Estate Planning 101

Every year in February, we buy flowers, cards, and gifts to celebrate the people we love. Sometimes we forget that there are other important things we need to take care of to ensure that those same people have the resources they need after we're gone, and to maximize the potential benefit to our heirs. Talking about end-of-life plans and drafting wills, trusts, medical directives, and powers of attorney is often either pushed off to the future or avoided entirely. As with financial planning, it is never too early to create and implement an estate plan, and it can be a process that brings peace of mind to you and your family, knowing that, if something happens, there is a plan in place. Below are a few general concepts to help you start thinking through an estate plan before meeting with your attorney.

Last Will & Testament

Purpose of a Last Will & Testament

• Avoid assets passing via the laws of intestacy
• Name your preferred Executor
• Name the Guardians for minor children
• Establish testamentary trusts

The Will is the first piece of a comprehensive estate plan. If you pass without a Will in place, there is obviously no method to discern how you would have preferred your assets to be distributed, and they will likely pass according to the laws of intestacy in your state. This distribution pattern may align with your wishes, or it may not, but it can create more complications in the estate administration process than if you had a Will in place. 

Throughout the drafting process, you can name an individual or corporate Executor, who will be the party responsible for managing the estate administration. (In naming an Executor, you should name a person or entity that you trust, that you believe is competent to administer the estate, and that has a reasonable probability of surviving you.) You have the opportunity in drafting a Will to not only determine how assets will be distributed, but within the same document, you can also name guardians for minor children (a decision which you do not want to leave to the courts) and set up testamentary trusts if needed (more information below). The ability to name guardians for minor children is a good reason for even younger couples to establish a Will. 

Revocable Living Trust

Purpose of a revocable living trust:

• Potential for decreased expenses over probate
• Potential for more privacy than probate
• Likelihood of expedited distribution of assets
• Ability to provide for financial needs in the event of incapacity

Establishing a Revocable Trust during life requires an initial cost (hiring an attorney to consult and draft the document) as well as a time burden (generally, most assets need to be transferred into the Trust's name). Typically, the person or couple establishing the Trust would name themselves as initial Trustee (or Co-Trustees), and name Successor Trustees to take control in the event of death or disability. The primary reasons for establishing a revocable trust during life are to avoid probate and provide for yourself in the event of incapacity. Avoiding probate can offer many benefits, including lower estate administration expenses, greater privacy, and a more expedited distribution of assets. 

If the individual who establishes the Trust becomes incapacitated, a Successor Trustee can step in to manage the Trust's assets for the benefit of the person who established the Trust. The Revocable Trust typically does not provide for any reduction in income or estate taxes. Even though the assets avoid probate, they are still included in the estate for estate tax purposes. (Similar to the Will and/or the Testamentary Trust, the Grantor of a Revocable Trust could also dictate that, at the death of the Grantor, the assets remain in Trust for the benefit of the beneficiaries, giving the Grantor some control after their passing.) 

Testamentary Trusts

Purpose of a testamentary trust:

• Ensure competent management of assets beyond death (e.g., investments, taxes, etc.)
• Control disposition of assets (distributions during the term of the Trust and upon termination) 

As mentioned above, a Testamentary Trust is typically established during the drafting of the Last Will & Testament. In other words, this can be accomplished in the same document as the Will. The Testamentary Trust is only established at the death of the person who established it through their Will (the Testator), so it offers none of the benefits of the Revocable Trust outlined above. Similar to the Revocable Trust, the Testamentary Trust offers no benefits in reducing estate taxes.

The primary focus of the Testamentary Trust is for the Testator to have some level of control over the assets after their passing. If the heirs of the Testator are not particularly financially-minded, the Testator can leave their assets in a Trust for the ultimate benefit of their heirs, but with another individual (or corporation) named as Trustee. The Testator can dictate, through the terms of the Will (and the corresponding Trust), what the Trustee may distribute, and when the Trust will terminate (the point at which the assets will be distributed outright to the beneficiary, typically at a specific age or at death). 

If a corporate Trustee is named, the Testator may have greater peace of mind knowing that the Trustee is capable of managing assets (investments), making prudent distribution decisions, and filing tax returns on time.

