A complete financial plan has many moving parts, many of which are handled by separate financial professionals. A financial advisor likely does not sell property and casualty insurance, but she’ll want to know and understand that a client’s home and property are protected. An advisor does not sell mortgages, but she’ll need to understand a client’s debts and liabilities in order to create a better plan. An advisor also does not create will, trusts, or other estate planning documents, but he or she needs to understand what the client’s plan looks like since so many of a client’s priorities can be gleaned from a look at their “end-game.”

But for financial advisors, it can be much larger than that. Not understanding a client’s estate plan can (and does) result in big losses . . . to relationships, to families, and to an advisor’s bottom line. Let’s look at three easy ways to lose clients by ignoring estate planning:

Loss #1:  Not funding the client’s revocable trust.

Money in the air.If a client already has an estate plan or has planning performed because of an advisor’s recommendation (a good recommendation, generally), the client may end up with a probate-avoidance tool called a revocable trust. A revocable trust more or less adds beneficiary designations to assets that would not ordinarily have them — real estate, cars, boats, furniture, personal property, etc. Because of this, the assets held by the trust avoid the probate process (and all of the probate-associated expenses, heartaches, and inefficiencies).

But this only works if the client’s assets are actually held in trust. Too often a client will have their revocable trust created, and then never actually add anything to it. This creates problems because if the assets aren’t held in the trust, then the assets are not controlled by the trust document and will likely have to go through the probate courts. Meanwhile, the client has paid for an estate plan which has become useless.

The attorney will do his or her best to give the client the proper tools to get these assets transferred. For example, the attorney will create and file the necessary real estate deeds and will draft assignments of closely-held business interests. But it’s the financial advisor who will be meeting with these clients regularly. By working with the client to make sure assets are titled correctly (including that beneficiary designations are accurate and valid), the advisor ensures that the plan works. When a client passes away, the advisor is the one often holding the bulk of the assets . . . if the advisor has involved himself in the estate plan, the family transition will more likely happen smoothly and without a hitch. This gives the advisor a chance to work with the family closely and, hopefully, gain their trust and confidence for another generation. For advisors who are less inclined to work with estate planning, a rough and frustrating legacy transfer can be a deal killer for retaining assets.

Loss #2: Not considering the effects of income taxation on estate planning.

We know and understand that estate taxes can be a problem when a client passes away. But what about income taxes?

When a client dies, their appreciated assets receive a step-up in cost basis. Briefly, this means that if that any stock, real estate, or other asset that would ordinarily get sold and have capital gains tax liability will instead transfer to the beneficiary with a new cost basis determined on the client’s date of death. The beneficiary can then sell these assets without incurring capital gains taxes. This is a really big deal for assets with substantial appreciation. Note that this only happened for transfers on death — if the client were to gift appreciated assets to a family member during the client’s life, the family member would take the client’s original basis and any sale could result in the realization of any capital gains tax liability.

What this means is that appreciated assets are a great thing to pass on to family members after death rather than during life. It also means that if a client is considering making charitable gifts, perhaps there are other assets that might make better sense to give. A great example is qualified money.

As you are aware, qualified IRA and 401K dollars are taxed as ordinary income when distributed to a beneficiary. This is also the case for beneficiaries of the next generation. If a client’s child has the choice between taking stepped-up, tax-free appreciated assets or assets that are taxed at the child’s effective income tax rate, you can guess which they would likely prefer. If there is one class of assets that are perfect for charitable donations, it is those assets that are taxed the highest — qualified money.

A client’s family member who realizes these savings is much more likely to want to work with the professionals who helped to make these savings a reality. Likewise, a huge, unnecessary tax hit will help to ensure that the client finds new professionals when creating their own family legacy.

Loss #3: Not considering tax-deferral for minor children: IRA trusts.

Little Boy Getting Money From An ATMFirst, it’s important to understand that minor children can’t own property, which means they can’t inherit property. This makes most beneficiary designations to minors invalid. There are some beneficiary designation forms which allow for a custodian to be appointed, but even these fall short because the child will typically get a full distribution of the funds at age eighteen (thereby creating a while other set of problems).

