Occasionally, those who are not estate planning attorneys will attempt to do their own estate planning. They think they can find a document online or use a friend’s document and they can figure it out. Unfortunately, there are many pitfalls one can go through.
Let’s take a look at three of these pitfalls that one should avoid.
Bill and Mary had a $500,000 home, a $500,000 IRA, and $500,000 in investments. They have three children, Aaron, Betty, and Charlie. Upon the death of survivor Bill and Mary, they want to leave the house for Aaron, the retirement plan for Betty, and the investments for Charlie.
The first problem with this plan, even if they assumed that they put in place the documents that achieve this distribution pattern, they may not have thought about the downsides. Bill and Mary’s plan didn’t foresee that they might sell the house, and that’s what they did. And the will of the house of Aaron fell. They added the home’s proceeds to the investment account. Since their plan left Charlie’s investment account, those assets went to him instead of Aaron.
There is a second problem with this plan, even assuming they put in the documents that get the plan done. They did not think about the income tax implications. While the three assets are currently the same value, the home and investments basically get a raise at death. In other words, when the beneficiary receives the assets, they will not owe income tax on them. However, an IRA is “income for the deceased” or “IRD,” which is an exception to the rules of increment. Assuming my house has a marginal state and federal income tax rate of 40%, the $200,000 from the IRA would be lost on income taxes. Perhaps it would have been better to leave the IRA to Charlie who is in a lower tax bracket or to spread the tax consequences on all three. After taxes, Betty will end up with $300,000, while each of her siblings will end up with $500,000.
There is a third problem with this plan, even assuming they put the documents that get you done. They did not think about the fluctuations in the values of various assets. Suppose they died ten years after the plan was drafted and the assets were worth $3 million. But their kids won’t get a million dollars. In fact, one of the children may get much less than the other children. how is that possible? The house that Aaron inherited could be in a neighborhood of diminishing property value. Its value dropped to $100,000. Bill and Mary continued to contribute to the IRA allotted to Betty and was worth $1 million upon the death of Bill and Mary survivors. The investments Charlie inherited did well and amounted to $1.9 million after the survivor’s death. Thus, Aaron would get the $100,000 home. Betty will get a $1 million IRA account (but it’s subject to $400,000 income tax). Charlie will receive an investment of $1.9 million. Thus, Charlie would have more than three times his sister’s after-tax value and 19 times his brother’s bequest value.
Estate planning is much more than just documentation. It also comes down to the knowledge and experience of the attorney making the plan.
Stephen C. Hartnett, JD, LLM
American Academy of Estate Planning Lawyers, Inc.
9444 Balboa Street, Suite 300
San Diego, CA 92123
Phone: (858) 453-2128