A solid estate plan can help ensure that your assets are distributed to your beneficiaries according to your wishes after you pass away, and can also be a key component of wealth management. But it’s also often easier said than done. Errors and omissions are not uncommon.
Estate planning mistakes can range from complex issues like understanding how to maximize tax efficiency to simpler mistakes like not having a plan at all.
“An estate plan doesn’t have to be complex,” said Pete Lang, founder and president of Lang Capital in South Carolina. “However, everyone should take the time to help ensure that their financial and personal affairs are in order prior to their death." (Related: Managing investments)
Here are some of the five most common estate planning mistakes advisers come across.
Not having a plan at all
“The number one mistake,” according to Josiah Grauso, adviser with ASC Financial Group in Pennsylvania, “is not having a plan at all. If you don’t have a plan, you completely lose control of the timing, distribution, and allocation of everything you leave behind.”
Having a will is a good place to start. Wills still must be reviewed through probate after you die, but they can help streamline the process, which can be lengthy and expensive without the benefit of documentation detailing what should happen to your assets.
Grauso notes that even with a will probate can take anywhere from six to 18 months to complete before assets are distributed to beneficiaries.
“Only about a third of US citizens have some form of estate planning,” according to Grauso, a statistic supported by a 2015 Harris Group estate planning poll1 commissioned by legal document service Rocket Lawyer, “so essentially the majority have nothing in place. A will alone may not be the best estate plan depending on your situation, but it’s better than no plan at all.”
Not naming beneficiaries
Some assets, like 401(k)s, IRAs and life insurance policies, are “non-probatable” — they traditionally pass immediately to the named beneficiary upon the owner’s death, outside of the probate system. Because of this, these assets generally ask for beneficiary information when the account or policy is set up.
Beneficiaries named on non-probatable assets take precedence: the named person will receive the asset even if the will states it should go to another person.
As such, it’s important to keep beneficiary information up to date, especially after a major life event like a death, divorce or birth of a child.
But, Grauso cautions, the real kicker comes if you name no beneficiary at all: if no beneficiary is named, the default beneficiary becomes your estate, and estates go through probate.
Allowing traditionally non-probatable assets to lapse into probate due to a lack of named beneficiary can result in a smaller inheritance, since assets subject to probate may go toward paying the decedent’s bills, debts, and any other claims on their assets before your heirs get whatever is left.
“Failure to name a beneficiary can result in assets that would normally avoid probate being forced through the probate system,” said Grauso, “which means that, just like any other probatable assets, they cannot be released until probate is over, and your heirs may pay probate costs they otherwise wouldn’t have had to pay.”
Making sure your “non-probatable” assets stay out of probate by keeping beneficiary information up to date can help avoid this, and ensure that the maximum amount goes to your intended inheritor(s). (Related: Understanding Insurance)
Not understanding tax implications
Any time assets are passed to a new owner, taxes have to be considered — but that consideration doesn’t always happen.
Although most Americans will never be subject to estate taxes, since the federal estate and gift tax exemption is $5.49 million (in 2017) and double that for married couples, they may still owe state-specific estate tax, capital gains from investment earnings, or income tax, said Lang.
Concerns about capital gains taxes come into play with appreciated assets such as 401(k)s, brokerage accounts or real estate.
It may be tempting to try avoiding capital gains taxes by adding your heirs as current co-owners of your assets now so that when you die the asset is already owned by them, thereby skipping probate. But assets that appreciate have two values that bear thinking about: their original cost basis, or what the current owner paid for the asset, and their stepped-up basis, which generally equates to current market value.
When heirs inherit an asset they receive it at a stepped-up basis, meaning that the cost basis for the heir is fair market value as of when it was received, rather than the value as of when the original owner took possession.
That benefit is lost when heirs are added as co-owners to an asset while its original owner is still alive. Anyone named on the document that lists original value will appear to have paid only that amount for the asset – meaning that when they try to sell it, they will pay taxes on all the gains the asset has accumulated since it was purchased by the original owner.
Not everyone owns assets that are subject to capital gains taxes, but most people do have to consider income tax, and received assets — whether gifted or inherited — are generally considered taxable income.
While some retirees may have to worry about estate or gift taxes, Lang said that the much more likely expense to consider in estate planning comes from income tax on withdrawals from the retiree’s tax-deferred savings vehicles. The question is how to best plan for withdrawals to attempt to be in a lower tax bracket than the retiree was in during working years while maintaining desired standard of living.
“Most retirees should consider shifting their focus to tax bracket control planning for their retirement,” Lang said, as withdrawals from 401(k) and other tax-deferred accounts are generally considered taxable income. “Those who do it right will leave much larger estates.”
Not understanding TOD/POD rules
Things like brokerage accounts and even some bank accounts, which would normally be subject to probate, can sometimes be made to skip the process by setting up a TOD (Transfer on Death) or POD (Payment on Death), which allow assets to go directly and immediately to the named beneficiary upon the owner’s death. However, while this may be a good way to keep assets out of probate, there are some considerations.
TOD/POD designations, similar to non-probatable assets like 401(k) accounts and life insurance policies, trump a will. So if you put all your heirs in the will but name only one heir as a POD on a specific account, that account will go entirely to that one heir.
“This is especially important if you want one heir to get more than the others,” said Grauso. “Some states require that if you have multiple names on a POD/TOD, you can only transfer in an equal distribution among the named beneficiaries.”
Different states handle TOD/POD differently, Grauso said, so it’s important to check your state’s requirements if you’re considering this route.
Failing to fund a trust after creating it
A revocable living trust is a common estate planning tool that allows assets to transfer immediately to named beneficiaries. When set up properly a trust may also offer tax advantages for you and your heirs.
“People think you need to be overly wealthy to have a trust, but you don’t,” said Grauso. “Anybody who owns any form of an asset — bank accounts, real estate, automobiles — they have an estate. As long as they’re set up, handled, and funded properly, trusts can be a powerful tool in bypassing the probate process and making sure your heirs receive assets according to your wishes.”
However, those who incorporate a trust into their estate planning should be aware of one of the most common mistakes advisers see, according to Lang: failure to fund the trust properly. Funding a revocable living trust involves transferring ownership of your assets by physically changing the titles from your individual (or joint) name to the name of your trust. With a revocable trust, you are not giving up control of the assets and they will be includable in the value of your estate, but will likely avoid probate.
Assets that are not properly retitled do not avoid probate, so it’s important to make sure the assets you intend to put in trust are handled correctly.
YODO (You Only Die Once)
Estate planning can be stressful for many reasons. To some, the process seems overwhelming. Others are uncomfortable pondering their own mortality, and fail to act. According to that RocketLawyer survey, 14 percent of Americans surveyed in 2015 did not even have a will, the most basic piece of an estate plan, specifically because they did not want to think about death.
“If you don’t do anything,” said Lang, “you or your heirs may end up in a tough spot, because there are so many things you need to consider when creating an estate plan.”
Indeed, having a solid estate plan is the best chance you have to control how your assets are distributed when you die. And you only get one chance to do it right.
Partnering with solid tax and financial advisors can help you navigate the intricacies of the process.
“There’s no time like the present,” Grauso notes, “to get your affairs in order, regardless of your age.”
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1Rocket Lawyer, “2015 Harris Estate Planning Survey: Data Highlights Sheet,” 2015