17 Estate Planning Mistakes and How to Avoid ThemEstate Planning
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A lot of people usually assume that only the wealthy need an estate plan. But the reality is every family should have a solid estate plan of their own.
Embarking on estate planning is a task most people would rather avoid, but it is essential. Apart from this, having an estate plan that holds water is very difficult.
There are many mistakes one could make in drawing up an estate plan. This article outlines the most common estate planning mistakes and how to avoid them.
Having this knowledge could be the difference between securing a solid future for your family or making them lose their inheritance to avoidable taxes.
Table of Contents
1. Not Grasping How Your Assets Will Pass Upon Your Death
Many people think that their will determines how their assets and properties will be distributed when they die. But because most people have their wealth as life insurance or retirement plan accounts, their assets are distributed outside of wills and trusts.
A lot of people misunderstand that wills and trusts only cover real estate and other properties. Assets like IRAs and life insurance pass to beneficiaries and cannot be subject to probate. The beneficiaries you name for these assets will be at the receiving end after your passing regardless of what your will says.
Pro tip: Of the most common estate planning mistakes, this is one you can easily avoid. When significant life changes happen, or even after 2/3 years, your beneficiary designations for IRAs and life insurance policies should be reviewed and made sure to align with your most recent estate planning goals.
2. Planning Your Estate Around Specific Assets
One of the top estate planning mistakes individuals make is bequeathing specific assets to a particular person. Unless there are clear reasons why a person should receive a specific asset, it is a terrible idea to do this.
For example, a man attempting to treat his three children equally after he passed transferred half of his house to the oldest, made his second child a signatory to his savings account and named his youngest as the sole beneficiary of his retirement plan.
As at the time of doing this, these assets were equivalent in value. However, before he died, he hit a rough patch and had to sell the house.
He put the proceeds in his savings account. He also was unable to continue funding his life insurance policy, and it lapsed. When he passed, the savings account went to the surviving signatory.
This man inadvertently disinherited two of his children by planning around specific assets. He could have avoided this if he had invested more in proper planning.
3. Not Minimizing Estate Taxes
Except in rare cases, estates grow over time and likewise, the taxes to be paid on them also increases.
But the provision of an estate tax exemption usually makes people ignore making a proper plan for estate taxes. Estate tax exemption is the highest amount you can pass to an heir estate tax-free.
Because the current worth of their estate is far below the exemption, some people will not take the fact that their estates could become taxable at the time of their death into consideration.
Good to know: Surviving family members end up paying massive taxes that could have been avoided had proper provision been made for the new value of the estate in previously drawn up estate plans.
4. Depending on Co-Ownership of Properties to Escape Probate
Some state law statutes say that probate must be opened after the death of one of the co-owners of any property. But most people do not know this and usually fall victim of this estate planning mistake.
Parents usually go ahead to make their children co-owners of their properties to escape tax and what not. The rationale behind this is that the said property is supposed to automatically pass to the child upon their death (by right of survivorship).
The reality, however, is that this action can cause unforeseen problems in the future.
- The parent’s Federal Estate Tax Exemption can be reduced because he/she gave a lifetime gift (if the half of the property was valued higher than $13,000 within the calendar year of the gift).
- Because the property was given to the child during the parent’s lifetime, the child takes the parent’s original basis in the half that was provided. This could result in capital gains tax to be due on the half received by the child upon the eventual sale of the property. This can be avoided if the parent does proper estate planning and the property goes to the child upon the parent’s death.
- Making a child co-owner to any property allows potential creditors of the child a legitimate claim to the property in the future. Your child could run into debts later in his/her life or could even be involved in a divorce before your death. This would open the door for creditors to force the sale of the property and use your child’s fractional share to satisfy the debts.
Pro tip: Instead of making your child co-owner to any of your assets, simply titling such assets in the name of your revocable trust will help the child receive the full benefits without having to go through all of these tax problems.
5. Not Putting a Disabled Beneficiary into Account
This particular estate planning mistake is peculiar to parents of children with disabilities. These parents make the erroneous decision of leaving the inheritance of their children in a regular will or trust.
However, upon the deaths of such parents, public welfare assistance will be suspended on the disabled child because of the inheritance. This results in the child spending most of the estate on medical and other needs.
Until the inheritance has been spent down to the statutory limit will such a disabled child be deemed eligible for public assistance again. This is not the intention of most parents in this category.
Pro tip: To avoid this situation, the inheritance of any disabled child should be passed to them using a specially-drafted trust that protects the child and keeps them in line for welfare assistance from the government.
