Smart people who've worked hard all of their lives to achieve financial success often make dumb estate planning mistakes. Those mistakes can result in their families losing over half of their assets when they pass between generations. They can destroy much of a lifetime's work. And they can inflict a great deal of pain and heartache to the people they love.
The irony is that most of the mistakes are easily avoided. With a little forethought, people of average intellect can construct estate plans which perpetuate their estates for generations. To do that, you and they have to avoid these traps:
The "I love you" Will
Unbalanced Property Ownership
Property Transfers Based on Non-Will Provisions
Improperly-Owned Life Insurance
Trying to Take it with Them
Lack of Liquidity
Equal Distribution to Heirs
Saddling Children with Debt
"It's all been taken care of . . ."
Everybody has an estate plan. If you don't create one, on purpose, through carefully drafted wills, trusts and other documents, then your state legislature will step in with a plan of its own. This plan, called the laws of intestacy, dictates who will get your assets, how they will get them and guarantees that your estate will pay the highest possible estate taxes in the process.
If you're happy with your state legislature deciding who will receive your assets after you're gone . . . and especially if you want to pay the federal government the maximum estate taxes, then no additional work on your part is required. But if you're not, then you have to develop estate plans of your own and they have to be developed now.
2. The "I love you" will
Most people have very simple wills. They say that when one spouse dies, all of his/her property goes to the surviving spouse and, when they're both gone, all of the property goes to their children. Very straight forward. And, for people with modest estates, these wills work fine.
For people with estates which exceed $5,000,000, however, these wills create thousands of dollars of unnecessary taxes. These simple wills waste an opportunity to keep up to $4,000,000 of assets free of estate taxes. On a $5,000,000 estate, this single error can cost over $900,000.
The solution is to have provisions in your wills or living trust agreements which create a bypass trust (also known as a credit-shelter trust) at the death of the first spouse.
3. Unbalanced property ownership
If each spouse owns substantially equal property, then bypass trusts can function neatly to avoid estate taxes on up to $4,000,000 of assets. However, if one spouse owns millions and the other spouse has only a small estate, the bypass trust's effect will be largely wasted if the less affluent spouse dies first. To avoid that, spouses should consider the benefits of balancing their property ownerships.
4. Property transfers based on non-will provisions
Most people think that their wills control who will get what when they die. Surprisingly, many assets are transferred based on provisions which can contradict but supersede those of a will.
Bank accounts, certificates of deposit, retirement plans, IRAs, annuities, life insurance policies, real estate and countless other assets are often not controlled by wills. In the case of jointly-owned assets - bank accounts, stock accounts and real estate are often owned this way- the surviving joint owner often becomes the sole owner of the assets. And retirement plans, IRAs, annuities and life insurance proceeds transfer to named beneficiaries, not necessarily to the people named in a will.
Property ownership forms and beneficiary designations need to be coordinated with your will planning. If they aren't, your carefully drawn will can become meaningless and the estate tax savings which it tried to create will be defeated.
5. Improperly-owned life insurance
Life insurance is often a significant part of many affluent estates. Many people own life insurance because of the immediate liquidity it will provide and because they understand that life insurance death benefits are tax free. They're only half right.
Life insurance death benefits are not subject to income tax. However, they are subject to estate taxes if the policies are owned by the insured at his/her death. This can destroy up to 60% of the policies' values.
A very wise way to avoid this is to have life insurance owned by an irrevocable trust. While the needs of the surviving spouse need to be addressed, life insurance which is intended to pass to future generations should clearly not be owned by the insured's.
6. Trying to take it with them
There are only three ways to reduce estate taxes: spend the money, have a bypass trust and give it away while alive.
Affluent people, especially the self-made variety, often do a very poor job of either spending it or giving it away. They got where they are, financially, by being "accumulators" and they have a hard time with not continuing that lifetime habit.
While thrift is an admirable quality, too much of this good thing plays right into the IRS' hands. They and Congress want you to have the biggest estate possible when you die.
They want your ignorance, procrastination and paranoia to stop you from taking advantage of a whole range of laws which can result in your estate paying zero taxes while you maintain your financial independence forever. The IRS collects millions and millions of estate taxes every year which could have been legally avoided from the estates of people who never quit being"accumulators".
7. Lack of liquidity
Many affluent people create estates of great value which, at death, are very illiquid. Holdings of real estate and family businesses often represent 90% or more of affluent estates. But, if those estates are subject to taxes of over 50%, those assets often have to be sold at fire-sale prices to pay them. Estate taxes are generally due within nine months of death.
Forcing your family to choose between sacrificing a treasured asset or taking on an enormous burden of debt to pay estate taxes is simply stupid. It is also totally avoidable.
8. Equal distribution to heirs
Most people have great love for all of their children and they want them to share equally in their estates. An admirable intent, but "equal" is not the same thing as "equitable".
While dozens of examples exist, a common problem, often mishandled, is when a person owns a business in which some of the children participate. Giving both participating and non-participating children equal shares of the business is a near guarantee for disaster. This blunder has destroyed more businesses and families than probably any other estate planning mistake.
If you have a business, a farm or some other income-producing asset and some of your children participate in its management, don't carve it up equally between all of your children. Provide the business to your participating children and give your non-participant children non-business assets. If this creates an unbalanced distribution, consider creating additional assets through life insurance.
9. Saddling children with debt
The same kind of people who would blanch at a $500 MasterCard bill often leave their children with a range of estate problems that can only be solved by millions of dollars of new debt.
Illiquid but substantial estates often have to borrow great amounts of money to pay estate taxes. Those borrowings can come from a bank or, in some cases, from the Treasury, but they all require complete repayment of principal plus substantial interest. Too often, the assets which triggered the tax - and the loan - can't generate enough income to cover it.
Enormous debts are also created when children who participate in a family business are compelled to buy-out their non-participating siblings' interests. This not only creates great financial pressures but the process of negotiating a buy-out can create much acrimony. Many families have been destroyed by just such a challenge.
Life insurance is frequently the best solution to these financial problems. Too often, however, affluent people and their advisors don't adequately explore this option because of ignorance and misunderstanding.
10. "It's all been taken care of . . ."
Good estate planning is never truly "done". As your circumstances change and evolve over the years, your plans need to be kept current and apace with them.
Few attorneys call in their clients for an annual estate plan review. Fewer clients sit down, annually, and take stock of their situation. But if they did - if you do - millions of dollars can be saved and much heart-ache can be avoided.
Most people spend more time arranging a single vacation than they spend on estate planning in their lifetime. If you're affluent, that's not smart. It's very smart, however, to meet annually with your financial advisers and ensure that your plans are both current and complete.
Here's a test to see if they are: will your current plans give what you have to whom you want, when you want, in the way you want and do it all at the lowest possible cost? If you answer "yes", then congratulations and we'll see you next year.
If not, then make an appointment now to fix this problem. No one can do it but you and you may have a lot less time to solve it than you think. And if you're not sure about that, go back and read item number one on this Top 10 list of estate planning mistakes - the one about procrastination. And then grab the phone.