What Is Estate Planning?

Planning for the future is a major component of wealth management, and that includes thinking about your legacy. An estate plan ensures that your wealth is shared with the people, charities and causes closest to your heart.

Estate planning defined

Estate planning is the process of deciding how you want your personal and financial assets distributed after you pass away. An estate plan also specifies how you want to live out your later years. What are your wishes in the event of extreme illness? Who do you want making financial and medical decisions on your behalf? These are the questions to consider when making an estate plan.

Who needs an estate plan?

The word estate can be misleading. It may sound like an estate plan is only for ultra-wealthy people. But an estate simply refers to your financial assets, whatever those may be. So regardless of whether you consider yourself wealthy, an estate plan may benefit you.

Not only does estate planning ensure that your assets are divided as you intend, it also protects your loved ones. Without a plan, the state where you're a resident will take over your assets when you pass away and divvy them up according to state law. That means your spouse and children may not receive as much support as you would have left them, and the state could decide who looks after your children if your spouse has also passed away. This is why an estate plan may be especially important if you're divorced or have chosen not to get married—often, state laws reflect more traditional family arrangements, meaning things may not be left as you want them if there's no plan in place.

How to choose your beneficiaries

The first step in estate planning is taking stock of your assets. You'll need to account for houses, vehicles, financial accounts and family heirlooms such as antique furniture, artwork and jewelry.

Then, decide who will inherit these assets and how. You can leave everything to one person, such as your partner. Or you can distribute percentages of the estate to several heirs—for instance, dividing it equally among your children. If there are specific assets you want to leave to particular people, you can stipulate that as well.

If you'd like to establish a philanthropic legacy, you can also donate all or part of your estate to a charity. You can divide your assets among your closest family, friends and chosen charities to ensure that everyone you care about is supported.

What does estate planning include?

An estate planner or financial advisor can tell you which documents your circumstances require. But as a general rule, you'll need the following:

• Trusts and wills: You need a trust or will to define how your assets should be distributed. A financial advisor can help you decide which structure is best for you.
• Guardianship designations: This specifies who will care for your children if you and your spouse or partner should pass away while they're minors.
• Retirement plans and life insurance: Include documents related to any retirement accounts and life insurance policies you have, as well as information about the beneficiaries for those.
• Powers of attorney: Power of attorney, or POA, gives someone else the right to make decisions for you if you're unable to speak for yourself. There are several types of POA, so discuss them with your estate planning advisor.
• Advanced medical directives: These include a medical POA, do-not-resuscitate orders and a living will.
• Letter of intent: If you have certain wishes regarding your funeral or final arrangements, you can include them in the letter of intent, which is typically more detailed and personal than a will. This is also where you can share any value you want to pass on to your family and make requests about how your gifts are used.

Tax obligations—and opportunities

Tax laws surrounding your estate are complex, so you may want to work with a tax advisor to determine your best strategy. But you should be aware of estate taxes and transfer taxes. Depending on the size of your estate (meaning the total worth of your assets), a federal estate tax may be assessed after your death. Some states have an estate tax as well.

If you're subject to an estate tax, you may be able to reduce it by transferring some assets as gifts before your death. In that case, you'll need to be aware of transfer taxes that you or the gift recipient may owe. Depending on where you live, the state may charge your beneficiaries an inheritance tax as well.

A tax advisor can help you determine what you and your beneficiaries may owe and how to minimize your tax burdens.

So, what is estate planning? It comes down to being intentional about passing on your wealth to children, causes and trusts. When you define your wishes, you reassure your loved ones that they're doing right by you even under challenging circumstances.