The 7 Most Common Estate-Planning Myths Worries about probate or high estate taxes keeping you up at night? Put your worries to bed with this primer on the most common myths you can afford to ignore.

Excerpted from Estate Planning, Wills and Trusts (Entrepreneur Press)

Myths and misunderstandings dominate the public consciousness when it comes to estate planning. Some are the result of incomplete media reports, while others arise from half-truths and exaggerations put forth by "advisors" interested in generating a quick fee or commission. Further, labels such as "death tax" and other politically charged mischaracterizations are given life by politicians "spinning" estate-planning issues to stimulate political support in close elections. Your estate plan should be motivated solely by family considerations and sound legal analysis, not by imaginary monsters under the bed. A brief description of these myths is set forth below. By reading them, and then forgetting them once and for all, you can find your way to an estate plan that is based on reality and meets your goals and your family's needs.

Myth #1: Probate = High Cost and Long Delay
"Even if you know nothing about estate planning, you probably know that your failure to do the 'right' estate planning will result in your heirs being bogged down in a lengthy and costly preceding called probate." Not true.

The probate process does cost money in the form of attorney's fees, court filing fees, and miscellaneous costs. Most methods of avoiding probate cost money as well. You need to understand the real costs of probate, and the real costs of avoiding probate, before you make your choice. Taking cash out of your monthly budget today (and, in some cases, every year for the rest of your life) to avoid probate many years from now may be a greater burden than the impact of letting your heirs pay probate costs out of the inheritance you leave them. If you are on a tight budget and/or a fixed income, the impact of spending a small number of your dollars now may mean a major sacrifice in your lifestyle. Most likely, your children wouldn't want you to make that sacrifice just to leave them slightly more money later (and if they do want you to make that sacrifice, maybe they don't deserve any inheritance at all).

In order to compare the costs of probate with the costs of avoiding probate, you need to understand the probate procedure. While the procedure varies from state to state, in general terms, a probate proceeding is opened upon your death to make sure that all of your debts are fully paid, and to distribute any remaining assets to the people you have designated in your will. If you did not leave a will, then each state has its own set of rules defining which of your relatives will be entitled to receive your property. Under these rules, your surviving spouse and children are very high on the list and likely to share everything (in proportions that depend on the rules of the state where you were living at the time of your death). On the other hand, if you have no surviving spouse or children, everything will pass to your nearest living relatives (or "next of kin"), possibly your brothers and sisters, or nieces and nephews, or even a great nephew in Minnesota whom you have never met. The probate process begins when a person designated in your will-called the executor-files the initial probate papers with the court. If you did not have a will, or did not designate someone in your will to handle the probate, then a friend, relative, or the public administrator (a local-government agency that serves when there are no friends or relatives willing to do so) can file the initial papers.

A simple probate will remain open somewhere between six and 18 months, during which time the executor follows court-mandated procedures to:

• provide notice to interested parties ("beneficiaries" named in your will to receive your property and "heirs" who may receive your property under state law if not left elsewhere by your will-for example, your spouse, children, grandchildren, parents, grandparents, or brothers and sisters);
• permit beneficiaries and heirs to challenge the validity of your will or some provision contained in it;
• provide a formal inventory and valuation of each of the assets in your estate;
• sell any assets that need to be liquidated (such as real estate or a business);
• pay your burial expenses and debts;
• pay any estate taxes, if your estate is large enough; and
• provide a detailed accounting and distribute the assets to the people, and in the manner, provided in your will.

The formal probate procedures provide protection to your beneficiaries and heirs, and ensure that your assets are properly handled and distributed to the people you have named in your will. The procedures are not nearly as burdensome or restrictive as they seem at first glance. Most transactions-such as liquidating stocks, selling real estate, or continuing to operate your business while a buyer is located-can be performed without advance permission from the court. Necessary transactions are simply carried out as needed and accounted for in reports given to the heirs and beneficiaries, and simultaneously filed with the court. Perhaps more importantly, your executor will likely be able to provide reasonable living expenses for your family during the probate process.

There is an economic cost to probate that should not be ignored. The cost includes attorney's fees, executor's fees, court filing fees, and other miscellaneous costs. Many states set the attorney's fees and executor's fees as a percentage of the value of the assets in the estate (typically with a decreasing percentage applied as the size of the estate increases). Other states allow the attorney to charge fees based on an hourly fee and the actual number of hours necessary to handle your probate, subject to court approval based upon "reasonableness."

