Estate planning can provide peace of mind, ensuring that your assets, interests and loved ones will be protected after you die, but it is also fertile ground for some costly mistakes.
Whether due to oversight or improper planning, estate planning missteps can undermine your intent and drastically diminish the financial legacy you leave behind. They can also create added stress for your heirs in a moment of grief.
“Mistakes happen frequently,” said Steve Hartnett, an estate planning attorney and associate director of education for the American Academy of Estate Planning Attorneys in San Diego, California, in an interview. “It is often because the individual, or the attorney, did not consider the complete financial picture.”
The following list of estate planning blunders can help shed light on some of the most costly mistakes to avoid, most of which are easily avoided.
Estate planning may be a financial priority, but it is not exactly a day at the beach.
Few among us like to consider our own mortality, some superstitiously fear end-of-life preparations, and younger individuals often mistakenly suggest that wills and powers of attorney documents are the sole domain of the elderly.
As a result, far too many Americans delay drafting the legal documents necessary to protect themselves and their loved ones.
According to Rocket Lawyer, a San Francisco-based firm offering discount legal services, the majority (64 percent) of Americans do not have a will, and more than half (55 percent) of Americans with children do not have a will.1
That is a big mistake, said Hartnett.
“Failure to do estate planning is probably the most common mistake,” he said, noting parents who fail to name a legal guardian for their minor children may be putting their kids’ future at risk. “Even if you don’t have much money, you need a will, because whether you know it or not there is process in place. Your assets will be distributed somehow when you die.” (Related: The Basics of Wills)
The consequences of dying intestate, a legal term that means dying without a will, can be dire. Absent instruction from wills and beneficiary forms, said Hartnett, the courts will decide how best to divvy up your assets, which may not reflect your intent.
At minimum, everyone should have a will, a financial power of attorney, which identifies the individual you would like to make financial decisions on your behalf should you become too ill or incapacitated, and a health care power of attorney, which identifies the person you want to make health care decisions for you in the event you are unable to do so for yourself, said Lou Ulman, an estate planning attorney with Offit Kurman in Baltimore, Maryland.
Your estate plan should also include a living will, also known as a healthcare directive, which outlines your preferences for end-of-life medical care, he said, noting such documents ensure your wishes are carried out and also relieve your loved ones of trying to guess what you would have wanted – a common source of family infighting.
“People who do not have lots of money still need to make a decision as to who is going to talk to the doctor for you if you are not able to and who will pay your mortgage bills and file your tax return if you become mentally unable to handle financial matters,” said Ulman.
Outdated Wills and Forms
If you made a will 20 years ago, but haven’t touched it since, chances are it is out of date. Estate planning documents are not a “set it and forget it” solution.
Hartnett advises clients to review their estate planning documents and beneficiary forms every couple of years, and always after a change in family status, including a birth, death, divorce or marriage – even a relocation if you move out of state.
“There are all sorts of reasons why you may need to periodically update your estate plan,” he said. “It could be that the assets you own are worth dramatically more now than they once were or that you need to change your beneficiaries. Perhaps one of your kids has special needs so you want to leave your assets in a special needs trust.”
Others make the mistake of changing their will, but failing to update the beneficiaries for their retirement accounts (IRAs and 401(k)s), life insurance policies and annuities, which are often the largest assets in their estate.
That can be an expensive oversight.
Indeed, the beneficiary forms for such accounts are legally binding documents, which trump whatever is stated in your will.
If you change your will after a divorce, but forget to update your IRA beneficiary form, that asset would still go to your ex-spouse (or her heirs) decades from now when you die.
“Failure to coordinate beneficiaries is a common error,” said Ulman. “A couple may come in and set up a trust for their young children, but have a life insurance policy issued before they had kids so the beneficiary to that policy may still be their mom or dad, who is now in a nursing home. They don’t understand that beneficiary designations take priority over their wills.”
Failure to Title a Trust
Trust accounts serve many roles. They can help protect assets from creditors, they ensure your estate gets distributed to your heirs in the timeframe and manner you desire, and they keep details of your financial affairs private – including your assets, debts and designated heirs.