6. Not Making Special Provisions for a ‘Problem’ Child
Are you a parent conscious of protecting your legacy? But your heir or beneficiary is one you’re sure will not constructively use his inheritance. Or he will spend off the estate in a few years living lavishly?
Failure to put specific things in place will ensure your ‘problem’ child does all this and squanders your hard-earned wealth in no time.
Most people attempting to curb this usually hold an inheritance in a trust until their ‘problem’ beneficiary reaches a certain age they are sure he/she would have grown more mature. Or they decide that the entire inheritance of the child be distributed as monthly payments across some years.
Some even go as far as deciding to asset-protect that particular child’s share until the child dies. Others will say the child must submit to a drug and alcohol test over some time before the authorized trustee can release an inheritance to the child outright.
Good to know: As long as an inheritance is being held in trust, it can be shielded from the beneficiary’s spending habits, from divorcing spouses, and even from creditors. Another advantage of your trust is that it can control where the inheritance goes upon the death of the beneficiary.
7. Poor Drafting
Let’s consider these two examples to better illustrate the concept of poor drafting.
Consider a man who bore three children, and upon the opening of his will, it read: I leave my estate to “my surviving children.” This sounds fair. But after perusal of different scenarios, what did this man mean?
If one of his children died, did he want his estate divided between the other two children, or he would have still preferred a three-way division and the deceased child’s share to pass to the dead child’s children (who are his grandchildren)?
Another man’s will left his estate to be shared equally “between his descendants.” When the will was drafted, he had just two children, but at the time of his death, one of his children already gave birth to three other children. Now, by law, his estate will be divided equally into five places with each descendant receiving one-fifth of the overall share.
He probably meant for his estate to be shared equally between his children regardless of how many grandchildren but the poor draft of his will did not reflect that.
A superbly drafted estate plan would have made intentions of both men clear. A will worded thus, “I leave my estate equally to my living descendants, ‘per stirpes'” makes it clear that the second man’s properties should be divided equally among the first two children.
8. Attempting To ‘Do It Yourself’
This in itself can be considered one of the top estate planning mistakes. There are a lot of websites online that offer a cheap and perhaps easy way for you to do the drafting of your estate planning documents. Agreed, most parts of estate planning are mostly personal and must be done on your own.
However, you are not an expert, and you will find yourself trying to work your way through confusing legal documents if you don’t get expert help.
You do not want to make mistakes that could cause your plan to be inoperable or carried out incorrectly. To ensure that your documents reflect your wishes accurately, you should hire a competent estate-planning company such as Trust & Will.
No matter how modest your estate is, it will still represent a tremendous amount of money lost for your family if the planning is poorly done.
9. Depending on Beneficiary Designations
Relying solely on beneficiary designations is one of the estate planning mistakes to avoid at all costs! This method does not cater for handling unforeseen circumstances and contingencies.
For example, a man named his son and daughter as beneficiaries of his life insurance policy. However, the son predeceased his father by two months. The insurance company paid the surviving beneficiary — the daughter. The son’s family were all left out to dry.
Most of us would like to think that the man would have preferred for his son’s half of the money be paid to his family, but the insurance company had no choice. To avoid this sort of scenario, naming a trust as the beneficiary of your life insurance will allow you to control how the proceeds will be passed to your heirs no matter the contingency.
Pro tip: Your trust can also name a person to manage and distribute the inheritance for minor children and grandchildren.
10. Leaving Property to a Minor Child or Grandchild
If you leave your estate to a minor, or if your beneficiary is still a minor at the point of your death, the executors of your will or insurance policy as the case may be will only pay your benefits to a court-appointed guardian. This person may be someone you would not want. The cost of getting such a court order is high.
A perfect example is if you want the share of your deceased daughter to go to her children. If they are still minors at the time of your death, the courts will grant the children’s father (her ex-husband) priority to receive the share as the children’s guardian.
However, if you leave the inheritance in trust for such a beneficiary, the trust will specify who is going to manage the funds and make necessary distributions to support the needs of the minors.
It will also specify at what age the funds should be turned over entirely to the beneficiary or when the child could become the trustee of their trust.
Good to know: As long as an inheritance is being held in trust, it can be shielded from the beneficiary’s spending habits, from divorcing spouses, and even from creditors. Another advantage of your trust is it can control where the inheritance goes upon the death of the beneficiary.
If invested properly, the inheritance could grow, ultimately leading to greater financial support over time.
