Plan Ahead to Pass Your Wealth to Your Heirs

If you die without a will (called "dying intestate"), the appropriate state will apply its probate laws to determine how your property will be split up. Create a will and estate plan that ensure your assets to go the right people or organizations, and with the most tax advantages.

The subject of how best to pass along your accumulated wealth at death is usually referred to as "estate planning." Even if you presently have only rather modest wealth, you're probably a candidate for at least some basic estate planning.  And your ownership of a small business only increases the likelihood that you will have an estate planning need. 

Although the estate planning process is primarily concerned with passing along your wealth at death, to be effective, it requires your lifetime participation.  You may have the most experienced and savvy probate lawyer and the most competent and trustworthy executor, but the money-saving and tax-saving opportunities that they will be able to use for your heirs' benefit will be limited unless you have done some planning during your lifetime to achieve this result.

What Happens to Property at Death?

Although death is not something that most of us like to think about, the fact is that unless you're willing to face up to this unpleasant thought now, chances are that the people who you wish to receive your property after your passing will end up disappointed. Why? Because if you die without having made out a valid will, the state in which you live, and/or where the property is located, will dispose of it — and the recipients may be radically different from how have in mind. A will can distribute your assets to whom you want.

In addition providing you with the ability to control who receives your wealth, it is advisable for you to have a will. Important reasons include:

States Allocate Assets of Those Dying Intestate

If you die intestate—that is, without a will—the state where you have your permanent residence will apply its probate laws to determine how your property will be split up among your closest relatives. If you have property in another state (or states) there will be ancillary probate in each of those states, applying the laws of those states.

When we say "closest" relatives, we mean closest by legal relationship. Your state's probate court will not be able to consider whether you loved or loathed a particular relative. The question will be limited to the relative's legal relationship to you. Thus, if a person falls within your state's category of closest living relatives entitled to inherit from you, that person will get a share of your wealth at death.

A state's inheritance categories include:

When Intestacy Applies

Even if you have a will there are two main instances when state intestacy rules must still be applied:

Having a Will Puts You in Charge

If you execute a will during your lifetime, you exercise control over what happens to your property—including your business—after your death. Specifically, you can control: 

If you don't execute a will, the state in which you live in effect will write one for you. Unless you have no interest at all about what will happen to your property after your death, this is something that should be avoided.

Determining Who Will Get Your Property

Generally speaking, you can give your property to whomever you wish. With a few exceptions, you can't be forced to give your property to anyone.

The most important exception to this rule involves spouses. In one form or another, almost all of the states provide that a spouse can insist on receiving a specified minimum amount from the estate (often 1/3 to 1/2, depending on whether there are children from the marriage). Thus, if a deceased person's will doesn't give the spouse this minimum amount, the spouse can elect to receive what is known as his or her "forced" or "statutory" share. If this happens, the will remains valid, but the spouse gets the specified share and the amounts received by all other beneficiaries are reduced according the state's applicable probate rules.

Another exception involves contractual wills. If two people execute a joint and mutual will (a single will that is effective to dispose the property of both people), as long as both are living they can make changes to the will anytime they want to. However, once one of them dies, the will becomes irrevocable and unchangeable with respect to the survivor. If this is the case, it generally will not matter that circumstances have changed such that the decedent would have changed the will if he or she were still around to do so.

Warning

Because a joint and mutual will—or any other form of contractual will—can lock you into a plan for distributing your wealth that is outdated in light of changed circumstances, you may want to avoid such arrangements. If you want to exercise some degree of continuing control over property that you transfer after death, a trust arrangement usually is preferred.

Further, although some people who opt for joint and mutual wills may do so in hope of saving money, such savings will be minimal, if anything at all. The will document will still have to be probated twice (once at the death of each testator), and the cost of preparing such a document will not be materially less than other types of wills.

You Can Tailor Bequests to Meet Individual Needs

If you don't have a will, your home state will distribute your wealth equally to your closest relatives, even if one is the richest person in the world and another is a pauper. A will gives you the ability to consider how much someone needs your property and/or how generous you want to be to a specific person. A will also gives you the power to clearly direct the distribution of specific items of your property to the specific persons or organizations that you choose.

Relying on state law isn't the best even with money and other easily divisible property, but, as a practical matter, some items (such as furniture or jewelry) can't be split up among multiple recipients. If this is the case, your heirs can agree to who gets what, and the probate court will probably go along with their wishes. If no agreement can be reached, however, the administrator of the estate will probably decide that there is no alternative other than to seek the probate court's blessing to sell the property and distribute the proceeds to the heirs. This "solution" will usually be to everyone's disadvantage, since such tangible personal items may be hard to sell at a price that reflects their value to family members. You can avoid these problems by having a will that specifies "who gets what."

