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Dan Stanek:

You may have heard that it's important to have an estate plan, but what is an estate? What's an estate plan and why is it important to have one? To answer these questions, let's imagine the story of a man named Bob. Now our friend Bob lived a long prosperous life and recently passed away.

Over the course of his life, Bob accumulated a fair amount of things. He had a nice car, a nice house, shares in a company that he helped build, he had an investment portfolio and retirement savings. He even had fine art and jewelry collections. Now because Bob was a widower when he died, there's a question about who should get all Bob's stuff now.

As it turns out, while Bob was still living, he nominated his good friend Harry to be in charge of distributing his stuff as he wanted. Bob chose Harry for this role because he knew that he had the time and expertise to handle it. Harry is what we call an executor. Now, if Bob had wanted, he could have named a trust company as executor, or he could have had Harry and a trust company work together as co-executors.

But in this case, let's assume that Harry is working alone. So after Bob passed away, Harry went and gathered all Bob's stuff and put it into a giant box. This box is what we call Bob's estate. If you were to add up the value of everything in Bob's box, you'd find that his estate would be worth a little over $35 million.

So now the question is, who gets the stuff in the box? Let's imagine a line of people calling dibs on the contents of Bob's box. Who would be at the front of the line? Bob's creditors.

These are people that Bob owed money to when he died. For example, he owed $1 million on a home loan. Now that creditor would come to the front of the line, and after talking things over with Harry, would take the million that's owed to him. Next in line would be Uncle Sam, the federal government.

The federal government is only allowed to take from estates that are above a certain amount. That amount varies from year to year. Some years, it has been as low as $600,000, or in other years, as high as $12.06 million.

Let's say that in Bob's case, it's $12.06 million. That amount is off limits to the federal government. Anything above that amount is fair game.

This amount is what we call Bob's taxable estate. Because Bob's total estate after his creditors are paid is about $34 million, his taxable estate is $22 million. The amount the government would be able to take from Bob's taxable estate is determined by the estate tax rate. The estate tax rate can vary from year to year.

Let's say that it was 40% at the time Bob passed away. At this rate, the federal government would receive about $9 million from Bob's estate. Also, depending on which state Bob lived in when he died, that state government might also receive a share. So after Bob's creditors, the federal government, maybe the state government, the next group of people would step to the front of the line.

These are the people that Bob ultimately wanted to pass his estate onto. In Bob's case, it's his daughter and his grandchildren. But it could just as easily have been a family friend or a charity which would have had the additional benefit of reducing his estate tax bill. The point is, Bob's box that was once over $35 million is now about $25 million by the time his daughter and grandchildren get to the front of the line.

Knowing all that, why is the estate planning important? Well, it's important for three key reasons. The first reason, it allows you to control who gets what. Instead of Bob's family and friends arguing over the remaining assets, Bob spelled out all of that in a will.

He could have also set up trusts, which would have given him the flexibility of not only naming who gets what, but also when, for what reasons, and in what amounts. If Bob hadn't done this, if he hadn't set up trusts or articulated his wishes in a will, then the state government would have decided who gets what based on a set of default rules, and those might not be the people that Bob wanted, or the amounts for those people that he wanted.

The second reason an estate plan is important is it allows you to choose your executor. You're Harry, the person or the trust company responsible for making sure everybody gets the right stuff.

This is important because if you die without naming an executor, then the state government will choose your executor, and that person might not be the best-suited to oversee the whole process. The third reason is it allows you to reduce the size of your estate - your box. Instead of accumulating things so that you die with an enormous estate, you can employ certain strategies, make thoughtful gifts to family or charity, for example. This makes sure that more of your estate goes to the people you want and less goes to taxes. An estate plan allows you to define your own legacy.

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