Step 8, Next Gen Investments, took us into the realm of generational wealth, as we explored how to help the next generation while we are still alive. Step 9, Create an Estate Plan, takes this one step further as we think about how we can benefit the next generation after we pass away. This step focuses on the legacy that we will leave behind. It involves taking the personal wealth you have worked hard to build during your lifetime and efficiently transitioning that to the next generation. An effective Estate Plan ensures that your wishes are carried out after you are gone. It also makes the transition to the next generation as smooth as possible by avoiding probate court and minimizing taxes. An Estate Plan will look a little bit different for every individual and family. The most important thing is to spend a little time and effort to create one that works for you.
What is an Estate Plan?
According to Investopedia, the term estate planning refers to the preparation of tasks that serve to manage an individual's financial situation in the event of their incapacitation or death. (Citation: 1) Essentially, it’s the process of putting your desires for your assets into writing, so that they are carried out even when you can no longer manage them yourself. Typically, you lose the ability to manage them because you pass away, but an Estate Plan also kicks in if you become incapacitated and are no longer capable of making your own sound decision. A common misconception is that estate planning is reserved for the ultra-wealthy. This is not true – not one bit. While it is true that the ultra-wealthy may have more complicated estate planning needs, such as minimizing estate taxes, I would argue that’s it’s actually more important for the everyday family. If the ultra-wealthy pass away without an Estate Plan, they may trigger expensive probate and taxes, but in all likelihood, they will still end up creating generational wealth. If the everyday person passes away without an estate plan, probate and other issues may completely wipe out their ability to create generational wealth. Everyone should have an Estate Plan, but every person’s Estate Plan will probably look a little bit different, depending on their needs.
Different people’s Estate Plans will have different components, but a basic Estate Plan will typically have the following components:
Will – A will is a document that outlines your wishes after you pass away. When you create a will, you become the “testator.” In the will, you elect an “executor” to follow through on the instructions in your will. Typically, a will includes instructions on guardianship for minor children and pets, distribution of property and assets, charitable donations, and funeral arrangements. An important note is that a will on its own will not cause your estate to avoid probate court (discussed later). Instead, it will simply provide instructions for the probate judge to follow. Another important note is that if you have a trust, you typically will still want a “pour over will” to direct assets to the trust that you may neglect to properly place into the trust.
Trust – A trust is a legal entity that can hold your assets. The most common type of trust used in estate planning is a Revocable Living Trust. A Revocable Living Trust permits you to transfer assets to named beneficiaries without going through probate court. While you are alive, you are the “Trustee” of your trust and have decision-making powers. When you pass away, that power passes to your “Successor Trustee.” Your Successor Trustee is in charge of following the trust instructions to make sure assets pass down to your beneficiaries as you desire. One important note here is that to effectively use a Trust to avoid probate court, you need to make sure your trust is “funded” with all of your major assets. This typically involves moving ownership for major assets from yourself to your trust, as well as naming your trust as the beneficiary for accounts that have a beneficiary. A trust that is not funded is useless on its own.
Financial Power of Attorney – A Financial Power of Attorney is a legal document that outlines and gives someone authority to manage your financial affairs if you are unable to do so. This is important to make sure that your financial affairs are handled by a trusted person if you become incapacitated.
Healthcare Power of Attorney – A Healthcare Power of Attorney is a legal document that empowers someone to make health care decisions on your behalf. This is important because it makes sure that your health decisions are made by a trusted person if you become incapacitated. Another important document along these lines to complete is a Healthcare Directive. This is a document that outlines your wishes on sensitive health issues like your “pull the plug” preferences, organ donation preferences, etc.
Another major component of an Estate Plan is your Successor Trustee decision. This is the trusted person who will be handling the administration of your trust after you pass away. The key here is that this should be someone you completely trust to work in your best interest and someone you trust to be responsible in the handling of your trust. Your Successor Trustee can be a family member, a close friend, or even a company that provides professional Trustee or Fiduciary services. Whichever direction you decide to go, it’s necessary that your successor trustee has the capacity to handle the responsibilities and preferably some financial or legal experience. Make sure you talk to your successor trustee about the responsibility. You don’t want to spring this important responsibility on someone who does not want it.
It’s also key to decide who will benefit from your Estate Plan. In other words, who will be your beneficiaries? If you have kids or grandkids, you might put them down as beneficiaries. You can also put other family members like your parents if they are still around, cousins, nieces, nephews, etc. If you don’t have an obvious beneficiary, you can put down a non-profit or charity as your beneficiary. If your goal is to create generational wealth, just think about which beneficiaries will be most likely to help you fulfill this goal.
Why is an Estate Plan important?
Many avoid making and Estate Plan because, let’s be honest, it’s no fun to think about death and incapacitation. It’s also sometimes no fun to work hard on something you won’t personally see the benefits of. However, if your legacy and creating generational wealth are important to you, creating an Estate Plan is essential.
Creating an Estate Plan is important because it’s really the only way to ensure that your wishes are followed. If you pass away without an Estate Plan, you are leaving things up to chance. Yes, maybe your loved ones will inherit your assets, but there’s really no guarantee.
