Core Estate Planning Documents — CFP Exam Guide

A last will and testament is a legal document that directs the distribution of your probate assets after your death. It names an executor to manage the estate administration process. It's crucial to understand that a will only controls assets titled in your individual name without a beneficiary designation.

The will can also nominate guardians for minor children. Without a will, the court will decide who raises your children, potentially leading to unintended consequences. Furthermore, a will can create testamentary trusts, which become effective upon your death, to manage assets for beneficiaries, especially minors or those with special needs.

For the CFP exam, remember that a will doesn't avoid probate. It simply guides the probate court in distributing assets. Also, a will is revocable and amendable during your lifetime through a codicil (an amendment to the will).

A durable power of attorney (POA) for property or financial matters allows you to appoint an agent to manage your financial affairs if you become incapacitated. The 'durable' aspect means the POA remains valid even if you are mentally incapacitated. Without a durable POA, a court might need to appoint a guardian or conservator to manage your finances, which can be a lengthy and costly process.

The POA can grant broad or limited powers to the agent. Common powers include paying bills, managing investments, and selling property. For the exam, understand the importance of specifying the powers granted. A general POA grants the agent broad authority, while a limited POA restricts the agent to specific actions.

Example: John executes a durable POA naming his daughter, Mary, as his agent. If John becomes incapacitated due to a stroke, Mary can use the POA to manage his bank accounts and pay his bills, preventing financial hardship.

A health care proxy (also known as a medical power of attorney) allows you to appoint an agent to make health care decisions for you if you are unable to do so yourself. An advance directive, often called a living will, outlines your wishes regarding medical treatment, especially end-of-life care. These documents work together to ensure your health care preferences are respected.

The health care proxy gives your agent the legal authority to access your medical records and make treatment decisions. The living will provides guidance to your agent and medical providers regarding your wishes, such as whether to prolong life with artificial means.

For the CFP exam, understand the difference between the health care proxy (appoints an agent) and the living will (expresses your wishes). Both are crucial for comprehensive health care planning.

A revocable living trust is a legal entity you create during your lifetime to hold your assets. You typically serve as the trustee, managing the assets for your benefit. The primary benefit of a revocable living trust is probate avoidance. Assets held in the trust pass directly to your beneficiaries according to the trust terms, bypassing the probate process.

During your lifetime, you can amend or revoke the trust. Upon your death, the trust becomes irrevocable, and a successor trustee manages the trust assets according to your instructions. The trust can provide for ongoing management of assets for beneficiaries, similar to a testamentary trust created in a will.

For the CFP exam, remember that funding the trust (transferring assets into the trust's name) is essential. A trust is only effective if it holds assets. Also, a 'pour-over' will is often used in conjunction with a revocable living trust to catch any assets not titled in the trust's name at the time of death.

Beneficiary designations on accounts like retirement plans (401(k)s, IRAs), life insurance policies, and annuities dictate who receives those assets upon your death. These designations supersede instructions in a will. Transfer-on-death (TOD) designations can be used for brokerage accounts and some types of real estate, allowing these assets to pass directly to beneficiaries without probate.

It's crucial to keep beneficiary designations up-to-date, especially after major life events like marriage, divorce, or the birth of a child. Failure to update beneficiary designations can lead to unintended consequences. For example, an ex-spouse might inherit retirement assets if they are still listed as the beneficiary.

For the CFP exam, remember the order of priority: beneficiary designations trump wills. TOD designations are a simple way to avoid probate for certain assets.

How you title your assets significantly impacts how they will be distributed after your death. Assets held jointly with right of survivorship pass directly to the surviving owner(s), regardless of what your will states. Assets held in your individual name without a beneficiary designation are controlled by your will and subject to probate.

Common titling options include: individual ownership, joint tenancy with right of survivorship (JTWROS), tenancy in common, and trust ownership. JTWROS is often used by married couples, ensuring the surviving spouse inherits the asset automatically. Tenancy in common allows each owner to have a separate share that can be passed on through their will.

Example: A married couple owns a house as JTWROS. Upon the death of one spouse, the surviving spouse automatically becomes the sole owner of the house, bypassing probate.

The CFP exam often presents scenarios where inadequate estate planning leads to problems. A common scenario involves a client who remarries but fails to update their beneficiary designations, resulting in assets passing to their ex-spouse instead of their current spouse. Another scenario involves a client with a will but no revocable living trust, leading to a lengthy and costly probate process for their heirs.

Consider a client who becomes incapacitated without a durable power of attorney. The exam might ask about the steps required to manage their finances, highlighting the need for a court-appointed guardian or conservator. Another frequent topic is a client with minor children and no will, prompting questions about who will become their guardians and how their assets will be managed.

Remember to analyze the scenario carefully and identify any missing or outdated documents. Pay attention to asset titling and beneficiary designations, as these often override the instructions in a will. The key is to understand how different estate planning documents interact and how they can be used to achieve the client's goals.