The title is a little misleading, of course. We are not going encourage 6 ways to fumble your estate planning. The idea, of course, is to avoid fumbling the ball. Following are 6 areas in which a little understanding will help people avoid some potential estate planning fumbles and to hang on to the ball.
1. Failure to Understand How Your Assets will Pass on Your Death.
Many people assume their Wills control how all of their assets will pass upon their death, but many assets are not subject to Wills. Wills, however, only control “probate” assets. Probate assets are assets subject to the probate process, which is the default mechanism for transferring assets on death. The default only applies when no other mechanism applies.
Many assets are not probate assets because they have built in mechanisms for passing on death.
Joint tenancy assets, for instance, pass to the surviving joint tenant(s). Assets with beneficiary designations pass to the named beneficiary(s) (life insurance, IRAs, 401(k)s, annuities, trusts, etc.). Assets that are “payable on death” pass to the designated payees. If there is a mechanism “built in” to the asset that directs where it passes on death, the asset is not a “probate asset” and is not controlled by a Will.
Take fictional George for instance. He had three (3) kids and named his oldest son as the beneficiary on his life insurance. People do that sometimes because they trust one child to distribute the asset to the all of the children fairly. His Will left his estate equally to his three children. Upon George’s death, the oldest son gets all of the life insurance, and he also gets one third (1/3) of the probate estate. The oldest son now owns the life insurance proceeds and is not required to share them. In fact, if he does choose to share them, he must file a gift tax return with the IRS because it will be considered a gift from the oldest to the other two kids.
Harry is another example, When Harry was single, his brother helped him buy a house and the two of them became joint tenants of the house. Out of gratitude, and because he had no one else, he also named his brother as the beneficiary on his retirement plan and his life insurance. Don had a falling out with his brother, and Harry also got married for the first time at age 60. Harry took out a loan to pay off his brother and put the house in joint tenancy with his new wife. He also had a Will prepared to leave everything to his wife, but Harry did not get around to the life insurance or retirement plan. When Harry died suddenly of a heart attack at age 65, the life insurance proceeds and the retirement plan, which was most of Harry’s estate, went to his estranged brother, while his wife got the house with a big mortgage attached.
Do your Will, but look at all of your assets and consider how they will pass. You may need to make changes to be sure your wishes are accomplished.
2. Failure to Avoid Probate
The term, “probate,” refers to the proceeding in which a Will is filed, any disputes over its validity are addressed, any claims against the decedent (the person with the Will who died) are resolved, all of the last bills and debts are paid, and the estate is distributed to the people who should receive it. Probate also refers to the court in which these proceedings take place.
Probate can be expensive, time consuming, and frustrating. Because probate is a court proceeding, an attorney is required to handle it. The attorney is entitled to get paid (as well as the administrator or executor of the estate). In Illinois, a six (6) month window must pass after all notices are mailed and published before the estate can be closed. The process takes about nine (9) months at a minimum, and snags along the way might stretch that time out many months, or even years. Even the most modest of estates might run $3000-$5000 in fees and costs (if everything goes well).
Probate is also a matter of public record. Once a probate estate is opened, the estate inventory, debts, family members and their addresses, and everything about the estate is an open book for the world to see.
A probate estate creates a ready-made platform for disgruntled heirs to challenge your Will. A simple letter to a probate judge by a disgruntled heir can tie up probate for a year or more.
If you own real estate in other states, you will not only need a probate estate in the state in which you were residing; you will also need an ancillary probate estate in every other state in which you own real estate.
The best way to avoid Probate is with a Living Trust created during your lifetime into which you transfer all or most of your assets.
3. Counting on Joint Tenancy to Avoid Probate
Married couples usually own their primary residence, bank accounts and other assets in joint tenancy so that the assets will automatically go to the surviving spouse when one spouse passes. Many married couples use the device of joint tenancy to avoid probate and in place of a Will.
Joint tenancy works as a simple estate plan when the first spouses, but joint tenancy only avoids probate on the first death. If no other planning is done, everything will end up in probate when the survivor dies if this is the only estate plan.
If both spouses pass in a common event in which the order of deaths cannot be determined, two probate estates may be necessary. Half of the assets may be countable in the husband’s estate, and half the assets may be countable in the wife’s estate.
If estate taxes are an issue, joint tenancy is the worst possible plan. All the joint family assets will be countable in both the first spouse’s estate and the survivor’s estate. Spouses can protect up to $4M (state) and $5.34M (federal) from estate taxes by separating their assets between and not holding assets in joint tenancy.
Joint tenancy is a limited and flawed estate plan even between spouses.