But the cost of fees should not be viewed in a theoretical vacuum. Don't listen to promoters of "trust mills" that inflate probate fees to their largest theoretical amount simply to scare you into paying for an off-the-shelf trust package designed to avoid probate (and put money in the wallet of the promoters). In California, for example, the attorney and the executor are each entitled to receive a statutory fee based on a percentage of the value of the assets in the estate. The statutory fee starts at 4 percent each. That's 8 percent in addition to court filing fees starting at about $300 (and going up substantially with the value of the estate), plus incidental expenses of hundreds of dollars. If the real cost of probate is 9 or 10 percent of value of the estate, then of course you need to avoid probate. But the real cost is nowhere near 10 percent. First, in most instances the executor is a relative or family friend who is willing to serve without fee. In addition, while the attorney's or executor's fees start at 4 percent, that number is only applied to the first $100,000 of value in the estate. The percentage drops to 3 percent for the next $100,000, 2 percent for the next $800,000, and then to 1 percent or less. For most probates in California, the actual cost will be in the neighborhood of 2.5 percent of the value of the estate. On a $1 million estate-in California that's an average house, a retirement account of a few hundred thousand dollars, a nice car and a handful of miscellaneous investments-expect probate to cost about $25,000.

While this cost is substantial, the analysis shouldn't end there. The cost of probate-which will be paid after you are gone and no longer need your monthly income to pay monthly living expenses-must be weighed against the direct economic cost of an estate plan designed to avoid probate. These costs include additional fees paid to prepare the estate plan and any additional costs that may be incurred as a result of the estate plan after you are gone. Professional fees will vary by locality and by complexity of the estate plan, but rarely are they less than $1,000, and they often exceed several thousand dollars. In addition, certain types of estate plans may result in accounting fees being incurred each year to prepare a separate tax return. Finally, while the cost of administering a trust at the time of your death is likely to be less than the cost of probate, that million-dollar estate that might cost $25,000 to probate in California will still cost several thousand dollars in legal and accounting fees to implement and administer at the time of your death.

Myth #2: Without a Will, the Government Will Seize Your Property
"If you die without a will or trust, the government will take all of your property." Wrong.

If you die without a will or trust, the laws of the state you called home just before you died will determine who will receive your assets. In some states, your surviving spouse will receive everything. In others, your spouse will share your assets with your children or parents. Without a will or trust, however, your assets will generally not go to a live-in significant other, or to stepchildren that you raised like they were your own flesh and blood. (Some states, however, are beginning to grant inheritance rights to registered domestic partners, which may include nonmarital relationships with same-sex or opposite-sex partners.)

In very rare cases, such as when you have no living relatives of any kind-not even a fourth cousin, twice removed, for example-your property will go to the state. By having a will or trust, you can avoid this outcome and leave your assets to close friends or charities that you care about.

In general, state law will not take your money away when you die, and for many people, it actually leaves property exactly where you would want it to go.

Myth #3: You Must Have a Trust to Avoid Estate Taxes
"Estate taxes-sometimes called inheritance taxes or death taxes-will take one-half of everything you have, unless you have a trust or a will." Simply wrong. For more than 98 percent of us, the estate tax will be far less than 50 percent. In fact, it will be zero.

At the risk of oversimplifying, there is no estate tax on the first million dollars (or more) in your estate. In 2007 and 2008, you can leave up to $2 million completely free of estate tax. In 2009, that amount increases to $3,500,000. In 2010, there is no estate tax no matter how much you are worth. To keep things confusing, if the law does not change before January 1, 2011, the estate tax will apply to everything over $1 million in assets. This quirky, roller coaster estate tax system is the result of political accounting-and accountability-that was applied in the mid-1990s when the current law was passed. Most estate planners expect these rules to change-and hopefully become a little smoother-before 2010.

For purposes of this myth, what you need to know is that the estate tax is not affected by whether or not you have a will. It may be affected, however, by having a trust, if you are married. Properly designed, the trust may allow you to double the amount that can be left to your children (or friends) free of estate taxes. In 2007, for example, that meant a married couple using a trust could leave $4 million to their children (or friends) free of tax. Generally speaking, there is no estate tax when assets are left to your spouse or to a charity, no matter how big your estate may be.

It is important to note that as an entrepreneur you may be able to structure your business ownership in ways that can reduce taxes. A well-crafted buy-sell agreement, limited partnership, or limited liability company may allow you to protect the existence of the business upon your death and reduce the estate taxes for your family.

Myth #4: Without a Will, My Kids Will Lose the Family Farm (or Business)
"The family farm-or family business-that Mom and Dad hoped to hand down from generation to generation will need to be sold to pay the 'death tax.' " Not true, for several reasons.

First, remember the first $2 million is tax free ($4 million with a family trust). That increases to $3,500,000 (and $7 million) in 2009. Some family businesses, or farms, may be worth more than that. Most aren't. Therefore, no tax. The family will inherit the business tax free, and your children can continue to run the family business.

