Personal Finance 101: The Basics of Estate Planning

A Tutorial on Estate Planning: What You Need to Do to Make Sure You’re Covered

101A few days ago, I made an offhand mention of my will, which drew a lot of questions from readers about their own wills and other things they need to be taking care of in terms of being sure that their estate planning is in order. After reading those questions, I thought it would be worthwhile to prepare a short tutorial on estate planning.

1. Life Insurance

Ask yourself three questions: are you married? Do you have children or other dependents? Are you planning on marriage or children in the near future? If any of those have a “yes” answer, you should have a life insurance policy of some sort.

Life insurance really isn’t a complicated game. Most of the options out there are beneficial only in certain situations – whole-life insurance plans, for example, aren’t a bad choice if you’re buying for a young child. For most young and middle aged adults, however, the best option is term life insurance. Just shop around a little bit for a good policy and get one with a 20 or 30 year term (covering the period where you might have children under your roof).

How much should you get? An actuary friend of mine made a good suggestion. Take the number of people in your household, multiply that by five, then multiply that by your annual salary. From that, subtract your net worth.

So, let’s say you have a total of four people in your household, you make $40,000 a year, and you have a net worth of $100,000. Multiply the number of people in your house by five, giving you twenty, and multiply that by your annual salary, giving you $800,000, and subtract your net worth, giving you $700,000. That’s how much your term life insurance benefit should be.

That’s a good way to estimate and will give you a very strong number to ensure the security of your family over the long term. Be wary of life insurance loopholes that insurance companies may try to dupe you with.

2. A Will

A will is basically a simple document stating what you want to happen to your property in the event of your passing. After you pass away, the will is used in public court in a process known as probate to make sure your wishes are handled fairly. For most people, a will is an essential document – if you have an executor you trust and a well-written will, your stuff will go where you want it to go.

Wills are quite simple to set up, but you still should consult an attorney to make sure you’re following all of the procedures that apply in your state.

Key things to think about:

Who should be the executor? It should be someone you trust deeply.
Who should have my assets? Also, how should they be divided up?
Who should have my personal heirlooms?
Who would gain custody of my children? Talk this over with the people you have in mind and make sure they’re okay with it.

3. A Durable Power of Attorney

A durable power of attorney is a document that you sign giving someone else the power to handle your finances and legal affairs should you become incapacitated, but it expires upon your death. Basically, you’re saying to everyone in the world that you’ve designated a particular person to represent you if you’re incapacitated for some reason. The person you designate, called an “agent,” is legally bound to act in your best interests, and you can revoke this person at any time, so you can’t just get ripped off by someone.

If you’re married, by default your spouse has power of attorney if you’re incapacitated. The only benefit of such a document is if you’re unmarried or if you want to be covered in the event of an accident that incapacitates both you and your spouse.

In truth, this is most useful simply to designate one person that’s in charge of things should you become sick. Without it, lots of people can potentially try to claim power of attorney and a legal mess can ensue while you’re incapacitated. If things are basic and straightforward, this document is perhaps not vital, but if you have a lot of assets and a lot of interested parties, it’s probably worthwhile to designate someone. As with other documents, contact a lawyer and get it done right.

4. A Living Will

A living will states the health care directives you want to be followed should you be unable to tell the doctors yourself. Do you want to be on life support for a long time at the desire of your family, or do you want to spare them the anguish of a long and drawn-out scenario? What about methods to save your life? Some people have strong feelings on these issues and should have a living will – others can simply trust their spouse or whoever they’ve designated to have power of attorney over them. If you want to be certain your specific wishes are fulfilled, make sure you’ve prepared a living will.

5. A Master Document for Your Survivors

A few days ago, I wrote about creating and maintaining a master financial document for your survivors. Basically, this is a document explaining all of your assets and debts and everything that needs to be done to close them out and get the assets in your accounts to the people that should have them.

It’s a great thing to have – I know from experience that such documents can be an enormous help to a family burdened with grief. Take the time to prepare such a document and make sure the important people in your life have a copy.

What About a Trust?

Many financial advisors speak lovingly about setting up a living trust in order to help with the process of transferring an estate after you pass on. These can be very effective because they allow you to avoid the court system and have your estate directly transferred to your beneficiaries upon your passing without the costs and waiting required with probate, but there are some costs – mostly legal fees – in setting one up.

Basically, if you don’t have children or you don’t have any significant assets (a net worth of less than several hundred thousand or so), a living trust probably isn’t worth the effort. However, if you do have children, particularly adult children that you wish to transfer your assets to when you pass on, you should definitely think about a living trust. As I have two young children, I have been researching the pros and cons of doing this and am considering setting one up simply so that if something happened to my wife and I, they would be very well protected.

My advice if you’re considering this? Get a few quotes from various lawyers on what they would charge to set one up for you. Don’t do this with a “create your own living trust” package – this is important enough to make sure it’s done correctly by a legal professional.

One Last Thing…

Write a few letters. Write one to your wife telling her how much you love her. Write one to your husband telling him that you loved him every day of your life. Write one to your kids telling them how much they mean to you every day. These things will mean so much when you pass away and they can no longer hear your voice – they all likely love you more than you think they do.

Doing all of these things feels rather grim, but remember you’re doing them to help your loved ones in the future. Think about how much you love the important people in your life and consider how much help your small effort now will be for them later. Then take the time and get these things done.

Trent Hamm

Founder & Columnist

Trent Hamm founded The Simple Dollar in 2006 and still writes a daily column on personal finance. He’s the author of three books published by Simon & Schuster and Financial Times Press, has contributed to Business Insider, US News & World Report, Yahoo Finance, and Lifehacker, and his financial advice has been featured in The New York Times, TIME, Forbes, The Guardian, and elsewhere.