But trusts cannot accomplish any of those missions if you fail to move assets into the account, including real estate, stocks, cash or mutual funds — which happens all too often.
“Everyone does not need a trust, but when they do they need to spend the time to retitle their assets in the name of the trust,” said Ulman. “Sometimes people will buy property after they open the account and forget to add them to the trust, which means those assets will still have to go through probate.”
Probate is the costly and time consuming legal process of distributing your will after you die. (Related: Probate…Why People Fear It)
“There is a misconception that a revocable living trust saves taxes,” said Ulman. “It is tax neutral, but it does avoid probate and is private, whereas a will is a public document.”
Indeed, once a will is filed with the probate court, it becomes public record so anyone interested (think disinherited heirs and nosey neighbors) can request a copy.
Triggering the Estate Tax with Life Insurance
Wealthy individuals who die while maintaining ownership of their life insurance policy could inadvertently create a taxable event for their heirs.
Indeed, while life insurance death benefits are not subject to federal or state income taxes, proceeds may still be subject to estate tax if the insured had any “incidents of ownership” when he died. (Related: Tax Advantages of Life Insurance)
Only the portion of one’s estate that exceeds the federal estate exemption limit, which is $5.45 million ($10.9 million for married couples) in 2016, would be subject to the 40 percent federal estate tax. (Note: the $5.45 million exemption is only available to U.S. citizens and permanent residents at the time of death and each state may have an additional tax and a different exemption amount).
“If you have a $10 million life insurance policy and wanted to remove that policy from your taxable estate you would have to put it in an irrevocable life insurance trust,” said Hartnett. “Otherwise, if you own it and die tomorrow, that death benefit becomes part of your taxable estate.”
One potential pitfall could be when a wife is named the outright beneficiary of her husband’s life insurance policy. The proceeds would generally not be taxable to his wife upon receipt (life insurance proceeds are usually tax free to the beneficiary), but any remaining assets from the policy when she dies would be included in her taxable estate, which could increase the size of her taxable estate, potentially subjecting her estate to estate taxes at her death.
To help shelter the life insurance proceeds from estate taxes at the beneficiary’s death, the insured could instead make a gift of his existing policy to an irrevocable life insurance trust (ILIT), or have an attorney draft a new trust to purchase a new policy where the trust would be owner and beneficiary.
Either way, the trust could be structured so that the surviving spouse receives all of the income generated by the trust for her lifetime, plus be allowed access to principal for any additional funds needed.
Because the policy is owned by the trust, any proceeds that remain upon her death would not be included in her taxable estate and would pass to her heirs estate tax free.
Estate planning using trusts is complicated, however, and trusts must be structured carefully to provide proper protection. Always consult an attorney for advice.
Making Children Joint Owners of your Assets
Another estate planning no-no is to name your children as joint owners of your assets, which gives their creditors access to your money.
“I do a lot of seminars and I tell people that if they remember one thing tonight, do not make your children joint owners of your assets,” said Ulman. “That is a huge mistake. They may tell me that their son or daughter is very responsible, but I just ask if their child drives a car. If they do, everyone else on that road is a potential creditor.”
A better option is to name your child your power of attorney and payable-on-death beneficiary to your bank or brokerage accounts, which allows her to access those accounts if needed during your lifetime but keeps those assets out of her estate – and away from the hands of her creditors.
“I had a client lose her life savings of $80,000 because her son’s business went under and the bank he owed money to filed liens with other banks to see if he owned any outside accounts and sure enough he was listed as a co-owner,” said Ulman.
When it comes to crafting a bulletproof estate plan, good intentions are never enough.
Failure to put the proper documentation in place could result in a serious tax hit to your heirs, or deny your loved ones their rightful inheritance.
As such, legal advice is critical, said Ulman.
“Not finding the right attorney to guide you is probably the biggest blunder of all,” he said. “Look for an estate planning specialist, as a general attorney can pull books from the shelf and help you create a will, but they are always trained on the tax implications, strategies for avoiding probate, and how to protect your assets if you go into a nursing home. If you get the right guidance you will be OK in all those areas.”
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1 Rocket Lawyer, “Make-A-Will-Month survey,” 2014.