A good Estate Plan that includes a Trust is also the only way to guarantee that you avoid probate court. Probate is the legal process for distributing an estate’s assets. Probate typically is an ugly process that you want to help your loved ones avoid. Probate is a slow process. Typically, assets won’t actually be transferred over to beneficiaries for well over a year. Probate is also expensive. You must hire expensive lawyers and pay probate court fees. Probate is also the process where you hear of unfortunate family drama. During the process, it’s not uncommon for family members to quarrel over how assets should be distributed. In my entire career, I’ve never seen someone go through probate without complaining about how awful the process was. A Trust is really the only way to ensure that your family doesn’t have to go through this process. The tradeoff you usually must make is to spend some time and a couple thousand dollars now so that your family doesn’t have to spend years and tens of thousands of dollars after you pass away.
An Estate Plan is also important to minimize the amount of taxes that your estate and beneficiaries will have to pay when they inherit your assets. For high-net-worth families, this could involve complex strategies to avoid or minimize the Estate Tax. For others this might involve maximizing assets that pass down tax free like life insurance or Roth IRAs. It might also involve keeping your assets that benefit from a stepped-up cost basis when they pass down. These are assets that if you sold while you were alive, you may be responsible for capital gains taxes on the growth. However, if you pass them down to the next generation, they get a stepped-up cost basis, meaning their cost basis becomes whatever the value of the asset is when they inherit the asset. If your beneficiary sold the asset right then, they could potentially pay zero in capital gains taxes. Some examples of these types of assets include rental properties, non-retirement investment portfolios, and individual stocks.
How do I create an Estate Plan?
Creating an Estate Plan can seem daunting, but it may not be as complicated as you think.
Just follow these steps:
- Think through your plan.
- What assets do you have?
- Who do you want to oversee the handling of your assets after you pass away?
- Who do you want your beneficiaries to be?
- Create your Estate Planning documents (i.e. Will, Trust, Financial Power of Attorney, Healthcare Power of Attorney)
- For complicated situations, engage a full-service estate attorney who will guide you and create these documents for you.
- For simple situations, any financial professional that has access to estate attorney created documents can help you put together these documents.
- If you consider yourself legally savvy and have a simple Estate Plan, there are online services where you can create these important documents. Caution, these documents aren’t always backed by an estate attorney and may not hold up as well in a court as documents drafted by a real attorney.
- Fund your trust and check beneficiaries.
- Look at all your accounts. Are they titled correctly? Do they have the right beneficiaries?
- Typically, non-retirement accounts and properties should be owned by your trust. Retirement accounts and life insurance accounts should have your trust as a beneficiary.
- A financial planner can help you look at all your accounts and make the right decisions.
- Review your Estate Plan regularly.
- Update your Estate Plan anytime you have a major life change. (i.e. purchase a new property, inherit assets, new family member, family member passes away, etc.)
- If nothing has changed, you should review your Estate Plan at least every 5 years.
Preparing your beneficiaries
Another important step to ensure that your Estate Plan leads to generational wealth is to prepare your beneficiaries. First, inform them that they are a beneficiary. It’s important that they both expect and accept this. Second, make sure you educate them on your wishes. Just because they are inheriting your assets, doesn’t mean they’ll necessarily use them in the way you envision. If you talk with them and communicate your wishes, they will be more likely to deploy the assets they inherit in the way that you want. Lastly, make sure they are educated on building generational wealth. All too often, people inherit wealth and blow it all during their lifetime. By inheriting wealth, they should have a head start in the generational wealth building process, but it’s still critical that they know the steps. To teach them, maybe send them a copy of this guide, connect them with your financial planner, or teach them yourself. There are lots of ways to do this, but make sure they are financially literate and understand the steps to turn the wealth they inherit into generational wealth.
Final Thoughts
Creating an Estate Plan is key to building generational wealth. It’s the step that transfers your personal wealth into generational wealth. This step does take a high level of unselfishness. You need to sacrifice some of your own time and money, so that that your beneficiaries can efficiently inherit the wealth that you’ve worked hard to create. Why would you do this? The answer is: your legacy. If you want to leave a legacy of generational wealth that hopefully continues for generations to come, an Estate Plan is required. An Estate Plan is not just for the wealthy or for the elderly. It’s important for every adult to create. Please do not wait to start creating your Estate Plan. The world is unpredictable and who knows when the time might come for your personal wealth to turn into generational wealth.
This blog post is a rough draft for Chapter 9 of 10 for my Step-by-Step Guide for Building Generational Wealth. For now, each step will be in the form of a monthly blog post. I really hope to get your feedback and thoughts. After finishing the step-by-step guide, I plan to revisit each blog post, add detail, implement changes based off of your feedback and thoughts, and then publish the guide into a book. While creating a book is a daunting task, the impact that I think this book will have on my community continues to motivate me.
Works Cited:
- https://www.investopedia.com/terms/e/estateplanning.asp
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Investment Services LLC nor any of its representatives may give legal or tax advice.