Hardly a week goes by without news of a celebrity who has died intestate, disrupting families and enriching their lawyers. Maybe you’re smarter than that. You have a will and a power of attorney for financial and health care. But if you don’t update these documents and beneficiary designations regularly, your heirs could still find themselves in a legal morass after you die or pay more taxes than they have to (we’ll take care of that, too). Worse still, part of your wealth could go to an illegitimate heir.
The basic components of an estate plan include a will or living trust (or both), a living will, and a financial and health care power of attorney (also known as a health care power of attorney). POA designations give someone you trust the authority to manage your finances or make healthcare decisions in the event you become incapacitated. You can also use a Power of Attorney to appoint someone to manage your digital assets, e.g. B. Your online and social media accounts.
Some individuals use living trusts to avoid probate proceedings and appoint a trustee to manage their estate after their death (see When do living trusts make sense??). Whether your estate is simple or complex, you should review all of your documents every three to five years, or more often if your life changes fundamentally, says Marcos Segrera, financial advisor at Evensky & Katz in Miami. We have provided a checklist on the opposite page to help you determine if you may need to update your estate plan.
Your beneficiaries are key
Certain assets, such as Things like your retirement accounts and insurance policies require you to name a beneficiary who will inherit the account when you die. This ensures that after your death, those assets go directly to your beneficiaries outside of the probate process.
Naming beneficiaries usually supersedes instructions in your will or trust, so getting them right is important, says Letha McDowell, an attorney at Hook Law Center and president of the National Academy of Elder Law Attorneys. You should also name conditional beneficiaries in case you and the primary beneficiary — usually your spouse — die at the same time or within a short period of time, McDowell says. Although 401(k) plans routinely remind participants to review their beneficiaries, they rarely advise them to name a conditional beneficiary, she says.
If you don’t name a beneficiary – or the primary beneficiary before you dies and you don’t name a new beneficiary – the proceeds will be paid to the estate, meaning they will go through the probate process. This could significantly delay the process of distributing assets in your estate and cause headaches and expense for your heirs.
Federal law requires qualified plans, such as B. 401(k) plans, go to the surviving spouse unless the spouse agrees to relinquish that protection. If you want those funds to go to someone other than your spouse—for example, you have remarried and want your adult children to inherit the funds—your spouse must sign a waiver giving up the right to receive funds.
These spousal protections do not apply to IRAs. In most states, you can designate anyone you want as a beneficiary of your IRA (a spousal waiver may be required if you do not designate your spouse and live in a community property state). So while a spouse can be the default beneficiary of a 401(k), once the funds are transferred to an IRA, that protection disappears.
Look at your non-retirement accounts
While not required, you can – and should – arrange bank and brokerage accounts that pass directly to your heirs outside of the estate. This process is typically referred to as a Transfer-on-Death (TOD) or Pay-on-Death account, and the forms should be available from your financial institution. You may prefer this option to a joint account, which also bypasses inheritance but gives the joint owner an equal right to the assets in the account. With a death or death account, you retain control of the account until you die. Beneficiaries can claim the account outside of the estate by providing proof of identity and a death certificate.
As with beneficiary designations, these accounts supersede your will or trust, so it’s important to ensure they are up to date and have conditional beneficiaries.
If you change a beneficiary designation, you should receive a confirmation from the account. Keep this acknowledgment with your other estate planning documents, says McDowell.
marriage or divorce
State laws vary regarding current and ex-spouses, but there have been a few unfortunate cases where a life insurance payout went to an ex 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 out by Warren Hillman, who died of leukemia in 2008, should go to his former wife because she was named as a beneficiary of the policy . Hillman’s widow received none of the money.
death of a spouse
Because most couples designate each other as beneficiaries, surviving spouses must update their beneficiary designations as soon as possible. This may not be the most important thing when you are grieving, but it will make probate for children and other survivors much easier after your death. (You’ll also need to update your will and living trust.) If you’ve named conditional beneficiaries, you may not need to do this step, but you should make sure your choice of those beneficiaries hasn’t changed.
Change of Accounts
If you have transferred 401(k) plans to IRAs or opened new bank or brokerage accounts, you should ensure that the beneficiary (or TOD) designations are correct. If you are transferring a brokerage account to another firm, be sure to transfer all beneficiary designations as well. While you’re at it, make sure all accounts with beneficiary designations are up to date, including 401(k)s left by previous employers.
In this way, you reduce the tax burden on your heirs
Although beneficiary designations along with a living trust keep your assets out of the estate, these measures will not protect your heirs from state or federal estate taxes.
In 2023, estates valued up to $12.92 million ($25.84 million for a married couple) are exempt from federal estate tax. However, it will drop to about $6 million by 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 much lower estate tax exemptions. Oregon intervenes on properties valued at $1 million or more. https://www.kiplinger.com/retirement/inheritance/601551/states-with-scary-death-taxes
You can reduce or avoid federal and state estate taxes by giving away money while you are alive. In 2022, you can give up to $16,000 to as many people as you like without reducing your estate tax credit, and your spouse can give the same amount.
New rules for IRAs. While even a $6 million threshold would exempt most estates from federal estate tax, your adult children (or other unmarried heirs) could still be on the hook for a large tax bill if they inherit a traditional IRA.
But under the Setting Every Community Up for Retirement Enhancement (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 entire amount — or the money to an inherited IRA transfers that must be used up within 10 years of the original owner’s death. And according to guidelines issued by the IRS earlier this year, many heirs who choose the latter approach must make annual payouts based on their life expectancy and use up the account balance in year 10. Payouts, the heirs can wait until year 10, to use up the account.)
The 10-year rule does not apply to surviving spouses. They can put the money into their own IRA and let the account grow tax-exempt until they need to take RMDs, which currently start at age 72. Alternatively, spouses can put the money into an inherited IRA and make distributions based on their life expectancy.
The Roth workaround. If you want to minimize the tax burden on your heirs, one option is to convert some or all of your IRAs into a Roth. Inherited Roth IRAs are also subject to the 10-year non-marital heir rule, but with one key difference: withdrawals are tax-free.
If you convert money in a traditional IRA to a Roth, you must pay taxes on the conversion. But this is one case where the bear market could be your ally because taxes are based on the value of the IRA when you convert.
Before converting funds, compare your tax rate to that of your heirs. If your tax rate is much lower, a conversion might make sense. The math is less convincing if your heirs’ tax rate is lower than yours, especially if a conversion could put you in a higher tax bracket. Additionally, a large conversion could trigger higher Medicare premiums and taxes on Social Security benefits.
One of the perks of converting towards the end of the year is that you should have a pretty good idea of your income in 2022, which makes it easier to estimate how much the conversion will cost, says Ed Slott, founder of IRAhelp.com .