Ensuring Your Estate Plan is a Fine-Tuned Machine
Statistics tell us that around 60-70% of Americans have not signed a formal estate plan, meaning they will leave their affairs to the often-unintended direction and inefficient administration of state probate. Yet for those of us who have planned ahead, signing well-designed last wills and revocable or living trusts is only the beginning of a much longer process to create an “ideal estate plan” that handles post-mortem affairs properly.
Whether your estate plan takes the form of a last will or a trust, the directives within the documents can only work as designed when the written plan coordinates with title and beneficiary designations, both primary and contingent, on your underlying assets. Like channels in a river, the document can only direct assets designed to flow within it, and the asset flow depends on registration outside the four corners of the estate planning instrument.
One of the most common mistakes in estate planning occurs when people fail to assign proper beneficiary designations to their assets. Improper designations can undermine the written objectives of an otherwise well-designed estate plan. For example, many individuals prefer that their children take possession of their inheritance at a later age of maturity, such as 30, 35, or 40. The trust instrument a client executes may establish separate trusts for this purpose, but if a client names the children directly as beneficiaries, perhaps as contingent or secondary beneficiaries to a surviving spouse, those assets will “flow” like a river to the children unrestricted and often with irrevocable tax consequences at whatever age the children may be at the owner’s passing.
This can be even more problematic if a child beneficiary dies, leaving the owner’s young grandchildren as survivors, and the beneficiary designation is set up in a “per stirpes” manner. Again, the written will or trust may have planned for such a contingency and would have protected a grandchild via a separate trust for their share if the beneficiary designation had aligned with the trust. However, absent proper alignment of the beneficiary structure, the grandchild could end up receiving potentially hundreds of thousands of unrestricted dollars as a present for their 18th birthday, or whenever applicable state law indicates they have reached the age of majority.
Possible Tax Consequences
Improper title and beneficiary designations can also prove costly in the form of tax and administrative inefficiency. Now more than ever, individual estates contain significant tax-advantaged assets that carry major implications as to how quickly and to whom the tax will be attributed. Assets payable to a trust with improper provisions could compress the required withdrawal period in half from 10 to five years, further trapping the required tax at rates inside a trust that are double what they would have been if they had been paid directly to an individual beneficiary. Similarly, executing a trust instrument doesn’t always prevent probate. All assets must be retitled or otherwise aligned to confirm that the trust instrument owns or receives that asset for efficient probate avoidance. A pour-over last will is a safeguard but not required if the plan is correctly aligned.
Even when documents align properly at the start, plan owners should review them in detail every few years to confirm they continue to work with new accounts or real estate and new beneficiary designations, both primary and contingent. Tax law changes can also undermine over time what was once the most efficient structure.
Estate plans are not unlike complicated machines that can be designed to operate smoothly under several different loads or contingencies. Nonetheless, like any machine, if the wiring is incorrect, sparks can fly, and the machine may not operate as intended.
Michael T. Cyrs
Senior Director of Wealth Transfer