11. Not Considering the Income Tax Area of Your Assets
A man’s two most significant assets were his (traditional) IRA and his life insurance; both were equal in value. Consequently, he named each of his children as beneficiaries of each of the two assets.
A problem arose when he died, and the children realized they were not getting equal value in inheritances. Proceeds from life insurance are free from income tax while the proceeds from an IRA are income taxable. The second child lost a third of his inheritance to income tax.
This is another reason to avoid planning your estate around specific assets. The best option for this man was to leave all his assets to a trust, with the trust sharing the children’s inheritances equally between them.
He could also have named all his children as beneficiaries to each of the assets, but this is not as watertight as leaving the assets to a trust.
12. Not Considering All the Tax Consequences of a Gift
A man suffering terminal ailment heard that probate could cost his children a substantial amount of money. So, he decided to deed his home to his children two months before he eventually died.
By law, this action is seen as a gift, and it exposed the children to unfair taxable gain figures when they decided to sell the house. They eventually ended up paying a substantial amount in capital gains tax that was obvious the man didn’t want.
Had the house been owned by a living trust as at when the man died, then the children would have inherited it with a ‘step up in basis.’ This means that the basis for determining taxable gain would have been the fair market value of the house as at when their father died.
The children would have paid no capital gains tax when they sold the house. The man’s attempt to avoid probate by gifting the house to his children backfired.
13. Funding a Gift to Charity Using the Wrong Assets
Charities cannot be charged income tax by the government. So, it makes sense for you to save your family from paying unnecessary income tax by making a charity a beneficiary from a taxable income asset.
A lady wanted to leave $10,000 to her church after she died, and the rest of her assets to her children. Her inexperienced attorney made the mistake of drafting the lady’s trust as told: “$10,000 to my church and the rest shared equally among my children.”
The lady’s huge IRA passed to her children, who were required by law to pay income tax on it. If the lady had used her IRA to fund the money for the church, there would have been $10,000 less taxable income to her children, consequently increasing the amount that they inherited after income taxes by as much as $3,000 (using a 30% rate for both state and federal income taxes).
The inexperience of the lady’s attorney eventually cost her children $3,000.
14. Neglecting to Fund Your Living Trust
A couple had enough foresight to have a Living Trust, but contrary to instructions from their attorney, they did not re-title their assets. The attorney, acting in the best interest of his clients deeded their home to their trust. This couple, however, later sold the house and bought another one in their names and not in the name of the trust.
The husband died first, and after the wife’s death, all of their assets including their new home were subject to probate and were included as a part of her taxable estate. By neglecting to title their assets in the name of their trust, they did not achieve any of their two planning goals: avoiding probate and estate tax reduction.
Pro tip: Some people plan and have living trusts. Having a trust, however, is not all you need to do for proper estate planning.
You have to fund the trust with your assets by replacing record title or beneficiary designations as instructed by your attorney. Hiring an attorney that offers this service is also an option.
15. Not Doing an Estate Plan While Divorce Is Pending
Love always makes people do things like make their spouses inherit from their wills or trusts. But most people do not want these spouses to benefit from their wills after a divorce.
These spouses eventually end up benefiting because they made the typical estate planning mistake of forgetting to change their asset beneficiaries (especially on life insurance and qualified retirement plans).
For cases where your spouse is automatically disinherited from your will after the divorce, but you die before the divorce is completed, they still benefit and inherit under your will.
Pro tip: The best option is to change and review your estate plan immediately divorce is filed. Waiting until the end of the divorce proceedings could prove fatal.
16. Failure to Have Proper Beneficiary Designations on Your IRA
In some cases, the primary people you leave certain assets (like your IRA) might not be able to inherit them. This could be because the beneficiary has died since the last time you updated your will. Or in rare events, they do not want to inherit something you bequeathed to them.
After your death, your IRA would automatically be bequeathed to your estate which may mean it lands in the hands of people you may not want. Perhaps, the children of the primary beneficiary would have been your preferred target.
This makes it a no-brainer always to confirm your beneficiary designations (or file for a new form) and never rely on your memory.
17. Not Having an Estate Plan at All!
Not having a plan on hand is the one of the top estate planning mistakes. Because an estate plan is naturally implying death, most people usually decide to leave it till later in their lives when they’re old.
If you do not lay down a plan for how and to whom your assets will be distributed, most states have one for you, but it may not be what you would want. Not a lot of persons would deliberately let their state legislature write an estate plan for them, but that is a result you get if you die without a pre-existing plan.
What is your experience with estate planning? Are there any estate planning mistakes we missed? Let us know your thoughts in a comment below!
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.