Trust & Estate

What is Estate Planning and Why Do High Net Worth Individuals Need It?

What is Estate Planning and Why Do High Net Worth Individuals Need It?
March 22, 2024

Estate planning is the process of anticipating and arranging for the management and disposal of a person's estate during their life, in the event they become incapacitated, and after death. It involves the bequest of assets to heirs and the settlement of estate taxes.1 For high net worth individuals and families, estate planning is especially critical to ensure their wealth is preserved and passed on according to their wishes while minimizing taxes and legal challenges.

Key Components of Estate Planning

Some of the key tasks involved in estate planning include:1

  • Making a will
  • Setting up trusts to limit estate taxes
  • Naming an executor and beneficiaries
  • Establishing a guardian for living dependents
  • Making charitable donations to limit estate taxes
  • Creating or updating beneficiaries on plans such as life insurance, IRAs and 401(k)s
  • Setting up funeral arrangements
  • Establishing annual gifting to qualified charitable and non-profit organizations to reduce the taxable estate

While estate planning is important for everyone, it is especially crucial for high net worth individuals and families who have more assets to manage and often face more complex financial situations. Without proper planning, a significant portion of one's estate can be lost to taxes or distributed in a way that does not align with their wishes.

Minimizing Estate Taxes

One of the primary goals of estate planning for high net worth individuals is minimizing potential estate taxes. Federal estate taxes can be as high as 40% and can significantly reduce the wealth passed on to heirs.2 However, there are several strategies that can be used to minimize these taxes:

  1. Setting up irrevocable trusts: Assets placed in an irrevocable trust are removed from the taxable estate, thus lowering the estate tax bill. These trusts can also provide asset protection from creditors and lawsuits.2
  2. Making charitable contributions: Charitable donations made during one's lifetime or at death can reduce the size of the taxable estate and lower the estate tax liability.1
  3. Utilizing the annual gift tax exclusion: As of 2024, individuals can give up to $17,000 per recipient per year without incurring gift taxes. This can be a way to gradually transfer wealth while minimizing taxes.3
  4. Creating a family limited partnership: Family limited partnerships allow high net worth individuals to transfer wealth to their heirs at a discounted value for gift and estate tax purposes while still maintaining control over the assets.4

Planning for Incapacitation

In addition to planning for the distribution of assets after death, estate planning also involves preparing for the possibility of becoming incapacitated. This includes designating trusted individuals to make financial and medical decisions on one's behalf. Key documents for incapacitation planning include:2

  • Power of attorney: Gives a designated agent the authority to make financial decisions
  • Advanced healthcare directive/living will: Specifies end-of-life medical treatments
  • Healthcare power of attorney: Designates an agent to make medical decisions

Without these documents in place, the court may have to step in to appoint a guardian, which can be costly, time-consuming, and may not align with the individual's wishes.

Avoiding Probate

Probate is the legal process of administering an estate after someone dies. It can be a lengthy and expensive process, especially for high net worth estates. Strategies to avoid or minimize probate include:2

  • Creating a revocable living trust: Assets placed in a living trust bypass probate entirely. The trustee can efficiently distribute assets to beneficiaries without court involvement.
  • Utilizing transfer on death and payable on death accounts: Certain accounts, such as bank accounts and brokerage accounts, can be set up with beneficiary designations so that they transfer automatically to the named beneficiary upon the owner's death.
  • Holding property in joint ownership: When property is owned in joint tenancy with right of survivorship, it passes directly to the surviving owner without going through probate.

Protecting Beneficiaries

Estate planning is not just about minimizing taxes but also about protecting beneficiaries. This is especially important for high net worth individuals who may have concerns about heirs mismanaging their inheritance. Some strategies to consider include:

  • Creating spendthrift trusts: A spendthrift trust can be set up to distribute assets to beneficiaries in a controlled manner, such as in installments or for specific purposes like education or healthcare. The assets in the trust are protected from the beneficiaries' creditors.5
  • Establishing a special needs trust: For beneficiaries with disabilities who receive government benefits, a special needs trust can provide supplemental financial support without jeopardizing their eligibility for public assistance programs.5
  • Prenuptial and postnuptial agreements: For high net worth individuals concerned about preserving assets in the event of a divorce, prenuptial and postnuptial agreements can be used to specify how property will be divided.4

The Importance of Reviewing and Updating an Estate Plan

Estate planning is not a one-time event but rather an ongoing process that should be reviewed and updated regularly, especially after significant life changes like marriages, divorces, births, and deaths. Failing to update an estate plan can result in unintended consequences, such as assets being distributed to the wrong beneficiaries or incurring unnecessary taxes.3

High net worth individuals should work closely with a team of professionals, including an estate planning attorney, financial advisor, and CPA, to develop and maintain a comprehensive estate plan tailored to their unique needs and goals. This team can help navigate the complexities of estate planning and ensure that the plan remains up-to-date and effective.

Communicating Wishes to Family Members

Finally, it's important for high net worth individuals to communicate their estate planning wishes to their family members. This can help prevent conflicts and misunderstandings after their death. While the specifics of the estate plan need not be disclosed, it's advisable to have a general conversation about the goals and values driving the decisions.3 This can provide peace of mind for both the individual and their loved ones.

In conclusion, estate planning is a critical component of wealth management for high net worth individuals and families. By taking proactive steps to plan for the distribution of their assets, minimize taxes, and protect their beneficiaries, they can ensure that their wealth is preserved and passed on according to their wishes. Working with a team of experienced professionals and regularly reviewing and updating the plan can provide the best outcome for all involved.