When we review estate plans, there are some common mistakes we come across. You may think some of these are obvious, but we have seen them enough to assure you that they are not. Here is our list of the 10 mistakes we see most often.
- Skipping the basics. With the increase in the gift and estate tax exemptions to $5,00,000, which under current law is in effect through December 31, 2012, we are experiencing a renewed interest from clients in estate tax planning. Many clients are intrigued by the idea of using their $5 million lifetime gift tax exemption (or a portion of it) to transfer wealth to their children now. Is this a good idea? In many cases it is, but first things first.
The best made estate plan is built from the ground up, so make sure the basic estate plan is in place before diving into the more complex, and often irrevocable, estate planning. Why is this important? The process of planning the basic documents, such as the Will and revocable living trust, should uncover most issues. That process is the time to review the client’s financial picture and family dynamics, which is an essential consideration in any estate plan. If the basics are skipped, you increase the likelihood of missed issues or oversights. Typically, the more advanced estate tax planning involves irrevocable steps that cannot be easily undone, if at all.
The more advanced estate tax planning should be pursued in many cases, but it is important to slow down the pace if necessary and get the basics in place. A thoughtful plan is a more efficient and accurate plan.
- Skepticism about life insurance. It is fairly common for clients to be hesitant about incorporating life insurance into their estate plan. Often clients have a negative view toward life insurance, because they are distrustful of life insurance agents and do not see the value in paying premiums on a policy that may never may pay or on paying large premiums over a potentially long period of time. However, there are many situations where life insurance is an invaluable aspect of an estate plan and, if properly explained to the client, can alleviate the client’s hesitation.
For example, a term life insurance policy is a relatively inexpensive way to provide a non-working or lower income earning spouse with comfort that they would not have to sell the family residence or dramatically change his or her lifestyle in the event of the death of the higher earning spouse. A “second to die” policy can provide the liquidity needed to pay estate taxes, so the beneficiaries do not have to sell assets they may prefer to retain. The use of an irrevocable life insurance trust should always be considered, although it may not always be necessary.
- Ignoring the retirement plan coordination. In every estate plan, the beneficiary designations for the retirement plans must be coordinated with the wishes of the client. In some cases, the retirement plans are a critical part of the estate plan and in other cases they are only a small piece. Either way, an incorrect beneficiary designation, or no beneficiary designation at all, is a problem in the event of a death. The clients often need assistance completing these forms. Most importantly, the client should obtain written confirmation of the designations from the retirement plan administrator and should provide a copy of that confirmation to their estate planning attorney. The written confirmation ensures that both the client completed the form properly and that the retirement plan administrator processed the form correctly.
In the event of a marriage or divorce, new beneficiary designation forms must be completed. Forgetting to complete new forms when the marital status changes can result in the wrong person receiving the retirement plan.
In addition to making sure the beneficiary designations are correct, the income and estate tax aspects of retirement plans need to be considered. If the beneficiary is a trust, will the retirement plan proceeds be held in a “conduit trust” to extend the period of time over which the beneficiary will receive distributions? For the clients who are charitably inclined, should the beneficiary of the retirement plan be a charity? These income tax aspects should be considered. With respect to estate taxes, the living trust should be reviewed to ensure that the right party is paying any estate taxes related to a retirement plan.
Also, since the retirement plans pass outside of a living trust, this must be considered in the drafting. If the bulk of a client’s net worth is in a retirement plan, then the desired result may not be obtained under the living trust. While this sounds obvious, it is easy to overlook if focused on drafting the estate plan.
- Overlooking the impact of federal and state estate tax. We all know there is a federal estate tax and we advise our clients about the current federal estate tax exemption and how it impacts them given their net worth. The federal estate tax exemption is not likely to be overlooked. However, what can be overlooked is what the estate plan says about payment of estate tax. Suppose there is a piece of real property held in joint tenancy. What does the living trust say about payment of the estate taxes on that joint tenancy asset? If it is supposed to be paid by the joint tenant, how will the trustee collect the estate taxes from that joint tenant? If there are specific distributions to be made to individuals, does the estate plan address whether or not those distributions are made free of estate tax? There are real economic consequences that result from these issues, so the boilerplate estate tax provisions need to be reviewed in each case to ensure the correct result.
