Vanilla

Mar 08, 2023

5 min read

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11 Common Estate Planning Mistakes to Avoid

These common estate planning mistakes could leave your clients vulnerable to unintended consequences such as probate, loss of assets in a divorce, and avoidable estate tax liability.

Financial advisors can help their clients avoid the 11 most common estate planning mistakes listed below.

#1 Not updating estate planning documents regularly

Some clients may think that creating an estate plan is a one-and-done proposition, but you should review and update your client’s estate plan with them when they experience any of the following:

• Major life events: Your client’s estate planning documents should reflect significant milestones, such as having a child, getting divorced or married, and death in the family.
• Notable changes in assets: An increase in assets without appropriate tax planning could result in significant estate taxes, which would leave less for the client’s beneficiaries.
• Significant changes in the law: Changes in applicable state and federal laws can affect your clients. The IRS implemented substantial tax law changes in 2012 and 2017, which changed estate tax exemptions.
• Change in fiduciaries or beneficiaries: Who oversees the estate and who benefits from it may change over time. It’s a good idea to check with your client occasionally to see if these names need updating.

#2 Failing to update beneficiary designations

Certain types of assets may only pass to beneficiaries after the client’s death by completing a beneficiary designation form, namely life insurance and retirement accounts. As a preliminary matter, your client must have proper beneficiary designations in place. Going forward, and in conjunction with any estate planning changes, your client should review their existing beneficiaries —who will receive the assets if something happens to the client—and update those designations in coordination with their overall estate plan.

Failure to update beneficiary designations could result in the following:

• Wrong Beneficiaries: Assets such as retirement funds and life insurance payouts will go to the person (or people) listed as a beneficiary, not necessarily the person your client wants to receive them. For example, your client’s children would not receive the benefits if an ex-spouse was still listed as a beneficiary, no matter how long their divorce has been.
• Probate: If your client has assets that can only pass via a beneficiary designation but has not named beneficiaries for those assets, the only way to transfer those assets to beneficiaries is through the probate process.

#3 Not planning for multiple post-death distribution scenarios

Life and death don’t always happen in a neat order: Children sometimes die before their parents. Entire families can perish in unexpected accidents. While it’s difficult to discuss, you should talk with your client and help them plan for the following scenarios:

• What should happen if a beneficiary predeceases the client? In case this occurs, the client needs to plan where their assets should go, write in contingencies, or change or name backup beneficiaries.
• Should the beneficiary have full control of the assets? What should happen to your client’s assets when the beneficiary dies? Your client can document that decision in advance, or they can give the estate to the beneficiary and let them decide what happens to it after they’re gone.
• What if there is a common accident? What should happen to the estate if your client and their beneficiaries are involved in an accident together? Advise your client to name a residuary beneficiary (someone who receives the remainder of the estate after paying debts) and/or a contingent remainder beneficiary (someone or a charity who gets the remainder of the estate when the primary beneficiaries are gone).

#4 Requiring mandatory distributions to beneficiaries

Mandatory distributions of principal to beneficiaries at certain ages, such as 18, 25, or 30, are standard in many estate plans. These age-based distribution practices are an estate planning mistake for the following reasons:

• Creditors: Age-based distributions can leave assets subject to creditors, or the assets could become marital/community property, with half lost in the case of a divorce.
• Estate tax exemptions: If your client has significant assets, make sure the estate planning documents account for applicable tax planning and provide maximum flexibility for more than one generation.

#5 Failing to consider creditor protection

Divorce is the primary creditor for most people. The U.S. divorce rate has dropped to a 40-year low, but the divorce rate among people 55-65-years old has more than doubled. This rate change means that Americans heading into retirement are more likely to get divorced than ever before.

Help your clients avoid the common mistake of failing to consider how they will protect their estate from creditors. There are many different estate planning techniques that can aid in asset protection for both your client and their beneficiaries.

#6 Naming the wrong trustee

Not just anyone in your client’s life is qualified to be a trustee—the person who will manage the trust. Choosing the wrong trustee is a decision that can have disastrous impact on your clients plan and is a mistake that is easily avoidable.