Irrevocable Trust

Purpose of an irrevocable trust:

• Avoidance or reduction of estate taxes
• Ensure competent management of assets beyond death (e.g., investments, taxes, etc.)
• Control disposition of assets (distributions during the term of the Trust and upon termination)

While the above two Trusts (Revocable and Testamentary) do not offer any benefit as it relates to reducing estate taxes, the Irrevocable Trust established during life is usually set up for this express purpose. Oftentimes, you will see an individual or couple establish this Trust during life and begin gifting assets to the Trust to remove future appreciation of those assets from their estate, thereby ending life with a lower total estate value than if they had never removed the appreciation of those assets. 

One approach to gifting assets is to gift $19,000 (2026) or less per year to avoid any gift tax consequences. A married couple may be able to work with their CPA to gift-split and together make a gift of $38,000 (2026). Another strategy some have used is to gift above the annual exclusion limit. In 2026, an individual may gift up to $15 million. If a gift is made in excess of the annual exclusion ($19,000 or $38,000 if gift-splitting) (2026), there are generally no immediate gift or estate tax consequences (up to the lifetime exemption); however, it is recommended that the individual's CPA is notified to file a gift tax return. Any gifted assets above and beyond the annual exclusion will reduce the lifetime exemption. The goal of these gifts is typically to remove future appreciation of those assets from the estate. From that perspective, it is often recommended to transfer assets that the Grantor anticipates will appreciate significantly. 

One important caveat regarding this strategy is the step-up in basis. Under current tax law, the assets that remain in the estate at the time of death receive a step-up in basis, meaning the asset's cost basis is increased to its current market value on the date of death. In a world of perfect timing, this would mean the heirs could sell the assets without paying any capital gains taxes (although it rarely works perfectly due to the time required to administer the estate and transfer ownership of the assets to the heirs). Regardless, the step-up can effectively erase all or a significant portion of the gain on inherited assets. When assets are transferred to an Irrevocable Trust, they do not receive a step-up in basis at the date of death. The trade-off here is that the appreciation is removed from the estate for estate tax purposes, but the Trust or the heirs will pay taxes on the gain if it is sold. Similar to the Testamentary Trust, the Irrevocable Trust can also provide for expert management (investments, administration, distributions, etc.) upon the Grantor's passing.

Irrevocable Life Insurance Trust

Purpose of an Irrevocable Life Insurance Trust:

• Remove life insurance death benefits from the estate for estate tax purposes
• Provide liquidity to the estate
• Create legacy wealth for heirs
• Ensure competent management of assets beyond death (e.g., investments, taxes, etc.)
• Control disposition of assets (distributions during the term of the Trust and upon termination) 

An Irrevocable Life Insurance Trust (ILIT) accomplishes goals similar to those of the Irrevocable Trust outlined above. The Grantor of the Trust can create a Trust during life, and either have the Trust purchase a life insurance policy on his life or transfer a policy to the Trust. Generally (even if owned outside of a Trust), the death benefit of a life insurance policy is not taxed (from a federal income tax perspective). Still, if the insured also owns the policy on his life, the death benefit can be included in the value of the estate for estate tax purposes. 

If done correctly, transferring ownership of a life insurance policy to an ILIT can remove the death benefit from the estate for estate tax purposes. Once established, the Grantor will usually make periodic gifts to the Trust, which the Trustee can use to pay premiums to keep the life insurance policy in force. The goal is to make gifts to the Trust that are equal to or less than the annual exclusion ($19,000 in 2026) so as to avoid gift tax consequences on those amounts. At death, not only is the death benefit excluded from the estate, but the Trust is often written so that it can make loans to the estate during the estate administration process. This is helpful if the majority of the estate is illiquid (real estate, farm, ranch land, etc.) and the Executor needs cash to pay attorneys, accountants, taxes, and other expenses. 

After administration is completed, the Trust can continue to be administered for the Grantor's heirs per the distribution terms that he or she outlined when drafting the document. Even if liquidity for the estate is not a concern, this can be a good way to establish a significant source of legacy wealth for heirs that is not included in the estate for estate tax purposes. 

The Bypass and Trust Portability

Purpose of an The Bypass and Trust Portability:

• Portability allows the second spouse to utilize their current exemption, plus the frozen exemption amount of the first spouse who has passed away (as elected on Form 706).
• Bypass Trusts are not as common since portability was introduced, but they continue to offer a way to protect assets after the first spouse's death.
• Bypass Trusts remain an effective tool for capturing the exemption amount and sheltering future appreciation on trust assets from estate taxes.
• Assets that transfer outside of the Trust to the surviving spouse would generally receive a step-up in basis at both the deaths of the first and second spouse to die, whereas assets funded to a bypass trust would only receive the first step-up.
• Income generated on assets funded into a bypass trust would be taxed at the trust tax brackets, which are more compressed than the individual or married rates.