In addition to the federal estate tax, some states have a state estate tax. We no longer have a state estate tax in California, but that does not mean we can ignore the issue for our clients. If a client owns real property in another state, we must evaluate if that state has an estate tax and how it would apply to our clients.
- Too many seats at the table. A fairly common approach to dividing assets among different groups of beneficiaries is to give the separate groups a percentage. This creates a number of problems by giving that beneficiary a seat at the table, so to speak. A beneficiary that is entitled to a percentage of the estate will be concerned with any and all issues that effect the value of the estate, such as valuation issues and costs of administration, because each of these will impact the amount ultimately received by that beneficiary. On the other hand, a beneficiary that receives a specific dollar amount need not be concerned with issues, since it does not change his or her distribution. Where possible, encourage clients to stay away from percentages or formulas that can back fire. Instead, select a dollar amount that they are comfortable with and review it periodically.
- Giving one child control over another. A typical response from clients about the question of who should be trustee is often followed with “can my responsible child be the trustee?” This is appealing, because it keeps the burden off other family members or friends and it avoids the trustee fee that would be paid to a financial institution. While we have no doubt that there are many situations where the child is perfectly capable of handling the job of trustee, we advise against giving one child control to the exclusion of another child. Our experience is that it can be a costly mistake that causes disputes that could have been avoided.
Even in the best family situations, the child that is left out of the decision making process will most likely not be pleased. There are important decisions that need to be made in the trust administration process, such as whether to sell certain assets, valuation issues and when to make distributions. Giving one child control over these economic decisions to the exclusion of another creates an unpleasant dynamic even when everyone has good intentions. It is generally a better practice to name a financial institution, if practical, given the size of the estate, or a trusted and responsible family member or friend (other than a beneficiary), or even naming all children as co-trustees, rather than giving one child control over another.
- Ignoring the personal effects. The personal effects can be the most difficult asset to divide and distribute. Beneficiaries can have strong personal feelings about what items of the personal effects they want and they can disagree about the value of certain items. It is important to have a system in place in the estate plan to resolve these disputes. There may also be special circumstances resulting from the structure of the estate plan that require consideration. For example, if a residence is left in trust for use by a beneficiary such as a second spouse, with the residence to ultimately pass to children, then the contents of that residence should be specifically addressed. Otherwise, you may have an unpleasant situation where the beneficiary of the residence has the contents immediately removed by the beneficiaries of the personal effects. If there are any items with a large value, they should be addressed specifically.
- Not following through on title to assets. A fully funded living trust is the desired goal in any estate plan. An hour of time now can save thousands of dollars later. In California, if the client signed a Will and a general assignment of assets to a living trust, we often can petition the Court for confirmation that an asset is owned by the living trust, but this process takes months and is not guaranteed. The professional advisors should help the clients with completing this process. It is tedious to the clients and they may not understand the significance or the ultimate cost for failing to follow-through, so this is an area where the assistance of professional advisors is critical.
- Letting the client avoid the Advance Health Care Directive. The process of thinking about and completing an Advance Health Care Directive can be unpleasant. The client has to consider health issues and topics such as life support and organ and tissue donation. The health care power is a critical part of everyone’s estate plan. When the health care power is needed it is invaluable. If the client resists completing the health care power or wants to think it over, encourage them to complete one now and change it whenever they want. It is generally better to have something in place, rather than nothing.
- Not doing an estate plan at all. If your client is going to live forever and will never be disabled, then skip the estate plan. For everyone else, make sure your estate plan is in order to protect your family.
An estate plan is essential to the long-term well-being of your family and heirs. Because your family’s needs change and the legal and regulatory environment continues to evolve, your estate plan should be reviewed and amended periodically.