A will also allows you to give away property in other than the fractional shares that would be dictated by your state's probate rules. In fact, you don't have to divide by fractional shares at all. You can give specific dollar amounts, make specific bequests ("2,000,000 shares of GM stock, " or "my collection of silver-plated spoons from the Millard Filmore memorial"), or set the amount of the transfer by a mathematical formula. (Such formula bequests are often used in connection with plans to minimize federal estate taxes.)

Exceptions to Property That Can Be Passed Down

In relatively few situations, your directions will not be honored by the probate court. Some of these situations might include the following.

Marital and Community Property

As an additional protection for spouses, some states limit your ability to transfer property that was acquired during the marriage. Depending on state law, you may be able to transfer only a one-half interest in such property, even if only your name appears on the documents of title. Besides this protection with respect to specific properties, your spouse may elect to claim a forced share of your estate if this amount is more that what is provided in your will.

Jointly Owned Property

Joint tenancies and tenancies by the entirety have survivorship features (that is, the surviving tenants automatically get ownership rights to the whole property). Therefore, your will cannot effectively transfer these interests. 

They are said to "pass outside of the will." However, you can transfer your interest in a tenancy in common, but you can't transfer the property subject to the tenancy, since the other tenants in common also have ownership rights in the property.

Life Insurance Proceeds

The proceeds of insurance policies on your life will be paid at your death to whomever you named as beneficiaries of the policies. Unless you have specified your estate as the beneficiary—and this usually is not a good idea, since it subjects the proceeds to probate costs and delays—your will does not control the pay-out of the life insurance proceeds.

Charitable Transfers

Many states limit the amounts that may be transferred to charity at the expense of close family relatives.

Trusts

If you have a trust that is set up to continue operation after your death, property placed in the trust before your death will be governed by the trust document, rather than your will.

Transfers Against Public Policy

Regardless of the type of property that you are giving away at death, a probate court will not enforce a condition that is against public policy. If you include such a provision in your will ("I give John the right to live in my mansion provided that each Valentine's day, he throws a rock through Mary's window") the probate court will either void the transfer altogether, or transfer the property without enforcing the condition.

Your Options for Tailoring Bequests

A will provides you with the ability to distribute property with conditional ownership or limited ownership. For example, you may want to let a close friend use a certain property for the remainder of his or her lifetime, but at this person's death, you want the property to come back to your heirs(rather than your friend's).

Can you do this? The answer is "yes." You can do this, and other things that will restrict or condition the recipient's use or ownership of the property. Some of the more common methods of doing so are listed below.

Warning

These are general discussions—designed to alert you to what may be possible. As will be noted in our discussions that follow, you will need to be particularly careful when restricting property use by will, and you are well advised to seek the advice of an attorney who regularly deals with wills and trusts.

Split Property Interests Divide Ownership by Time

The right to use property that you transfer by your will can be split among different people, based on the passage of time. One person (or group of people) can be given the right to use the property currently, while another person (or group of people) can be given the right to use the property at some future date. A person having the current use is said to have a "present" interest, while the second person is said to have a "future interest."

Within the context of split interests in property, there are two main types of present interests:

There are two main types of future interests that are relevant to our discussion here: remainder interests and reversions.

Uses of Split-Interest Bequests

Although split interest bequests can still be made by a will, it's often advantageous to have such interests structured within a trust arrangement. Doing so will normally reduce estate settlement costs, since a long-term continuing involvement of a probate court can be avoided.

Warning

The above discussion of split interest bequests is meant to show, in broad terms, the possible uses of split interest bequests. However, because a detailed discussion of this subject is beyond our scope here, and because the rules that apply to such interests vary from state to state, it is strongly advised that you consult an attorney if you want to use a split-interest bequest.

Bequests Can Provide for Shared Ownership

Your will can transfer property to others in shared ownership (either in a tenancy in common or joint tenancy). You might want to consider such a bequest if you have a property that cannot be easily divided and there are two or more people you would want to benefit equally. Keep in mind that such an arrangement should only be considered if you're reasonably sure that these people can use and enjoy the property in harmony. If this is the case, shared ownership may be okay, but a tenancy in common might be more fair to the heirs of the beneficiaries, since the survivorship feature of a joint tenancy means that only the beneficiaries of the surviving tenant will ultimately get the property (unless the joint tenants agree to a partition of the property during their lifetimes).