Prior to the year 2011, bypass trusts (or credit shelter trusts) were a common estate planning tool. Portability was introduced in 2011 and, in some ways, reduced the need to create a bypass trust. In either scenario, there wasn't much of an issue upon the death of the first spouse to pass away, as that spouse's assets would pass to the survivor under the marital deduction. However, prior to portability, and if a bypass trust was not put into place, at the death of the second to die, any assets in excess of the individual lifetime exemption for the surviving spouse would be subject to estate tax. The bypass trust was sometimes used to capture the lifetime exemption amount of the first spouse to pass, allowing the couple to combine exemption amounts at the second spouse's death to shelter more of the remaining estate from estate tax. 

With the introduction of portability, you are no longer forced to create a bypass trust in order to capture the exemption amount of the first spouse; rather, an election may be made to "port" the exemption of the first spouse to pass to the surviving spouse, such that at the death of the second to die, the survivor can use his or her exemption amount, plus the "frozen" exemption amount of the first spouse to pass. (The surviving spouse's exemption amount may have been increased by inflation adjustments, whereas the exemption ported from the first spouse to the second is frozen at the amount for the year of his or her passing.) (One important item of note is that, in order to port the exemption to the surviving spouse, an election has to be made on Form 706 (estate tax return).) Typically, these are filed when dealing with a taxable estate, but if it is possible that the estate will grow to be a taxable estate between the dates of death of the first and second spouse to die, it might be beneficial to file Form 706 even though it is not required, if only to make the portability election. 

It may seem that the bypass trust is completely irrelevant now that portability is an option, but there may still be reasons to consider it as part of an estate plan. One reason is simply to maintain control of those assets after death. Oftentimes, these trusts are drafted to benefit the surviving spouse during his or her life, and then remain in Trust for the benefit of children (or be distributed outright to those heirs at the death of the second spouse). This can help to ensure that biological children are not inadvertently cut out of an estate plan due to a second marriage. Additionally, as mentioned above, when portability is elected, the exemption of the first spouse to die is frozen at the time of death. The assets that pass to the spouse, however, will likely continue to appreciate.

It is possible that while the exemption limits may cover the total estate today, the estate may appreciate in value, surpassing the combined exemption amounts in later years, especially if the survivor has a longer life expectancy. A bypass trust, if implemented correctly, would not only capture the exemption amount in the year of death but would also shelter all future appreciation on those assets from estate tax at the death of the survivor. This benefit, of course, has to be contrasted with the opposing drawback of a lack of step-up in basis at the death of the second to die. If portability is elected, the assets would receive a step-up at both the first and second to die; however, if a bypass trust is utilized, the assets funded into that Trust would be excluded from the estate, and therefore not receive the step-up in cost basis at the death of the second to die. 

Additionally, it must be considered that trusts have more compressed tax brackets than individuals or married couples, so there could be negative income tax implications if assets are funded into a bypass trust. The complexity of this strategy underscores the importance of working with a qualified attorney and accountant at every stage of the estate planning cycle. 

Ancillary Estate Documents and Strategies

In addition to the strategies outlined above, it is recommended that, during the estate planning process, an attorney draft powers of attorney (financial and healthcare) and medical directives. Establishing a power of attorney gives another person or entity the ability to handle your affairs in the event of incapacity. 

The authority granted in a power of attorney ends upon the grantor's death. It is important to have both a financial and a healthcare power of attorney in place, so that both financial and health-related decisions can be made during incapacity. Medical directives allow an appointed individual to make healthcare decisions at the end of life. They are also important documents to have on file, and can alleviate conflict between family members and ensure your wishes are carried out. 

There are many other estate planning strategies that can be implemented to accomplish a variety of goals. Some of those strategies are effective tactics and should be included in the discussion with an estate planning attorney. They are outside of the scope of this article, which is meant to address some of the most commonly-used strategies, and establish a baseline of knowledge prior to meeting with a qualified attorney to discuss the specifics of your estate plan..

We understand some of these topics can be complex, so we are here to help. Please get in touch with your local First Financial Trust office for more information on which of the above strategies is best suited for you.