This problem is solved using a minor’s trust, which can be written directly into a will or revocable trust plan. A trustee is appointed who can accept property on a child’s behalf — the client then names the trust as the account beneficiary on the relevant beneficiary designation forms.

The big red flag with these trusts is that they must be written in a very specific way if they are going to be receiving qualified retirement assets. The trust must be a “see-through” trust for IRS purposes — it must be able to use the child’s life expectancy when calculating the required minimum distributions which all beneficiaries of inherited IRAs must take. If the trust does not meet IRS requirements for see-through trusts, or if a beneficiary of the trust is a non-human entity (like the estate or a charity), then the IRA must be cashed out within five years. Not only does this destroy the opportunity for tax-deferred growth, but the cash-out will likely be taxed at the trust’s astronomical tax rate (a trust hits it’s maximum tax rate at less than $15,000 in ordinary income per year).

Fortunately, the advisor is the ideal professional to make sure minors are not named directly as IRA beneficiaries. For those who miss this planning opportunity, a client’s tax hit may be all that is needed to ensure the next generation goes elsewhere for their planning needs.

A team-approach is the best approach to any financial plan. Financial advisors, CPAs, attorneys, banking specialists and insurance brokers all have an important role to play. Ensuring the plan is a cohesive one is a surefire way to make the client’s legacy a powerful and effective one — and to ensure a client’s family sees the value your firm adds for generations to come.

creates wills and trusts for families who want to feel secure that their loved ones are cared-for. Philip is a trust and estate attorney based in Minneapolis, Minnesota. Philip is the author of Trustee University: The Guidebook to Best Practices for Family Trustees, available at Amazon.com in paperback or Kindle edition (free chapter available here!). He also works with trustees and beneficiaries who need help with their trusts. You can contact him here.

 

You know estate planning has a lot of moving parts . . . guardianships and trustees for children, real estate and deeds, incapacity planning, charitable giving, business succession, and estate taxes are just a few concerns that clients have when putting together their plan. But one of the biggest problem areas comes from something entirely within the client’s (and their financial advisor’s) control . . . beneficiary designations.

Beneficiary designations operate independently of a will or trust document because these beneficiaries are named under a contractual agreement with the financial company. Life insurance, IRA accounts, brokerage accounts, and any other financial asset that allows the client to choose his or her beneficiary does so under contract law. At the client’s passing, these beneficiaries will receive the client’s funds regardless of what the client has written into a will or trust agreement. If a client has an ex-spouse listed as a beneficiary under a life insurance policy, but leaves everything to the current spouse in a will, then guess who gets the life insurance—the ex-spouse, unless the contract specifies otherwise

Last Will and Testament PapersAnd we like it that way! Beneficiary designations allow a convenient way to augment an estate plan. The assets are kept out of the probate courts and are paid to beneficiaries quickly and privately. Remember, probate is public—a will file can be pulled from the court records any time, along with any documents filed along with it. Probate is also expensive and emotionally draining. Non-probate beneficiary designations make this process easier and less expensive.

But this simplicity is a double-edged sword. Because these designations are simple and straight-forward, they are often taken for granted. Using the wrong beneficiary designations can cause an asset to go to probate when it would not have otherwise. It can cause adverse tax consequences. It can cause someone to receive money when they are in the midst of a divorce or bankruptcy proceeding, causing them to lose their inheritance. Beneficiary designations throw a wrench in estate plans specifically because they are so easy to change.

What are the biggest problem areas with beneficiary designations? Let’s look at the top five that I have experienced. The first is, hopefully, common sense:

Mistake #1: Not Keeping Beneficiary Designations Up to Date
Because beneficiary designations are a creature of contracts rather than estate planning law, they operate completely independently of a will or a trust agreement. If a life insurance policy has an ex-spouse listed as the sole beneficiary, then that is where the money is going. The current spouse can certainly sue the ex for the funds, but the chances of winning are slim . . . the benefit of the doubt goes to the person who made the beneficiary designation (and that person, now deceased, is typically not available to testify). If the beneficiary designation is so easy to update, and the client listed his or her ex, then clearly the client meant for these assets to go to his or her ex, right?

