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Heir on the Side of Caution

by Corey Sunstrom, CFP®

If you are like most people, you probably feel there’s never a great time to discuss life insurance benefits.  It can be morbid and uncomfortable to consider what happens when we pass on. No one wants to talk about death while strolling through the neighborhood on a brisk evening, the last rays of the sun peeking through the trees. But that’s exactly the moment my wife chose to pop this question: “So what’s going to happen with your life insurance when you die?” My first thought was that we needed to cancel our cable subscription- she’s been watching too many Lifetime movies. My second thought was: even though there never seems to be a good time to talk about it, the best time is always the present. 

What we leave behind is an important topic to consider before it happens! (We don’t generally see a lot of people coming back from the grave to settle their assets.) There’s a good chance we all want to leave behind a sum of money to our spouses and/or other beneficiaries.  And, for any of you that have been the point person for a family member’s estate after their death, you know the intricacies and challenges of getting everything settled.  Naming beneficiaries up front is a vital part of your personal estate planning, and will ensure there is clarity regarding your assets. 

There are many moving parts when it comes to planning; it’s easy to make errors with even the best of intentions.  Below are a few of the mistakes we commonly see when reviewing beneficiaries for a client.

Mistake #1 - Failing to Name Beneficiary, or Naming Your Estate

This may seem like I am -ahem- estating the obvious, but it’s important to make sure you have beneficiaries on your accounts in the first place. Absences of beneficiaries generally occur with Individual and Joint Brokerage accounts (non-IRA’s).  Attaching a TOD (Transfer on Death) is vital to ensure those funds have a place to land.  There are also potential pitfalls of naming your estate as the beneficiary.  This will cause your assets to go through probate. (If you’ve never been to probate, be thankful. It’s less fun than the DMV.)  If you leave an IRA to your estate, your beneficiaries will no longer be able to control taxes on their inheritance.

Mistake #2 - Naming a Trust as the Beneficiary of Your IRA

Maintaining trust is the biggest component of any solid relationship…but that’s a whole different article.  A fiduciary trust can be a vital piece of your estate plan, but you need to make sure it’s utilized the right way.  Trusts help protect the money we leave behind by giving us more control over how the funds are spent after our death.  The one major caveat of many trusts is that they are taxed at a much higher rate than individuals.  The top tax bracket for individuals is 39.6% and is applied once an individual’s income crosses $418,000.  The 39.6% tax bracket for trusts begins at income of $12,500 or higher.  Why is this significant?  If you leave your IRA to a trust, and the trust is not properly set up, most of the money being passed down will be taxed at the highest tax rate possible. Not good.  If it is vital to leave money to a trust due to particular situations, you should confirm with an attorney that the trust is set up correctly to receive IRA funds at individual rates.

Mistake #3 - Failing to Update Beneficiaries During Life Changes 

Believe it or not, beneficiaries have a habit of working their way off the inheritance list from time to time.  (Kids...don’t forget to call your parents on their birthday!)  Joking aside, there can be many situations where we need to update our beneficiaries.  Premature death, divorce, and other family issues can cause us to rethink how and where we want to leave funds.  It is vital to revisit our beneficiary designations on a consistent basis, especially when situations or life changes.  Occasionally, the change may be as simple as a beneficiary updating their given name, which would alleviate confusion down the line. 

Mistake #4 - Naming Children as Joint Owners of Accounts

Have you ever considered owning accounts jointly with either your parents or kids?   Many times, the reasoning is sound:  “We are going to give access to our kids, since it will ultimately be their money anyway”,  or:  “We want them to have access to the funds in case we cannot make decisions for ourselves in the future.” There are 2 things we have to be careful of in these circumstances:

  1. Naming your children or other family members as a joint owner on your accounts technically counts as a gift and may be reportable on your tax return.  This could result in eventual gift taxes. Surprise!

  2. Once a child becomes the joint owner of an account, the assets in that account become subject to the creditors of that person.  If a child has credit issues, or is sued for any reason, half of the account could end up in the creditor’s hands.

Making sure possessions and assets land in the right hands is an important part of our financial lives - and it is why estate planning exists!  By setting up your accounts correctly, reviewing periodically, and making the appropriate adjustments along the way, you can sleep easier at night knowing your intentions will be fulfilled.  Your beneficiaries will appreciate the thought you put into the process when settling your estate, and will ultimately have a much easier time inheriting the money you worked so hard to earn.  And, putting a plan into place means your conversations during evening walks will be way less uncomfortable. ⧫


Tax and Legal Disclosure:

This material is for informational purposes only. It is not intended to provide tax, accounting or legal advice or to serve as the basis for any financial decisions. Individuals are advised to consult with their own accountant and/or attorney regarding all tax, accounting and legal matters.