Estate Planning for the CFP Exam: Trusts, Wills, and Tax Strategies

Estate planning is one of the most complex domains on the CFP exam because it combines legal concepts, tax mechanics, and financial planning strategy. Candidates who know only one layer (usually the legal document layer) often miss questions that test how those documents interact with tax law. This post covers the full scope of estate planning the CFP exam tests, from foundational documents to sophisticated transfer strategies.

The Basic Documents

Every estate plan starts with a core set of legal documents. Understanding what each one does and what happens without it is fundamental to the CFP estate planning domain.

The Will

A will is a legal document that directs how a person's probate estate will be distributed at death. "Probate estate" refers to assets that pass through the court-supervised probate process, typically assets in the decedent's name alone with no beneficiary designation.

Without a will, assets in the probate estate pass according to the state's intestacy laws, which distribute assets based on family relationships regardless of the decedent's wishes. For clients with non-traditional families or specific wishes about who should receive their assets, dying intestate can produce outcomes very different from what they wanted.

The CFP exam tests the scope of a will: a will controls only probate assets. It cannot override beneficiary designations on retirement accounts, life insurance policies, and annuities. It cannot control assets held in joint tenancy (which pass by right of survivorship) or assets held in a trust (which pass under the trust's terms).

Durable Power of Attorney

A durable power of attorney (DPOA) authorizes an agent to act on behalf of the principal in financial matters. The "durable" designation means the power remains in effect even if the principal becomes incapacitated.

A regular (non-durable) power of attorney terminates if the principal loses capacity, which is exactly when a power of attorney is most needed. Clients who do not have a durable power of attorney in place may require court intervention (a conservatorship) to manage their finances if they become incapacitated.

Healthcare Directive and Healthcare Proxy

A healthcare directive (also called a living will) specifies the principal's wishes for medical treatment in scenarios where they cannot communicate. A healthcare proxy (also called a healthcare power of attorney) appoints an agent to make medical decisions.

These documents are not financial planning instruments, but the CFP exam tests planners' awareness of them as part of the comprehensive planning conversation.

Probate vs. Non-Probate Assets

Probate is the court-supervised process of validating a will, paying debts, and distributing assets. It can be slow, public, and expensive.

Non-probate assets transfer outside the probate process:

• Assets with beneficiary designations (retirement accounts, life insurance, annuities)
• Assets in joint tenancy with right of survivorship
• Assets in a revocable or irrevocable trust
• Assets in a payable-on-death (POD) or transfer-on-death (TOD) account

A common CFP exam scenario: a client has a will that says their IRA goes to their children, but the IRA beneficiary designation names their ex-spouse. The IRA goes to the ex-spouse. Beneficiary designations override wills.

Revocable vs. Irrevocable Trusts

Trusts are legal arrangements in which a trustee holds assets for the benefit of beneficiaries. The tax and estate planning implications depend heavily on whether the trust is revocable or irrevocable.

Revocable Living Trust

The grantor (creator) retains control over the trust and can amend or revoke it at any time during their lifetime. Because the grantor retains control, the trust assets are included in the grantor's taxable estate and are subject to the grantor's income taxes during their lifetime.

Revocable trusts are primarily probate avoidance tools. They do not reduce estate taxes or protect assets from creditors. But they allow assets to pass to beneficiaries without going through probate, which provides privacy and efficiency.

Irrevocable Trust

Once created, an irrevocable trust generally cannot be modified or revoked without the consent of beneficiaries. Because the grantor gives up control, the trust assets are typically removed from the grantor's taxable estate and are no longer subject to the grantor's creditors.

Irrevocable trusts are the estate tax planning workhorses. Common irrevocable trust types tested on the CFP exam:

• Irrevocable Life Insurance Trust (ILIT): Holds a life insurance policy. If structured correctly, the policy proceeds are not included in the insured's gross estate, removing large insurance proceeds from the taxable estate.
• Charitable Remainder Trust (CRT): The grantor contributes assets, receives an income stream for life or a term of years, and the remainder goes to charity. The grantor receives a charitable deduction equal to the present value of the remainder interest.
• Charitable Lead Trust (CLT): The reverse of a CRT. Charity receives the income stream first, and the remainder goes to non-charitable beneficiaries (typically heirs). Useful for reducing the taxable value of assets passing to heirs.
• Qualified Personal Residence Trust (QPRT): The grantor transfers a personal residence to a trust, retaining the right to live there for a term of years. At the end of the term, the residence passes to beneficiaries at a discounted taxable gift value.
• Grantor Retained Annuity Trust (GRAT): The grantor transfers assets to a trust and receives an annuity payment for a fixed term. At the end of the term, any remaining assets (above the annuity value) pass to beneficiaries with minimal or no gift tax.

The Federal Estate Tax

The federal estate tax applies to estates that exceed the applicable exclusion amount. Under current law (post-Tax Cuts and Jobs Act), the federal estate tax exclusion is $12.92 million per person (2023 figure; adjusted annually for inflation). This amount is scheduled to sunset back to approximately $7 million (inflation-adjusted) after 2025, which the CFP exam may test as a planning consideration.

Portability: A surviving spouse can use any unused exclusion of the deceased spouse, effectively doubling the exclusion for married couples. Portability must be elected on the deceased spouse's estate tax return (Form 706) even if no estate tax is owed. This election has a deadline.

Unlimited marital deduction: Assets left to a U.S. citizen spouse are entirely exempt from estate tax. This deduction is unlimited. However, it merely defers the estate tax to the surviving spouse's estate. For wealthy clients, strategic planning requires ensuring the first spouse to die fully uses their own exclusion rather than relying entirely on the marital deduction.

Annual gift exclusion: Gifts up to $18,000 per donee per year (2024) are excluded from gift tax and do not reduce the lifetime exclusion. Married couples can split gifts, effectively doubling the annual exclusion to $36,000 per donee.

Generation-Skipping Transfer Tax

The generation-skipping transfer (GST) tax applies to transfers (by gift or at death) to persons who are more than one generation below the donor (grandchildren, great-grandchildren). The GST tax rate is 40 percent and the exemption is equal to the basic exclusion amount.

The purpose of the GST tax is to prevent wealthy families from entirely avoiding the estate tax for a generation by skipping the children and leaving assets directly to grandchildren.

The Step-Up in Basis

When a decedent owns appreciated property and it passes to an heir, the heir's tax basis is "stepped up" to the fair market value at the date of death. This eliminates the capital gains tax that would have applied if the decedent had sold the asset.

The step-up in basis is one of the most powerful estate planning tools for highly appreciated assets. A client who holds appreciated stock with a large embedded gain may be better off holding it until death (to receive the step-up) rather than selling and gifting cash.

By contrast, assets in IRAs and other tax-deferred accounts do not receive a step-up in basis. Those assets are ordinary income when distributed.

Estate planning on the CFP exam rewards candidates who understand how legal structures, tax mechanics, and financial planning strategy interact. Cover the documents, the trust types, the estate tax mechanics, and the basis rules together rather than in isolation.