“Death is not the end. There remains the litigation over the estate.” – Ambrose Bierce
We work hard to protect our wealth from many things while we’re alive. We try to avoid taking on too much investment risk. We try to avoid losing purchasing power to inflation over time. We have insurance policies in place to recover things we lose or to provide us with certainties. It would be a shame to work so hard during our lives to protect what we have, to then lose much of that which we hope to pass on to a beneficiary due to a failure to plan.
Unfortunately, many families will lose some of the wealth they try to pass from one generation to the next. According to the Williams Group1, “Roughly 70% of families lose a chunk of their inherited wealth, mostly due to estate battles…” Thankfully, there are actions you can take today to mitigate the erosion of the wealth you hope to leave behind.
In 1997, the federal estate tax exemption was $600,000, and the top estate tax rate was 55%. In 2019, the exemption has been increased to $11.4 million, effectively making estate tax planning irrelevant for the vast majority of Americans. However, taxes can still find a way to chip away at the value of an inheritance.
A common example is a Traditional IRA account. If you die with a Traditional IRA and no designated beneficiary named, the recipient who will ultimately inherit the account will lose out on something called a stretch IRA. With a stretch IRA, the person inheriting the account will be able to take minimum distributions from the account over their life expectancy, minimizing the amount of taxable income that individual will realize each year. Without the stretch IRA, the inheritor may be forced to withdraw the entire IRA by the end of the 5th year after the year of death, likely resulting in a substantially higher tax burden.
Another example of a potential tax pitfall is when an individual attempts to pass along non-qualified investments in brokerage accounts (stocks and funds are typical examples). I’ve seen instances in which a client, likely trying to avoid probate, will add a child on to an investment account as a joint owner. Say that client had purchased shares of stock long ago that has now tripled in value. When the client dies, the child will become the sole owner of the account. However, the child will not receive a step-up in cost basis. Had the client instead added the child as a beneficiary and not added as a joint owner, the child would be able to sell the stock immediately upon death and realize no capital gains. Instead, as a joint owner, the child is stuck with the original cost basis of the shares of stock, and upon selling those shares, will likely pay capital gains tax.
Probate is the legal process to distribute an estate after death. The process is time-consuming, and the fees vary depending on which part of the country you are located in. The typical all-in cost of probate might be between 2-8% of the value of the probate estate. The most common items to go through probate are homes, vehicles, and investment accounts. It is possible to minimize, or even avoid altogether, the assets you own that will be subject to probate.
One of the more common probate avoidance tactics is to name beneficiaries (but not naming your estate) on the accounts you own. This could include life insurance policies, annuities, and other investment accounts. These accounts will be distributed upon your death according to the beneficiary designation, and not according to your will. In addition, consider setting up transfer-on-death registrations on things like your vehicles or bank accounts.
Another commonly used technique is transfer property to a trust. A revocable living trust will pass along property held within it directly to your beneficiaries. You can name beneficiaries to your trust, bypassing the probate process.
Settling an estate can, unfortunately, be a messy business. Not only are your beneficiaries dealing with the loss of a loved one, but they’re also trying to navigate the settlement process, which can take months or even years. All of this stress can lead to disagreements or fights between two (or more) otherwise level-headed people. Disputes over who gets what cannot only ruin relationships but can be financially costly.
While it may be an uncomfortable conversation, you may want to talk with your heirs about what your plans and wishes are upon your death. Take stock of what you own and consider getting input from your heirs about what they may want. The more open the lines of communication, the less likely there are to be disagreements after your death.
Also, you may want to have something called a no-contest clause. This is a clause in a will or trust designed to deter someone from challenging your documents after you are gone. For example, a no-contest clause may spell out that if a beneficiary contests the amount of the estate they will inherit, they will forfeit the share that was left to them.
As always, our team of financial professionals and estate attorneys is here to help you to and through retirement. You can fill out the form below or give us a call at 913-393-1000 to request a meeting with a financial planner.
Investment advisory services offered through Barber Financial Group, Inc., an SEC Registered Investment Adviser.
The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.