Wills

What do I need a will for?

Young or old, single or married, with or without children, everyone should have a will. A will names your heirs and determines how your assets are distributed after you die. A will can also name guardians for your minor children.

A will must comply with state laws to be valid. When drawing up a will, make sure the document is written, witnessed and signed according to the law. You must also name an "executor" of your will-someone who will settle your estate according to your wishes.

If you die without leaving a will, your assets will be distributed to your closest relatives as determined by the courts and not necessarily as you would have liked.

What is probate?

Whether you have a will or not, your assets pass through probate after your death (unless you have structured your estate with trusts to bypass probate). Probate is a legal process through which the courts settle your estate. The executor named in your will is the one who initiates the probate process by presenting your will to the courts. If you do not have a will, the courts will appoint an administrator of your estate. Your relatives and creditors are officially notified of probate by the courts.

The type of property that must pass through probate includes property you owned in your name alone and your spouse's share of marital property if your spouse is deceased.

If you do not have a will, the courts decide how to distribute your property to your heirs. If you do have a will, the courts will determine if your will is valid, inventory your property, determine the value of your estate through appraisals and pay outstanding debts and taxes you owed at the time of your death. Some of your estate might have to be sold to generate cash to pay the bills, and it is the executor's job to decide whether or not to sell real estate, investments and the like in order to satisfy your debts.

Until all your bills are paid, the courts may freeze your estate's assets. However, the courts will usually allow your heirs to take some short-term funds out of the estate for general support during the probate process.

Finally, the courts give your heirs whatever is left as directed in your will.

Probate can take anywhere from a few days to several months to complete. Probate is also going to cost your family. They may need to hire an attorney, pay for appraisals of your things and cover court costs for filing papers. The fees typically come out of the estate, which means your heirs receive that much less in the end.

Some types of property do not go through probate but rather, go directly to your heirs. They include jointly owned assets, property held in trust, 401(k) plans, pensions, life insurance and annuities.

If there are ways for you to avoid probate, it may be in the best interest of your heirs to pursue them.

How can trusts help me avoid probate?

Trusts are a way to avoid probate-and possibly reduce estate taxes. A trust is a legal structure between one person, called a trustee, and another person, called a beneficiary. A trustee holds property in trust for a beneficiary-that is, a trustee has legal title over the property and maintains full control but manages it for the beneficiary.

While some trusts are created at the time of death as directed by a will, a "living trust" is a trust you set up while you are alive. You can be the trustee of your living trust.

A living trust allows you to decide how your property will be managed during your lifetime and how it will be distributed upon your death, while maintaining your control over the assets during your lifetime and avoiding probate after your death. When you create a living trust, you must fund it by transferring your property from your name to the trust.

Another advantage of trusts is the privacy they afford both you and your heirs. A will becomes public record during the probate process-so all your assets and debts become public. The terms of a living trust, on the other hand, remain private.

Trusts do not make good sense for everyone. Setting up and managing a trust can require time and money. Often, an estate must be large enough to justify creating a trust. Also, a simple living trust does not reduce estate taxes for those with sizable estates. In order to address estate tax issues, you may have to create a more complicated trust structure.

How will my estate be taxed after I die?

It depends. For starters, all property left to your spouse is exempt from estate taxes, as long as your spouse is a U.S. citizen. Second, property that you bequeath to a tax-exempt charity is also exempt from estate taxes. If, excluding those factors, you have an estate that is worth more than a certain amount, depending on the year of your death, then estate taxes apply. Currently, the estate tax affects only estates of more than $1.5 million. Those estates are taxed a maximum rate of 48 percent.

In 2001, Congress passed a law that will repeal federal estates taxes in 2010. In the meantime, the top tax rates will gradually fall and the estate tax exemption will gradually rise. However, the law "sunsets" in 2011, which means that unless Congress votes to extend the repeal, estate taxes will revert to what they were.

There is no way of telling what might happen, so you should continue to do estate tax planning until a complete repeal actually occurs.

What type of trusts will help me reduce estate taxes?

  • Bypass trusts

Also called "marital bypass trusts" and "AB trusts," this type of living trust is designed for married couples with children and can save heirs enormous amounts of money they would otherwise have to pay in estate taxes.

Normally, when the first spouse dies, the estate passes to the other spouse tax-free. But when the surviving spouse dies, estate taxes become an issue if the estate is worth more than the estate tax exemption, considerably reducing the amount left to the couple's children or other heirs.

With a bypass trust, the estate of the deceased spouse "bypasses" the surviving spouse and is held in trust for the children while allowing the surviving spouse to use the assets for the rest of his or her life. This reduces the surviving spouse's estate by half of what it would have been if the entire marital estate had been left to the surviving spouse.

Of course, you do not know whether you or your spouse will die first, so you should structure the bypass trust to be implemented when either you or your spouse dies.

  • QTIP trusts

This type of trust is used in conjunction with a bypass trust. It is often useful in second marriages where one spouse is worth much more than the other and there are children from a previous marriage.

If you are worth $3 million, for example, you could shelter $1.5 million of it (the current estate tax exemption) in a bypass trust. If you left the remaining $1.5 million to your spouse, he or she gets to decide what happens to that money after your death-which means your spouse could decide not to give it to your children.

But if you set up a QTIP trust for the remaining $1.5 million naming your children as the beneficiaries, your spouse could use the income generated by the trust during his or her lifetime, with the assets going to your beneficiaries upon your spouse's death. If the amount put in the QTIP trust is under the estate tax exemption, your children would not owe any estate taxes on it. If taxes are owed, you will have at least postponed paying them until your second spouse dies.

Keep in mind that if your second spouse is considerably younger than you, your children will not get their inheritance until your second spouse dies, which could be a long way off. In that case, a QTIP trust might not be the best option.

  • Charitable trusts

This type of trust is intended for those who wish to use their estates to make large gifts to tax-exempt charities. There are several variations of charitable trusts.

Charitable remainder trusts allow you, the creator of the trust, to receive income from the trust's assets during your lifetime. Upon your death, the assets in the trust are transferred tax-free to a charity you have named. You also get a current tax deduction when you set up the trust.

Charitable lead trusts provide a stream of income to a charity of your choice for a set number of years. At the end of that time period, the assets in the trust are transferred to your heirs. With this type of trust, you can make sizable contributions to charity while still ultimately passing on your assets to your heirs.

Pooled income funds work like charitable remainder trusts, but they involve several people contributing to them. All the contributors to the fund receive income for life. After your death, the charity receives your portion of the fund.

Wealth replacement trusts also work like charitable remainder trusts, but they use life insurance to replace the assets that go to the charity. With these trusts, your heirs receive their inheritance, and the charity gets a donation.

Because federal laws and your financial situation can change, you should review your estate plan on a periodic basis. You should also revisit your plan in the event of divorce, death of your spouse, remarriage and birth of a child. If you move to another state, check the estate tax laws in that state as they can vary.

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