Updated on 09.04.14

Personal Finance 101: The Basics of Estate Planning

Trent Hamm

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.

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  1. Frugal Dad says:

    I like the formula your actuary friend provided better than the typical “10 times annual salary” suggestion. I think 10x salary is an oversimplified formula, and the one you provided gets you closer to your actual insurance needs.

    The letter-writing idea is also a great one. I’m fortunate to still have my grandfather in my life, but about ten years ago he wrote a letter and gave it to me around my 20th birthday. I still refer to that letter often for inspiration. The power of the written word from a loved one lives on for an eternity.

  2. GBlogger says:

    Nice summary, Trent, on a topic that I think definitely can use the coverage! We have all of these and a living trust — which we put in place shortly after the birth of our first child. If you go with a living trust, it changes some of these documents (if you already have them). For instance, your will then essentially dumps everything into the trust, and the trust takes care of things; and your life insurance contingent beneficiary may become the trust; and so on. I am a fan of the trust also because it gives us some additional options if my wife and I were both to pass — such as having the guardian of our children getting access to the money in the trust for the kids, but with some checks (a separate trustee).

  3. Jo says:

    I would add “Plan your Funeral” to the list. At minimum set out in detail your wishes (organ donation, burial (green burial) v. cremation, charities to benefit, where and how you want the service, hymns/songs). You may also wish to look at pre-paying a funeral which in some jurisdictions is a decent investment.

  4. Eden says:

    Nice write-up!

    My only question is- why whole life insurance for a young child? Why any life insurance at all really? Children don’t earn an income. If, God forbid, a child passes away, you should have cash in an emergency fund to cover expenses or you can purchase a rider on your own term policy to cover that.

  5. Saving Freak says:

    Life insurance is definitely the number one thing on any list. If you do that one wrong you have set those who you leave behind with headache after headache. Another good suggestion on the amount to get is if you end up with less than 500K needed from Trent’s formula above go ahead and get 500k of life insurance. This is where the price break is and you will pay about the same amount for any coverage that is within a few hundred thousand of 500k

  6. "Mo" Money says:

    Life insurance is an important tool in personal finance, but I disagree with whole life for anyone. It’s expensive insurance, and the saving plan is not that good.

  7. Andy says:

    This is great advice. I really need to set up a will. I also just read an article on the NYTimes blog “Well” about how living wills can be unclear when they are needed, i.e. everything looks fine when you make it, but if someone has to use it then disagreements often arise about the meanings of things. So, just make sure that is as clear as possible.

  8. Lisa says:

    Cool summary, Trent. Thanks. From a personal finance perspective, when I called a couple of lawyers last summer to get an idea of what it would cost to have a will drawn up, I was quoted from between $850 – $1500. (I’m single with no dependents and not many assets, so the will would have been very simple.) Instead of going to a lawyer, I ended up purchasing a copy of Quicken WillMaker Plus for $30 and writing the will myself. If you need to get your affairs in order and your estate planning needs are pretty straightforward, it’s definitely worth considering the software route.

  9. Chris says:

    Brilliantly done! I like that formula for life-insurance.

  10. !wanda says:

    Do you really need life insurance if you’re married and aren’t planning to have children?

  11. We have a trust and I think it’s essential for anyone who owns a home (at least in California) since the value of the home alone is worth preventing having to go through the probate process.

    We have term life insurance but we’ve been considering purchasing whole life insurance as a way to avoid tax implications later–one of the problems about socking away money in retirement accounts is that by age 59 1/2, a lot of people are taxed at rather high rates b/c of the income levels and there are some who might benefit from some of the universal life insurance policy options that exist today. I’m no financial expert but I’m looking into it since I don’t want to have to pay high taxes once I start retirement withdrawals, albeit in 20 years.

  12. !wanda says:

    @Andy: I read that article too, and what I took away from it was that it is very easy for medical situations to get very complicated very quickly, making it impossible to create a comprehensive living will. Therefore, it’s most important that you also communicate your general values with your loved ones, particularly the one who will have power of attorney, so that they can carry out the spirit as well as the letter of your living will.

