It Starts With a Will

A good estate plan only starts with well-drafted documents. Whether a person uses a Last Will and Testament or a combination of a Will and a "living trust," paying attention to the details of how property is titled and what beneficiary designations are made for "non-probate" assets is essential. It's coordinating a person's economic reality to the documents.

I frequently see situations where more than half a family's wealth consists of an IRA, 401(k) account and life insurance. In those cases part of my responsibility as an estate planner is to alert the client to the need for intelligent choices of the beneficiaries for those assets and to help the client to implement those choices.

Consider the hypothetical case of Mr. & Mrs. Hitech. They both work for telecommunications companies. They have three children: two from their marriage and one from Mrs. Hitech's previous marriage, with the oldest (hers) attending college at the University of Georgia. Each has life insurance policies totaling $600,000 and retirement accounts of about $500,000. With their other assets each would leave an estate worth over $2 million. However over half of that wealth is in retirement accounts or death benefits from life insurance.

After the tax reform bills passed in 2010 and 2017, the Federal Estate Tax has become a non-issue for over 99% of the population. The Hitech family should be safe from the IRS because (as of 2020) over $11 million can be passed to the children without any estate tax. That "exempt amount" may revert back in 2026 to a lower amount established in 2011. However, adjusted for inflation that is likely to be no less than $6 million. Thus, tax planning has become less important. For most people the selection of the primary and secondary beneficiaries on the retirement accounts and life insurance is equal in importance to what is done in the wills and/or trusts. Those designations could be pivotal in the transmittal of wealth to the surviving spouse and children in a fashion satisfactory to the client.

A person can title his or her property in several ways, all of which have implications for how ownership of it will pass in the event of death. It is common for a husband and wife to have their home and other real property titled jointly with right of survivorship. This approach emphasizes flexibility over predictability. It postpones the issue of the ultimate passage of title to a non-spouse beneficiary (such as the children of that marriage, or of multiple marriages) to the "second death," the death of the surviving spouse, whoever that might be.

If the spouse is the sole beneficiary in our fictional Hitech family, there is a real possibility that the entire $4.0 million of family wealth will be controlled by the wishes of whoever happens to be surviving spouse. If there is a trust in the will of the first spouse to die it may get few, if any, assets because practically all of the decedent's assets never "passed under" the will (and thereafter to the trust). Why would that happen? The answer would be those beneficiary designations and the residential property owned “joint with right of survivorship.” Even in a case where there is no blended family, there is no guarantee that the surviving spouse will not re-marry and leave the entire family wealth from the first marriage to that second spouse.

There are a couple of challenges facing Mr. & Mrs. Hitech: (1) Do they want to treat the children from the different marriages equally in the division of assets? (2) How do they make sure that all of those non- probate assets go into a trust for the children in the event that there is no surviving spouse?

For a married couple who have children from two different marriages, there are two common approaches: one is to treat all of the children as one class of beneficiaries who will receive equal shares from the combined wealth of the husband and wife after both of them have died; a second approach is to identify particular property as going to a child or children (often in a trust) with the balance going outright to the spouse.

The first approach requires that the surviving spouse hold to the plan after the "first death," even if there is a second marriage. The alternative would be to use a trust to hold the property of the first spouse to die for the benefit of the surviving spouse with a final distribution to the children after the "second death." But there is a pitfall even with a conservative approach. Assume a trust that will ultimately benefit the children is built into the plan. The beneficiary designations for the life insurance and retirement accounts must be updated to designate the trust, or if the client wishes, the spouse individually, or a mix of the two.

Even a "conventional" family can run into trouble. If it is a younger family, then minor children could be mistakenly named as direct "secondary" beneficiaries of life insurance or retirement accounts. Instead (most of the time) the secondary beneficiary for the life insurance and the retirement accounts should be a trust for the minor children.

An older couple often faces the dilemma that the surviving spouse could be disabled. Usually the spouse should not be named as the direct beneficiary of a size-able retirement account. Instead a specially designed trust should be receiving the account with that surviving spouse as the sole beneficiary of the trust during that person's remaining life.

It should be obvious by now that drafting a good set of documents is only part of the solution. A person must formulate a plan to coordinate the economic reality with the legal documents. Otherwise those documents could be like someone who is "all dressed up with no place to go."