The Most Common Estate Planning Mistakes

Do It Yourself?


When it comes to “do it yourself” as estate and business planning attorneys, we often find that what our clients think is “a simple solution” often turns out to cause the biggest problem for their estates.

Omitted beneficiary designations, and errant or problematic titling of assets, are a very common source of mistakes and resultant problems for our clients. Although we, as estate planners, are aware of the most common mistakes and their consequences, many people aren’t. Simple, well-intentioned actions, and failures to act, often result in major problems.

The type of mistakes we see usually involve title to assets, and ways of holding property, that our clients feel will serve to avoid probate. The property is set up by the client to pass at death without probate, and we aren’t even told about the property because the owner believes it is already taken care of. Here are some of the most widely-committed mistakes that can lead to unintended consequences.

1. Converting financial accounts to joint ownership. In this scenario, most often an elderly parent will decide to have one or more financial accounts (such as a bank account or mutual fund) held jointly with an adult child. The “simple” move is designed to avoid two problems. First, it substitutes for a financial power of attorney. The chosen child can “help pay my bills”. Instead of using a durable financial power of attorney that gives the adult child the power to manage the accounts when the parent is unable to, the joint title takes care of that. Each owner has authority over the cash in the accounts and can make decisions. Second, the joint ownership. The elderly parent figures that their child will outlive them, and thus probate is avoided. The child will automatically succeed to full ownership to the account after their parent passes away.

But, the creation of the jointly-held account often results in problems. In most states, half the jointly-held account is subject to the claims of creditors of either co-owner (you or your child’s). I’ve explained to many a parent that it is not necessarily a good idea to put your son or daughter’s name on the title to your home, or your checking account. Your assets could end up in someone else’s hands if your adult child divorces, loses a lawsuit, or runs up big debts. Also, it unfortunately isn’t unusual for adult children to start using such joint accounts to fund their own lifestyles. Once a person is listed as a joint tenant, regardless of whether they ever put money into the account, they could empty it out completely if they wanted to, without permission of the person who actually worked for the funds, and deposited them to the account.

There also could be tax problems. The IRS is going to consider the creation of the joint account as a gift of half the account from you to the child. You didn’t intend for the child to own the property. It only was a way to help you manage the assets and avoid probate. But the IRS says you made a gift.

When the account has assets other than cash, your heirs could lose a valuable benefit. After assets are inherited, the heirs increase the basis of the assets to their current fair market value. All the appreciation that occurred while you owned the property isn’t subject to capital gains taxes. When the account is owned jointly, however, the increase in basis only occurs for half the account. The other half is treated as a gift from you to the other co-owner, and that co-owner takes the same tax basis you had in the assets.

2. Naming only one child beneficiary as a perceived convenience. I’ve had families come in after the death of their mother or father and when reviewing the situation find that the parent decided to “keep things simple” by naming only one adult child as beneficiary of life insurance or a bank account, including an IRA. The parent’s intent, which often was expressed to the children before the parent died, is that the child who is named as beneficiary will use it to pay expenses, such as their funeral expenses and final medical bills, and then “split” the account or insurance evenly with the other children, thus making it “simple” and easy to administer.

But “the law” doesn’t necessarily allow this to be as “simple” as it sounds.

Of course, once one child takes title to the property, the asset becomes subject to the claims of any of his or her creditors. So, you don’t want to do this with anyone who might have credit problems. Also, there are likely to be tax consequences if that child does split the property with the other children. As new legal owner of the property, anything he distributes to the other siblings is technically a gift from him to them. The $14,000 annual gift tax exclusion allows him to give that amount tax free each year to each of the siblings. Any gifts above that amount, however, reduce his lifetime estate and gift tax exclusion. And he has to file a gift tax return reporting the gifts.

If the account is an IRA or other qualified retirement plan, the child has to take a distribution, pay income taxes on it, and give the after-tax amount to the other siblings. There’s no provision in the law for an IRA beneficiary to either split the account with others who also weren’t beneficiaries or to rollover part of the account to non-beneficiaries. The only way to transfer part of the IRA to another sibling is to take a distribution and pay income taxes on it.

Finally, the child has no legal obligation either to pay bills, including the funeral bill, or to share the property with the others. There are many instances of one child being given responsibility for an account or an estate and simply claiming that the parents meant for him or her to have all of it.