  13. boardmadd says:

    Whole Life for Children is unnecessary, IMO. The goal of having life insurance is to provide an income for those who will need it in the even that yo uare no longer there. Underaged children tend to not fit this scenario. You may want to have burial expenses insured; and that can be added to your existing term life insurance policy as a rider and for little expense.

    I like the formula for term life, that’s a great way to determine the actual need (at 40, the insurance gets a little more expensive, so having a clear number that appropriate is helpful).

  14. Johanna says:

    @!wanda: If you have a mortgage payment that won’t be covered on your spouse’s income alone, or if your spouse earns much less money than you do (or doesn’t work at all), then life insurance could be a good idea. There may be other examples too.

  15. dj says:

    Very thoughtful post. A life can change in a second: car accident, heart attack, and can devastate a family. It’s difficult, but get it done and take the emotion out of it. Even discuss funeral plans (cremation/burial/). They can be very expensive and you don’t want to be making financial decisions at that moment. I’ve seen it with a widow getting taken, pushing flowers, services, high-end caskets, etc. It’s unfortunate, but funeral directors are like insurance agents, financial planners, and stock brokers. Lots of fees. I went to my bank recently and they pushed annuity. A financial advisor pushed life insurance. Why? Because they are lucrative to them (i.e., fees).

    Checkout: Nolo press. They have some of the best books on these issues. Also a good financial column is Scott Burns in the Dallas Press.

  16. Steve says:

    What about a young couple that doesn’t have kids yet, but plans on having N children in a few years? Should we estimate N now and get insurance based on that, estimate N but wait until the first pregnancy, or get a smaller amount of insurance now and increase it with every addition to the household?

  17. tom says:

    Shouldn’t the calculation be:

    (Number of people in your family – you) x 5 x annual salary

    If you pass away, you don’t need the money, only your family.

    I ask because I need to purchase life insurance and this would make a big impact on how much I would buy.

  18. James says:

    Hi Simple Dollar,

    Another wonderful post as usual.

    Just wanted to quickly comment, your estate planning will probably be modified by the area in which you live. For example in DC, you don’t have the go to probate if your assets are under a certain dollar limit, I think its a million or so, but am not exactly sure. The main point here is that estate planning should not be one size fits all.

    Also, you might not need a separate life insurance policy if you are already covered through your work.

    Just wanted to add my 2 cents!



  19. constant learning says:

    @wanda: do not underestimate the impact of a death. It is more than a financial blow; the emotional impact may affect the survivor’s ability to function at work as well.

    My mother was diagnosed with brain cancer at age 52. I was her primary caretaker for the last six months of her life. Not only did this disrupt my job during my mother’s life, but the emotional and physical impact still made it difficult for me to function for at least a year following her death. If it was not for the patience of my boss, I would have been fired or given a long leave of absence.

    Life insurance is intended to care for the survivors and is one way to show your love to your family after you are gone. It also can assist with the financial burden if the survivors, in their grief, are unable to go back to work immediately or need to take a less demanding job for a time until they are able to regroup.

  20. If you buy a life insurance policy on your child you’re basically gambling that your child is going to die young. I don’t know why anyone would want to do that.

  21. Mary Frances says:

    My husband used to work in the life insurance industry, and the reason for getting a whole life insurance policy on a young child is to ensure their insurability in the future. For instance, if the child was later diagnosed with a medical disease that disqualified them from life insurance, they would already have a whole life policy, that they could then upgrade as needed as an adult. Of course you have to make sure the policy has the option of increasing coverage later in life.

    Trent, how are you evaluating the adequacy of the formula provided by the actuary? When we purchased our term insurance we considered what we would want to happen if the other spouse died. For instance, if my husband died, I would want to pay off all debt including mortgage and have enough money in investments to generate living expenses so that I can stay home with our child(ren). I would also want an additional sum set away to help care for his parents as they age, since they do not have any savings. We calculated how much cash would be needed to meet these goals and then purchased the appropriate policy. I don’t know that I would feel comfortable using a formula, since each family’s needs are so different.

  22. Mary Jo says:

    If a child is diagnosed with a serious, but “livable” illness (like diabetes), he/she may not be eligible for term life insurance as an adult. If whole life insurance is purchased before the diagnosis, this may be the only life insurance policy ever available to the child once he/she grows up.

