7 Common Estate Planning Mistakes
Let’s go ahead and be honest with each other right out of the gate here.
Estate planning is not a cheerful topic to discuss.
Like doing your taxes, you know it’s something you shouldn’t ignore but you also know the process will be arduous at best.
I’d love to tell you I have a magic solution for that, but I don’t.
None of us gets out of here alive and therefore, we must make plans for our estates after our demise.
And, in estate planning, like most other subjects, if you’re going to do it, you might as well do it right.
In that spirit, let’s walk through seven common estate planning mistakes that I have either seen or heard about, to help you make the most of your own estate planning process.
As we do so, I need to remind you that I am not an estate planning attorney. Nothing in this post should be considered legal advice. You should reach out to a licensed attorney for guidance in making your own estate plans.
1) Incomplete Estate Plan
By far the most common error people make in estate planning is not making a plan at all.
About 68% of Americans die without a will or a valid estate plan.
In those cases, the courts get to decide how the estate is settled based on state law. Not ideal.
Even if the state managed to somehow fulfill your wishes exactly, without instructions from you, your estate could become the center of legal action and estrangement among your descendants.
The bottom line is the lack of a will or estate plan could cause chaos for your loved ones.
And remember that estate plans don’t stop at a will. There are several other documents that most estate plans should include:
- Will or Trust – This is the document (will) or legal entity (trust) that will serve as the legal path for distributing assets to your heirs according to your wishes.
- Durable Power of Attorney – A DPA allows an agent to act on your behalf if you are unable to do so for yourself. Such an option could be critical if you become incapacitated or mentally unable to make sound decisions about your finances and property.
- Medical Power of Attorney – Like a Durable POA, a Medical POA allows an agent to make medical decisions on your behalf if you are unable to do so.
- Advance Healthcare Directive – Allows you to document instructions about how decisions should be made regarding your medical care if you aren’t able to. Normally, an AHCD includes a Medical POA and a living will.
- Beneficiary Designations – After your death, your financial custodians will give your assets to the named beneficiaries of your various accounts and these selections will supersede other estate documents. More on this in a bit.
- Letter of Intent – This is a document that communicates “who gets what” to your executor. Odds are it won’t be legally binding, but it will make their lives much easier as they try to guess how you would have wanted your stuff distributed to others.
- Guardianship – If you haven’t already nominated guardians for your minor children in a will or a trust, then you’ll need to name them in another document. Otherwise, the courts will do this for you.
2) Outdated Estate Plan
Mistake number two is to have an outdated estate plan.
If you’ve had a will or trust in place for very long, it’s highly possible that your preferences toward your heirs or executor may have changed.
- There could be loved ones named in your will that have passed away.
- Maybe your executor has moved far away and would have a difficult time fulfilling your wishes.
- Perhaps your children have gotten married or divorced or blessed you with grandchildren that you’d like to consider in your estate.
- Laws could have changed, resulting in a need to alter the instructions in your plan.
- The value or nature of the assets in your estate could have changed in such a manner that wasn’t foreseeable when you first arranged your estate.
To avoid an unfortunate mishap, it’s a good idea to review your estate planning documents at least once annually.
It would be a shame for your wishes to go unfulfilled or be delayed when a simple update could avoid it.
3) No Account Beneficiaries
I couldn’t find any statistics about how often errors are made here, but I do know of cases where people have failed to either name account beneficiaries outright or forget to keep them up to date.
If you have any sort of financial accounts like a savings account, 401k, or IRA, you need to name account beneficiaries.
As I mentioned previously, these institutions will follow your account beneficiary designations over your will or trust, so it’s very important to pay attention to this.
If you fail to name a beneficiary, then your assets will probably have to go through probate, which could be lengthy and expensive.
If you fail to update a beneficiary, you could accidentally leave your assets to someone you didn’t mean to.
The most salacious example is people who leave large retirement accounts to an ex-spouse instead of the person they were married to at death. Ouch.
In addition to divorce, you may also need to update this information if you have enjoyed the addition of or suffered the loss of a child, spouse, or other family member.
I would recommend that you add this to your annual estate review process.
