COMMON ESTATE PLANNING MISTAKES
Planning for the unknown turns out to be tough.
Estate planning can be difficult, but it doesn’t have to be. Most often, the hardest aspect of putting together a tailored estate plan comes down to two simple things:
Here are some examples of estate planning mistakes we see far too often.
This is the most common mistake, by far, and the easiest to rectify! It’s incredibly important to understand that building our estate plan is – in large part – designed to work while you are living. If you become incapacitated without the proper powers of attorney, the only way your family will be able to take care of you and ensure that your wishes are carried out until you recover will be to petition the court to appoint a guardian. That can be a lengthy process and is easily avoidable.
Further, if you pass away without an estate plan in place, your estate is subject to probate. As we mention in our Frequently Asked Questions (link), even if you don’t put together a plan, the state will provide one for you – and you and your family aren’t going to like it very much. The state intestate laws (the state’s plan for your estate) provides you with no control over who your heirs will be and how the estate will be distributed.
Make a plan. We promise that just the peace of mind alone will make it worth it.
Many of our clients reluctantly approach us almost with a sense of shame: “We know we should have done this a while back, but…” There’s no shame in this (if you don’t have a plan but are reading this, you can start the process right now), and you aren’t alone. According to a 2017 survey by Caring.com, more than half of Americans do not have a will. Just 42 percent of U.S. adults have estate planning documents, such as a will or living trust. And only 36 percent of parents with children under the age of 18 have an end-of-life plan in place.
We’ve found that the hardest part is simply deciding to get started and scheduling your Strategy Session. Take control and claim ownership of getting you estate plan set up! We cannot emphasize enough how much of a weight will be lifted when you face this and build a plan suited for you and your family. The stress of not having a plan is far greater than that of putting one together.
Many people think their wills or trusts control how all of their assets will pass upon their death. This isn’t entirely misguided, but many people hold much of their wealth in the form of retirement plan accounts or life insurance. As a result, many assets pass outside of wills or trusts. Wills and trusts control real estate and other property that you own, but there are certain assets, like life insurance and IRAs, that are not normally subject to probate and which a will or trust will not affect.
Note, however, that, if an estate plan utilizes trusts, it’s both possible and often desirable to name the trust itself as the named beneficiary of these types of assets. We would be happy to discuss such options during a Strategy Session.
Beneficiary designations intuitively seem like a good way to govern dispositions, but they are inflexible and don’t manage contingencies very well. For instance, if you name your son and your daughter as the beneficiary on your life insurance policy, and your daughter predeceases you, do you think the insurance company will pay the proceeds all to your son? Or do you think the insurance company will pay your daughter’s half of the proceeds to your daughter’s children?
(Almost certainly the proceeds are going exclusively to the son.)
By naming a trust as the beneficiary of your life insurance, your trust can control exactly how the proceeds will be distributed, including such contingencies. The trust can also name a person who will manage and distribute the money for minor children or grandchildren.
Let’s say your two major assets were your life insurance and your (traditional) IRA, and they were of equal value. So you named your son as the beneficiary on the life insurance, and named your daughter as the beneficiary on your IRA. The proceeds of life insurance are income tax free, but the proceeds from an IRA are generally all subject to income tax. So even though you intended to give equal shares to your two children, your daughter would end up with a significantly smaller inheritance.
This is one of the reasons we discourage our clients from leaving specific assets to specific persons. Instead, consider naming all children as beneficiaries, or better yet, leaving all assets to your trust, with the trust dividing them equally and providing who will receive what in the event a child should predecease you.
Although this is a general problem, perhaps the most costly type of this mistake involves real property. Consider this scenario: you decide, in an effort to remove your primary residence from probate, that you would like to gift the property to your three children. After you have passed, your children decide it’s time to sell the home and sell it for its fair market value: $500,000. They discover that their “basis” for the sale was what you paid for the property twenty five years ago: $100,000.
The taxable gain that your children face is $400,000! Depending on your children’s income level, even if they hold the property for the one year needed to qualify for long-term capital gains taxation, they could be paying up to 20% capital gains tax on the sale – $80,000.
Here’s the kicker: if your children had inherited the property through your will or trust, they would have received a “step up in basis,” which would have meant their basis in the property was fair market value at the time they inherited the property.
They would have owed no capital gains tax on the sale at all.
