It's an old story but a persistent one: the botched estate plan. Sometimes even lawyers screw them up. Chief Justice Warren Burger, who wrote his own will, reportedly omitted clauses that would have saved his family $450,000 in taxes. What's that old saw about the attorney who represents himself?
One reason errors are common, says Stephen J. Silverberg, president of the National Academy of Elder Law Attorneys, is that people assume any lawyer is qualified to write a will. Not so. "Estate planning is a legal specialty, just as cardiology is a medical specialty," he notes. Another reason is lawyers' failure to look beyond the documents they prepare. Wills don't govern accounts with beneficiary designations, such as 401(k) plans, life insurance policies and Individual Retirement Accounts. All too often, slip-ups involving IRAs cost heirs thousands of dollars in future earnings.
The will your bank wrote
The legal document that determines who inherits your IRA—often your biggest financial asset—is not your will but the beneficiary-designation form you get from the bank, brokerage, or other custodian that holds your account. In addition to that form, you also must pay attention to the fine print in the IRA plan, which is written to protect the company, not you or your family. (Some custodians, for example, restrict your heirs' freedom to move your IRA to another company.) Unfortunately, nobody may read these documents until it's too late. "I'd say 90 percent of lawyers don't ask to see the client's IRA forms," says Silverberg.
Worse, you may not even have a copy. Many people assume the custodian keeps the papers on file. Don't assume! Silverberg recalls one case in which a brokerage located a missing document in a box under the office coffee machine. And the financial crisis has only worsened the problem, says Ed Slott, a tax accountant and IRA expert: "Banks and brokers go out of business, advisers are laid off, and forms are lost." (To get a new form, call the custodian or go online.)
The price of a missing form
Your survivors can still get your IRA without the beneficiary form—the default beneficiary is your estate—but they'll have to empty the account and pay taxes on it much faster. For example, let's say you leave a $400,000 IRA to your 40-year-old daughter. If she is named as the beneficiary on the IRA form, she can stretch annual withdrawals from the account over her life expectancy, in this case, another 43.6 years. (Her first required minimum distribution would be $9,174—$400,000 divided by 43.6.) Her withdrawals are taxable, but the IRA balance keeps growing untaxed. Assuming an 8 percent annual return and minimum withdrawals, the IRA would grow to almost $1.2 million by the time she's 65, and she'd already have received $671,000.
But if the beneficiary form is lost or misplaced, the result is quite different, because the beneficiary—your estate—has no life expectancy. In this situation, if you died before reaching age 70 1/2 the IRA must be emptied within five years; if you lived past 70 1/2 it must be emptied over your remaining life expectancy. (At age 75, for example, that would be 13.4 years.) Either way, your daughter loses decades of untaxed investment growth.
An incomplete or ambiguous IRA form can be even costlier. Slott remembers six siblings who inherited their mother's $600,000 IRA. Her beneficiary form listed their names—but not what share of the account each child was to receive. "The bank decided the first named child was the primary beneficiary, and the others just contingent beneficiaries," says Slott. "It paid the entire IRA to the oldest child. To divide it with her siblings, she had to withdraw the money, paying more than $240,000 in taxes that could have been avoided if the mother had just put two words on the form: 'equal shares.'"
Making things right
Such mistakes are easily fixed while you're alive. "Tell the bank or broker to send you all the paperwork," says Silverberg, "and show it to your lawyer." You'll want your lawyer to make sure that the custodian's rules allow your heirs to move the IRA to a different custodian via a trustee-to-trustee transfer that avoids triggering taxes.
Your lawyer should also make sure that your heirs are free to name successor beneficiaries, so that your grandchildren can, if necessary, continue taking distributions from your IRA based on their parent's life expectancy. The IRS permits that—but some custodians' rules do not. If you're not satisfied with the rules, move your IRA to another company. And keep copies of all the completed IRA forms with your will.
The Truth About Living Trusts
No estate-planning tool is marketed more aggressively than the living trust. Fast-talking salespeople fronting for unscrupulous law firms sell living trusts at "free lunch" seminars, claiming they're a smart way to avoid legal fees and taxes. Not true. Here are their real pluses and minuses.
PLUS: Your estate may avoid probate
Unlike assets distributed via your will, assets placed in a trust avoid probate—the legal procedure by which a court validates the will. Trust promoters play up this fact, describing probate as a costly nightmare. (The reality: In some states it's complex; in others, quick and cheap.) But many assets you own—including all jointly held assets, retirement accounts, life insurance policies, and annuities—bypass probate anyway. And despite living trusts, many estates end up going through probate after all because some asset intended for a trust was never transferred to it.
PLUS: Living trusts can be convenient
You can appoint a co-trustee to manage your finances if you become incapacitated. You can preserve your privacy after death, because a trust (unlike a will) is not a public document. And a trust is harder to challenge than a will, which may be important if you plan to disinherit someone or if your executor will have difficulty locating your relatives—they would have to be notified before a will is probated.
MINUS: You won't reduce your taxes
As the trustee, you still control all your money, so you haven't cut your tax bill.
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MINUS: You won't save on legal fees
A trust costs at least 30 percent more than a will to draw up, says the National Academy of Elder Law Attorneys' Stephen Silverberg, though a custom-tailored trust prepared by a qualified lawyer may cost you less than a generic document sold at a seminar. (For advice on finding a lawyer, go to naela.org. Be sure to get an engagement letter from the attorney you choose that spells out the services to be provided and the charges for those services. "You want to know everything upfront," says Silverberg. "There should be no surprises."
Contributing editor Lynn Brenner wrote about getting the most from Social Security in the September-October issue.
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