And we want to keep it that way. If angry would-be beneficiaries were to sue financial companies and win, those companies would probably stop letting us use beneficiary designations altogether. So it remains that if a client’s will says “leave everything to my spouse” and the life insurance beneficiary designations say “leave everything to my parents,” it’s going to the parents.

On that note, consider if the beneficiary designation were written so as to give the assets to a beneficiary who is not allowed to own property:

Mistake #2: Naming a Minor as Beneficiary
People who are under age eighteen can’t own property, which means they also can’t inherit property. This might seem like common sense when you think about it, and yet many (if not most) young families name their children as the secondary beneficiary on their financial assets. This beneficiary designations will fail, and an asset that otherwise
Little girl with moneywould have skipped the probate process will now go to probate court. An attorney will
work to get these assets into a conservatorship for the beneficiary, which is itself an expensive process. Perhaps even worse, the child will received the assets outright when they are still very young, typically at age eighteen. Have you seen an eighteen year old receive a lump sum of $100,000? I have. It doesn’t go well.

Some policies allow a custodian to be appointed when there is a minor beneficiary involved, which allows the custodian to accept the funds on the minor’s behalf. This solves the problem of the minor not being able to inherit property, but it does not solve the problem of the beneficiary receiving a very early inheritance.

The solution is often a simple one . . . a testamentary trust can be created directly in the client’s will, and the trust can be named by the client as the beneficiary of his or her financial assets. The trust only exists on paper unless it is needed, at which time it springs into existence and can accept funds on behalf of the beneficiary. The client can determine the terms of the trust . . . does the beneficiary get a lump sum at age twenty-five? Thirty? Never? While in trust, what can the trust pay for? Often college and health expenses are a top priority, with funds to pay for a first home or for a small business sometimes allowed as well.

Testamentary trusts solve all kinds of problems, and they’re not just for children. Trusts can be created for spouses, for charities, or for adult children with special needs. But sometimes the client doesn’t know who he or she wants to leave their money to, so they make a big mistake:

Mistake #3: Naming The Client’s Estate
First, let’s revisit the fact that assets with beneficiary designations skip probate, which means they skip the whole “estate” court process. This is often a good thing . . . though there are some merits to probate (particularly when there is a dispute), probate is expensive, time consuming, emotionally draining, and inefficient. Having a valid beneficiary designation makes this process easier because that entire asset skips probate altogether. Nonetheless, clients often want their life insurance policy, IRA, brokerage account, or other asset to just go to their heirs, so they write in that the assets should go to their “estate.”

This may seem convenient because the asset will now be controlled by the client’s will . . . which means it is now a probate asset. Not only does this cause the asset to go through probate, it can also has the effect of generating a lot of tax liability. If an IRA or other qualified asset lists anyone other than an individual as a beneficiary, then that entire asset must be paid out within five years. This can be caused in more ways than one . . . by naming an estate, or by naming a trust that is not a “see-through” trust for IRS purposes. If the trust does not qualify for this treatment, it accepts the entire IRA over five years. Tax-wise, this can be disastrous (note that if the trust does not make income distributions, this will be taxed at the much higher trust level).

And that brings up the next big point. Beneficiary designations have many consequences, not the least of which can be caused by:

Mistake #4: Lack of Tax Planning
To reiterate, leaving tax deferred, qualified assets to a non-individual can be murder on the100 Dollar money packs pocket book, since assets left to non-individuals must typically be paid out within five years. For tax-deferred money, this means the beneficiary’s effective tax rate can hit the stratosphere. Estates and trusts—or at least, trusts that weren’t drafted in anticipation of receiving qualified funds—are taxed at an astronomically higher effective rate than individuals.

Fortunately, trusts (including will-based testamentary trusts) can be drafted to be “see-through” trusts, which avoid the five-year distribution problem by allowing the trustee to collect required minimum distributions from inherited IRAs on the beneficiary’s behalf. This treatment is not available for assets left to an estate or if the trust has a non-individual as a beneficiary, such as a charity.

