Fifty-eight percent of Americans have no will, according to a 2017 Caring.com survey. That means state laws, rather than the wishes of their loved ones, will determine what happens to the property and assets of the deceased.
But before the 42 percent of Americans who do have a will start congratulating themselves on helping their heirs avoid such challenging situations, it’s important to remember that even well-planned estates can cause problems for those who inherit. Here are the potential issues your heirs may face, and how you can make sure your final wishes are followed.
1. Your heirs don’t know where to find your estate plan
You may have very specific wishes regarding everything from your burial instructions to who will get your mint condition Cal Ripken rookie baseball card — but those intentions can’t be followed if your heirs don’t know where to find your will and other estate planning paperwork.
Unfortunately, this is a relatively common situation, since many people consider talking about inheritance to be taboo or uncomfortable. Even if your heirs know that you have a safety deposit box in the bank, they may not know which bank, or which branch, or where to find the key.
This is why it’s important to discuss your estate plan with your family. Introduce your kids to your attorney so they know whom to call in the event of your death. It’s also a good idea to create an “in case of emergency” folder that provides your loved ones with the information they will need about where to find your estate documents, as well as the information necessary to handle your banking, taxes, bills, and other issues if you become incapacitated or pass away. (See also: 9 End-of-Life Cost Savings Your Survivors Will Thank You For)
2. Your will is too vague
There are number of ways that a vaguely-written will can cause your heirs problems. The classic example would be if the deceased simply states that her jewelry is to be divided among her children. This kind of imprecise language can end up causing a rift among siblings if more than one wants the same brooch — or if anyone feels slighted as to how the jewels are distributed. It is best to make sure valuable items are specifically distributed in your will to ensure that your wishes are followed without causing family strife.
But a vague will can have bigger consequences than hurt feelings for heirs. For instance, sometimes a will specifies that one family member is to inherit all of the money because the deceased had a verbal agreement with that heir to share the money with another family member. (You may remember this as the beginning of the plot of Sense and Sensibility.) Without specific language in place, there is no guarantee that your heir will do what you asked.
These sorts of informal agreements are often created in order to protect assets for minors or other individuals who cannot directly inherit — such as special needs adults who rely on government assistance and would lose it if they were to come into a large sum of money. Since a verbal arrangement can be disregarded, it is far preferable to create a trust to ensure the money goes to the person you want it to. There are a number of different types of trusts that can make sure your wishes are followed, can protect the government assistance of the family member in question, and will allow for no confusion or misunderstanding. (See also: The Fair Way to Split Up Your Family’s Estate)
3. Your beneficiaries don’t match your will
If you put together a well thought out estate plan in your will, but forget to update your beneficiaries on your assets, then it doesn’t matter how detailed your estate plan may be — your assets will be distributed according to the beneficiary designation rather than your will.
This is a common issue for many estates, since relationships often change and account holders don’t think to update their beneficiary designations. Everyone should review their beneficiary designations every few years to make sure they are not leaving unintended money to ex-spouses, estranged siblings, or other family members who have drifted out of their lives.
4. You name the estate as a beneficiary
A common error in estate planning is if you name your estate as the beneficiary of your IRA, 401(k), or life insurance. If instead you name a person as your beneficiary on these sorts of products, the assets can pass to your beneficiary without having to go through probate. That means the individual beneficiary will receive their money, no matter how many creditors have claims on your estate. But if your whole estate is your beneficiary, the money must go through probate — and your heirs will get only what is left after creditors have been paid.
In addition, if your estate is the beneficiary of your IRA or 401(k), your heirs must liquidate the investments within five years of your death, and pay the required taxes. If instead an heir is named as a direct beneficiary, they may have the option of delaying the required minimum distributions until they reach age 70½, allowing the money to grow tax-free until then. (See also: 6 Times You Need to Update Your Will)
5. Your non-spouse heir cannot roll over a retirement account
Even if you name an individual as the beneficiary of your IRA or 401(k), if the beneficiary is anyone other than your spouse, there are still some pretty big tax pitfalls that could affect your heir’s inheritance. Non-spouse beneficiaries of tax-deferred retirement accounts cannot roll IRA or 401(k) money directly into their own retirement accounts without triggering a major tax bill. That’s because a rollover would cause the entire amount to be considered taxable income. For that reason, it’s preferable for non-spouse heirs of IRA and 401(k) accounts to take the money as required minimum distributions (RMDs) over a lifetime to minimize the tax bite. This is known as the “stretch” option.
Unfortunately, stretch RMDs are not without pitfalls. If your heirs do not take the correct required amount, there is a tax penalty of 50 percent of whatever they were supposed to take, plus whatever their ordinary income tax rate would be on the amount. To avoid this problem, you can direct your IRA or 401(k) custodian to administer inherited IRAs and automatically take care of any required minimum distributions.
6. Your annuity can push your heirs into a higher tax bracket
Passing on an annuity can be a good way of providing regular income to your heirs after you die. However, annuities also come with a potential tax problem since these products are also tax-deferred. An inherited annuity has untaxed growth, and the insurance company holding your policy will issue a Form 1099 for that untaxed growth to your heir, which means it will be included in the heir’s gross income for the year. Depending how much growth there is, this could push your heir into a higher tax bracket, and the annuity payments they receive during the first year may end up being swallowed up by the increase in that year’s taxes.