beneficiary designation

The Foundation – Part 2: Probate Avoidance

Continuing with Part 2 of this three part series, I am going to briefly cover some of the most popular probate avoidance strategies. As a refresher, the purpose of this series is to cover the fundamentals and foundation of estate planning and some of what I typically go through with a client during an initial estate planning consultation, including the following topics:

Part 1 – Last Wills & Testaments and Powers of Attorney
Part 2 – Basic Probate Avoidance Strategies
Part 3 – Joint Revocable Living Trusts

For purposes of this post, it is extremely important to remember that if any of the following probate avoidance measures are used with respect to any of your assets, the distribution of those assets upon your death will NO LONGER be controlled by your Last Will & Testament. The designation or form you used to avoid probate will now control the distribution of that asset upon your death. This is one of many reasons why it is important to talk to an experienced professional when drafting your estate plan; the experienced professional can work with you to ensure that your entire estate plan (i.e., your Will, your beneficiary designations, etc.) works together to achieve your desired goals and results.

Example: The “Average” Estate

A significant portion of most individuals’ estates are made up of the following assets: a house, bank accounts, retirement/brokerage accounts, life insurance, an automobile and tangible personal property (e.g., your household furnishings, antiques, collectibles, etc.). By implementing a few of the probate avoidance strategies below, most individuals will have the peace of mind in knowing that a significant portion of their estate, if not all of it, will avoid probate.

And, even if not all of the assets avoid probate (e.g., like the car and the tangible personal property), if those remaining probate assets are below a certain threshold amount, your State may still provide a way to transfer those assets without the need for probate after your death (e.g., in Wisconsin, if you probate assets are under $50,000, they can be transferred by affidavit and probate can be avoided). This should be a goal for almost all estate plans – to at least have the value of your probate assets below the probate threshold amount in your State.

Joint Ownership

Generally, any assets held and titled as joint ownership property pass to the survivor of the joint owners outside of probate. Common assets that can be held jointly include bank accounts and real estate. However, keep in mind that the asset will pass fully to the survivor, even if you wish it to go to someone else.

Beneficiary Designations

Any assets where you can and do designate a beneficiary will pass to the beneficiary outside of probate. Common assets where beneficiary designations are used include retirement accounts (e.g., pension plans, 401(k)s, IRAs), life insurance policies and brokerage accounts. If you wish to designate a beneficiary to any of these types of accounts, you can do so by requesting a beneficiary change form from your account administrator.

Payable on Death Accounts

Similar to beneficiary designations, payable on death accounts allow you to designate a beneficiary of that particular account. If such a beneficiary is designated, that account will pass to the beneficiary outside of probate upon your death. Payable on death accounts are particularly useful when it comes to your bank accounts. Most banks (if not all) will allow you to name a beneficiary to your bank account, you just need to speak to your banker.

Transfer on Death Designations

Again, similar to beneficiary designations, transfer on death designations are used to pass interests in property upon your death to a named beneficiary without the need for probate. The most common use of transfer on death designations are for real estate and business interests. This type of probate avoidance strategy will usually involve seeing an attorney to draft the transfer on death designation.

Marital Property Agreements (with Washington Will provisions)

For married couples in some States, marital property agreements with Washington Will provisions can be used to pass all of the decedent spouse’s property to the surviving spouse upon the death of the first spouse without the need for probate. If otherwise consistent with your estate plan, this can make the time and expenses involved at the first spouse’s death much easier to cope with. However, only some States allow for this type of probate avoidance strategy. This will also require you to see an attorney to draft the agreement.

Trusts

Any assets held in trust will also pass to (or be held for) the beneficiary of the trust without the need for probate. Generally, almost any asset can be held in trust; thus, this can provide a lot of flexibility and the most overall probate avoidance. Additionally, this will also require an attorney to draft the trust agreement. In Part 3 of this series I will focus solely on trusts so be sure to check that out once I post it.

Recap: The “Average” Estate

Above I stated that a significant portion of most individuals’ estates are made up of the following assets: a house, bank accounts, retirement/brokerage accounts, life insurance, an automobile and tangible personal property. The following is a recap of the probate avoidance strategies that can be used to pass those assets to your heirs without the need for probate:

House – joint ownership, transfer on death designations, and trusts.
Bank accounts – joint ownership, payable on death accounts, and trusts.
Retirement/brokerage accounts – joint ownership, beneficiary designations, and trusts.
Life insurance – beneficiary designations and trusts.
Automobile and tangible personal property – joint ownership and trusts.

Conclusion

As you can see, there are multiple ways to avoid probate in regards to a particular asset and among your entire estate. The strategy and combination of strategies chosen will be different for every individual; some strategies may provide more advantages than other strategies depending on your individual circumstances. Additionally, many of the above probate avoidance strategies can be achieved for relatively little cost and time while saving your estate and your heirs A LOT of time and expense after you pass.

