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You Now Have Heirs

When you mention the words "estate" and "estate planning," most people think that this applies only to the wealthy. The truth is that everyone should have a plan for how their estate will be distributed at their death and who will be the guardians of their children. Now that you've added a child to your family, you can no longer afford to leave important decisions regarding your family and finances to others in the event that you're no longer around.

Don't Let the State Make Your Decisions: Draft a Will

If you don't have a will and you and your spouse both pass away, the laws of the state where you lived will determine how your assets are distributed. The laws are different for every state.

If your children are minors, the disposition of your assets will be subject to court administration until the children reach the age of majority, generally age 18 or 21, depending on the state where you lived. This is a tedious process and one that your family will want to avoid. The results may not be in the best interests of your children. For example, many states have requirements that your children's assets be invested only in government-insured securities, which are typically low-yielding investments. These selections, while very safe, may not be the best choices for, say, college planning purposes, if your children are still young.

How can you avoid the state getting mixed up in your financial affairs? Get a will prepared.

The legal terms often included in will documents are not always understood to include adopted children. If your child is adopted, make sure the language contained in the will specifically treats adopted children the same as natural born children.

Choosing a Guardian

Let's put finances aside for a moment. Have you thought about who is going to care for your child if you're not around? Sure, you've probably made your wishes known informally. The courts would take this into consideration but would not be bound when making their final decision. Is the decision about who will raise your child one that you want to leave to the courts? Definitely not! That's another reason why drafting your will is so important.

In the will document you would name the guardian. It is important to choose someone who shares your values and beliefs and basic philosophy on how a child should be raised. Most often, individuals choose a blood relation based exclusively on the family relationship without giving consideration to the fact that the person's views on child-rearing may be dramatically different from theirs. Also, make sure you speak to the person before naming them the guardian. You may feel your older sister and her husband would make the ideal guardians for your child, but sis may already have her hands full with four kids of her own and may not be up to it. It is a tremendous responsibility. It must be carefully thought out and you shouldn't have any uncertainty surrounding your decision.

In addition to your will, consider making an audio recording or videotape leaving directions and instructions to the guardian on how you would like to see your child raised. Although not legally binding, it would be an invaluable reference for the guardian during difficult times.

If you're a single parent, it is probable that the courts would award guardianship to the surviving parent in the event of your death. If this is unacceptable to you, you need to make sure to name a guardian of your choosing in your will. You will have to make a strong case in an affidavit filed with the court as to why the surviving parent is unfit to be guardian of your child. If this is important enough to you, you will have to designate available assets to mount a court fight to challenge the court's decision, should it go against your wishes. In any event, make certain that the property guardian is someone of your choosing.

In Trusts We Trust

Don't fall into the trap of thinking that trusts are just for the rich; they're not! One example that's appropriate for anybody is called a testamentary trust.

This type of trust is set up within your will and comes into being only after your death. It is especially useful since the terms of trust provide for the management of trust assets and provide for how the money is invested, spent, and eventually distributed to your children after they themselves become adults and, hopefully, are capable of managing it themselves.

Make sure your beneficiary designations on the trust agree with those in your will. Check all the elections you have made on your benefit plans and life insurance and make sure they are consistent with your overall estate plan. The beneficiary designations control where your assets go, not your will. Also, how property is titled can govern how the assets are distributed.

If you are using a trust, you will choose a trustee. The trustee could also be the named guardian, but this is not required. The trustee is charged with the duty of making sure your instructions are carried out in managing the trust money. You could be very specific, or be more general, specifying that the trustee has discretion to spend money as needed for the safety, health, education, and general well-being of your child. You could tie strings to it, for example specifying that the money be spent only for education.

Instead of giving your child a lump-sum payout from the trust upon reaching a certain age (usually 18), consider paying out their inheritance in installments. Getting big bucks at the age of 18 may not be in your child's best interest. For example, it could result in your child not going to college and soon squandering away the money.

You shouldn't take chances. Leaving the disposition of your assets tangled up in government red tape is not wise financial planning. Leaving the money outright to the guardian of your child with instructions that it be spent for their welfare with any remainder going directly to them when they reach 18 is dangerous too. Without the benefit of a trust, you completely give up legal control of the money, and the money becomes subject to the creditors of the guardian. If the guardian gets into financial trouble, that money could very well disappear.

In Whose Name?

Before you begin setting aside money for your child, you need to decide where it will go and, in whose name,, you'll put it. The money can be in your name, in the child's name, or in a custodial account.

1. In Your Name. This has several advantages. First, you have control over the money, so if you need it for an emergency, it is legally yours. Second, it is a smart move if you think your child will qualify for financial aid for college. The financial aid formulas used by most colleges require that a student contribute 20% of his or her assets to college each year. On the other hand, you as the parents, are expected to contribute a good deal less, usually 5.6% of your assets each year. If there's too much money in your child's name, they may not qualify for financial aid.
2. In Your Child's Name. You may reap tax benefits if you put assets in your child's name instead of your own, depending upon the dollar amount involved and your child's age. The basic rule to keep in mind is that the child's unearned income above a certain level is taxed at your rate until your child is 19; thereafter all of your child's earnings are taxed at their rate. If you decide to put the money in your child's name, you can simply set up a savings account for your child at your bank. Your child can add to it on a regular basis, an excellent way to learn about the advantages of regular saving.
3. In a Custodial Account. You can set up a custodial account through the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfers to Minors Act (UTMA). You can open a no-fee custodial account at a bank, brokerage house, or credit union. The adult custodian, you or someone you appoint, controls how the money is invested and spent until the child reaches the age of majority, in most states 18 or 21. The key difference between the two types of custodial accounts is in the types of property you can transfer into them. An UGMA can only hold bank or credit union deposits, cash, securities, mutual funds and life insurance policies. In an UTMA you can give your child virtually any type of asset, including real estate and collectibles.

Custodial Account Primer

• Money in a UGMA or UTMA can be used only for the benefit of the minor.
• If you name yourself custodian and you die while the account is still in effect, the money is included as part of your taxable estate.
• You cannot close the account and take the assets, even if you are the sole source of the assets. The transfer to the child is irrevocable.
• Your child will have full use of the account upon reaching the age of majority. That means that they can use the money for college, which is probably what you intended in the first place, or they can use it to buy a new BMW—it is up to them as an adult.
• While your child is under age 19, limit the taxable investment income earned in the account to a maximum of $2,100 a year. The first $1,050 is tax-free; the rest is taxed at the child's rate (usually 10%). These thresholds are adjusted annually for inflation.

This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.