One of the biggest wealth transfers our nation has ever seen is about to take place. Over the next 25 years, as much as $68 trillion of wealth will be passed to succeeding generations.
This transfer of wealth presents unique planning opportunities for those who are prepared, but also tremendous challenges due to the ever-changing legal and tax environment surrounding estate planning.
Taking a few simple steps now can potentially help save your beneficiaries thousands in legal fees and taxes.
Here are five of the biggest estate planning blunders you’ll want to avoid:
1. Not properly designating beneficiaries
Failing to properly designate beneficiaries is one of the most common estate planning mistakes. This can be easily overlooked when setting up a retirement plan for the first time or when switching investment companies.
One of the great advantages to adding a beneficiary to your account is that by doing so, your account bypasses the timely and costly process of probate and passes directly to your beneficiaries.
Depending on state law and individual circumstances, the probate process can drag out for years and may put your loved ones through unneeded frustration and disputes in attempting to prove to the courts who the intended beneficiary should be.
A common mistake is setting up bank deposits such as CDs and savings accounts without beneficiaries. There is a simple designation you can add to these non-retirement accounts called a transfer on death or “TOD” designation. A TOD designation allows the account to bypass probate and transfer directly to your beneficiaries.
One thing to keep in mind is that accounts with properly listed beneficiary designations will override what is written in your will or revocable living trust. For this reason, you should carefully review your investment and bank accounts to ensure your beneficiaries are accurate and match your intentions correctly.
2. Putting down a minor as a beneficiary
Naming minors such as young children or grandchildren as beneficiaries on your accounts may result in unintended consequences if they are still minors when you die. Most minors don’t have the legal authority to take control of inheritance or investment accounts until they reach the age of 18 or 21, depending on the laws of your state.
If a minor does receive an asset as a beneficiary, a court-appointed guardianship will be established to supervise and manage the assets on behalf of the minor.
Thankfully, it's easy to avoid the uncertainties of a court-selected guardianship. By simply listing a guardian for the minor child inside your will, the court will appoint the person you chose to manage any investments or property the minor inherits until they reach age 18 or 21.
Another approach is to establish a trust for your children or grandchildren. With this arrangement, your trust would name a trustee who is typically a trusted relative or friend to manage the assets a child inherits until they reach the age you specify. A benefit to this approach over using a will is that it allows your loved ones to bypass the probate process altogether.
3. Failing to fund a trust
Establishing a trust is a great first step, but many individuals fail to properly fund their trust after it is established.
The act of placing your assets into the trust is called “funding.” Funding may include changing the ownership of your bank and investment accounts from being individually owned to being owned in the name of the trust. It may also include designating your trust as the beneficiary on life insurance, retirement accounts and annuities.
If you commit the time and resources to create a trust but do not fund it, and have a will with contradictory instructions, it could mean that your intentions for the trust are disregarded. Assets not in the trust are outside of the trustees’ control and therefore may be required to go through probate.
4. Creating a tax nightmare for your heirs
One of the great advantages of passing on real estate or other highly appreciated investments or property is that your beneficiaries get what is called a “step-up” in basis. This means they are not responsible for any income taxes on the appreciated assets when they are received.
An exception to this rule is when it comes to inheriting retirement accounts such as 401ks and traditional IRAs. Unless you are a surviving spouse, inheriting a traditional IRA or 401k means you are now responsible for the taxes owed. With the passage of the SECURE Act in 2019, most non-spouse beneficiaries are forced to fully withdraw a 401k or IRA within 10 years. This withdrawal is counted as ordinary income for beneficiaries and could mean a massive increase in income taxes for your heirs.
One of the ways to potentially reduce your heir’s tax liability is to consider converting some or all of your retirement account assets to a Roth IRA during your lifetime. This allows you to pay the conversion taxes at your current income tax rate, which may be much lower than your children or grandchildren’s tax rate. When you die, any money that is passed inside a Roth IRA goes completely tax-free to your heirs.
Another way to pass retirement accounts tax-free to your heirs is to purchase a life insurance policy where the annual life insurance premiums are funded from withdrawals from your retirement accounts. Similar to a Roth IRA, a life insurance death benefit passes tax-free to your heirs.
By converting a portion of your retirement accounts into life insurance, your beneficiaries are not stuck with a tax bill when they receive the funds. You can choose a life insurance policy that allows for cash-value growth so you can still access your funds for withdrawals in your lifetime.
5. Not going through the estate planning process
Let’s face it – beginning the estate planning process is rarely viewed as fun or exciting. Thinking through your legacy plans can be somewhat overwhelming and even scary. However, properly establishing your estate plans now not only takes care of your loved ones financially but can also save them a lot of emotional stress after you’re gone.
Spending a few hours planning today can significantly impact your family for generations. One of the best gifts you can leave your family is a solid estate plan.
David Nicholas is president and founder of Nicholas Wealth Management. He maintains FINRA Series 7, 63 and 65 securities designations and has life and health insurance licenses in Georgia.
Securities offered through World Equity Group, Inc. (WEG), members FINRA and SIPC. Investment advisory services offered through Bluepath Capital and Triumph Wealth Advisors. Nicholas Wealth, Bluepath Capital and Triumph Wealth Advisors are separate entities, and are not owned or controlled by WEG.