Estate planning is generally about as fun as taxes. You don't want to think about a time when you won't be here. But like taxes, death is certain, so you plan. But there's planning and then there's proper planning.
There are more than a few ways to mess up the best of intentions. Here's how to avoid critical estate planning mistakes.
There's a lot to consider when creating an estate plan and you are going to need the help of professionals like an experienced estate attorney to draft a will and trust. You may need to consult your health care provider to discuss medical documents dealing with incapacity. Your financial advisor can help with estate taxes and protection. “If you're not an expert in these fields, don't pretend to be one. Estate planning is too big to do yourself, and too important to mess up,” says Tom Hegna, author of Paychecks and Playchecks: Retirement Solutions For Life.
Trying to avoid legal fees by using a form or non-attorney service from the Internet could create problems for heirs and administrators. Don't go cheap. The cost of “fixing” the problems, if they can be fixed, will often be far more expensive than the attorney fees for preparing a will or trust. “One of my favorite lines is from the old Fram Oil Filter commercial, 'you can pay me now, or pay me later,'” says Scott Haislet, an attorney and CPA.
Be clear about joint tenancy
The principal advantage of the joint tenant approach is that it's cheap, fast and easy. But Haislet, describes how it can be tricky.
Say mom owns real estate called Blackacre. She wants to leave it to her only child, Charlie. She could adopt a living trust to provide that Charlie gets Blackacre at her death. Instead, she transfer Blackacre to herself and Charlie, as joint tenants with right of survivorship, intending that she will die first and the property will automatically go to Charlie when she does (which it will if death occurs in that order).
However there are problems with joint tenancy. Does Charlie get a 100% “step up” in federal income tax basis? “It's not entirely clear,” says Haislet. What if Charlie is in a car accident with a big claim against him? The victim could seize Blackacre. What if Charlie dies first? Blackacre is in mom's estate and subject to probate. What if Charlie becomes incapacitated? If mom needs to sell or finance Blackacre, she won't be able to do it absent getting a court order, Haislet explains.
What's the solution? “Avoid those joint tenancy problems by establishing a living trust,” says Haislet.
Julie Malekhedayat, a tax partner with Perisho Tombor Ramirez Filler & Brown says she had a client who had changed the title of two real properties in order to refinance. The client changed from revocable trust (living trust) to personal names. Then the husband died and the properties were no longer in the trust for administration and not available for funding the bypass trust. This issue is still open, but if the surviving spouse wants to use these properties for the bypass trust, she will need to go to probate court to try to return the properties to the trust, says Malekhedayat. Alternatively, the properties will need to go through a probate proceeding to pass the properties to the heirs. “The moral of the story – remember to re-title real estate to a living trust after refinancing.”
Furthermore, if the estate plan is outdated, your legacy could be going to the wrong person. People who have had multiple marriages and divorces or children in multiple relationships, they need to have a heightened awareness that their estate could be headed for trouble if they don't take action, warns Hegna. “If only Marilyn Monroe was alive today we could ask her. 'Did you really intend for your estate to go to your acting coach's third wife?' I'm sure she would say otherwise,” says Hegna.
Get proper protection
Most people don't realize how this low interest rate environment causes people to be underinsured. In a 1% interest rate, you need $5 million to produce $50,000 of annual income. Even in a 5% interest rate environment, yo need $1 million to produce $50,000 of income. “Don't leave the ones you love in a dangerous financial situation,” says Hegna.
Creditors can tap your revocable trust
Sometimes people think a revocable trust will protect their assets from creditors. This is generally not true says Haislet. The reason for adopting a revocable trust should be to avoid probate and avoid asset management in case of incapacity. Estate taxes can also be avoided or reduced in some cases, says Haislet.
Some people don't coordinate the estate plan with beneficiary designations. They expect the family trust agreement to cover all of their planning, but assets that have a beneficiary designation (retirement plans, annuities and life insurance), for example, or are held in joint tenancy (bank accounts, cars), are not subject to the trust agreement, points out Mary Kay Foss, a CPA with Sweeney Kovar.
She had a client who named his wife as beneficiary of his trust. The trust agreement provided that his wife would get the residence outright and that his share of other assets would fund a bypass trust. With the IRA and the residence going directly to the spouse, there was only a small amount of assets that would go to the bypass trust. The solution was to have the widow disclaim an interest in the residence so there were more assets to fund a trust. The the residence was allocated to her as her share of the family trust.
Just do it
Procrastination could come back to haunt you and your heirs. No one knows when they are going to die. Right up there with not forming a plan, is pushing it off to a future date. You never know when “too late” is going to be. “Don't delay planning,” says Hegna.
If you fail to plan, the government will settle your affairs. Most likely, your remaining assets are not going to be distributed in the manner you desire. Even a simple will is better than nothing at all.
Says Hegna, “Failing to plan is the worst case scenario.”