Top 10 estate-planning mistakes

(Article by Sue Stevens from Morningstar.com, 12 July 2007)

How to avoid overpaying estate taxes and prevent infighting among your heirs.

As a financial advisor, I see all kinds of issues and problems regarding clients' estate documents. Many times we'll discover that the arrangements spelled out in the documents are not at all what a client wants today. Often, we help clients deal with sensitive family issues that need to be reflected legally. Dealing with death is never easy, but it's worth it to take the time to plan your estate. When you do, take care to avoid these classic mistakes.

If you don't have estate documents, like a will or living trust, the state decides who gets your assets. If you go to your state's Web site, you should be able to see how they distribute property.

I bet most of you would rather have some input into that decision. If your estate is at all complicated, please don't try to create an estate plan yourself. Go to an attorney who specializes in estate planning. (You don't want to leave it in the hands of an attorney who does many types of law.) One place to look for an estate attorney is Lawyers.com. Choose "Estate Planning" as the type of lawyer (under "Trusts and Estates").

If you do have estate-planning documents but they are more than five years old, have an estate attorney review them. If you need to make changes, you may be able to amend your plan rather than start over with new documents.

If you don't have durable powers of attorney for health care and property, make sure you get those executed when you do the rest of your estate planning. You only need to think of cases like Terry Schiavo to understand that you need to commit your wishes to paper so there is no misinterpretation by hospitals or family members.

2. Choosing the Wrong Trustee, Executor, or Guardian
Many of you haven't created estate documents or updated existing ones because you just can't settle on whom to have act on your behalf.

You want to find someone with similar values to be guardians to your kids. They shouldn't be too old or too young. For the trustee's role, you want to find someone savvy enough financially to manage your money. And you need to find someone who is willing to put in the time and effort to wind up your affairs in the executor role as part of the settling of your estate.

Don't think you'll find the perfect person. That's a sure way to procrastinate indefinitely. Get as close as you can in choosing the right person for each role. And remember, you can always change who is listed in your documents if you find someone better suited to one of these jobs.

3. Not Funding Your Trusts
If you've gone to the trouble to put trust documents in place, don't fail to retitle your financial accounts and fund your trusts. All this boils down to is a flurry of paperwork. But if you don't do it, your carefully crafted estate plan may be a bust.

If you haven't completed this paperwork yet, you'll need to change your individually held accounts to trust accounts. You will be the primary trustee in most cases until you can no longer manage your affairs.

If you have an irrevocable life insurance trust, make sure the policy pays out to the trustee of your ILIT.

4. Not Using the Full Exemption Equivalent Credit
The "exemption equivalent credit" is a complicated-sounding term that just means you get to bequeath as much as $2 million without paying estate tax. Even if you don't have $2 million, you can still use your exemption to pass whatever you do have to the people or organizations that mean the most to you--free of estate tax.

One of the biggest mistakes married people make is leaving all their possessions outright to their spouse. In so doing, each spouse isn't able to take full advantage of his or her exemption equivalent credit, and the full estate (of both spouses) will be taxed at the second death.

So how can married couples take full advantage of each partner's exemption equivalent credit? If your estate is more than $2 million, you need to consider a "credit equivalent trust," or "B trust." Each spouse would set up this type of trust, and each can fund it with as much as $2 million. That amount would then qualify for the exemption equivalent credit and would not be subject to estate taxes. Income can be paid out to the surviving spouse, and principal can be tapped for certain purposes.

By setting up the credit equivalent trust, as much as $4 million (using the credit for both spouses) is free from estate tax.

5. Failing to Equalize Spousal Estates
A lot of times, one spouse ends up with more of the financial goodies in his or her name. While that may boost an ego here or there, it's actually counterproductive when trying to pass the most assets you can to your heirs.

Here's why: If the couple didn't get the full benefit of both of their exemption equivalent credits, the second spouse may die with more than the $2 million allowed to pass estate-tax-free per person. The assets over $2 million and under $4 million could have been estate-tax-free if the couple had taken advantage of putting as much as $2 million in each name.

Sometimes that may mean putting the house (typically one of the bigger assets) in the spouse's name with fewer assets. If the marriage is on sound footing, that works out just fine. But if you think there's a possibility of divorce, just remember you're giving up your ownership in the house.

6. Failing to Plan for the Care of Family Pets
Fellow planners and some clients sometimes laugh when I say that I often include pets in the estate-planning process. But from my experience, I've found that many individuals consider pets to be just as much a part of their families as people. To ignore pets' care after your death would be a mistake. I know there are millions of pet owners out there who would agree with me.

So what should you do? The Humane Society has prepared a booklet called "Providing for Your Pet's Future Without You" that you can download. It explains how to devote a portion of your will or trust to the care you want for your pet after you're gone. You can name whom you want to care for your pets, set up money to pay for that care, and set a level of care that you expect your pet to receive.

7. Not Using an ILIT to Shelter Large Amounts of Life Insurance
We talked about using the exemption equivalent credit to save on estate taxes above. The other common way to manage estate tax is to hold your life insurance policies in an irrevocable life insurance trust.

If you have smaller amounts of life insurance, you don't need to go to the expense of having another trust set up. What's a smaller amount? Let's say less than $500,000. A good test of whether you need this type of trust is if your current taxable estate (your house, your retirement plans, your investment accounts) is more than $2 million. If so, it's relatively inexpensive to set up an ILIT.

The trustee of the ILIT should be the beneficiary of your life insurance policy. As long as you live three years after assigning your policy to the trustee of the ILIT, that insurance money won't be part of your taxable estate.

Alternatively, if you're in good health, you can apply for a new life insurance policy purchased by the trustee of the ILIT and avoid the three-year waiting period.

8. Not Sharing Your Estate Plan's Contents with Your Family
While it may give you some satisfaction to know you control what happens with your assets after you've died, you don't necessarily want to spring this information on your family when they read the will. That often leads to big family fights over what each person thinks they "deserve."

A better approach is to talk to your family before you're gone. Let them know what you're planning to do and why. It may not be a particularly comfortable discussion, but at this point in your life you need to be able to speak your mind and live with other people's disapproval.

In some cases, attorneys recommend leaving $1 to an heir you basically don't want to receive any of your assets. This makes it perfectly clear you didn't just forget to mention them in your will (or trust).

9. Leaving an Unorganized Mess of Financial Records
Have you ever had to dig through another person's paper archives for any reason? If so, you know it can be torture. Not to mention the fact that some of your assets may never be found because no one can find the life insurance policy or bank account records.

You owe it to your family to be organized. You can download a simple form for this purpose by clicking here. Fill it out and give a copy to the person you choose to be executor and another copy to your attorney.

10. Not Coordinating Beneficiary Designations
Lots of people don't realize that a will doesn't necessarily control all of their assets. For example, even if you have a will that leaves everything to your spouse, if you own real estate in joint tenancy with rights of survivorship (a very common way to hold property) with anyone other than your spouse, your spouse won't be entitled to it. Ditto for life-insurance policies that specify someone other than your spouse as beneficiary. I've seen this happen when people name a beneficiary for a retirement account or life insurance policy before they were married (or divorced) but then forget to change it.

Whenever you update (or create) your estate documents, go through all your life insurance policies and work-related benefits, such as retirement plans and even stock options, to see if the people listed as beneficiaries are still whom you would choose today.