  23. !wanda says:

    @Tight Fisted Miser: Whether you buy insurance doesn’t affect whether your child is going to die young…

  24. James says:

    Nice post, Trent. The last section on writing letters to loved ones really hit home for me. Love is eternal, there’s no better way to spend our short time here than to share our love with others.

  25. Jamie says:

    It seems to me that the most underbought insurance is actually disability. I am amazed at how many employers have not offered it, yet it is potentially more debilitating not to have disability insurance than it is to not have life insurance. Crazy!

    You might want to add that to your list!

  26. Tucker says:

    I am in the midst of settling my mom’s estate (one reason why I got serious about finances and found this site).
    A couple mistakes I made: my sister’s car was in my mom’s name, and I didn’t get it signed over before Mom died. Now, it has to go through probate, instead of already being in my sister’s name. Lesson: if you know it’s coming, get as much done as you can before.

    I also have discovered that her 2006 taxes were never filed. So now the estate has to cover any penalties. Lesson: sit down and make sure you understand the whole financial picture–not just the estate part of it.

    One thing I did right was have a joint checking acct. with Mom. So a) I could keep paying bills and b) in Ohio at least, that account doesn’t have to be part of the estate, since it’s a joint account.

    One other thing: don’t assume that the hospital has the living will, even if your loved one has been there before. I thought my mom had authorized certain steps, when the hospital had done them as standard, because they didn’t know differently.


  27. Donna says:

    Just wanted to respond to the comment regarding waiting until you are expecting a child to obtain life insurance, I work for group insurance and if you apply for coverage while pregnant you will not be given the coverage. Also the life insurance your employer provides or you obtain through your employer is very expensive to convert and keep if you leave he employer or loss your job.

  28. Bella says:

    I know how complicated it can be when no will were written… I work in the domain and see how much more fighting there can be without a well done one. It definately is an investment.

    Regarding the letters to our loved ones, is really is a great idea and will likely recommend my clients to write some up!

  29. Bobby Doshier says:

    Hello again. Great article. May I suggest one other thing that is essential: a Durable Power of Attorney for Healthcare. This document should be separate and apart from a financial and legal affairs DPA to protect confidentiality of the maker. Keeping them separate, healthcare providers will not have access to the contents of a financial/legal DPA until/unless it becomes necessary. A Healthcare DPA appoints your agent to act and make decisions on your behalf when you are unable to do so. For many reasons, the healthcare DPA agent may be and very often is different from the financial and legal DPA agent. We have separate DPA’s and have successfully used them for different reasons at different times without releasing confidential information to others without a need to know.

    Our Healthcare DPA was created by a well known estate planning law firm and has some unique features. One can actually force healthcare providers to do as the agent says or they do not get paid from estate funds. This is especially important when physicians follow the hipocratic oath without regard to desires of the agent.

    Again, great article.

    Bob Doshier
    Cotter, AR

  30. Bella is right.

    There is nothing more disheartening than an estate with no will. The lack of which results in in fighting, confusion, and resentment.

  31. Doug Ramsdell says:

    Thanks for all the good advice, Trent & fellow readers.

    I just want to put in a word or two about designating a health care proxy instead of, or in addition to, a living will.

    A health-care proxy is a person (usually a spouse, but it could be anybody) whom you empower to carry out your wishes regarding medical care should you become temporarily (coma) or permanently (brain death) unable to speak for yourself.

    The living will is a great start, but it’s limited: it’s a piece of paper covering whatever specific situations you dream up; the health care proxy is your advocate under ALL medical circumstances and interprets your wishes to fit many diverse and unforeseen circumstances (which a piece of paper cannot do).

    If you’re young and happily married with kids, your spouse becomes your health-care proxy kind of de-facto, but if you’re a single parent, divorced, or expect to be either of those, a health care proxy might be a really good idea (especially if you have deeply held beliefs on feeding tubes, artificial hydration, etc.–stuff that doctors aren’t allowed to make decisions about).

  32. Beth says:

    My first concern is the universal/whole life policy discussion because the agents make more money on these and the company really cashes in with the fact that the clients’ family do not actually get to keep both the policy and the cash value when they die. And if you borrow from your own investment/life insurance, you are charged interest on your own money. Whatever is not paid back is taken out of the face value if/when you die. I have done some research and study recently.

