8 Common Estate Planning Mistakes
And How You Can Avoid Them
Not having an estate plan can have catastrophic consequences for almost anyone, regardless of net worth or family situation. Furthermore, a large percentage of estate plans currently in force are either out of date or have yet to be properly funded.
— Kyle E. Krull, owner of Kyle E. Krull Law Offices
Estate planning is one of the most neglected areas of personal financial planning in America. Millions of people spend countless hours monitoring their investment and retirement portfolios while neglecting to prepare basic legal documents, such as a will or a trust.
The estates of many wealthy taxpayers have been devastated by taxes and settlement costs because they failed to take the proper precautions. The assets of others have been posthumously transferred to people who were not the intended beneficiaries --- ex-spouses for example.
There are several common mistakes people make when they attempt to get their final affairs in order.
1. Failure to Fund the Estate Plan
Many consumers visit an attorney or estate planner and dutifully pay to have the necessary legal documents created to complete their estate plans. Some, however, then don't retitle their assets in the names of the trusts they have created.
"The most common estate planning mistake by far is the failure to fund the revocable living trust," said Leslie Daff, an estate planner with practices in Laguna Beach and Irvine, California, and Overland Park, Kansas. "Many times a deceased client's heirs will come in to see me and discover that the trust was not funded and the property is still subject to probate, which means that it will not be distributed to the heirs in the way that was intended."
Overlooking this simple step can lead to a nasty surprise for estate planning clients who believe that their task is finished once they leave the planner's office.
8. Joint Ownership Errors
Many married couples automatically assume that everything that they have should be owned jointly. This works fine most of the time, but the right type of joint ownership must be used.
There are several types, the most common being "joint tenants with right of survivorship." In this arrangement, all assets titled as such will pass to the surviving partner upon the death of the other.
"Tenants in common" is another alternative, It stipulates that half of the assets will pass to one person's estate when she dies, while the other partner or partners retain the remainder. "Tenancy by the entirety," a third option, requires the signatures of both partners to be valid. For example, a checking account titled in this manner requires that both spouses sign the check.
Couples who want their assets to pass to the other automatically when one spouse dies should choose the "right of survivorship" option. However, wealthier couples who need to avoid estate taxes might need to use the tenants-in-common option to ensure that the assets of each passes upon death into a trust or other entity.
Failure to use the proper form of ownership can result in a substantial tax bill and other complications upon the death of the first spouse.
2. Not Having an Estate Plan
Another common error concerning estate plans is the simple failure to have one.
Many Americans don't have any type of will, trust or power of attorney to protect themselves or their loved ones in the event of their death, disability or incapacitation. Even people with substantial assets fail to do this. They may name a transfer-on-death beneficiary for their bank, brokerage and retirement accounts, but they create no plan for additional assets.
Property that is not titled in the name of a trust is also vulnerable to lawsuits and other legal action.
Perhaps most important, people who do not have a will are leaving their children at the mercy of the courts, which may decide to place their children with less than ideal guardians if something happens to the parents.
3. Failure to Use Unified Credit
Every person in America is provided with an estate tax credit known as the unified credit, which allows you to leave a certain amount of assets ($1 million in 2011) to your heirs without paying estate tax. However, the law allows you to leave an unlimited amount of assets either to charities or surviving spouses without incurring estate tax. This is known as the unlimited marital and charitable deduction.
Married people who leave all their assets to their spouses, however, effectively forfeit their credit, which is not counted due to the unlimited deduction rule. Those assets will be included in the estate of the other spouse when he dies. A type of trust known as a credit-shelter trust must be used to preserve the deceased spouse's unified credit until the death of the surviving spouse.
A couple with assets of $4 million owned jointly who do not do this will effectively forfeit one of their unified credits. If both spouses die at once, then $2 million of the assets will pass into each of the spouses' estates, where each of their unified credits will be applied, leaving $1 million in each estate subject to estate tax. But if one spouse dies and his assets pass directly to the surviving spouse through joint tenancy, then the deceased spouse's credit will not be used. The surviving spouse now has the entire $4 million in assets but can only shelter $1 million from estate taxes with his own credit. A million dollars of the dying spouse's assets must be moved into the credit shelter trust to preserve the deceased spouse's unified credit and shield another $1 million worth of assets from taxation.
In this example, $1 million would go into the trust and the other million of the deceased spouse's assets would pass to the surviving spouse. Then, when the surviving spouse dies, both spouses' unified credits will be used to reduce the net taxable amount of assets to $2 million.
4. Failure to Make a Gift of Assets Before Death
Making a gift of assets is one of the simplest ways to reduce a taxable estate. Americans may give a certain amount of cash or assets each year ($11,000 in 2011) to anyone they choose without incurring gift tax.
People with substantial assets who are facing tax issues may greatly reduce their taxable estates by giving some of it to their heirs each year before they die. Not doing so may result in a much larger --- and unnecessary --- tax bill.
5. Incorrect Beneficiaries
Trusts, retirement accounts and annuity contracts have beneficiaries that must be specified by the account or contract owner. The beneficiaries may be changed due to marriage, for example, or divorce, among other reasons..
In some cases, a trust is listed as the beneficiary, while in other cases a trust cannot or should not be used for this purpose. Many times, however, no beneficiary is listed on an account, which means that everything in that account must go through probate upon the owner's death. Probate is the legal process that any asset for which no beneficiary is specified --- and any asset that is not part of a trust --- must go through to pass to the heirs. Probate should be avoided because it is an expensive and public process and it can drag on for months in some cases.
Failure to keep the beneficiaries current on an account can cause substantial problems --- such as the assets being passed to the wrong party --- when the account owner dies.
6. Inadequate Life Insurance Coverage
Not adequately protecting loved ones and other dependents with life insurance can have dire financial consequences. Virtually all adults need some form of life coverage, if only to pay off any debt they leave, plus burial and other final expenses. Rick Grover, a life insurance agent in Overland Park, Kansas, says that the hardest part of his job is making people understand why they need coverage. "So many people just don't think that it will happen to them," Grover said, adding, "They don't want to contemplate what life will be like for their families and loved ones if they're gone."
Those with small children and whose spouse is not employed usually need a policy that will pay from three to 10 times the amount of their salary or other annual income. Failure to do this can leave those who depend on the breadwinner destitute. A 2008 study by the Life Insurance Management Research Association, however, indicated that as many as one in three adults had no life insurance, and those who did typically carried only group life coverage through their employers.
7. No Living Will or Powers of Attorney
A complete estate plan does more than dispose of assets after someone dies. It also specifies when that person should be taken off life support and provides other medical directives in the event of disability or incapacitation.
Powers of attorney give a specified party the power to manage the victim's material assets if he is unable to do so. Neglecting to include these documents in an estate plan can place enormous burdens on loved ones, such as forcing them to make life-altering medical decisions without clear direction from the victim.
They may also be unable to pay for any services rendered because no one is authorized to make transactions on the deceased's behalf.
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