“Estate planning is only for the rich.” “I don’t have any assets.” These are two statements I often hear. While most people today will not leave an estate subject to federal estate tax, there are other non-tax issues which should be considered and discussed as part of the “estate planning process”. When I meet with new clients who have had Wills, Powers of Attorney and Living Wills prepared by another firm (or worse, Legal Zoom), I often encounter the same mistakes made over and over again. I have highlighted five of the most common mistakes made in estate planning. Hopefully by informing others of these mistakes, the end result will be that less mistakes will be made going forward.
#1 Not reviewing Beneficiary Designations
Life insurance policies and retirement plan accounts are common assets and most clients I meet have both (often times multiple policies and multiple retirement accounts). These “beneficiary assets” pass to the persons (or organizations) named on a beneficiary designation form with the insurance company or custodian of the retirement plan. Clients often mistakenly assume that by updating their Wills they have directed to whom all of their assets will be distributed. For example, let’s assume a married couple in their late 30’s meets with their attorney to discuss their estate plan. They have three minor children whose ages are 12, 9 and 6. The attorney discusses the preparation of Wills for the two of them which include contingent trust provisions for their children. The trust provisions state that if a child has not attained 30 years of age, his or her share shall not be distributed outright but instead should be held in trust and managed by a trustee until the child attains 30 years of age. The attorney prepares the Wills for the clients but neglects to discuss the beneficiary designations for their life insurance policies and retirement plan accounts. Assuming the clients had named their children as the outright beneficiaries of such assets, the life insurance proceeds and retirement account funds may be accessed by the child to spend as he or she wishes by as early as age 18. I can assure you most parents would not be happy with this result. It is imperative to discuss the beneficiary designations of such assets with the client and coordinate the designations with the clients’ overall estate plan.
#2 Failing to Discuss the Tax Clause in the Will
A Will typically includes a provision commonly referred to as a “tax clause”. The tax clause provides the source for the payment of death taxes. The tax clause is often included in a Will (or Living Trust) as if it was a typical administrative provision and is not properly considered and discussed with the client(s). The tax clause can have a significant impact on the actual amounts the beneficiaries will receive and therefore is a provision which is often the subject of litigation. For example, let’s assume a client resides in Pennsylvania and has designated his girlfriend as the beneficiary of his IRA. The client has a Will which provides that all of his assets passing there under shall be distributed to his three adult children. If the client’s attorney included a tax clause in his Will which provides that all death taxes shall be paid from the residue passing under the client’s Will, the result will be that the client’s children will bear the death taxes attributable to the IRA client left to his girlfriend. The tax rate for amounts passing to an unrelated beneficiary (i.e. girlfriend) is 15%. Therefore, the client’s girlfriend will receive the IRA but will not be required to pay any portion of the PA Inheritance Tax attributable to the IRA. On the other hand, the assets passing to the client’s children will not only be reduced by the Inheritance Tax attributable to the amounts passing to them (the tax rate is 4.5% for amounts passing to lineal descendants), but will also be reduced by the Inheritance Tax on the girlfriend’s inheritance. It is possible that this may be exactly what the client wanted; however, it typically is not the desired outcome. It is important to remember is to review and discuss the tax clause and understand the impact it will have on the beneficiaries.
#3 Failing to Include Special Needs Trust Provisions for Disabled Beneficiaries
A disabled person is often entitled to benefits and programs provided by the federal, state or local government. In order to qualify (or continue to qualify), the disabled person typically must not have resources (assets) of his or her own. A trust which includes discretionary distribution provisions whereby a distribution will not supplant government benefits and will not be counted as a resource of the disabled person. It is very important to not leave outright distributions of assets or money to a disabled person as it may unintentionally result in the loss of certain benefits and programs for the disabled person. The advisor should always ask a new client whether there are any family members who are disabled under the social security disability rules and regulations.
#4 Adding a Child as a Co-Owner to Your Bank Account for Purposes of Convenience
I have administered many estates where a parent added his or her child as a co-owner to the client’s account solely for convenience purposes. Typically it is done to allow the child to pay bills, withdraw money, etc. The potential problem with adding a child as a joint owner on an account is the fact that upon the client’s death, the account immediately becomes the account of the co-owner child. Absent litigation and direct proof that the client did not intend for the account to pass solely to the co-owner child, the child is not required to share any portion of the account with anyone else. If convenience is desired, it is best to add child to the account as a power of attorney.
#5 Equating “Probate” with “Tax”
I often hear this when talking with my clients, “I was talking with a friend of mine who said I need to avoid probate, and to do so, I should create a living trust to which I should transfer my assets.” I then explain to the clients that avoiding probate does not mean avoiding tax. It is true that there are certain states in the country where the probate process should be avoided at all costs. Pennsylvania is not one of those states and the truth is Pennsylvania’s probate system is rather simple. Almost always, I recommend the use of a Revocable Living Trust for a client with out-of-state real estate. By transferring the ownership of the property to the Living Trust, the executor will avoid an ancillary estate administration in the state where property is owned.