assets or a different person) would have the authority to manage your online accounts after you die.

If you have children, your will should designate guardians in case both parents pass away. "You want to name a guardian who really has the ability and life expectancy to survive the youngest child to the age of 18," says Russell Fishkind, a trust and estate lawyer and professor of estate planning in New York University's Certificate in Financial Planning program.

-- Durable power of attorney: This document grants your spouse or other party the power to make financial or legal decisions on your behalf if you become incapacitated, which Charley Moore, a lawyer and founder and chairman of Rocket Lawyer, refers to as "the vice president rule."

[See 8 Steps for Building a Solid Estate Plan.]

-- Healthcare proxy: Also called healthcare power of attorney, a healthcare proxy grants the power to make medical decisions, including end-of-life decisions if you are incapacitated and unable to communicate those decisions yourself. Without a healthcare proxy, family members could make some healthcare decisions depending on the state. "But there will be the considerable cost of going to court and the related legal matters that arise from that," adds Jonathan Blattmachr, a former estate planning attorney and a director at wealth advisory firm Eagle River Advisors. "Also, determining you are incompetent will be a matter of public record."

In some cases, it may make sense to create a trust for your assets instead of leaving them outright, because trusts offer more control over who receives your money and the way in which they receive it. For instance, if you left money outright to a spouse who later remarried, that money could flow through the second marriage and may or may not find its way to your children.

Various types of trusts accomplish different goals. A QTIP (Qualified Terminable Interest Property) trust, also called a marital QTIP trust, provides for the marital deduction and ensures that a spouse cannot use assets to benefit a future spouse or nonmarital children. A special needs trust provides for a special needs child without jeopardizing his or her access to government benefits, while an age-terminating trust for minor children would distribute portions of the inheritance at predetermined ages. A pet trust would provide care for your pets after you die.

Trusts have other benefits, as Blattmachr points out. "Money that's in trust that someone else put there can be made completely immunized from creditors," he says. By avoiding probate court, trusts also provide greater privacy.

However, a trust only benefits your estate if you actually transfer assets into it. According to Mayoras, failure to transfer all assets was one of the issues with the Michael Jackson estate and is a common estate planning mistake.

[See 6 Celebrity Estate Planning Errors--and Tips.]

As you age and perhaps divorce and remarry, it's also important to keep your beneficiaries updated. Otherwise, an ex-spouse could have the power to make life-altering healthcare decisions or receive an inheritance. As children reach majority, trusts should be updated to remove age-terminating trusts as appropriate.

Estate tax is another faucet of estate planning, which is further complicated by fluctuations in the estate tax exemption. Currently, the federal exemption is $5.12 million, but it's scheduled to reset to $1 million in 2013. For those whose assets exceed the exemption, here are a few strategies for minimizing estate taxes:

-- Set up specialized trusts. Certain types of trusts can minimize estate tax. For instance, under a GRAT (grantor retained annuity trust), you would receive an annuity for a fixed number of years. "If the individual lives until the annuity payments end, anything that passes to successor beneficiaries will be gift and estate-tax free," says Blattmachr. "The GRAT will be 'successful' if the property owner lives until the annuity term ends and if the trust property has gone faster than the IRS has forecast." However, the benefits of GRATs and other specialized types of trusts may restricted in the future. A charitable remainder trust, where money is distributed to heirs for a period of time and then to a charity, is another option for tax savings.

-- Transfer over time. Instead of waiting until you die, you could transfer assets or property gradually to reduce the estate tax liability. For instance, if you wanted to leave a vacation home to your two children, Sara Robicheaux, dean of business programs and associate professor of finance at Birmingham-Southern College, says, "you could essentially break it up into shares and give away 1/20 to each child each year, and over 10 years, the entire ownership shifts to the children."

[See Questions to Ask When Drafting an Estate Plan.]

-- Pay educational or medical costs. In addition to gifting up to $13,000 ($26,000 if you're married) in cash or property without tax implications, you can also distribute assets by paying the tuition (not room and board) or healthcare costs of someone else. "If, for instance, you have a grandson who's going to medical school, grandma or grandpa can pay that and it won't be considered a taxable gift," explains Blattmachr. Be sure to discuss that option with your financial planner to ensure that you won't need that money later.

-- Move to a different state. Several states have their own estate tax, and the exemption is often lower than the federal exemption. For instance, it's currently $675,000 in New Jersey, so that would impact smaller estates. These can also fluctuate, according to Blattmachr, but if you're living in a state with high estate tax, he says it's worth considering a move before you die.

Although several websites offer templates for creating a will and other legal documents, the experts who spoke to U.S. News recommend hiring a professional to avoid mistakes while navigating complex estate laws that vary by state. (Rocket Lawyer, mentioned earlier, offers a hybrid model by combining online tools with referrals to lawyers to review legal documents.)

Mayoras says she's had people come to her office with wills or trusts that weren't created correctly. "If you don't use an attorney who specializes in this area, you're losing a lot of possibilities that you would otherwise have," she adds. "What if there isn't an estate tax situation? What happens if your children pass away? There's a lot of what-ifs, and there's no way checking boxes on a form is going to account for that."

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