Hardly a week goes by without news of a celebrity dying intestate, breaking up families and enriching their lawyers. Maybe you are smarter than that. You have a Will and you have appointed a Power of Attorney for Finance and Health Care. But unless you regularly update these documents and beneficiary designations, your heirs could find themselves in legal trouble after your death or paying more than they would have in taxes (we’ll cover that too). Even worse, some of your assets may end up in an illegitimate heir.
The essential components of an estate plan include a living will or trust (or both), a living will, and a power of attorney for finance and health care (also known as a health care proxy). Power of attorney appointments give an individual you trust the authority to manage your money or make health care decisions if you become disabled. You can also use a power of attorney to designate an individual to manage your digital assets, such as your online and social media accounts.
Some individuals use a living trust to avoid a will and appoint a trustee to manage their assets after their death (see When you make living trust make sense?). But whether your property is simple or multi-layered, you should review all of your documents every three to five years, or more often if you experience a major life change, says Marcos Segrera, a financial advisor at Evensky & Katz, in Miami. We have provided a checklist on the corresponding page that you can use to determine if you may need to update your estate plan.
Your beneficiaries are the key
Some assets, such as your retirement accounts and insurance policies, require you to name a beneficiary who will inherit the account upon your death. This ensures that these assets will go directly to your beneficiaries after your death, outside of a will.
Beneficiary assignments usually replace instructions in your will or living trust, so it’s important to get them right, says Letha McDowell, an attorney at Hook Law Center and president of the National Academy of Legal Advocates. You should also name potential beneficiaries in the event that you and the primary beneficiary — usually your spouse — both die at the same time or within a short period of time, McDowell says. Although 401(k) plans routinely remind participants to review beneficiaries, they rarely advise them to name a potential beneficiary, she said.
If you don’t name a beneficiary – or the primary beneficiary will pass away before you and you don’t designate a new beneficiary – the proceeds will be paid into the estate, which means they will be subject to probate proof. This could significantly delay the asset allocation process in your estate, causing headaches and costs for your heirs.
Federal law requires that eligible plans, such as 401(k) plans, go to the surviving spouse unless the spouse agrees to give up that protection. If you want that money to go to someone other than your wife — you remarry, for example, and you want your older children to inherit the money — your wife must sign a waiver of the right to receive the money.
This spousal protection does not apply to the IRA. In most states, you can name anyone you want as a beneficiary of your IRA (a marital waiver may be required if you don’t name your spouse and you live in a community property). So, while the spouse may be the default beneficiary of the 401(k), this protection disappears once the money is transferred to an IRA.
Consider your non-retirement accounts
While not required, you can – and should – arrange for bank and brokerage accounts to pass directly to your heirs, outside of a will. This process is usually known as a Transfer Upon Death (TOD) or Pay-On-Death account, and the forms should be available at your financial institution. You may prefer this option over a joint account, which will also bypass a will but give the joint owner an equal right to the assets in the account. With a TOD or Pay-On-Death account, you can control the account until your death. Beneficiaries can claim the account out of a will by submitting proof of identity and a death certificate.
As with beneficiary assignments, these accounts supersede your will or trust, so it is important to make sure they are up to date and have potential beneficiaries.
If you change the beneficiary designation, you should receive confirmation from the account. Store this assertion with your other estate planning documents, says McDowell.
Marriage or divorce
State laws differ regarding current and former spouses, but there have been some unfortunate cases where life insurance payouts have been made to a former because the original owner failed to update the policy beneficiary. In 2013, the Supreme Court ruled that the proceeds of a $124,500 federal life insurance policy taken by Warren Hellman, who died of leukemia in 2008, should go to his ex-wife because she was named the beneficiary on the policy. Hillman’s widow did not receive any money.
Since most spouses call each other patrons, surviving spouses need to update their beneficiary assignments as soon as possible. This may not be your top priority when you’re grieving, but it will make the validation of the will much easier for the children and other survivors after your death. (You will need to update your will and living trust as well.) If you designate potential beneficiaries, you may not need to take this step, but you should ensure that you do not change your selection of those beneficiaries.
Change in accounts
If you’ve renewed more than 401(k) plans into IRAs or opened new bank or brokerage accounts, you must ensure that your beneficiary (or TOD) assignments are correct. If you transfer a brokerage account to another company, be sure to also transfer beneficiary designations. While you’re at it, be sure to update all accounts with beneficiary designations, including 401(k)s you left with your previous employers.
How to reduce your inheritance tax bite
Although beneficiary assignments, along with a living trust, will keep your assets out of a probate, these actions will not protect your heirs from federal or state estate taxes.
In 2023, estates worth up to $12.92 million ($25.84 million per couple) were excluded from federal estate taxes. However, it will drop to about $6 million in 2025 unless Congress extends the estate tax provision of the Tax Cuts and Jobs Act. In addition, 12 states and the District of Columbia have significantly fewer tax breaks. Oregon kicks in real estate worth a million dollars or more. https://www.kiplinger.com/retirement/inheritance/601551/states-with-scary-death-taxes
You can reduce or avoid state and federal property taxes by donating money while you are alive. In 2022, you can give up to $16,000 to as many people as you want without reducing your estate tax exclusion, and your spouse can waive the same amount.
New rules for the Irish Republican Army. While the $6 million minimum would exclude most estates from federal estate taxes, your adult children (or other unmarried heirs) can still find themselves in trouble for a large tax bill if they inherit a traditional IRA.
But under the Prepare Every Community to Promote Retirement (SECURE) Act of 2019, adult children and other unmarried heirs who inherit an IRA must either take the lump sum – and pay taxes on the full amount – or transfer the money to the inherited IRA. Within 10 years after the death of the original owner. Under guidance issued by the IRS earlier this year, many heirs who choose the latter method must make annual withdrawals, based on life expectancy, and deplete the account balance in the tenth year. (If the original owner dies before taking the required minimum distributions, heirs can wait until the tenth year to exhaust the account.)
The ten-year rule does not apply to surviving spouses. They can transfer money into their IRA and allow the account to grow, with taxes deferred, until they have to take RMDs, which currently begin at age 72. Alternatively, spouses can transfer money to an inherited IRA and take distributions based on life expectancy.
Ruth’s solution. If you want to reduce the tax bill for your heirs, one option is to transfer some or all of your IRA to a Roth. Inherited Roth IRAs are also subject to the 10-year rule for unmarried heirs, but with a fundamental difference: Withdrawals are tax-deductible.
When you transfer money in a traditional IRA to a Roth, you must pay taxes on the transfer. But this is an example where a bear market can be your ally, because taxes are based on the value of the IRA at conversion.
Before transferring any money, compare your tax rate with that of your heirs. If the tax rate is much lower, a transfer may make sense. The math is less convincing if your heirs’ tax rate is lower than yours, especially if the transfer could push you into a higher tax bracket. Additionally, a large transfer can increase Medicare premiums and taxes on Social Security benefits.
One of the advantages of converting at the end of the year is that you should have a good idea of your income for 2022, says Ed Slot, founder of IRAhelp.com, which makes it easy to estimate the conversion cost.