But on that note, consider a beneficiary who is charitably inclined. If there is one asset that should likely go to a charity, it is qualified funds. A qualified charity won’t have to pay taxes on funds received from tax-deferred sources like IRAs or 401Ks. A beneficiary will . . . IRA and 401K assets don’t receive the “step-up” given to appreciated non-qualified assets. If there is an opportunity to take advantage of the step-up in cost basis of other assets while leaving assets that would otherwise be taxed as ordinary income to a charitable beneficiary, it could be an incredibly effective tax strategy. Speaking of taxes:

Mistake #5: Forgetting About Credit Shelter Trusts
Minnesota has an estate tax exemption of $1.4 million per person in 2015, rising to $2 million by 2018 (though as of this writing, other proposals are in front of the legislature). The issue with the Minnesota estate tax exemption is that it is not portable . . . if one spouse dies and leaves their assets to the surviving spouse, the surviving spouse does not get to inherit the deceased spouse’s exemption, and therefore can’t “stack” the deceased spouse’s exemption on top of their own. This means the survivor could die with assets above and beyond his or her own estate tax exemption, paying tax on the difference.

The solution is to leave assets to a trust for the benefit of the surviving spouse (called a credit shelter trust). If drafted property, this trust will allow the deceased spouse to use his or her exemption, while still providing assets that can be used if the survivor needs them above and beyond the survivor’s own assets. This can save hundreds of thousands in estate taxes.

But this only works if the trust is funded. Too often clients pay an attorney to draft an effective credit shelter trust, and then they forget to leave assets to it. If the credit shelter isn’t given any assets, it’s going to be tough for it to shelter anything from estate taxes. Even financially savvy clients can sometimes forget about this aspect of their plan when there are dealing with the myriad of other aspects of their financial planning.

Conclusion
Of course, even proper planning doesn’t guarantee it will work if the client doesn’t keep up with it. Creating an effective testamentary or revocable trust only works if it is funded properly and if the assets with separate beneficiary designations are coordinated with the rest of the plan. A proper financial plan is broad, and estate planning is only one part . . . with the financial advisor as the captain, make sure the task of estate planning is given to a capable co-pilot who can make sure the client sees the big picture.

creates wills and trusts for families who want to feel secure that their loved ones are cared-for. Philip is a trust and estate attorney based in Minneapolis, Minnesota. Philip is the author of Trustee University: The Guidebook to Best Practices for Family Trustees, available at Amazon.com in paperback or Kindle edition (free chapter available here!). He also works with trustees and beneficiaries who need help with their trusts. You can contact him here.

 

 

cover4_1 lowI spent the first six years of my post-law school life working as a professional trustee — first for a large national bank, then for a smaller boutique trust company. I learned so much from these experiences that it’s difficult to pinpoint any specific point where I really felt like I truly understood trusts . . . what motivates grantors to create them, what considerations attorneys must take into account when drafting them, and what a trustee truly needs to understand when managing one. But I can tell you this: the learning process was one that took years. Not weeks or months, but a years-long process that involved reviewing and discussing with my colleagues thousands of trust documents. I’ve since written articles for legal journals around the country about various trust rules, laws, and proposed laws. Yet still I find myself regularly looking up trust statutes and best practices while hoping to find a positive resolution for my clients.

I am always impressed when an individual steps up to act as the trustee of a trust. The trustee is the trust’s “CEO” — the person who manages the assets, decides what distributions to make, keeps records, sends statements, ensures tax returns are filed, et cetera. In short, a big job which is typically done for free by someone known personally by the grantor (the grantor is the person that created the trust with a lawyer). Trustees can (and in many cases should) be professionals, but more often than not, they are family members of the grantor with little or no experience. What takes a professional years to learn becomes the immediate responsibility of this family member. I really admire that family member’s willingness to step up and do the job.

The down side to being an inexperienced trustee may be obvious. I’ve worked with many who found themselves over their heads  . . . angry beneficiaries, outdated records, delinquent taxes, under-performing or under-diversified investments . . . you name it, I’ve probably seen it. I’ve been asked by other attorneys how their client can learn to be a trustee so that they might avoid these frequent problems. Not having a ready answer, I decided to write a thirty page brochure discussion this topic.

