After reviewing thousands of estate plans over many years we have found that most contain one or more defects. Sometimes the problems are minor and will only result in some unnecessary expense or delay for heirs. Sometimes the mistakes are serious and will cost unnecessary millions in estate taxes or will even cause the estate to pass to unintended heirs. The following are some of the more common problems we routinely encounter.
No funding—Funding is the process of transferring assets to a trust. It involves preparing deeds, assignments, beneficiary designation forms, new account forms and similar documentation. One of the main purposes of a revocable trust is to avoid probate proceedings upon your death, but that won’t happen if you continue to own assets in your own name and don’t assure that all are transferred to the trust. A life insurance trust is intended to avoid estate tax on insurance proceeds, but that won’t happen unless the policy has actually been transferred to the trust. It is rare that we encounter an estate plan where all trusts have been fully and properly funded. You must have that aspect of your estate plan reviewed periodically.
Not Protective—The primary purpose of most trusts should be to better safeguard the inheritance for the benefit of heirs. A properly designed trust will protect the inheritance in the event your child or other heir is sued, is divorced or encounters some other misfortune. The trust will also help assure that assets pass from children to grandchildren and on down your bloodline and will not be diverted to in-laws or other unintended beneficiaries. However, the majority of trusts we review do not contain those protective features. That is an issue that should be discussed with your estate planning attorney.
Wrong Trustees—Selecting who will take over to manage your affairs in the event of your incapacity or death is an important consideration. Often your adult children or other family members may be the best choice, but in some cases a trusted advisor or a trust company will be preferable. The selection of successor trustees should be carefully considered and should be periodically reexamined. Just as important may be the mechanism by which the new trustee will assume his or her responsibilities in the event your faculties should decline. The change of trustees can be an awkward and difficult event and may even involve court intervention. However, there are procedures that can be included in a trust to assure that the transition from one trustee to the next will happen seamlessly and without a problem at the appropriate time.
Insufficient tax planning—The current exemption from federal estate tax is only $3.5 million. Beyond that threshold, 45% of the estate will be lost to tax without some advanced planning initiatives. Fortunately, there are a number of techniques that can reduce or eliminate the estate tax. In some cases the required tax planning is quite simple and may involve little or no cost. In other cases the necessary procedures may be more complex. However, the point is that there is much that can be done to control estate taxes. There is an old adage that the estate tax is partially voluntary. You can ignore the problem and volunteer to pay the tax, or take some planning steps and reduce or even avoid the tax.
Misguided IRA planning—Individual Retirement Accounts and other qualified retirement plans can be powerful accumulators of wealth because the account can grow for many years at pre-tax yields. However, at death most of the IRA or other retirement plan can be lost because it is subject to both income tax and estate tax. Without careful planning, the combined taxes can result in a 75% or greater dissipation. The tax rules relating to IRAs and other qualified plans are complex and must be carefully applied in each estate where there is a significant IRA or other qualified plan.
The above is a small sampling of some of the deficiencies we encounter in many, if not most, of the estate plans we review. The biggest mistake overall, however, is not having your estate plan reviewed every few years, or annually in the case of a complex plan. It is those periodic reviews that uncover potential problems and allow for the implementation of new techniques and strategies to control estate taxes and better assure that your heirs will receive their inheritance in the most efficient and protected manner.