The Top Ten Estate Planning Mistakes to Avoid

We have all heard the probate horror stories. A Will took five years to be probated, generating hundreds of thousands of dollars in attorneys’ fees. All of the assets from someone else’s estate were stolen by the personal representative (executor), leaving the family with nothing. The probate judge was unfair. Such stories instill fear about probate administration, which can lead to estate planning decisions with unintended consequences. The following is a listof the top ten estate planning mistakes one should avoid:

1. Adding Children’s Names to Residential Deeds, Vehicle Titles, Brokerage Accounts, etc.

More often than not, this is a very bad idea. Adding a name to a deed, title or account conveys ownership, with all the legal rights and responsibilities that go with it. Parents usually regret this decision once they learn that they cannot sell, mortgage or even refinance their home without their children’s consent and involvement. For bank or brokerage accounts, distribution checks cannot be cashed or rolled over without the signature of all listed owners. Perhaps the most important concern is liability exposure. Assets to which children’s names are added are at risk for levy by the children’s creditors.

Capital gains taxes are a rarely considered, but very important concern. In most situations, when one sells a capital asset, such as a home, the tax assessed would be based on the difference between the sales price and the original purchase price. This is known as the “tax basis.” Typically, when a child inherits a home from his parents, he enjoys a “step up” basis, meaning his tax basis would be the value of the home at the time of the parents’ death. Then, if the child immediately sells the home, there would be no capital gain.

If the child is added to the deed prior to the parents’ death, however, he will only enjoy the step up in basis for the percentage of the home he did not own prior to his parents’ death. Depending on the value of the equity in the home, adding a child’s name to the deed may create a “taxable event,” requiring the filing of a federal gift tax return.

2. Leaving Everything to One Child, with the Understanding that He or She “Will do the Right Thing.”

Many parents will add the name of just one of their children to their assets, with the understanding that this child “will do the right thing” for his siblings. Typically, the selected child is either the oldest, the perceived smartest, or simply the one who happens to be still living at home. These arrangements are almost always an invitation for probate litigation, especially when the selected child feels entitled to more than his fair share.

3. Having Estate Planning Documents Prepared by an Inexperienced Attorney.

Some inexperienced attorneys present seminars for the sole purpose of scaring people away from probate, and toward more costly estate plans involving the use of trusts.

These attorneys may not mention, however, that some smaller probates may be completed quickly in Probate Court, with just a simple will. While estates with complex tax considerations typically require the use of trusts, some estates could benefit from administration through the Probate Court. An experienced planning attorney will take a detailed history for each client, analyze it and then provide the pros and cons for each estate planning option.

4. Poor Trustee Selection.

If an estate plan requires a trust, the most important decision with respect to the plan will be selection of the trustee. Michigan law provides enormous power to trustees. In most situations, the selected trustee will manage and distribute your assets without court supervision.

Too often, parents will select a favored son-in-law or best friend who happens to be “good with numbers.” This should never be the primary consideration. Trustees are usually permitted to hire attorneys, accountants, financial planners and other professionals, to assist in the administration of the trust. Instead, the individual selected to serve as trustee should the one believed to be the most trustworthy. The trustee should share the client’s goals and values, and should have a clear understanding of how the client would want his assets to be managed and distributed. Absent court intervention, the trustee will have complete control over the trust’s checkbook.

5. Improper Tax Planning.

An estate plan which reduces probate fees will not necessarily reduce the federal estate tax. Probate fees are governed by state law, and the federal estate tax is calculated according to the Internal Revenue Code and corresponding Treasury Regulations. For example, naming a beneficiary on an insurance policy will avoid probate, but the face value of the insurance policy could still be subject to the federal estate tax. Depending on the total value of the estate, the applicable tax rate could be as high as 35% for 2012, and even higher once the current tax law sunsets.

The tax rates, and the formula for calculating the federal estate tax, have changed often in recent years. Experienced estate planning attorneys will keep abreast of the changes in the tax laws, and advise their clients accordingly.

6. Failure to Complete the Estate Plan.

This is perhaps the saddest and most frustrating mistake. When one has a trust prepared, and then fails to fund the trust, unintended consequences may result. To fund a trust, one must legally place the desired assets into the trust, by either designating the trust as the owner, naming the trust as a beneficiary or by executing a pour-over will with the appropriate provisions. Tangible assets should be listed in the trust’s schedule of assets. Each method of funding has a different purpose and tax consequence. Michigan also allows individuals to execute an “Assignment to Trust” to serve as a catch all, but there are situations and certain assets for which this method of funding will not work.

A failure to fund a trust means that the assets will pass to beneficiaries through probate, or in accordance with the last beneficiary designation on the account or insurance policy. The result could be that the wrong beneficiaries receive the wrong assets, with possible adverse federal estate tax consequences. Expensive litigation would then typically follow.

Equally important to the failure to fund a trust is the funding of a trust with inappropriate assets. For example, it is not always advisable for a married couple to place their primary residence into a trust, because this would alter their ownership as a “tenancy by the entireties.” The result could be decreased protection from creditors. While there are circumstances in which it would be appropriate to place a primary residence into a trust, this should never be done without the advice of an experienced estate planning attorney. The same rational applies to an Individual Retirement Account (IRA). Changing the ownership of an IRA from an individual to a trust creates a “taxable event.” Naming a trust as a beneficiary to an IRA will also have tax consequences. While this situation may be unavoidable, an attorney should be consulted before any changes are made.

7. Failure to Preserve Homestead Exemption.

If a primary residence is placed into a trust, the correct statutory election should be made with the local municipality, in order to preserve the Homestead Exemption. This is necessary in order to limit the rate at which the local municipality can increase property taxes.

8. The Unknown Estate Plan.

All the money, time and effort that one puts into an estate plan will be useless if no one can find it. Fiduciaries and/or beneficiaries should know that an estate plan exists and where the documents are located.

Depending on the bank, beneficiaries may need a court order to gain access to a safe deposit box. Some banks will allow limited, supervised access to a safe deposit box in order to allow family members to view a will. One should be familiar with the bank’s policies and procedures regarding access. Other options for storing planning documents include a fire-proof safe at home, the attorney’s office or at several locations to ensure someone finds them.

If confidentiality is not an issue, some insurance claims adjusters have recommended that important documents be stored in the refrigerator. If the seal remains intact, the refrigerator may provide better protection from fire and water than a desk drawer.

9. Burial Instructions Contained in Wills.

In most cases wills are not reviewed until after the funeral. So, if one wishes to be buried in a Corvette, arrangements should be made outside of the estate plan.

10. Unequal Distributions.

An estate plan that provides for unequal distributions among children is not a mistake, per se. However, unequal distributions may cause discord among the children that could lead to probate litigation. Such estate plans should be created only after careful consideration.

Some parents may leave more money to an irresponsible child under the belief that this child “needs the money more.” The unintended message, however, could be that the irresponsible child is being rewarded, while the responsible children are being punished. Other parents amend their estate plans often, disinheriting children and then bringing them back, as a form of punishment or reward for particular behavior. When creating an estate plan, one should be mindful that this could be the last word to the children. There may not be time to amend the estate plan after the family fight of the week is resolved.

Our attorneys are available to prepare estate plans, answer questions and review estate plans currently in place to ensure the plans are updated as tax laws and family situations change.

Linda Davis Friedland is an attorney in our Livonia office where she concentrates her practice on commercial litigation, labor and employment Law, corporate and business law, estate planning, utilities law and municipal law. She can be reached at (734) 261-2400 or lfriedland@cmda-law.com.