Thirty pages turned into 300 (free chapter here). I hope this book will help family members to better understand what is involved in the management of a trust, what they need to do when taking on this important responsibility, and how better to communicate with beneficiaries. Importantly, the book discusses the various professionals a trustee may need to hire (investment professionals, attorneys, accountants, and professional co-trustees). These professionals have every expectation that their clients understand the trusts they are working on; I hope this book will help.

creates wills and trusts for families who want to feel secure that their loved ones are cared-for. Philip is a trust and estate attorney based in Minneapolis, Minnesota. Philip is the author of Trustee University: The Guidebook to Best Practices for Family Trustees. available at Amazon.com in paperback or Kindle edition (free chapter available here!) He also works with trustees and beneficiaries who need help with their trusts. You can contact him here.

I’d like to think my wife and I are on pleasant enough terms where I am never going to ask
Marriage and money concept of high wedding cost and divorcemyself this question: can I disinherit my spouse?  But the decision to disinherit somebody doesn’t always come about because you don’t like each other; there can be other reasons why it makes sense to leave your assets to someone other than your spouse.

One such reason might be that your spouse simply has enough assets in his or her own name and you have both agreed that your assets are best used somewhere else . . . perhaps in a trust for the education of your grand kids, or maybe for a charity that you support.  Another reason could be estate taxes — by leaving assets to another person (or to a trust), you prevent your spouse’s estate from getting so large that estate taxes will be due on his or her passing.  Yet another reason may be a concern that your spouse will be taken advantage of when you are gone, and you want assets to be held for him or her by a trustee.  So: can I disinherit my spouse?

Spousal Rights

The most important part of this answer is this: in Minnesota, you cannot — ever — disinherit your spouse through your will or trust document (by itself).  In Minnesota your spouse has a guaranteed right to his or her spousal share.  This means that even if your will is drafted to give all of your money goes to charity, and you change all of the beneficiaries of you IRAs and life insurance (your “non-probate” assets) to the names of your children, your spouse still has certain rights including the right to live in the house for his or her life and for some monthly support from the estate.

According to Minnesota law, your spouse also has a right to a percentage of the augmented estate.  The augmented state is (simplified) the value of your stuff plus the value of your spouse’s stuff.  If you and your spouse have been married for only a year, your spouse has a guaranteed right to three percent of the augmented estate.  This percentage increases every year of marriage until year fifteen, in which your spouse has a guaranteed right to fifty percent of the augmented estate — regardless of what you’ve written in your will or other planning documents, and regardless of how you’ve written your beneficiary designation for your non-probate accounts.   It follows that if at the fifteen-year mark the surviving spouse has more than fifty percent of your combined assets in his or her name already, then those assets already exceed half of the augmented estate and there is no additional claim to a spousal share.

Waiver of Rights

So, your spouse has a guaranteed, inalienable right to get a portion of your estate, right?  Not so fast.  There are three ways your spouse can forfeit his or her share.

  1. Pre-nuptial agreement:  Properly drafted, a pre-nuptial agreement can allow you and your spouse to disinherit each other.
  2. Post-nuptial agreement:  Your spouse can agree after you are married to forfeit certain property rights. This includes the right to his or her spousal share.
  3. Consent to will:  Your spouse can sign an acceptance of the terms of your will, including a will that completely disinherits him or her.

You’ll notice that all three of these options involve your spouse affirmatively giving permission to you to give his or her share to someone else.  This makes sense, since the spousal share is at its core a property right, and we can give away our property as we choose.  Your attorney should use extreme caution when drafting any of these three documents: your spouse should have his or her own attorney review the terms of the document to make sure he or she understands what is being given up and any consequences of doing so.

Disinheriting anyone is a big decision that can carry big legal consequences.  Make sure you contact an attorney who is experienced in estate planning before making any major decision that affects your loved ones.  Done properly, there are ways your assets may better serve your family than if they are all left to your husband or wife.  Please contact me so I can help.

creates wills and trusts for families who want to feel secure that their loved ones are cared-for. Philip is a trust and estate attorney based in Minneapolis, Minnesota. Philip is the author of Trustee University: The Guidebook to Best Practices for Family Trustees. available at Amazon.com in paperback or Kindle edition (free chapter available here!) He also works with trustees and beneficiaries who need help with their trusts. You can contact him here.

Keywords: trusts and estates, Minnesota wills, revocable trusts, estate attorney, probate, estate planning

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