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What You Need to Know About Estate Planning Today

Christine Benz

Note: This video is part of Morningstar's October 2014 5 Keys to Retirement Investing special report.

Christine Benz: Hi, I'm Christine Benz for It's 5 Keys to Retirement Investing week. Joining me to discuss the topic of estate planning and essential estate-planning documents is Deborah Jacobs. She is an estate-planning expert. Deborah, thank you so much for being here.

Deborah Jacobs: I'm happy to be here. Thank you for having me.

Benz: We are focusing on retirement planning all this week, and we'd like to look at estate planning. What essential documents should every pre-retiree and retiree be thinking of as they are setting the groundwork for their estate plans?

Jacobs: Many people, when they think about estate planning, think it’s a way of giving away their stuff, dealing with things that happen after they die. But the first chapter of my book, Estate Planning Smarts, has absolutely nothing to do with giving away your stuff. It involves planning for later stages of life, including events that could happen without much warning.

So, I recommend that everybody have a durable power of attorney first of all, which gives somebody authority to step into your shoes to handle financial matters if you, for any reason, can’t do it for yourself--which might just be temporarily, say, when you are in the hospital. As a matter of fact, this particular document is something that I recommend parents get their 18-year-olds to sign as they go off to college. So, this is absolutely not just for old folks.

The other document, in a similar vein, is the health-care proxy: another one that everybody over the age of 18 should have. This authorizes someone to make decisions about your medical care if you can’t. It’s sometimes called the health-care power of attorney, which can be a little bit confusing because it shouldn’t be confused with the durable power of attorney, which just applies to financial matters.

Often now, when you are admitted to a hospital for any reason, they will ask you whether you have a health-care proxy. They'd like to have it in their files. In some hospitals now, if you don’t have one, if you haven’t done one, they have in their standard admission paperwork a proxy that you can fill out. So, that’s really important.

The other thing that goes with that is a living will expressing your preferences about end-of-life care. Some lawyers who prepare these documents combine the language about that in the health-care proxy. So, you might have one document covering both those issues.

Everybody should have a will. Some people like also to have a living trust, which can serve a couple of different purposes both while you are alive and after you die. But even if you go that route and have a living trust--which some people prefer in certain states because it doesn’t need to be admitted to probate unlike a will and it doesn’t need to become a public record--you do need to have a will because there are some things that you can only do in a will, namely appoint a guardian for minor children. It's very important for young parents and even people who become parents later in life to take this step in a will. If they don’t do that, a court will do it for them.

The other reason to have a will, even if most of your stuff is being passed through a living trust, is because inevitably there are assets that don’t get put into the trust. So, the will can sweep things up even if your main transfer method is through the living trust. These two documents are very often confused. A lot of people don’t understand the difference between a will and a living trust.

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Benz: Deborah, I want to talk a little bit about beneficiary designations. People might have those associated with their various financial accounts. How do those interact with those documents that you've just outlined?

Jacobs: Yes. That's very important. Although many people do not consider beneficiary designations as estate-planning documents, they for sure are. And a common misunderstanding is that retirement assets, for example, pass under a will or a living trust and they absolutely do not. They are passed according to the beneficiary designation forms that you fill out when you open the account and which you can later amend.

The same goes for the proceeds of life insurance policies. It's enormously important to fill out these beneficiary designation forms, naming not just a primary beneficiary but also an alternate beneficiary--sometimes called the contingent beneficiary--who can benefit from those proceeds or those assets if the primary beneficiary dies before you.

With respect to retirement accounts, if you do not name a beneficiary on the IRA beneficiary designation form or on the beneficiary designation for your 401(k) or 403(b) or whatever your employer's plan happens to be, your heirs may lose a lot of the income tax benefits that are associated with these accounts--namely, instead of being able to, in the case of IRAs, for instance, stretch out withdrawals over their own life expectancy, it might be necessary for your heirs to withdraw the assets as soon as within five years of your death.

In the case of a Traditional IRA, they would need to pay income tax on all that money at the time that it comes out of the IRA wrapper. So, it's very important to fill out beneficiary designation forms and keep them up to date.

In the life insurance arena as well as in the retirement arena, there was actually a year or so ago a U.S. Supreme Court case in which an ex-wife and a widow battled in court for 10 years over who was entitled to the husband or ex-husband's life insurance policy and--believe it or not--the ex-wife won because this fellow had not changed his beneficiary designation on his life insurance policy, even though it'd been more than 10 years since he'd been married to this woman.

Benz: So, obviously, it's easy to hop online and make those beneficiary designation changes, but how about the other documents? Increasingly, there are services that offer to create an estate planning for you--to draft these powers-of-attorney documents, for example. Is that advisable? You certainly could save by doing that, and I think that's the big attraction. Are there drawbacks? And what should people know before they go to one of these [do-it-yourself] estate-planning kits?

Jacobs: I like to collect stories of people who got burned this way because I think it's the best way to teach people about all the pitfalls of doing it on your own. And I really discourage people from doing this because there are just so many things that can go wrong.

At the same time, I thoroughly understand the reluctance to spend a lot of money on estate planning, because it's something that you will never live to see the benefits of, even if your heirs do. So, what I recommend that people do instead is to feel free to negotiate--don’t be intimidated--to negotiate with lawyers over what they are charging you. If you have a relatively simple estate plan, you can bet that the lawyer who is preparing these documents is using some software themselves to do it. They are not sitting there writing these documents with a quill pen.

So, you should negotiate to pay for the lawyer's time spent filling out the appropriate questions on the software so that it generates the document properly and in conversation with you. The flip side of this is that I do think that people need to be respectful of their professional's time, understand that the meter will be running, get all of their materials together in advance, and not treat your lawyer as a shrink who you're going to tell all of the problems with your kids and so forth when you go to do your estate plan. Be very concise in summarizing your estate-planning goals. I hope that people will use my book to help identify their goals and to help them save money when they do meet with a lawyer. But I strongly discourage people from doing these things themselves. It's like trying to fill your own tooth.

Benz: I would assume you would also say people can save some time and save some lawyer fees if they come into these engagements with some of the basic stuff that they need. So, information on their financial assets and so forth.

Jacobs: A list of their assets, a list of their heirs, a list of people they want to benefit. And I also like to have people run their beneficiary designation forms by their lawyers as well. A lot of estate planning, de facto, is now occurring outside of the lawyer's office with these so-called nonprobate assets--life insurance, retirement accounts, savings, bonds, for instance. All of these assets pass outside of a will or a living trust.

Retirement accounts, in particular, are one of the main assets for a lot of people. When you think about what your net worth is, it probably consists primarily of your home and your retirement accounts. So, I think you need to make the lawyer aware of everything that you own, which is also important for tax planning, though fewer people now will be affected by estate tax than in the past.

Benz: Deborah, thank you so much for being here. Thanks for providing such a comprehensive overview of essential estate-planning documents.

Jacobs: Thank you for having me.

Benz: Thanks for watching. I'm Christine Benz for