Factors to consider when reviewing your client’s trustee appointments:

• Is the selection current? If not, your client should remove or replace the trustee’s name in the estate planning documents. Outdated trustees may find it more difficult to execute your client’s wishes or may no longer be the best person for the role.
• Will the person represent the best interest of your client’s family? You want to ensure that your client has chosen a trustee who understands their wishes and will carry them out with the utmost integrity. Ensure that your client has chosen well by asking them to describe the trustee and their relationship. Discuss with your client any concerns you have about the trustee.
• Does the person have the necessary skills to be an effective trustee? Although the trustee doesn’t need to be a professional, they need to be organized, responsible, and dependable.
• Will the person be alive when your client needs a trustee? Some of the most trusted people in your client’s life may be significantly older than the client. Encourage your client to consider whether their chosen individual will be around to enact their wishes. Don’t forget to inquire about declines in the trustee’s mental or physical health.
• Is the person a U.S. citizen? If your client’s trustee is not a U.S. citizen, the trust may become a “foreign trust.” A foreign trust is subject to laws outside of the United States, even if a U.S. citizen created the original trust.

#7 Not planning for retirement assets

Retirement accounts are often one of a client’s most valuable assets. The average 401(k) balance in the United States was at least $100,000 in 2019. Without your advice, your client risks failing to plan for their retirement assets and their distribution.

Failing to plan for retirement beneficiaries in an estate plan means that your client may not designate the assets properly, or the right beneficiaries may not receive the full benefits. For example, suppose a client’s spouse is the primary beneficiary of a retirement plan. In that case, it’s within the spouse’s control to designate beneficiaries after the client’s passing unless the client included retirement assets as part of their overall estate planning.

Be sure to review your clients retirement accounts in conjunction with their estate plans so that money is not lost or overly taxed.

#8 Triggering the estate tax with life insurance

If an affluent individual maintains ownership of their own life insurance policy at the time of their death, the policy death proceeds may be subject to estate taxes. There are two basic ways to ensure that death proceeds don’t become taxable at their death: 

• Designate a spouse as the beneficiary: Let’s say, for example, that a husband names his wife as the beneficiary of his life insurance policy. This would generally not be taxable for the wife upon receipt—however, any remaining assets from the policy at the time of her death could become part of her own taxable estate. Although this method may not avoid estate taxes, it does delay them until the surviving spouse’s death.
• Use a trust: To shelter the insurance policy from estate taxes, the insured could set up an Irrevocable Life Insurance Trust (ILIT) and gift the policy into it. Another option is to have an attorney to set up a new trust, purchase a new insurance policy, and name the trust itself as the policy’s owner and beneficiary. This method may avoid estate taxes even at a surviving spouse’s death.

The goal of any of these methods, of course, is to avoid estate taxes on the proceeds from a life insurance policy so they do not become taxable for beneficiaries or heirs down the line. 

#9 Not minimizing inheritance tax

Being named the beneficiary of a loved one’s assets might sound nice—but without a well-structured estate plan, beneficiaries may find themselves facing hefty inheritance taxes. In some cases, strategically gifting certain assets before death can be a great way for a wealthy person to minimize the taxes their beneficiaries encounter. 

For example, the estate owner can gift up to $18k tax-free each year during their lifetime, enabling them to impart assets to beneficiaries while avoiding inheritance tax. 

#10 Not factoring retirement costs

When making an estate plan, it’s crucial to consider and set aside the money a person will need to have on-hand once they are past their earning years and into retirement. In addition to factoring in basic day-to-day expenses, make sure to consider the cost of specialized care like a nursing home, retirement home, or at-home care. 

#11 Forgetting digital assets

Today, creating a thorough estate plan means also taking any digital assets into account, such as cryptocurrency, convertible virtual currency, or anything held in a digital wallet. Make sure the appropriate parties have the necessary information to access these accounts when the time comes by including logins and passwords in the estate plan. 

Avoid these estate planning mistakes

Financial advisors can help their clients protect their assets, now and in the future, by being aware of and discussing the seven deadly sins of estate planning with them. While the estate planning mistakes in this post are common, they are avoidable through awareness, advice, and planning. Reference these critical estate planning mistakes, and use Vanilla’s simple, intuitive estate planning platform to advise your clients about estate planning.

The information provided here does not, and is not intended to, constitute legal advice or tax advice; it is provided for general informational purposes only. This information may not be updated or reflect changes in law. Please consult with your financial advisor or estate attorney who can advise as to whether the information contained herein is applicable or appropriate to your particular situation.