Why estate planning is crucial, and what kind of huge debt you could be leaving to your family if you die prematurely. Homeowners, a living trust is crucial, as well as the rest of the estate planning checklist.
Estate planning can be an overwhelming process. So much so that people just throw their hands up in the air and give up. But there’s a huge danger in doing nothing, because everyone has a plan: the state’s default plan.
Estate Planning for Dummies
There will be many blog posts on the specifics around this process but let’s start with the basics and let’s start building an estate planning checklist, of sorts.
The audience this is relevant to:
- Any homeowner who does not have a living trust.
- If you recently purchased a home, have a high mortgage liability, and low equity, this especially applies to you.
- If you have accumulated a certain amount of assets (such as a single family home, or a robust retirement account)
You are in danger of losing a large part of what you’ve worked so hard for, to probate costs with the additional bonus of ripping your family apart.
Estate Planning Case Study
So to illustrate this, I have a case study. For me, things really come to life to me when there’s a specific hypothetical scenario I can follow. Without further ado:
Case Study
Tom and Mary, in their early 30’s, are middle class hardworking professionals who just got married and bought their dream home at 6 Picket Fence Dr in East Los Angeles, CA, a rapidly gentrifying area. They put a down payment of 3% as first time homebuyer’s, on a $800,000 purchase. They feel it’s a good investment as property prices seem to be going up rapidly. Life is good.
Shocking Event
A few years later, after they have two young children, busy with their lives, they take a trip out of the country to go hike Mt. Everest, but both never return. The children are left with Mary’s parents and though Tom and Mary are not here to speak for their intentions today, wanted the children to inherit the property.
The Emotional Aftermath
The young children and Tom and Mary’s respective families are grieving. Naturally, finger pointing is going on. Mary’s family blames Tom’s for this loss and vice versa. Emotions are high, stress levels through the roof as they divide up childcare responsibilities. Now, to make matters worse, we have financial and legal ambiguities that will undoubtedly drive the two camps further apart with the two children used as political footballs.
The Financial Aftermath
Probate costs come first. Now the home is assessed at 1.2 million dollars. In addition, there were no named beneficiaries to both Tom and Mary’s 401(k) accounts at work. Each had about $250,000 saved up. Total probate estate is $1.7 million.
In California probate, the costs are 4% for the first 100,000, 3% for the next 100,000 and 2% above that. Base probate costs are now at $37,000. This does not even include the litigation costs as tensions escalate between Tom’s family and Mary’s family, or the lost time people take off from work to go to court for every little thing during the lengthy probate process.
Both Tom and Mary had life insurance policies at work ($50,000 each) but nothing to protect the mortgage. The outstanding mortgage is still about $800,000 (they’ve been paying interest only the last few years). The $500,000 in the 401(k)s would also not be enough to pay off the home. No one in the extended families can afford to pay off the house, so it is now being foreclosed.
The Legal Aftermath
The above $37,000 probate cost does not even include the litigation costs as tensions escalate between Tom’s family and Mary’s family, or the lost time people take off from work to go to court for every little thing during the lengthy probate process (1-2 years). A representative from both sides will be going to court to clear up the debts, wait for an orderly process to settle who will receive the 401(k) money (which is likely to be split up), guardians would have to be appointed for the young children (opening up a bitter custody battle), etc.
And we have barely touched the tip of the iceberg.
Begin on Your Estate Planning Checklist Now
Going through the estate planning checklist is essential, and you need to start now to have the protection you need. Every family has a responsibility to set up a living trust when you own a home, and even more so, when the mortgage liability is high.
In my next blog post, Part 2 in the series “Estate Planning for Dummies: The Basics”, I will talk about how this scenario can be avoided through the estate planning checklist specifically highlighting what documents are needed.
Additional resources:
In the meantime, please take a look at our Estate Planning Checklist page to learn more about the benefits of estate planning or take the Estate Planning Preparedness Quiz to see what needs to be done and how prepared you are.
Marc Ang is based in Claremont, CA, focused on spreading the gospel about pragmatic and educated financial and estate planning.