3. Failure to name a beneficiary, or to update the designated beneficiary. Failing to name a beneficiary for an IRA or other retirement plan means the estate will be treated as the beneficiary. That eliminates the potential for having a “stretch” IRA in which tax deferral can be maximized over the life expectancy of a designated beneficiary. Instead, the entire account must be distributed and subject to income taxes within five years.

Failing to name a beneficiary might also mean that an asset that normally would avoid probate must go through the time and expense of a probate process. It will be considered part of the estate and be distributed according to the terms of either the will or state law. For certain products, such as life insurance policies, the “standard” language of the insurance policy might have its own default rules for determining who is the beneficiary when one isn’t named. For example, the default provision in the policy might provide for the death proceeds to be distributed to the children of the insured, when the parent might not have wanted that to be the case.

For these, and many other, reasons, you need to keep beneficiary designations up to date. Too many people select beneficiaries when they open an account or buy a policy and never review the decision after marriages, divorces, deaths, and other events.

4. Not having contingent beneficiaries. The contingent beneficiary receives the property when the primary beneficiary already passed away or declines the property. When there isn’t a contingent beneficiary, then most of the time the consequences are the same as if no beneficiary were named. But sometimes state law or the rules of the account custodian might dictate a strange result.

The language of an insurance policy might dictate “who gets the proceeds” if a named beneficiary predeceases the policy holder. And, under that circumstance, a family member who either didn’t need the money, or a family member who was to have been disinherited, might take because there was no contingent beneficiary named.

5. Naming trusts as IRA beneficiaries. This is another “hairy” technical issue that needs a lot of planning.

We do not often recommend that a Trust be named beneficiary of a client’s IRA. This is because in most cases, when a trust is named IRA beneficiary, required distributions from the IRA are accelerated. The ability to “stretch” out the distributions, and maximize tax deferral amongst the family beneficiaries is lost. If a Trust is to be used, a carefully drafted document is required. Not just as an “easy out”.

6. Naming multiple co-beneficiaries to inherit assets as co-owners. This is frequently done with IRAs, financial accounts, and even real estate using a Transfer on Death Deed or a similar designation. The arrangement can work well.

Too often, however, the strategy leads to unintended problems. For example, often beneficiaries can’t agree on how to manage the property or how to split it. It can be a major problem with real estate, because they all have to agree on everything. If they agree to sell, then they must agree on a broker, the offering price, and how to respond to each offer. They also might have to contribute equally to property taxes and other expenses until the property is sold. We have recently been involved in a number of “partition” lawsuits — where siblings sue each other over the disposition of real estate which they have inherited, but can’t agree on how to manage. When that happens, it is truly a disaster for the family. The litigation is expensive financially, and, more importantly, emotionally — often, such litigation leads to the permanent destruction of the family bond.

A better structure is to split the property now or allow the children to benefit equally from the property but have one person manage it or handle the sale. For example, the property can be inherited by a trust or an LLC. The children receive all the income and gains. But only the trustee or the managing member of the LLC makes decisions about the property. That person can be one of the children or it can be an independent professional.

7. Naming an inappropriate beneficiary. This happens more than you would expect. For example, a minor should not be named the direct beneficiary of property or life insurance. If he or she is, then the child will receive full title and control of the property upon turning 18. We’ve been involved in several unfortunate situations where an inheritance is entirely spent on an exotic sports car when the money becomes available on the child’s 18th birthday. Rather than have that happen, when minor children are involved, you need to consider setting up a trust that manages the assets and distributes income and principal either on a schedule you set up, or at the trustee’s discretion.

Of course, you don’t want to give property directly to someone who might waste it, including someone with a history of financial mismanagement, substance abuse, or gambling issues. Property also probably shouldn’t be given directly to someone who might be divorced, subject to liability lawsuits, or is in a risky business. Such loved ones can benefit from the property if you have it managed and distributed under the terms of a trust.

Finally, “special needs” individuals shouldn’t receive property directly. This could disqualify them from receiving government benefits or other help. Instead, we can discuss how a special needs trust or supplemental needs trust could be used to benefit your loved ones.

All in all, whereas one might think that estate planning is just a matter of listing “who gets what” when you die, it is a lot more complicated than that. We are trained to help you get where you want to go, accomplish what you want for your loved ones, avoid the problem areas, and do it all as economically as we can manage.