Unfortunately, a lot of people do not have a will, let alone a comprehensive estate plan in place. People typically lack a will because they either procrastinate or simply don't think they need one. While there's a chance that everything might work out fine without a will, there are plenty of unexpected, but predictable, life events or situations that could seriously complicate matters. And those who don't have an estate plan may be surprised at the difficulties and disadvantages your beneficiaries may face.
Problems when you die intestate
States have what are known as intestacy laws. Intestacy laws provide the default method of dividing up an individual's assets - to their nearest blood relatives - if they die without a valid will. The typical estate plan tends to mimic how the assets would be divided under a state's intestacy laws, to the surviving spouse and children. Some then wonder why they bother taking the time and money to prepare an estate plan if the state is already going to divide their assets the same way.
A key problem is that when an individual dies without a will, they have no control on how or when their beneficiaries will receive their inheritance. The distributions will be made in accordance with your state's intestacy laws, with no consideration to the unique set of circumstances that your beneficiaries may have.
What kind of circumstances or life events may affect an individual's inheritance? While there are countless scenarios, here are some common ones:
Divorce or separation
If a beneficiary receives an inheritance before or around the time they are getting divorced or separated, they may lose a significant portion of their inheritance to their spouse. A state's intestacy laws will provide no additional protections for a beneficiary's inheritance. While inheritances are typically considered a separate asset, it is very easy to lose that status and be converted into marital assets. For instance, a house left to a beneficiary is a martial asset once they put their spouse's name on the deed or use marital assets to make improvements. An inheritance is also considered a marital asset once it is comingled. So, a $100,000 inheritance from your father placed in a joint bank account will likely be considered marital assets. If the beneficiary and their spouse get divorced, those marital assets, including one's inheritance, will now be split between the two parties.
Minor beneficiary
If money is left to a minor beneficiary with no specific will or trust provisions to protect the money, there could be significant issues. The first problem is that a minor beneficiary does not have the legal authority to take control of their inheritance. How the money is held can get complicated, and it depends on how much money is being inherited and varied state laws. If it's below a certain value, it may go into an account established under a state's Uniform Transfer to Minors Act. In some instances, a parent can personally assume management of the funds. If the assets are significant, they may be required to go into a court-supervised conservatorship. In any of these instances, the minor is relying on family members and the court to do the right thing with their money. All of this could be avoided if a will is in place to indicate how a minor's inheritance would be managed and by whom.
Beneficiary has a substance abuse or spending problem
When a person dies without a will, the estate's assets are distributed to the beneficiaries with no strings attached. They can put the money in savings, or they can spend it irresponsibly. For an individual with a substance abuse problem, this could end up funding their habit. When you forfeit control over how the money is being distributed, a person with an addiction would be given a lump sum of money to fuel that addiction instead of having it protected and used in a responsible manner. The same goes for those with spending problems. The money will most certainly not be used the way the decedent planned, and without a will to provide distribution instructions, a beneficiary will not be restrained from spending the money however they want.
Beneficiary needs to qualify for Medicaid
Medicaid eligibility is restricted to individuals with assets below a certain dollar threshold. If an individual receives an inheritance around the time they are applying for Medicaid, this could cause them to become ineligible. Even if the individual applying for Medicaid attempted to protect those assets through their own estate planning, there is a five-year look-back period of ineligibility in which any gift (e.g. putting the assets in a trust) during this time would result in a period of Medicaid ineligibility.
Beneficiary is receiving government benefits
Beneficiaries receiving government benefits are usually subject to certain income and asset thresholds. A lump-sum inheritance without any provisions on how and when that money will be spent may result in the individual losing their government benefits. That is because many government benefits, such as Supplemental Security Income (SSI) and Medicaid, are based on financial need, and an inheritance will be viewed as an additional source of income.
One of several children have predeceased the others
Let's go back to the fact that many estates will mimic a state's intestacy laws. In most states, the intestacy laws will divide up the assets between a surviving spouse and their children. If there is no spouse, then the entire estate typically will pass to their children, if they have any. This makes sense. However, what if you have grandchildren? While the thought is that your children will pass it along to them, certain life events under a state's intestacy laws may prevent that from happening. For example, if one of your children pass away before your inheritance is distributed, and you die intestate, the estate will likely only be distributed to your surviving children. That means any grandchildren from your deceased child will not receive an inheritance.
Start with a will
Having a will prepared, formally known as a last will and testament, is a great starting point for getting your estate's affairs in order. At its most basic level, a will is a legal document that puts in writing specific instructions for the distribution of your property and the care of any minor or disabled children. If you fail to prepare a will, it will leave the decisions of your estate in the hands of your state's intestacy laws.