4) Adding Co-owners to Assets
There are several things people typically do to try and avoid sending their assets through probate.
It’s completely understandable because the process is often lengthy and expensive.
One common way people try to do this is by adding loved ones (usually their children) as co-owners of accounts or major assets like a home.
Unfortunately, this could be a penny-wise and pound-foolish approach to estate planning because of the potential tax liability it creates for your heirs.
You see, when you pass away, many of the assets you leave to your heirs will receive a free step up in the tax basis when they are inherited.
As a result, any capital appreciation in the value of the asset will go completely untaxed to your heirs.
However, if they co-own the asset, then there is no step up in the tax basis because they were a co-owner before your death.
The most common example is a house.
Assume you bought a home many years ago for $100,000. Over the years it has appreciated in value and is now worth $750,000.
If you leave the house to your heirs, they will receive the full value of the $750,000 home completely tax free. Even if they decide to keep the house, the basis for future capital gains taxes will be $750,000, not $100,000.
However, if you put your heirs on the title to the house before you pass, the tax basis will remain at $100,000 until the last co-owner passes.
In other words, the decision to add your heirs to the title would have exposed $650,000 in appreciation to capital gains tax. That’s going to be a 15% ($97,500) or 20% ($130,000) error.
Instead of adding beneficiaries to the deed or title of your assets, make the assets transferable upon death or look into a trust or life estate deed.
5) Forgetting to Fund Your Trust
Speaking of trusts, they are a great way to not only avoid probate, but to also provide very specific directions in how the assets of your estate are managed after your death.
A trust is a legal entity that holds assets (the corpus) per the directions of the grantor (the person who creates the trust, to be managed by the trustee for the benefit of a beneficiary or multiple beneficiaries.
Trusts are more complex and more expensive to set up than wills, but as I’ve already pointed out, they can allow your estate to avoid the probate process altogether.
Depending on how complicated you make your trust, it can make the settlement of your estate much easier for your heirs.
However, all this planning could be for nothing if you fail to fund the trust after it’s created.
It can be a lot of work to transfer assets into a trust, but your trust won’t be much good without this all-important step that a shocking number of people forget to take.
On average, it costs a few thousand dollars to set up a trust but can be much more depending on how complicated you want it to be.
For the sake of your heirs, I highly recommend setting up a trust as opposed to allowing your assets to go through probate (which they will do if you only have a will).
6) Unequal Tax Consequences
If you have assets with future tax liability that will persist even through your death, you need to keep that in mind if you are trying to leave equitable shares of your estate to your heirs.
For example, let’s assume you have a Roth IRA with $100,000 and a Traditional IRA with $100,000 when you die. You also have two children and desire for them to inherit equal amounts from your estate.
In this scenario, the money in the Roth IRA is far more valuable than the money in the Traditional IRA because the Roth doesn’t have any future tax liability while the Traditional IRA does.
The child that inherits the Traditional IRA will have to share a portion of their inheritance with Uncle Sam while the heir of the Roth gets to keep it all.
Some other common places for varying tax liability include:
- Houses
- Taxable Brokerage Accounts
- Retirement Accounts
- Business Equity
- Land or Real Estate
- Life Insurance Proceeds
- Health Savings Accounts
7) Not Discussing Wishes with Family
Honestly, I can think of reasons you may not want to discuss your estate plans with your loved ones and that’s certainly your right.
However, if you don’t feel like your plans will be very controversial and you think your heirs can maturely handle the conversation, then let me encourage you to discuss your plans with your heirs before you pass away.
This will give them the peace of mind to know that you have actually thought about this and made a plan, and it can also serve to set expectations so emotions are defused a bit when it comes time to review your final instructions.
Additionally, you should consider including the letter of intent I covered in the beginning. While it may not be legally binding, it may be a great help to your executor as they attempt to locate all of your assets and distribute them as you wish.
Finally, be sure to tell your executor where to find your estate plans once you have them in a safe spot. It would not hurt to update your executor on this location every year as you conduct your annual review.
Wrap Up
We acknowledged from the start that estate planning is not a very cheery subject, but it is certainly necessary.
I hope this information will help you avoid common pitfalls so many others often fall into.
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