You might be tempted to use shared ownership to influence the behavior of one of your heirs. For instance, you would like one of your nephews to have a certain property, but aren't so sure that he is ready to handle it on his own. If you transfer it by will to the nephew in shared ownership with another heir—an older niece whom you trust more—your nephew may be reined in somewhat by the other owner. While such a transfer might work as you want, this situation could be handled much better by a transfer into a trust.

Wills May Restrict Property Use Provide for Powers of Appointment

When you create a will that substantially restricts your heirs' ability to use the property (or to pass it along to their heirs at death), two conflicting legal principles are involved:

What do these principles mean to you?

Primarily, that you can dispose of your property at death as you wish, but if you attach certain types of restrictions on the bequest, you run the risk that the bequest (or at least the restriction) will not be given effect by the probate court. Most states have specific rules limiting the time, or the number of generations, that a property restriction will remain effective. If you insist on using such restrictions in a will, consult an attorney, who can steer you clear of the type of restrictions that may lead to problems in your state.

Here we will consider two specialized forms of future interests that you can create in real property by way of a will. They are known as:

Simply stated, these provisions enable a person to provide that property given to a beneficiary will come back to the giver if a specified event or property use occurs. For example, a property could be given to "X, on the condition that alcoholic beverages are never sold on the premises."

The main difference between a possibility of reverter and a right of entry is that the possibility of reverter is automatically deemed to transfer ownership upon the happening of the specified event, while with a right of entry, your heirs would have to take legal action to get the property back after the event occurred.

The courts strongly disfavor both the possibility of reverter and the right of entry. Although each can still be used, if you're looking to use will bequests to change or control someone's behavior, you'll probably have a much easier time of it by bequeathing your property to a trust that can achieve the same result by use of different means.

Powers of Appointment

A power of appointment is created when you give a person the right to determine who will receive specified property that you own. You can create such a power that is effective while you are alive, or one that only arises by way of your will (called a testamentary power). While a power of appointment can be created by a will, as a practical matter, it's usually granted to the trustee or beneficiary of a trust.

A power is classified as a "general power of appointment" if the person holding the power can exercise it in favor of himself or his estate. If the power holder does not have the authority to do this, the power is called a "special power of appointment." Special powers receive favorable treatment under the federal estate tax.

Powers of appointment can be used as a means of influencing a beneficiary's behavior: you can give a trusted friend or family member the power to appoint property held in trust among a specified group of people, or the world at large. After your passing, this power holder can use the "power of the purse-strings" to nudge along your heirs to move in the direction that you would like. Certainly, you would have to have great trust in the person you name as holder of the power, but you could protect your heirs by specifying the small group of individuals that property could be given to, and by providing that, if any of the property has not been appointed at the power holder's death, such property is to be distributed to named individuals (whom you specify).

Powers of appointment can also be used in conjunction with a life estate where you want to give someone broad ownership rights in the property, but for federal estate tax or other reasons, you don't want to give full rights of ownership. To do this, you give the person a life estate plus a special power of appointment over the same property, exercisable by will. The power holder/life tenant gets the full use and enjoyment of the property during his or her lifetime, and the right to choose—from the group of appointees that you specify—who will receive the property at his or her death.

Using Trusts in a Conjunction Will

Sometimes the main function of a will is to give your executor the authority to collect your assets and cause them to be distributed to a trust that you have set up to receive them. This type of will (sometimes called a "pour-over" will) is often used when a trust is set up for estate tax savings, or to preserve family privacy.

A trust is a legal arrangement in which one person agrees to hold and manage the property of another person for the benefit of someone else. With a trust, three parties are involved:

Because of the historical development of trusts and the state law rules that govern them, the courts are much more likely to give effect to the transfer of broad powers to a trustee than they would to an executor. This means that trusts can be extremely flexible estate planning tools. 

And unlike your will, which becomes a public document when admitted to probate, trust arrangements—even those that are closely tied into an asset transfer from a will—can be kept from the public eye.

You might want to consider using a trust to:

Remember, trust arrangements cost money. Money for an attorney to draft them, and yearly fiduciary fees to the trustee for managing the trust property. Be sure that you have good reasons to incur these additional costs before you decide to use a trust.

