10 Common Estate Planning Mistakes (and How to Avoid Them)
People plan on having a good day, a good year, a good retirement and a good life.
People plan on having a good day, a good year, a good retirement and a good life. But why stop there? Why not plan for a good end of life, too?
End of life or estate planning is about getting plans in place to manage risks at the end of your life and beyond. And while it might be uncomfortable to discuss or plan for the end, everyone knows that no one will live forever.
Estate planning and end of life planning are about taking control of your situation. Death and long-term care later in life might be hard to fathom right now, but we can’t put off planning out of fear of the unknown or because it’s unpleasant. Sometimes it takes a significant event like a health scare to shake us from our procrastination. Don’t wait for life to happen to you, though.
Here are 10 common estate planning mistakes people make and suggestions for how to take action.
Written by Jamie Hopkins, Esq., LLM, MBA, CFP®, RICP®. He serves as Director of Retirement Research at Carson Wealth and is a finance professor of practice at Creighton University's Heider College of Business. His most recent book, "Rewirement: Rewiring The Way You Think About Retirement," details the behavioral finance issues that hold people back from a more financially secure retirement.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
1. Not having a real plan in place
I use the term “real plan” because everyone has some type of plan in place — it’s just likely a poorly designed plan for your situation with little thought behind its development. If you don’t have a will or trust in place, state succession laws and the probate process will help determine where your assets go. Do you really want your estate and end of life care determined by state laws and the court system?
- Solution: Be proactive and meet with an estate planner and financial planner to set up an end of life and estate plan .
2. Not updating plans over time
Estate planning isn’t a “set it and forget it” matter. Simply having a plan isn’t enough. Estate plans need to be updated after major life events, when your goals shift or when public policy changes.
For example, if you move to a new state, you need to review your estate plan. Legal instruments like wills, trusts and powers of attorney are state law driven documents, and moving can cause issues. If a new family member is born or someone dies, beneficiary designations might need modifications. And changes at the state or federal government level (e.g., the Tax Cut and Jobs Act passed in late 2017) can severely impact estate planning.
- Solution: Revisit your estate plan any time you (or the government) experience a big life change.
3. Not planning for disability and long-term care
Seventy percent of people age 65 will need long-term care before the end of their life. A private room in a nursing home costs more than $100,000 a year, and a home health aide costs more than $50,000 a year.
Long-term care is likely the largest unfunded retirement risk retirees face today, and it’s easy to see why when you look at the numbers.
Considering the facts, it’s clear that no estate plan is complete without some planning for things like disability and long-term care. When you’re still working, disability planning is about making sure you have the right amount of short-term and long-term disability insurance. As you move into retirement, the focus will shift to long-term care planning — how you want to receive it and how you want to fund it.
- Solution: Look into disability and long-term care insurance sooner than later. Every year you wait, the price goes up. Discuss your options with your adviser.
4. Not planning for estate tax liability
Estate tax liability feels like a rich person problem, which is true at the federal — but not necessarily the state — level. After the Tax Cut and Jobs Act of 2017, the federal exemption for 2019 is $11.4 million per person. This means a couple can exclude up to $22.8 million in a taxable estate from federal estate taxes. However, after 2025, the law reverts back to the previous $5 million exemption amount, indexed for inflation.
Currently, the government is in need of revenue and is looking toward new taxes as a solution. A wealth tax, raising income taxes or increasing estate tax revenue will likely all be on the table over the next few years.
- Solution: Be cognizant of new taxes as you plan — and be aware that a number of states also have inheritance and state estate taxes.
5. Improper ownership of assets
End of life planning can expose oversights surrounding asset ownership. The first mistake people make is not owning property jointly as spouses. On specific occasions, spouses may want to keep property separate. But when they own property together, it creates creditor protections and efficiencies in transferring property upon the first spouse’s death.
Improper ownership of assets could also be where a business owner accidentally titles business property in their own name, or when retirement accounts are put into a trust when the goal is to keep them outside the trust.
Other times, people think they’re outsmarting the system by deeding real estate property to their kids or selling property for $1. These transactions are actually treated as completed gifts, potentially creating a gift tax liability or at least a requirement to file a gift tax return form to the IRS.
Taking asset ownership too lightly or improperly executing it can cause problems when it pertains to estate and end of life planning.
- Solution: Figure out what your assets are and understand how they fit into your estate plan.
6. Lacking liquidity
Asset liquidity is important to have during life and especially after death. If your estate needs to be split among children, a surviving spouse or other heirs, it needs to have the proper amount of liquidity. Life insurance is an efficient way to create estate liquidity, help split up wealth and pay off debts.