4. Putting the House (or other assets) in Joint Tenancy with Children
Single, older parents will sometimes add a child (or children) as joint tenant on a house, bank accounts or other assets that can be held in joint tenancy as a way to pass the property on after death which will avoid probate. Your child(ren), however, must survive you. If it is one child, and the child passes first, the assets will still be subject to probate. If you have added more than one child, and one of the children passes before you, that child’s family will be cut out of the inheritance, as the asset will pass to the surviving children who are joint tenants.
On the same theme. When you transfer your home (or any other asset) into joint tenancy with your child(ren), your child(ren) become co-owner(s) of the property with you. Most people trust their children, but I have seen many trusted children get too focused on the money when their parents get old. Especially when the children are having money problems, the temptations can be great. As a co-owner of assets held in joint tenancy, your children have the same ownership rights you do.
A transfer of property into joint tenancy is also considered a gift. It is a transfer of ownership as noted above. If the gift amount exceeds the annual exclusion amount ($14,000 in 2014), a gift tax return must be filed with the IRS, and the value of the assets that you have transferred into joint tenancy will be deducted from your unified credit against gift and estate taxes.
If you have transferred property in to joint tenancy with your children and the house is sold while you are still alive, the primary residence exemption from income taxes (up to $250,000 of the gain) will be split. You can use your portion of the exemption because you live in the house, but your children would not be able to use the remainder of the exemption if the use is not their primary residence. That could result in a long-term capital gains tax bill to your children.
5. Adding Someone as Joint Tenant to a Bank Account
Many people add children or other people to their bank accounts, not only for estate planning purposes, but to allow someone else access to The person you add as a joint tenant, however, also becomes an owner of your account, having the same access to it as yourself. That is fine if you trust them, but there are other problems. A couple of examples will expose the problems inherent in using joint tenancy as an estate plan.
Jill Goodacre was a well-known model. In the 1990’s, she lost her checking account to her father’s creditors. It happened because she put her father on her checking account so he could pay her bills while she was traveling. Unfortunately, her father had several creditors. One of them obtained a judgment against him and garnished the joint account. The $80,000 in the account, which was Jill’s money, was required to be paid out to the creditor of her father because her father was an owner of the account as a joint tenant. He not only had the same rights as his daughter, but the account was considered as much his in the law as hers, exposing it to his creditors. To make matters worse, the IRS deemed the $80,000 of Jill’s money taken by her father’s creditors to be a taxable gift to her father! (It was a taxable gift the moment she put his name on the account in joint tenancy.)
Jill could have avoided that result by adding her father to the account “for convenience only” (meaning he would not be an owner, but would have access to pay her bills on her behalf). She also could have simply made her father her agent pursuant to a property (durable) power of attorney. At most banks, when you add someone’s name to an account, the low level banker does not advise you about the consequences. In my experience, bank personnel who handle these things often do not explain the difference between a joint account and an account for convenience only (and may not even appreciate or understand the difference themselves).
6. Relying on Beneficiary Designations Without a Backup Plan
Beneficiary designations work if your beneficiaries survive you, but they do not work if they predecease you. Beneficiary designations are not intended to substitute for a comprehensive estate plan, though they are often a component of a comprehensive estate plan. Beneficiary forms often fail to address potential scenarios and do not address all the contingencies that might be encountered.
For example, with two children, you might name them both as beneficiaries on your life insurance policy. If one of them predeceases you, how will the insurance company handle the proceeds? Most of the beneficiary forms I have seen say something like this: “Unless otherwise indicated, we, the insurance company, will pay to the surviving named beneficiaries.” Many of my estate planning clients would rather direct a deceased child’s shares to that child’s children (who have lost a parent).
If the beneficiary form is silent and no successor is identified, the deceased child’s half of the insurance proceeds will be paid out to your estate making them subject to probate. If you have not addressed this issue in your Will, the half that you want to go to the deceased child’s children will be split again among the beneficiaries of your Will. Your surviving Child (who already received half the insurance proceeds directly) will receive half of the other proceeds (assuming the Will directs the probate assets to be shared between your children, and the children of your deceased child will only receive half of the half of insurance proceeds that was meant for their parent (your deceased child).
One way to avoid these problems is not to rely on the life insurance beneficiary forms, but to name your estate (or better yet, a trust) as the beneficiary of your insurance. Then you can rely on the Will (or better yet, a trust), to deal with the possible contingencies the way you want them handled.
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There are many twists and turns to estate planning. The temptation is to be frugal and to “keep it simple”. Keeping things simple is fine, unless there are legitimate reasons to complicate the planning. Usually, there are good reasons to move from a simple estate plan to a more complicated one, depending on circumstances and goals. At a minimum, some comprehensive analysis of your situation and goals is wise; from there, you can identify the simplest way to achieve those goals in light of your circumstances. Doing only limited analysis and failing to consider all the issues and contingencies is a sure way to fumble your estate planning and leave a mess for your loved ones.
