Debunking Common Estate Planning Myths

by Anthony Marrone on 19 January 2008 2 comments
Photo: iStockPhoto

Given the tens of millions of Americans nearing the Golden Years, the fields of retirement and estate planning are expanding by leaps and bounds. Along with the growth of work for financial advisors and estate planning attorneys, has come the advent of self-planning. From managing your entire investment portfolio from your home computer, to preparing your own Wills, Trusts and advanced-directives using an online document-preparation service, the "do-it-yourself" sector of financial and estate planning is enjoying huge growth.

As more and more Americans rely on websites like LegalZoom to help them prepare pre- and post-mortem documents, it is important to understand the several "myths" of estate planning, and how these online sites fail to convey the risks involved with self-prepared documents.

Myth #1: You Need a Will
This is an absolute lie, perpetrated by online companies and sometimes unethical attorneys looking to generate business. Don't get me wrong, most people could benefit from a Will, but not everyone needs a Will. If you have minor children, you will want to prepare a basic Will as soon as possible to ensure guardianship of your children passes to a trusted family member or friend in the event of your premature demise. However, if you have no minor children, there are other ways to assure the meaningful disposition of your assets when you pass other then a Will.

For example, let's say Robert Jones is a widower with two adult children. Robert owns his personal residence that he's lived in for several years, has a life insurance policy, a small bank account and a rather large IRA account that pays him income on a quarterly basis. Robert also has a pension and receives income from Social Security. My advice here is that, in the absence of extreme family matters, i.e. his children are divorced, he is expecting to inherit a large sum of money from a relative, etc., there is no pressing need for Robert to have a Will. The personal residence can be re-titled (in most states) to give Robert a Life-Estate and pass the home to his two children when he passes away (outside of probate). Also, Robert's life insurance, bank and IRA accounts can all pass to his children by either naming them as Beneficiaries (in terms of the insurance and IRA) and also making the bank account payable to his children on death. Now, if we were to mix in several equity accounts, multiple pieces of real estate and different gifting ideas, Robert's planning becomes more complicated. But, for now, you can see that the idea that everyone needs a Will is simply misleading.

Myth #2: A Trust Automatically Avoids Probate
Trust planning is becoming more and more popular in the U.S., mainly because it is a creative way to meaningfully pass along large assets to your descendants while hopefully avoiding a probate proceeding. Without getting into too detailed a discussion about the different kinds of trusts available (they vary by state) it's important to note that having trust will not automatically avoid a probate proceeding when you pass. The first step after you execute your trust is to re-title your assets that you wish the trust, vis-a-vis the trustee to manage. If you pass away without re-titling all of your trust assets, then those assets which remain outside the trust will be subject to disposition according to your Will, and a probate proceeding will be likely.

Myth #3: Everyone Needs A Trust
This is nothing more than a ploy for business. Playing on the example from Myth #1, Robert Jones does not need trust-planning at all. While it is true Robert could have some type of trust to ensure the proceeds from his IRA account are managed/distributed according to his wishes, the truth is most of Robert's assets will pass to his descendants by operation of his beneficiary designations. Trust planning is advantageous in several situations, including second marriages, families who wish to provide for adult/minor children, including a child with a disability, high net worth individuals and those who hold certain types of assets, i.e. large investment funds, several pieces of real estate, etc. However, for most Americans trust planning will do little beyond cost you a chunk of money annually (trustees are entitled to annual commissions for managing your property in most states) and create more of a paperwork shuffle in managing and distributing your assets.

Myth #4: Giving Away My Money Is The Only Way I'll Qualify for Medicaid
Many online sites and attorneys advise elderly clients to actively give away their money in order to lower the available resources and qualify for Medicaid (to defer the cost of nursing care or placement in an assisted-living facility). The truth is, most baby-boomers are very independent when it comes to managing their finances, so while this type of strategy may have worked in the 1980s and 90s with the Depression-era babies, it will serve little utility as the baby boomers reach retirement age. There are several different ways to qualify for Medicaid without giving up total control to your money, and if anyone tells you otherwise they are flat-out lying. However, based on new federal regulations placed into effect almost two years ago, Medicaid will now require you to provide financial history account statements for five years prior to your Medicaid application. The lesson for those who feel they may need nursing-care and placement within the next decade, purchase long-term care insurance, and start keeping accurate details and records of your finances.

Myth #5: I Should Name My Estate As Beneficiary of My IRA/Life Insurance
Don't do this. I cannot think of any benefit here, especially because estates generally pay higher taxes than individuals, this type of planning will have serious tax consequences for your estate. The reality is a lot of people name their estate (i.e. Estate of Robert Jones) as the primary beneficiary of their IRA/life insurance/annuities, etc. This is bad for tax-planning purposes, and also because now those assets are forced to pass through your estate (rather then directly to your intendend beneficiaries) and will be subject to probate. This is a bad idea all around.

I hope you enjoyed my first post, and will look forward to many more posts which intersect the areas of personal finance, taxes and estate planning.

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Nora Dunn's picture

Welcome to Wise Bread, Anthony! You bring some great ideas and frugal-minded points to the table with this article.

I would like to add to the mix however, that some family matters - even simple ones at the onset - can get complicated. 

Example:

Mum (a widow) has two grown children: Jane and Bob. She has a Retirement Account, and a House - both of equal value. Jane has a young family and has expressed a desire for the house, so in order to make things "easy", she makes Jane title-owner to the house while she's still alive.  Then in order to make things even, she designates Bob as the direct beneficiary to her Retirement Account.  Great - each child gets what they want, and everything is even-steven.

Problem is, when Mum dies, the Retirement account is actually considered to have been "cashed in" (since it isn't being rolled over to a spouse), and the estate has to pay tax on it.

But who pays? Jane has the house free and clear, and doesn't have thousands of dollars kicking around for the tax bill with her family demands and lower income than Bob. She feels that Bob can afford the bill anyway, since he's single and a high-income earner. 

But Bob doesn't feel this is fair, because it reduces the amount of his own inheritance and he doesn't feel he should solely be on the hook for this even though his inheritance is in the form of cash. Besides which, the house has gone up in value since Mum gave it to Jane and Bob is feeling jilted.

And so begins a rift in the family that takes years or decades to resolve, if it ever gets resolved. All because of what seemed like a simple estate requiring no professional planning.

The solution here may involve a strategicially purchased life insurance policy to cover off taxes and equalize inheritances. Or maybe even naming the estate as beneficiary, so that the taxes can be paid out of it and the remainder of assets can be distributed accordingly. Who knows. But I do still believe that having a trusted professional quarterbacking the plan can save not only money in the end, but heartache too. 

(I will also note the above example may not be an issue in the US - I am referring to the Canadian  legal and tax system. However it is my impression that the US is similar in this regard).

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Christopher Smith

While it may be true that you don't necessarily *have* to have a will, if you have any assets to speak of (and certainly, as you mentioned, children) you absolutely *want* to have one. Speaking as the close relative of a judge who handles probate issues, dying "intestate" (without a will) virtually guarantees headaches in court.

However, I'd adjust this myth to point out that you don't need a lawyer or even an online service to prepare a will: Just list out all your major assets (except for the ones you've named beneficiaries for) and specify who should get each one, plus a catchall "other assets" category. Get the required number of people (often one or two) to witness it, and put it somewhere where your friends and family can get to it (not a safety deposit box, unless they can sign on it).