Estate planning is more than having a will or a trust, a power of attorney and a medical directive, which most of us do with the guidance of an attorney. Sometimes we make estate planning decisions which may not involve an attorney and we may not understand the consequences. And that means we may make mistakes.
Some of these “mistakes” are made with the best of intentions. An aging parent may want to show their love while they are still living to a child by gifting them stock, or a share in their house, or even their whole house. Or they want to remove an asset from their ownership to someday qualify for Medicaid should they require nursing home care. Or they may think that removing an asset from their estate will lower estate taxes, which few people are even currently subject to at the federal level. Or perhaps they think it will make things easier and less costly for their family by keeping the asset out of probate. Whatever the motivation, it is important to understand the full implications of such actions. In some situations, some of these actions may be appropriate, although they make this list because they are usually not appropriate and could be costly.
(1) Adding a joint owner, such as an adult child, to your account. There is usually nothing wrong with making a child the joint owner of a small checking account for the sake of convenience—in order to pay bills after death, or even late in life when we may be incapacitated. But adding a joint owner to a large account may be fraught with danger. First of all, it may be considered a gift, which may require you to report it as such to the IRS, even if there is no gift tax due. If it is a joint account with right of survivorship, that child will automatically take ownership of the entire account when you die, which may not be your intention if you have more than one child. Even if the account is held in a joint tenancy or as tenants in common, where you each may own half, that child will receive their half when you die while your half will become part of your estate.
Depending on how the account is set up, your child may have equal access to the funds, which may present problems if money becomes an issue for your child. Another danger is that the account could be exposed to any creditors that your child may have, including a spouse in a divorce action. Also, if there are highly appreciated stocks in the account, only your half will be given a “step up” in basis upon your death and your child will keep your low tax basis on their half which would result in higher capital gains taxes when the stock is sold.
In some states, an account can be designated as a “convenience account” in which case the account will become part of the decedent’s estate even though there is a joint owner. A better option is to use a durable power of attorney to authorize your child (or another person) to act for you in financial matters. You can decide if it should take effect immediately or only if you become incapacitated. And, like other documents, it should be revisited periodically to ensure that you are still comfortable with the person you selected to be your agent.
(2) Gifting your house to your child. As a completed gift this would require the filing of a gift tax return. One consideration is that giving away ownership to your home results in the loss of access to your home equity, should you need cash someday from a home equity line or reverse mortgage. If your house is worth much more than what you paid for it, remember that you are also gifting the tax basis and creating a large capital gain for your child, whereas if the house is inherited upon your death, the tax basis is stepped up to the market value. Also, if your child were to be in a divorce situation, the house could be considered a marital asset. And if your child dies while you are living there, you could be at the mercy of your child’s spouse, who could become the new owner. If your intention is to protect your house from long term care expenses, work with an estate planning attorney.
(3) Naming your estate as your IRA beneficiary. If your estate is the beneficiary of your IRA, the IRA funds will go through probate and be distributed according to the terms of your will. Not only could it add to the expenses of probate, but if any withdrawals are made from the IRA while it is held by the estate, they will be taxed at the much higher estate tax rates. More importantly, it could be costly in income taxes for your non-spouse beneficiaries, who would have to withdraw their shares of the IRA within five years. Non-spouse designated IRA beneficiaries who receive their shares directly from the IRA may be able to spread out their withdrawals over ten years, which can save income taxes as well as take advantage of the tax-deferred nature of an IRA for a longer period of time.
(4) Not updating your beneficiaries. It is important to review both the primary and contingent beneficiaries of your insurance policies, IRAs, 401(k)s and other retirement accounts regularly, but it is critical to do so if there has been a divorce or a death. If you have children and grandchildren a “per stirpes” beneficiary designation can ensure that if one of your children dies before you, that child’s children will receive his or her share, if that is your intention. You may even want to have an estate planning attorney draw up a customized beneficiary designation to ensure that your wishes are implemented, particularly if there is an issue with a particular child or grandchild. If you have a beneficiary with a special needs trust, the trust, rather than the person, should be named as the beneficiary.
(5) Not funding your revocable trust. Once your attorney has created your trust, you must then retitle your assets to be in the name of the trust. Otherwise, those assets will become part of your estate and will be probated and distributed according to the terms of your will instead of your trust. Of course, your IRA or other retirement plan cannot be titled in the name of your trust. You do have the option of making your trust a beneficiary, but in most cases that is not a good idea. However, there may be individual circumstances that may warrant naming your trust as a beneficiary, such as if there is an heir with credit (or other) issues, in which case your estate planning attorney can advise you.
(6) Not coordinating your retirement plan, life insurance, and trust beneficiaries with your will. It is crucial to understand how each of your assets will transfer after your death. Otherwise, your assets may not be distributed as you intend. For many people these days, the bulk of their investments are in IRAs and other retirement plans and are distributed to the beneficiaries that have been named in those accounts. The instructions in your will and trust are irrelevant to the distribution of retirement plan assets, unless your will or trust is the beneficiary, which is usually not the best practice.
(7) Not having a will or other documents. You may be reading this and thinking, “I’m OK. I have a will, power of attorney, health care proxy and medical directive, and even a trust.” But do the other important people in your life also have them? If your parent has not created a power of attorney and becomes incapacitated mentally, you may have to go to the trouble of getting a guardianship, which can be very costly. If your parent has not provided a medical directive, and you and your siblings do not agree on your parent’s course of care, your family relationships can be irrevocably damaged.
Sometimes a person may be reluctant to get certain planning documents. One approach may be to point out to them that estate planning is not just for death but also for possible incapacitation, whether physical or mental. Estate planning means that you care about the people in your life enough that you don’t burden them with decisions and complications that may be very difficult for them at an already emotional time.
As always, if you have any questions about estate planning, call us at (833) 888-0534 extension 2 or request an introductory meeting here.
The views and information contained in this article and on this website are those of West Branch Capital LLC and are provided for general information. The information herein should not serve as the sole determining factor for making legal, tax, or investment decisions. All information is obtained from sources believed to be reliable, but West Branch Capital LLC does not guarantee its reliability. West Branch Capital LLC is not an attorney, accountant or actuary and does not provide legal, tax, accounting or actuarial advice.
