Common misperceptions about the way wills, trusts and beneficiary designations work together can lead to the failure of your plan for the distribution of your estate. Because beneficiary designations supersede other planning documents, a major misunderstanding is that a person's assets will be distributed exactly as they've specified in their last will and testament or trust.
If you've drafted a last will and testament, you may think your estate planning work is done. After all, you've accomplished something a majority of adults in America have yet to address or continue to ignore.
Having a properly drafted will is a great start. It's a better option than having no plan at all - unless you'd prefer the state to have complete control through intestacy laws to decide how many of your assets are distributed and who distributes them when the time comes.
Unfortunately, a will by itself won't guarantee your intended beneficiaries will receive the money or property you want to leave behind. Also, a will can't be enforced until a probate court is petitioned to appoint a personal representative and the will is proven to be valid.
What's worse, a will is the subject of more litigation (the bulk of which originates from squabbling family members) than any other legal document because of conflicts with other planning documents, experts say.
Many people mistakenly think their estate planning affairs are in order once they've stated their intentions in one handy document. Indeed, a simple last will and testament may seem like a straightforward way to plan for the distribution of your estate, but this strategy can lead to disputes among loved ones, lawsuits and ill will if your paperwork's not in order and your true intentions are ignored.
Contrary to popular belief, terms of a will are not all-controlling, and potential pitfalls await that can cause your plan to fail.
“The days of a simple will are over,” says New York-based estate planning attorney Lisa S. Hunter. “A complete estate plan includes documents that address distribution of your retirement plans and life insurance, management of any individually owned businesses, guardianship of your dependents and medical care while you are still living but unable to make your own decisions.”
If your will describes what you really intend to happen, Hunter says, then you need to make sure its provisions are coordinated with the other elements of a comprehensive estate plan.
“People circumvent their own will all the time,” Texas-based estate planning attorney Bill Dendy tells CNBC. “They'll indicate in their will that they want their assets divided equally among their three children, but then they go and name one child as the beneficiary to their IRA account and another to their house or a joint bank account.”
What assets can avoid probate?
The way your assets are titled or transferred upon death determines whether they avoid the often long, costly and public process of probate administration. All states have legal documents that take priority over the stated intentions of a last will and testament and, upon the death of the owner, can distribute assets outside of the probate process and directly to beneficiaries. Laws vary from state to state on ways to avoid probate when distributing assets including bank accounts, retirement savings, securities, vehicles and real estate. Also, spousal survivorship rights may overrule various beneficiary designations. In many cases, if no beneficiary is named or the beneficiary dies before the owner without an alternate beneficiary, assets are payable to the owner's estate and distributed through the probate process.
Key documents include:
- Beneficiary designations - Retirement accounts, life insurance policies and annuities include beneficiary designations. Death benefits from policies and annuities and the balance of retirement accounts are paid to designated and alternate beneficiaries. Because of tax considerations, beneficiaries are often advised to consult with a professional to determine the most advantageous method to receive the inheritance.
- Payable-on-death (PoD) designation - Owners of checking, savings and money market accounts and certificates of deposit can simply fill out a PoD form at the financial institution such as a bank, credit union or thrift to designate a beneficiary. PoD's are sometimes called poor man's trusts or informal trusts because they distribute assets outside of probate like a revocable living trust. Generally, alternate beneficiaries cannot be designated on individual accounts, and funds in joint spousal accounts pass to the survivor.
- Transfer-on-death (ToD) designations - In many states, ToD designations can be utilized to distribute securities, brokerage accounts, real estate and vehicles to beneficiaries. Ownership of the ToD asset is transferred to the beneficiary, and the asset is not liquidated. Keep in mind that real property owned in joint tenancy with rights of survivorship passes automatically to the surviving joint tenants, regardless of what your will or trust might say.
- Revocable living trusts - Titling assets into and properly funding a revocable living trust will expedite the settlement of your estate. However, the instructions in a trust for the distribution of assets, just like instructions in a will, should be in sync with any beneficiary and PoD and ToD designations. If instructions in the will or trust don't line up with beneficiary designations, the intentions expressed in the will or the trust will likely fail.
When should I review my estate planning documents?
Problems - such as potential family estrangement over inheritance or assets going to the wrong people - are prone to occur when the wishes detailed in a will or trust don't jibe with superseding instructions. One key to achieving a successful estate plan is to review your will, trust and ToD, PoD and beneficiary designations regularly to make sure they are in agreement and leave little room for a misunderstanding in the future.
It's time to review all elements of your plan - wills, trusts, beneficiary designations, deeds, advance directives, powers of attorney - whenever there's a marriage or divorce, the addition of a child or grandchild, a death in the family or other changes in the family dynamics.
“Despite a testator's best intentions to communicate his or her dispositive wishes, estate planning documents are rife for disputes among family members apt to contest their inheritance,” says a State Bar of Wisconsin report. “As a result of ambiguity in the documents, family dynamics, or feelings of unfairness among beneficiaries and family members, wills are contested with stunning frequency.”