Choose Your Executor Carefully

If you die without a will, the probate court will appoint a person called an administrator, who will act as a fiduciary to collect your assets and pay your debts (including taxes). Then, after the time period set by state law, the administrator will distribute your assets to those people entitled to receive them.

If you have a will, you get to choose the person (or a professional fiduciary, such as an attorney or bank) to handle these duties. A fiduciary that is nominated under a will is referred to as an "executor" or sometimes as a "personal representative."

Your choice of an executor will be an important factor in how smoothly your estate is handled. You'll want an executor who will be able to deal with all estate beneficiaries in a way that will avoid friction, and foster any needed compromises and agreements among them. You'll want an executor who will work hard and work efficiently, so that everything is done on time; thus avoiding court delays and continuances. In probate matters, time is money, and attorneys' time spent in court is big money.

State law will gives great latitude if you choose to waive the requirement that the executor post bonds. It also will allow you to give your executor the power to enter into transactions, and make investments that a court would consider to be too risky for an administrator.

Deciding Between a Corporate or Individual Executor?

You can choose an individual or a corporate fiduciary to serve as your executor. You can also have more than one executor. In this case, they will be called "co-executors." Regardless of the number of executors, and whether they are individuals or corporate fiduciaries, they will be entitled to reasonable fees—set by the probate court—for performing their duties.

Because it is in the business of performing fiduciary services, you can expect that a corporate fiduciary would have the advantage of having a staff of people who are experienced in handling estate work. Such a fiduciary can be expected to be more knowledgeable of probate rules and deadlines than would most individuals serving as executor.

Some of your relatives may think that it's an honor to be named as executor of your will—although they may change their mind once they see how much work is involved. And other family members may feel that a corporate fiduciary would give much more impersonal service when compare with another family member.

The possible disadvantages of the corporate fiduciary are the following:

An individual, such as your spouse or another family member, serving as executor will presumably be more likely to have the heirs' trust than would a corporate fiduciary. The individual's strong suit usually is his or her knowledge of the deceased person, his family and financial set-up. Also, individuals serving as executors often elect not to accept fees for their services, to the benefit of the persons receiving property under the will.

Possible disadvantages to an individual serving as an executor include:

You may be able to get the benefits associated with both a corporate fiduciary and an individual executor by naming one of each as co-executors. State law will normally give you the right to determine the categories of estate decisions that require both their consents, those that only the corporate co-executor can decide (such as dealing with investments), and those that only the individual co-executor can decide (such as more personal matters, like determining which pieces of personal property goes to which beneficiaries).

Guardianship and Running Your Business During Probate

If you have minor children, this fact should be reason enough to have a will. While a court will not absolutely be bound to appoint the guardian that you have named in the will, your wishes normally will be respected. After all, you care about, and know, your children much better than any judge who will appoint their guardian, so why shouldn't he or she go along with your selection?

Types of Guardians

There are two types of guardians that your children will need: a guardian of the person and a guardian of the estate. The guardian of the person is the one with whom your child will live; this person will stand in your shoes to make the typical decisions that are made by a parent for his or her child. The guardian of the estate is the person who has the responsibility of managing your child's wealth (which came to the child from your estate, or from other sources) while the child is a minor.

The same person can—and usually does—serve both as guardian of the person and guardian of the estate. But, this does not have to be the case. You might have the situation where there is a family member who you would want to raise your children in your absence, but who you think is not able or willing to take on the task of managing the children's assets. In this case, you could designate someone else (or a corporate fiduciary) to handle only the money matters.

Agreeing on the Guardian

Make sure that you and your spouse agree on the same guardian and that this agreement is reflected by having the same person (or persons) designated in each of your wills. You might think that this would not be a big deal, since only the guardianship provision in the second-to-die parent's will would normally be utilized (guardianship automatically falling to the surviving spouse after the first spouse's death), but there are at least two situations where a failure to agree on a guardian could cause a problem. First, if both spouses die in a common disaster, the judge is faced with each of the wills nominating a different guardian. Second, if anyone contests the appointment of the person nominated in the surviving spouse's will, the fact that the other spouse died wanting another person appointed might add fuel to this action.

Requirement for Bonds

If you truly trust the person who you nominate as your children's guardian, you should normally have your will give this person the greatest possible authority to deal with your child's property, and should consider waiving the requirement that the guardian be required to post bonds with respect to the property subject to the guardianship. 

Doing this should cut down on the number of times that the guardian (or the guardian's attorney) has to go to court for permission to enter into transactions necessary for management of the property. If you really don't trust the guardian all that much, then by all means don't give him or her such wide powers to deal with the property and don't waive the bonding requirements, or consider appointing a separate guardian of the estate.