  33. Beth says:

    I have term insurance. The best product value for the price. Then you can just start a REAL investment account like a mutual fund that will provide much better growth.
    Then with the group policy, it is only good while you are employed there, and is usually not enough coverage.

    I agree with the disability insurance, but it costs considerably more than life insurance. More people are likely to be disabled than die.

    One solution to wills and any other need for legal assistance is pre-paid legal. It can be used to help with all kinds of situations like all that small print on all those documents we sign all the time, and even traffic tickets.

  34. Carol says:

    Planning funeral arrangements, including burial lots, would probably be really useful to your surviving relatives. My fatherinlaw recently passed away, which got my husband and I discussing which cemetary we prefer, as his folks and mine are at different cemetaries. I wouldn’t want my children to have to figure this out after we’re gone.

  35. Laura says:

    Do you have any suggestions how to get insurance for someone who is not in optimal health? My husband is the primary breadwinner, but because he has an autoimmune disease (in remission), we haven’t been able to get life insurance for him.

  36. Frank Kelly says:

    I think the calculation

    # of dependents * 5 * Annual Salary

    is off. At least for me. It’s 3 times higher than what I have now.

    I’ve created a spreadsheet to get the detailed costs year over year for 20 years of my term life policy, inflation adjusted, using average day care costs etc. and it came out in line with the 7X to 10X rule of thumb.

    Remember three things
    #1 For most people the goal of life insurance is to replace lost income of a working spouse – so the number of dependents shouldn’t have anything to do with your estimate

    #2 Don’t forget to factor in Social Security benefits to your spouse and children in case you pass. They’re actually quite high.

    #3 Don’t forget to insure a non-working spouse – in this case you WOULD factor in the number of dependents (for daycare etc.) but NOT an Income which is zero.


  37. Sharon says:

    Laura, find a couple of good insurance agents who represent more than one company and get started. He should be able to get some coverage, but he will have to pay a higher premium. Do it NOW while he is in remission.

    If he can get it, and this applies to EVERYONE, be sure to get the disability rider where the premiums are paid should he have to go on disability. My husband paid just 7 months on one life insurance policy when he became disabled 15 years ago. I would be surprised if they offer him this rider, but if they are that dumb, take it!

    And, all you folks sneering at getting a child life insurance, this is exhibit one on why it is a good idea. Take a good look at your own family tree and the diseases on it and make up your mind; however, a nasty injury can change things in a split second.

  38. MCC says:

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  39. An excellent primer all around. As an estate planning attorney, however, I would have a few caveats and additions.

    Regarding life insurance, most adults should have a combination of whole and term insurance — the term should be used to replace income, and can be reduced over time as children grow up and become less dependent, and investments and savings grow. Insurance should also NEVER have “my estate” as a beneficiary, as that may make the proceeds liable to satisfy creditor claims. Whole life policies should be smaller, and cover expenses that will occur with death regardless of age, such as funeral costs.

    And as a brief comment concerning the use of do-it-yourself will software, from a strictly mercenary point of view I’m a big fan. Because of the errors that inevitably arise, over time I end up getting more in additional fees from probating DIY wills than I lost by not drafting proper wills in the first place. Your readers should be aware that every dollar they “save” by doing it themselves may end up costing their heirs two or three dollars after their passing.

  40. Byron Udell says:

    That’s an interesting calculation to find out how how much life insurance you need. Thanks for passing the information along.

  41. Michael Shanabrook says:

    Excellent post–succinct, helpful and well-written.

    With respect to your discussion on Durable Power of Attorney, be aware that in most all states, your spouse DOES NOT automatically have power of attorney over your affairs if you become incapacitated. This is a very common misconception and surprises many people.

  42. Lisa smith says:

    This is great advice ,Life insurance is an important tool in personal finance
    The goal of having life insurance is to provide an income for those who will need it in the even that yo uare no longer there . i also like the formula for term life, that’s a great way to determine the actual need (at 40, the insurance gets a little more expensive, so having a clear number that appropriate is helpful).

  43. Sharon says:

    I just searched for this topic, wanted to point out that Trent neglected to mention here that same-sex couples must take extra precautions to arrange their affairs.

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