If you’re a business owner, liquidity ensures your heirs have the cash they need to operate your business immediately upon your death. If you have a buy-sell agreement or other plan to transfer your business within your estate plan, liquidity is crucial — without enough liquidity, the buy-sell agreement could cease to continue.
- Solution: Sit down with a trusted financial professional to determine how much liquidity makes sense for you and how you should go about creating it.
7. Not considering the impact of income taxes on you and your beneficiaries
Certain assets left to heirs can create unintended income taxes for your beneficiaries. While many people are aware that their IRAs and 401(k)s are subject to required minimum distributions (RMDs) after age 70.5, you might not know that inherited accounts can also be subject to RMDs. A 401(k) or IRA inherited by an adult child is subject to RMDs and these RMDs could impact the beneficiary’s tax situation. Money will have to come out of the account each year, and in most cases with traditional IRAs and 401(k)s, the entire distribution is taxable. The RMD is taxed as ordinary income and stacks on top of an individual’s current earnings.
If an heir is a professional in their peak earning years, the distribution will likely be taxed at the highest marginal tax rate. This isn’t ideal as it decreases the total wealth passed down.
- Solution: If the original account owner does Roth conversions while living, their beneficiary could avoid taxes upon withdrawal because typically Roth distributions are non-taxable. You’d have to pay taxes to convert a traditional IRA into a Roth IRA, but then you’d experience tax-free growth. If heirs are in higher tax brackets than you are, it can make sense to convert before the heirs receive the accounts.
8. Not planning for minor children/beneficiaries
Although it sits at No. 8 on this list, one of the most important goals of estate planning is to make sure your children are cared for in the case of you and/or your spouse’s untimely death.
You also need to have a proper will in place that designates a guardian. (Make sure you ask the relative or friend before listing them as the designated guardian.) Beyond naming a guardian, spell out instructions for how the money should support the children — too often people leave money to the guardian to manage at their discretion.
- Solution: Get life insurance to provide for your children, and make sure your will designates a guardian.
9. Not incorporating charitable gifting and bequests
Whether it’s a local nonprofit, church or alma mater, we like to give back to our community. Why not incorporate charitable giving into your estate plan?
The Tax Cut and Jobs Act of 2017 continues to prevent Americans from itemizing many deductions and, in turn, from receiving any tax benefits for their charitable contributions. Tax benefits aren’t the sole reason people give to charity, but they’re a nice bonus.
- Solution: Certain estate planning and gifting techniques, like donor-advised funds and charitable remainder trusts, allow charitable giving that maximizes the federal tax benefits.
10. Not reviewing impact of beneficiary decisions on retirement accounts
As you learned from No. 7 on this list, most retirement accounts are subject to required minimum distribution rules once the account owner turns 70.5. The goal of qualified retirement accounts is to provide tax, investment and creditor protection benefits to encourage and support retirement savings. However, since retirement accounts can be one of the largest assets that an individual owns, they can represent a large part of their estate. As such, it’s important to consider how to pass along the account and which beneficiaries are the best to inherit a retirement account.
Once the account owner dies, the creditor protections on 401(k)s and IRAs fall off for the most part and heirs are required to spend down the accounts. Further complicating the situation is the fact that wills and trusts don’t have much control over what happens to our retirement accounts. Instead, the driver for who inherits IRAs and 401(k)s is the beneficiary designation on the account.
In some situations, it is best to leave retirement accounts to the surviving spouse. However, in other situations you might want to split up an account between children, grandchildren, a charity or a spouse. If your heirs have creditor issues it can make sense leaving the IRA or 401(k) to a trust. But generally speaking, under today’s tax and legal system we want to start by leaving retirement accounts directly to most beneficiaries and only use trusts if the situation requires it.
- Solution: Beneficiary designations drive IRAs and 401(k)s, therefore, make sure these documents are up to date with the current and contingent beneficiaries aligning with your goals.
No one-size-fits-all plan exists for a good end of life or estate plan. Start with goal-based planning — determine what you want to accomplish and how your situation is unique. End of life planning ties into many areas of your life, so it’s important to be proactive and work with a team of qualified professionals like attorneys, tax professionals, insurance specialists and a financial planner.
Take the time to sit down and plan for a good end of life, so your heirs and assets survive and thrive.
Jamie P. Hopkins, Esq., CFP, RICP
Director of Retirement Research
Jamie Hopkins is a well-recognized writer, speaker and thought leader in the area of retirement income planning. He serves as Director of Retirement Research at Carson Group and is a finance professor of practice at Creighton University's Heider College of Business. His most recent book, "Rewirement: Rewiring The Way You Think About Retirement," details the behavioral finance issues that hold people back from a more financially secure retirement.