Running the Business During Probate

If you want your executor to continue to have your business run as a going concern once it becomes an asset of the estate, you'll need to give the executor the authority to do so. But, because the law looks at small businesses as among the most risky investments to keep in your estate, you may find that your executor will not agree to serve unless you include in the will a provision that will exonerate it for losses to business profits or value that occur during the period when it stays in operation.

Even with such an exoneration clause, an executor may not be willing to accept the office if taking control of an ongoing business is part of the job. As a fiduciary, the executor can't share in any of the profits if it does a bang-up job of running the company; it can only be exposed to the time requirements and the difficulties of operating it under difficult circumstances (and possibly the hostility or threatened lawsuits from heirs). This makes it all the more important that you have a concrete and workable plan for the succession of your business's management and ownership.

Providing Income During Probate

Your will should provide your executor with the authority to pay your family amounts needed for support during the period of estate administration. Although your executor (or even your administrator, if you died without a will) could get a court order allowing this even without a will provision, including such a provision may speed up the process and cut down attorney expenses and court fees.

Minimizing Probate Costs and Delays

Probate. Utter the word to almost anyone and be prepared for exclamations of hostility and disgust. But, what is probate? Can it—and should it—be avoided?

State probate courts have vital and necessary duties to perform:

The system is meant to protect the decedent's creditors, the decedent's heirs, and the interests of the taxing authorities. But these protections, even if they are necessary, create significant costs (mostly attorney and executor fees) and may also delay and complicate distributions of the assets to the heirs.

Many states have created expedited systems for dealing with smaller estates (for example, estates under $50,000), or those that contain no real estate. But even if you believe that the value of your estate will far exceed the amount that would qualify for these provisions, there are things that you can do to reduce some of the costs and delays associated with probate. Some of the major strategies for doing so are discussed below, along with possible drawbacks that may be associated with each.

Lowering Probate Costs

Having a will not only helps ensure that the people whom you want to have your property will in fact get it, but will also help reduce expenses and delays. When you have a will, you name an executor. 

Although an executor has basically the same duties as an administrator (which you would have in the absence of a will), the law gives much wider powers and authority to the executor. 

One effect of this is that an executor often will not need to get prior court approval for the same kinds of actions that an administrator would. This usually means less delay, and smaller court and attorneys' fees.

Evaluate Whether to Hold Assets in Joint Tenancy

It seems that everyone has heard about joint tenancies as the magical probate-avoiding device. And while it's true that probate will be avoided on the death of the first joint tenant, this doesn't apply at the survivor's death. Further, although many types of assets may be held in joint tenancy (homes, cars, bank accounts, investments), some items, such as furniture, collectibles, and other personal effects, do not lend themselves to ownership by way of a joint tenancy.

Life Insurance Not Paid to the Estate Is Not Subject to Probate

Under the laws of most states, life insurance proceeds that are paid to a named beneficiary (rather than paid to the estate) are not subject to probate. This means that the proceeds are normally quickly paid out to the beneficiaries of the insurance policy. This is often the best source of liquidity when other assets are held in probate. 

If you are concerned that there won't be enough liquid assets in your estate unless you name your estate as beneficiary, consider this instead: name a trusted family member or the trustee of a testamentary trust as beneficiary of the policy (if the trustee is also the executor, make sure this person is designated in the insurance policy in his capacity as trustee, rather than as executor). Provide directions outside of your will that you would like the recipient of the proceeds to make them available as loans, to the executor, as needed.

Property in Living Trusts Are Not Subject to Probate

Property contained in trusts created during your lifetime (living) trusts are not subject to probate. In contrast, trusts created at death, by means of your will, must go through probate. There are two general kinds of lifetime trusts that will avoid probate: irrevocable trusts (trusts in which you give up the right to change the terms of the trust or get the property back) and revocable trusts.

Although an irrevocable trust can successfully be used for reducing both federal and state income and death taxes, as well as avoiding probate, it's not a device that should be entered into without a lot of thought, planning, and competent professional advice. "Irrevocable" is a long time. Although it's true that you may be able to get a court to set aside your irrevocable trust because of changed circumstances, this requires a court action, legal fees, and the results are not certain.

When you read an article or hear an interview with someone talking about the use of a living trust to avoid probate, the discussion is probably referring to revocable living trusts. So what's the problem? There are some negative factors about revocable trusts that you should keep in mind:

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