Second, even if you are fortunate enough to own a family business worth more than $7 million, the tax code actually has special provisions to protect your family business-and even more special provisions to save the family farm. If your estate is greater than $7 million and the family business accounts for more than 35 percent of the value, any taxes due on your estate can be the paid over 14 years. If that isn't help enough, your children can pay interest only for the first five years, at interest rates in the 1 percent or 2 percent range, and then pay off the balance over the next nine years at an interest rate of about 4 percent. Even when the Federal Reserve Discount rate was below 1 percent in the year 2004, you couldn't get that low an interest rate on a first mortgage on your house!

Finally, if you don't want your family to pay off a 14-year, low-interest loan, as a business owner, you can buy life insurance to provide funds to pay any estate taxes that may become payable. By holding this life insurance policy in a special life-insurance trust, you provide a tax-free source of funds to fully pay the taxes due on a family business worth tens of millions of dollars, or more.

Myth #5: Trusts Always Reduce the Cost of Dying
"Probate is expensive. A living trust will avoid probate and save money." Avoid probate, yes. Save money, maybe.

Whether a living trust will save money when compared to probate depends upon your unique circumstances. Remember, probate and living trusts are two different methods to transfer your assets to your family or friends. It's true that a trust will do that at a lower direct cost than probate will. However, unlike most probates, trusts commonly distribute your assets over many years. For example, a trust may provide lifetime income to your surviving spouse and then continue distributing income to your children for many years (until they become mature enough to handle the money themselves). These distributions can last 10, 20, 30 years, or more. In each of those years, your family trust will incur accounting fees to prepare an additional income tax return (although additional income tax usually will not be due), and in some years additional attorney's fees will be incurred to resolve administrative issues related to the trust. Finally, if a family member is not serving as trustee, the fees paid to a private trustee over several years will exceed the cost of probate. Simply put, you need to evaluate the costs and benefits of a trust over the entire anticipated lifetime of the trust. Frequently, the benefits of a trust are great and the cost comparison to probate is favorable, but the analysis needs to be done on a case-by-case basis.

Myth #6: The Estate Tax is an Unfair "Death Tax"
Politicians often refer to the estate tax as an unfair "death tax." You work hard, you pay income tax your entire life, and then when you die, the government taxes the money you already paid taxes on, just because you died. Sometimes this is true; often it is not. Most estate tax is imposed on income that has never been taxed. How can that be?

There are two basic kinds of income tax in the United States. The most common is "ordinary" income tax on things like wages, interest earned on savings accounts, dividends on stocks, rent received on property, and the like. The other is "capital gains" income tax on the increased value of things you invest in such as stocks, real estate (including your house), and your family business. You pay tax on your ordinary income every year, whether or not you actually receive the money. If you earn $1,000 in interest on your savings account this year, you will probably pay around $300 in income tax even if the money you earned is still in your bank account.

Capital gains are different. If the value of a stock you own goes up $1,000 this year, you pay no tax unless you choose to sell the stock. If you have built a successful family business, either from the ground up or by buying an existing business, you haven't been taxed on the increase in the value of business. If you have used the profits of your business to buy stocks, real estate, and other investments, the growth in those investments may not have been taxed as of the time of your death. While most Americans receive the bulk of their income as "ordinary" income-and are fully taxed every year-if you have accumulated enough value to be subject to the estate tax, much of what you own is likely to be "capital gains" investments that have not yet been taxed: investments in your business, your family residence, and your brokerage account. Under our tax laws, these investments will go to your family or friends free of income tax and free of capital gains tax. Without the estate tax, these assets that have grown to be worth several million dollars (remember, the estate tax doesn't even start until $2 million-or $3,500,000 starting in 2008) can completely escape taxation. The result is either a well-deserved tax shelter for the most productive (and economically fortunate) members of our society, or simply "welfare for the rich." In any event, the estate tax is not an additional tax on death.

Myth #7: Estate Planning Is Asset Protection
You read about it in the newspaper and see it on the television news. A lawsuit filed because coffee is too hot. Fraudulent auto accidents staged to extract money from drivers of late-model, luxury cars. The list is endless and the message is clear: You need to take steps to protect your wealth from frivolous lawsuits. However, estate planning is not asset protection. A family trust does not shield your assets from lawsuits or business risks. Under most state's laws, a living trust or family trust is "transparent" and your assets are subject to the same risk of lawsuits or other loss as before you established the trust.

There are ways to protect your assets, but estate planning isn't the way. Some ways are simple, such as auto insurance and homeowner's liability insurance. Others are incredibly complex and require the help of highly-trained specialists. Consult your attorney or accountant for smart ways to protect your assets.

Want to know more about creating an estate plan that effectively ensures your estate is handled according to your wishes? Read more in Estate Planning, Wills and Trusts (Entrepreneur Press).