Imagine your spouse is ill, and you meet with an estate planning attorney to get your family affairs in order. Your attorney drafts a trust document and a will. You and your spouse sign it. You think everything is fine.
Your spouse passes, and shortly after that, you find that the accounts are not set up to transfer the way you both intended. Everything is not fine. Can this happen?
Yes, and it happens all the time.
The situation described above happened to a client couple that I’ll call Ralph and Sue. It was a second marriage, they had no children in common, but Sue had two children from her first marriage. She and Ralph had been together for ten years when Sue was diagnosed with pancreatic cancer. They met with an attorney right away.
They both agreed that Sue’s assets would be divided one-third each to Ralph and her two children. Here’s the problem. Most of Sue’s assets were in her company 401(k). The beneficiary on the 401(k) was Ralph, and although the trust document was written correctly, no one changed the 401(k) beneficiary.
Upon Sue’s passing, Ralph tried to get the 401(k) to send one-third to each of Sue’s children. But legally, the company is required to distribute the account according to the most recent beneficiary designation on file. And the most recent beneficiary designation said nothing about the trust or Sue’s children.
Ralph, being a good guy, rolled the 401(k) to his own IRA, withdrew the portion for the kids, paid the tax, and gave each of Sue’s children one-third of it. He had to claim all the income on his tax return since it came from his IRA. If the 401(k) beneficiary form had been updated to list the children directly, the tax cost would have been far less. And what if Ralph hadn’t been a good guy? The kids would have been out the money.
The Hidden Estate Planning Decisions You Make
When you think of estate planning, you probably picture a meeting with an attorney to prepare or update a will, trust, or a power of attorney. Yes, this is estate planning. Yet, even if you have never drawn up a will or met with an attorney to draft a trust, you are still actively, and often unknowingly, engaged in estate planning. It happens each time you open an account, name a beneficiary on an IRA, 401(k), annuity, or life insurance policy, or title a piece of real estate.
And, when you do have a will and trust, the account titles and beneficiary designations supersede what your will and trust say. Meaning the trust or will have no power over a direct beneficiary designation or account title. And when the titles and beneficiaries are not correctly structured, it can result in cumbersome (and possibly expensive) consequences for your family..
Take the case of George, a successful businessman now in his 80s. George had accounts with many brokerage firms and hired us to help him understand his investments. He wanted an independent advisor to explain things. In reviewing his accounts, we noticed many of the accounts listed only George or his wife as the owner. We asked George’s permission to talk to his attorney. George agreed. The attorney advised that the account titles needed to be changed to reflect their trust as the owner. Unfortunately, George’s wife passed away before this was done. Many accounts must now go through probate. For George, this will be costly and time-consuming. And it could have been avoided.
A Holistic View Helps Prevent Errors
When you title an account, there are consequences. For example, an account that is jointly titled or has a direct beneficiary doesn’t have to go through the probate process. It gets passed directly to the intended person. Doing this would have saved George a lot of money. Avoiding probate is one of many benefits to naming beneficiaries on accounts.
There are many ways to add beneficiaries to accounts. These types of account titles may be called Payable on Death (POD), Transfer on Death (TOD) or Designated Beneficiary Accounts (DBA). Real estate can be titled this way too. Many people are unaware of these options because when you visit a financial institution to open an account, most of the time, they simply do what you ask. They don’t explain other options and why having a beneficiary can be crucial.
Not only do you need to name beneficiaries, you also need to review them from time to time. Most retirement accounts, life insurance policies, and annuities offer you the ability to name a beneficiary, and you may have named someone a long time ago – an ex-spouse, or a parent or sibling. You must periodically review and update these beneficiaries. A new will or trust won’t take care of it.
Most people don’t want to be a burden on their family or children. One of the best things you can do to accomplish this goal is to get your estate planning in order. It may take some time and a bit of paperwork, but when you’re done, the peace of mind you feel is amazing. And if you work with a financial planner, they should be looking out for these things too.
Here at Sensible Money, it is standard operating procedure to discuss account titles and beneficiaries when we open accounts. But many investment firms, financial advisors, and banks don’t operate that way. They’ll open the account and ask very few questions. That means the responsibility is on you to make sure that there isn’t a lurking administrative nightmare waiting for your spouse or family.
By Dana Anspach. A version of this article was originally published on MarketWatch.