A few years ago, I received a phone call from a woman understandably upset that she might not inherit any of her deceased father's large 401(k) plan, even though he was divorced and she was an only child. Unfortunately, about a year before, her father had been divorced for the second time and failed to remove his ex-wife as the beneficiary of his 401(k).
When he unexpectedly died, his ex-wife remained the beneficiary of his account. According to the federal Employee Retirement Income Security Act (ERISA), she was entitled to receive the assets. While the man probably never intended for his ex-wife to receive these assets and entirely cut out his only child, that is exactly what happened due to a simple administrative oversight. The daughter was simply out of luck.
You don't have to be ultra-wealthy to reap the benefits from a well-thought-out estate plan. But you do have to make certain the plan is updated often so that these kinds of mistakes don't occur and hurt the people you love most.
Let's Start with the Basics
An estate plan consists of the legal documents that will provide clarity about how you would like your wishes carried out both during life and after you die. It consists of three primary documents:
A durable power of attorney for financial matters.
A health care power of attorney or similar document.
The latter two documents designate individuals to help make decisions involving your finances or health in case you cannot while you're still living.
I work with many individuals and families to help them design estate plans that effectively reflect their wishes and avoid common estate planning mistakes. Here are five common mistakes I see:
Mistake No. 1: No Estate Plan at All
It's not uncommon for me to work with people who have accumulated several million dollars in assets, yet they don't possess even a simple will. A will provides specific information about who will receive your money, property and other assets and therefore is important even for people with minimal assets.
Without a will, state law decides who will receive your assets, and it's not likely they will be distributed the same way you would want. Dying without a will, known as dying intestate, involves a time-consuming and costly process for your heirs that can easily be avoided by simply having a will.
A will may include several other important pieces of information that can have a significant impact on your heirs. A will provides the opportunity to appoint a guardian for your minor children and an executor to carry out the business of closing your estate and distributing your assets. In lieu of a will, these appointments will likely be made by a probate court.
Mistake No. 2: Missing or Incorrect Beneficiaries
Many people are surprised to learn that some of their assets, such as retirement accounts and life insurance policies, are not controlled by their will. To make certain the right person inherits these assets, a specific person or trust must be named as the beneficiary for each account.
As I've already pointed out, one of the most common pitfalls is failure to update beneficiary designations.
For example, a person may have opened an IRA when they were in their 20s. They may not have been married and could have named a relative or friend as the beneficiary. Fast forward years later when that person has married and may have kids of their own. If the employee passes away without changing the beneficiary, the amount in that account will go to the person they named decades ago instead of a spouse, their children or both.
Mistake No. 3: Incorrect Joint Title
Married couples can own assets jointly, but they may not realize that there are different types of joint ownership:
Joint Tenants with Rights of Survivorship (JTWROS): If one person passes away, their spouse or partner will automatically receive the deceased person's portion of the asset by order of law. This transfer of ownership bypasses a will entirely.
Tenancy in Common (TIC) -- Each joint owner has a separately transferrable share of the asset. Each person's will dictates who receives the share at their death.
It is not uncommon to see improper joint asset titling become an issue if a deceased person's share of a joint asset is intended to be used for a specific purpose, such as funding a trust, following their death.
For example, George and Mary are a married couple with a large amount of investment assets. Their non-retirement accounts are all owned jointly as Joint Tenants with Rights of Survivorship. Assuming George passes away first, his wish is to use a portion of the investments to fund a trust created by his will for the benefit of their four grandchildren. However, because all of the assets automatically go to Mary once he dies due to the JTWROS titling, there are no assets available from George's estate to fund the grandchildren's trust.
Mistake No. 4: Failure to Fund a Revocable Living Trust
A living trust allows a person to place assets in a trust with the ability to freely move assets in and out of the trust while living. At death, assets continue to be held in trust or distributed to beneficiaries, all of which is dictated by the terms of a trust document.
The major advantages of a revocable living trust are twofold: First, it reduces or eliminates the time and expense associated with the probate process, which is necessary with a will. Second, it provides privacy and protection from the probate process. A will, when submitted to probate, becomes public record, which makes it not only visible, but able to be challenged.
The most common mistake made with a revocable living trust is failure to retitle or transfer ownership of assets to the trust. This critical step is often overlooked after the "heavy lifting" of drafting the trust document is completed. However, the trust is of no use if it does not own any assets.
Mistake No. 5: It May Not Make Sense to Name a Trust as a Beneficiary of an IRA
The new SECURE Act, which went into effect on Jan. 1, 2020, calls for the removal of a provision known as the stretch IRA. This provision allowed non-spouses inheriting retirement accounts to stretch out disbursements over their lifetimes. It allowed assets in retirement accounts to continue their tax-deferred growth over many years -- a very powerful strategy.
But the new law requires a full payout from the inherited IRA within 10 years of the death of the original account holder, in most cases, when a non-spouse individual is the beneficiary.
Because of these changes, it may no longer be ideal for a person to name a trust as the beneficiary of their retirement account. It is possible that either distributions from the IRA may not be permitted when a beneficiary would like to take one, or distributions will be forced to take place at an undesirable time and unnecessary taxes will be generated.
It makes sense for people to speak with their attorneys and visit their estate plans to ensure that the new SECURE Act provisions do not create unintended consequences.
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