If there is conflict, a judge will likely have to weigh in on how your assets should be distributed. So, if you do not decide on who gets your assets and how they get them, the state or a judge will. When that happens, your assets may end up being given to people you did not want to have a share of your estate.
Specific ways to protect your beneficiaries (and your assets)
If you have not already created a will, you should immediately talk to an experienced estate planning attorney to go over your assets, goals and other considerations that may have an impact on your estate planning. This includes discussing your beneficiaries, their current situation and any concerns you may have about them. At this point, you can begin to lay the foundation for preparing an effective will.
But it's not just about creating a simple will. As mentioned, a basic will is likely to have the same provisions as if you died without creating one at all. Beyond just creating a simple will, there are certain estate planning strategies you can use to ensure that your assets will go to whom you want, how you want and when you want. Here are some estate planning tools and how they can benefit your beneficiaries and make sure that your plans and wishes are fully achieved.
Irrevocable trusts
Irrevocable trusts can be used to provide an inheritance to a beneficiary while shielding it from Medicaid, lawsuits and even divorce. An income-only trust is often used when an individual wants to shield their assets from the consequences of negative scenarios occurring. This type of trust would prohibit the individual from receiving the trust's principal but would provide them the income the principal produces.
For those with spending or substance abuse issues, there are certain irrevocable trusts such as a lifetime trust that may be beneficial. With this kind of trust, no lump sums are provided, and all spending must be approved by the trustee. This type of trust can shield the assets from potentially bad decisions by the beneficiary as well as harmful outside influences. You can further control the ultimate timing of this inheritance by specifying who is to receive whatever remaining funds are left in the trust when the beneficiary dies.
For concerns about younger potential beneficiaries or just general concerns about an individual receiving too much money too quick, you can set up an irrevocable trust that distributes portions of the inheritance to its beneficiary in stages. In these situations, a trust could split up the income in quarters giving the beneficiary a fourth of the trust at four different ages.
Irrevocable life insurance trusts
An irrevocable life insurance trust (ILIT) is a trust that one funds during their lifetime with life insurance policies. Although a grantor loses control after the trust is created, they are able to control its use by how they set up the trust. A grantor can set up a trust to, for instance, provide distributions in a lump sum, periodically or when the beneficiary attains a milestone such as a certain age or upon having a child. Once the ILIT is created, it will be used to manage and distribute the proceeds that are paid out upon the insured's death in accordance with whatever provisions you want to put in the trust. Having a beneficiary's assets in an ILIT can ensure that the assets are preserved from certain unplanned life events such as a lawsuit or divorce. It can also be used to protect assets from any potential creditor claims. For those with spending or other personal issues, this type of trust can provide a beneficiary with an inheritance, while simultaneously ensuring that the money will be responsibly distributed. With this trust you can appoint a trustee that will supervise the trust and only distribute proceeds according to your wishes.
Special needs trusts
This type of trust can be beneficial if you want to leave a portion of your estate to a loved one with special needs. Special needs trusts are typically used to leave money to a disabled individual who cannot earn a sufficient amount of income or live on their own. These irrevocable trusts provide for a beneficiary with special needs while ensuring they do not lose any government benefits they receive, like Supplemental Security Income and Medicaid. Not only does it protect your beneficiary from losing government benefits, but it also allows the grantor to have a certain level of control over the timing of the inheritance being distributed. Instead of providing the money in one lump sum, it is controlled under the terms the grantor set up in the trust that could last for many years.
Testamentary trust
For married couples, the desire is often to give all of one's assets to their spouse. However, there are concerns when doing that. In many cases, there is the question as to whether or not an inheritance will cause their spouse to no longer qualify for Medicaid and, instead the inheritance will have to be used to pay for long-term care. When an individual creates a will, they can include a testamentary trust for their spouse to protect their assets and control the timing of an inheritance. In this situation, a trust can be created for one's spouse with provisions that protect the spouse from being disqualified from Medicaid. The rules that govern Medicaid provide what is known as a “safe harbor” rule for testamentary trusts created for a spouse. As long as the trust is set up to provide the spouse support at the sole discretion of the trustee, the funds are considered unavailable for Medicaid purposes. This will ensure that your spouse gets their inheritance, can pay for things not covered by Medicaid and still be eligible for Medicaid if it is needed.
Life estate
A life estate is typically used for real estate and is a form of joint ownership that gives one person (the life tenant) the sole right to occupy and use the property during their lifetime and the other, the remainderman, a future interest in the ownership of the property when the life tenant dies. While a life estate can still be vulnerable to the life events of the remainderman, it can provide an advantage to a beneficiary as the property will not have to go through probate. So, if there are unexpected, or even expected, creditors of a decedent's estate, a beneficiary has the advantage of receiving a valuable asset without having to deal with any unexpected events that might occur through probate.