If you have a family member or loved one who has special needs and receives need-based government benefits, you have to be very careful to protect his or her inheritance in a Special Needs Trust. We all want to take care of our family – especially our vulnerable family members – and providing an inheritance without the shield of a Special Needs Trust imperils the continuation of government benefits. Put simply, if a Special Needs Person owns too many assets, he or she is disqualified from needed benefits. By shielding that inheritance in a trust with a third-party trustee, your loved one will retain benefits because the inheritance is owned by the trust and is not directly in his or her control.
A Will or Revocable Living Trust is merely part of a wholistic estate plan. Having one is important but isn’t enough on its own. In order to properly plan for your and your family’s future, it is essential to also plan for incapacity with powers of attorney and for end-of-life decisions with a Living Will. Further, it’s unlikely that a Will or Revocable Living Trust on its own will effect adequate tax mitigation.
That is, having a Will or a Revocable Living Trust is a necessary but not sufficient condition to establishing a well-rounded estate plan.
Living trusts must be funded to avoid probate and the need for guardianship. “Funding” a living trust means completing the process of retitling your assets from your individual name to the name of your trust. Funding includes both assets with titles (like real estate or bank accounts) and those without titles (like household furniture). If a Revocable Living Trust isn’t properly funded, one of the primary benefits of a living trust – avoiding probate – will be lost because the unfunded assets are subject to probate.
Estate planning is about “what if?” Your plan should include designated backups or alternatives for all of the key players, including successor trustee and personal representative. Don’t simply assume that everyone you name to act in specific capacities will be willing or able to do so when the time comes. Life is pretty unpredictable, so the name of the game is to draft your estate plan to be able to weather uncertainty. By providing alternates, you give your plan additional strength and flexibility to continue to function if the unexpected happens.
Yes, we understand all of the reasons why this seems like a good idea. Please don’t do it without consulting an attorney. There are a ton of reasons why this is usually a bad idea:
- Please reference Mistake No. 6. Putting your child on the deed with a joint right of survivorship does avoid probate, but it is itself a taxable event and strips your child of the step up in basis that would shield him or her from capital gain taxes.
- If your adult child is on the deed, his or her creditors can come after your property to satisfy debts.
- If your adult child is going through a divorce or is involved in a lawsuit, your property is at risk.
- More capital gains trouble: if you decide to sell the home, you can use your primary residence capital gains exclusion ($250,000 for individuals and up to $500,000 for married couples) only on your fractional share. Each of your children may have a large long-term capital gains tax bill to be paid that could have been totally avoided if the house had still been titled in the name of your revocable trust.
Your estate plan needs to be suitable for your family. Yet, as reflected in state intestacy laws, “default” estate planning has a clear bias towards traditional families. For example, estate plans for married couples, especially online “do-it-yourself-kits” often follow the “all to spouse” model at the death of first spouse. However, as more and more families are becoming more complicated, including children from prior relationships, separate assets and other differences, often make that kind of an estate plan a poor fit.
McGrannLAW has years of experience working with blended and non-traditional families. We can’t claim that we’ve seen it all, but our experience is both broad and deep enough to allow us to put together a plan as unique as your family is.
Riddle me this: what insurance company would ever pay out a $1,000,000 life insurance policy to a seven year old? Not a single one. Direct inheritances or payments to minors will cause the Court to appoint a guardian for the minor if no guardian is provided for in the estate plan. The court-appointed guardian may not be someone you would have picked.
The good news is that this is entirely controllable. Your estate plan should provide for exactly this type of situation: it should name guardians and/or custodians for any assets, should limit how the funds are used (if money is allocated for the care of the children, is it okay for the guardian to buy a BMW X5M with inheritance funds to drive around the children when a Honda Civic would do?), and under what conditions the minor children can receive their inheritance when they come of age.
If you’ve read this far, it should be abundantly clear that it is far easier to draft a well-intentioned mistake into an estate plan than it is to get it right. Yes, there are forms out there that you can download or purchase (LegalZoom is right here – provide link) that are cheaper than working with McGrannLAW or another estate planning professional. It’s been our experience that the seemingly benign errors made when modifying forms turn out to be far more costly than working with an excellent attorney.
As we have said elsewhere, we would be honored if you chose McGrannLAW to partner with you on this journey – but we encourage you to work with any competent attorney before resorting to LegalZoom or other DIY products. We are happy to provide a referral to another firm if for some reason you would prefer not to work with us.