Not infrequently a week goes by without news of a celebrity dying without a will, ruining families and enriching their lawyers. Maybe you’re smarter than that. You have a will and have named a power of attorney for your finances and health care. But unless you regularly update these documents and beneficiary designations, your heirs may still find themselves in a legal morass after your death or pay more than they had to in taxes (we will cover that, too). Worse, some of your assets may end up in the wrong beneficiary.
The basic components of an estate plan include a will or living trust (or both), a living will, and a power of attorney for finances and health care (also known as a health care proxy). A POA designation gives a person you trust the authority to manage your finances or make health care decisions if you become incapacitated. You can also use a power of attorney to appoint someone to manage your digital assets, such as your online and social media accounts.
Some individuals use living trusts to avoid probate and appoint a trustee to manage assets after death (see When Does Life Trust Make Sense??). But whether your estate is simple or multi-layered, you should review all your documents every three to five years, or more often if you experience major life changes, says Marcos Segrera, financial advisor with Evensky & Katz, in Miami. We’ve provided a checklist on the front page that you can use to determine if you need to update your estate plan.
Your Key Beneficiaries
Certain assets, such as your retirement accounts and insurance policies, require you to name a beneficiary who will inherit the account when you die. It ensures that the assets will go directly to your heirs after you die, outside of probate.
Beneficiary designations usually replace instructions in your will or living trust, so it’s important to get it right, says Letha McDowell, an attorney with the Hook Law Center and president of the National Academy of Elder Law Attorneys. You should also name a contingent beneficiary if you and the primary beneficiary — usually your spouse — die at the same time or within a short time, McDowell says. Although 401(k) plans routinely remind participants to review their beneficiaries, they rarely advise them to name a contingent beneficiary, he said.
If you don’t name an heir—or a primary heir before you and you don’t designate a new heir—the proceeds will be paid to the estate, which means they will go through probate. This can significantly delay the process of distributing assets in your estate, creating headaches and costs for your beneficiaries.
Federal law requires a qualified plan, such as a 401(k) plan, open to the surviving spouse unless the spouse agrees to give up that protection. If you want the funds to go to someone other than your spouse—you’ve remarried, for example, and want your adult children to receive the money—your spouse must sign a waiver giving up their right to receive the funds.
This spousal protection does not apply to IRAs. In most states, you can name anyone you want as your IRA beneficiary (a spousal waiver may be required if you don’t name your spouse and live in a community property state). So while a spouse may be the default beneficiary of a 401(k), that protection disappears once the funds are rolled over to an IRA.
Consider Your Non-Retirement Account
Although not required, you can—and should—set up bank and brokerage accounts directly to your heirs, outside of probate. This process is commonly known as transfer-on-death (TOD) or accounts payable-on-death, and the form should be available at your financial institution. You may prefer this option to a joint account, which will also bypass probate but give equal owners rights to the assets in the account. With a TOD or payable-on-death account, you maintain control of the account until death. Beneficiaries can claim accounts outside of probate by producing proof of identity and a death certificate.
As in the case of beneficiary designations, these accounts replace your will or trust, so it’s important to make sure they’re up to date and have contingent beneficiaries.
If you change the beneficiary designation, you must receive confirmation from the account. Keep that confirmation with your other estate planning documents, McDowell says.
Marriage or divorce
The law is different in relation to the current and ex-husband, but there have been some unfortunate cases where the life insurance payment went to the ex-husband because the original owner failed to update the beneficiary of our policy. In 2013, the Supreme Court ruled that the proceeds of the $124,500 federal life insurance policy taken by Warren Hillman, who died of leukemia in 2008, should go to his ex-wife because she was named as the beneficiary in the policy. Hillman’s widow did not receive money.
Death of husband
Since most spouses name each other as beneficiaries, surviving spouses should update their beneficiary designations as soon as possible. This may not be top of mind when you are grieving, but it will make probate much easier for your children and other survivors after you die. (You will need to update your will and living trust, too.) If you have named contingent beneficiaries, you may not need to take this step, but you must make sure your choice of those beneficiaries does not change.
Change in Account
If you have rolled over 401 (k) plans to IRAs or opened a new bank or brokerage account, you must ensure that the beneficiary (or TOD) designations are correct. If you are transferring your brokerage account to another firm, make sure that the beneficiary designation is also transferred. While you’re at it, make sure all accounts with beneficiary designations are up to date, including the 401(k) you left with a former employer.
How to Lower Your Inheritance Tax
Although beneficiary designations, along with living trusts, will protect your assets from probate, those measures will not protect your beneficiaries from federal or state estate taxes.
In 2023, estates worth up to $12.92 million ($25.84 million for married couples) are excluded from the federal estate tax. However, that will drop to about $6 million in 2025 unless Congress expands the estate tax provision of the Tax Cuts and Jobs Act. Additionally, 12 states and the District of Columbia have lower estate tax exemptions. Oregon kicks in for estates worth $1 million or more. https://www.kiplinger.com/retirement/inheritance/601551/states-with-scary-death-taxes
You can reduce or avoid federal and state estate taxes by giving money away during your lifetime. In 2022, you can give up to $16,000 to as many people as you want without reducing your estate tax exclusion, and your spouse can give up the same amount.
New rules for IRAs. While even a $6 million threshold will exempt most estates from federal estate taxes, your adult children (or other nonspouse beneficiaries) may still find themselves on the hook for a large tax bill if they inherit a traditional IRA.
But under the Setting Up Every Community for Retirement Improvement (AMAN) Act of 2019, adult children and other nonspouse beneficiaries who inherit an IRA must take a lump sum—and pay taxes on the entire amount—or transfer the money to an inherited IRA. which must be depleted within 10 years after the death of the original owner. And in the guidance issued by the IRS earlier this year, many heirs who choose the latter approach must take annual withdrawals, based on their life expectancy, and deplete the account balance in 10 years. (If the original owner dies before taking the minimum required. Distribution, heirs can wait until year 10 to delete the account.)
The 10-year rule does not apply to the surviving spouse. They can roll the money into their own IRA and let the account grow, tax-deferred, until they need to take RMDs, which now start at age 72. Alternatively, spouses can transfer money into an inherited IRA and take distributions based on them. hope of life
The Roth workaround. If you want to minimize the tax bill for your beneficiaries, one option is to convert some or all of your IRA to a Roth. Inherited Roth IRAs are also subject to the 10-year rule for non-spousal beneficiaries, but with a critical difference: Withdrawals are tax-free.
When you convert money in a traditional IRA to a Roth, you must pay tax on the conversion. But this is an example where a bear market can be your friend, because taxes are based on the value of the IRA when you convert.
Before changing funds, compare your tax rate with that of your beneficiaries. If your tax rate is lower, changing may make sense. The math is less interesting if your beneficiary’s tax rate is lower than yours, especially if the conversion could put you in a higher tax bracket. In addition, large conversions can trigger higher Medicare premiums and taxes on Social Security benefits.
One of the advantages of converting towards the end of the year is that you should have a pretty good idea of your income in 2022, which will make it easier to estimate how much the conversion will cost, says Ed Slott, founder of IRAhelp.com.