However, like I stated in Part 1, any plan starts with a good and solid foundation, and that includes your estate plan. That means that even if you engage in the above probate avoidance strategies, you still need to have a Last Will & Testament to “catch” those assets that you may have missed or that could have fallen outside the probate avoidance measures you took. Probate avoidance strategies must be integrated into an already existing solid estate plan; otherwise, the benefits and advantages such strategies provide will be diminished.

Make sure to check out Part 3 (Trusts) of this series when I post it. And, lastly, like with any topic I blog about, I am only scratching the surface of these topics, you must contact a professional in order to fully consider how these estate planning strategies will play out in your individual circumstances.

I hope this helps!

-Matt

The Monthly 5 and 5: Trusts as IRA Beneficiaries – Part 2

Last week in Part 1 of this month’s installment of The Monthly 5 and 5, I discussed five advantages of designating a trust as an IRA beneficiary. In Part 2 below, I will discuss five disadvantages. While this post will focus on IRAs, much of it may also apply to designating a trust as a beneficiary of other kinds of retirement assets. As you read in Part 1, designating a trust as an IRA beneficiary may allow you to achieve many of your estate planning goals; but, there are disadvantages that must be considered. Some of these disadvantages are caused by poor trust drafting and are avoidable, while others you are stuck with. Again, it should be noted that the discussion below is very summarized and only covers general rules; an experienced professional should be contacted before designating a trust as a beneficiary of your IRA (or other retirement asset).

Five disadvantages to designating a trust as an IRA beneficiary:

1. Stretch-Out of IRA Balance

Recall in Part 1 that if a trust is properly drafted and designated as in IRA beneficiary, the IRC allows you to “look through” the trust and “stretch out” the IRA balance over the trust beneficiary’s life expectancy. This allows the IRA balance to be protected and grow over a longer period of time; thus, creating more wealth to be transferred to the beneficiary. However, if the trust is not properly drafted, two things could happen: First, if the trust does not qualify under the IRC as a “look through” trust, then the trust will not be considered a qualified beneficiary of the IRA. Depending on the circumstances, this means that the entire IRA balance will have to be withdrawn within five years of the deceased owner’s death or the annual required minimum distributions will have to be taken over the deceased owner’s life expectancy instead of the trust beneficiary’s life expectancy. In most cases, this will result in a loss of any growth the IRA balance may have accrued over the beneficiary’s longer life expectancy and, most importantly, the beneficiary will have unfettered access to the entire IRA balance much sooner than you may have wished.

The second thing that could happen is: even if the trust does qualify under the IRC as a “look through” trust, and thus, considered a qualified beneficiary of the IRA, the trust may still be drafted poorly when considering the trust beneficiaries’ respective life expectancies. When determining which beneficiaries’ life expectancy to use to stretch out the IRA balance and calculate the annual required minimum distributions, the IRC requires you to use the life expectancy of the oldest beneficiary of the trust. Therefore, if the beneficiaries of the trust include both your 15 year old child and your 85 year old brother, the 85 year old brother’s life expectancy is what the annual required minimum distribution is going to be calculated with. This results in a much, much shorter stretch out than you may have wanted; again, causing loss in growth and protection of the IRA balance. If the trust and beneficiary designation had been drafted properly, both of the disadvantages above could have been avoided.

2. Taxes

Furthermore, recall from Part 1 the added tax advantages of stretching out the IRA balance over the trust beneficiary’s longer life expectancy. If the trust is drafted improperly like discussed above (i.e., the trust is a nonqualified beneficiary or the trust has an older beneficiary), then the tax advantages of stretching out the IRA balance are quickly lost. If the trust is a nonqualified beneficiary, then the IRA funds will have to be withdrawn within five years of the deceased owner’s death or over his/her shorter life expectancy, not allowing the beneficiary to reap the benefits of longer tax deferral as discussed in Part 1. The same is true if there is an older trust beneficiary that causes the annual required minimum distributions to be withdrawn over a much shorter life expectancy than otherwise could have been achieved.

Additionally, because the entire IRA balance will have to be withdrawn over a much shorter period of time (whether the trust is a nonqualified beneficiary or has an older beneficiary), this will generate more taxable income to the trust and/or trust beneficiary each year. This may result in the trust and/or trust beneficiary jumping into a higher tax bracket and thus, paying more in taxes on the IRA income than they would have had to if it had been stretched out over a longer period of time. Again, with proper drafting the above tax consequences could have been avoided.

Also note that the income tax brackets for a trust are much more condensed than individual income tax brackets; thus, if the annual required minimum distribution from the IRA is held and accumulated in the trust instead of distributed out to the beneficiary each year, this may result in higher income taxes.

3. Complicated & Costly

Designating a trust as an IRA beneficiary is both complicated and costly. It is complicated because the rules governing trusts as IRA beneficiaries are extremely complex and convoluted. There is no easy way about it. Both the trust document and the IRA beneficiary designation form must be completed correctly, considering a mess of rules, to ensure that your wishes are carried out the way you intended. There are many rules and options for the IRA owner to consider and that is why you need to work with a professional to ensure it is done correctly.

Because professional advice and drafting must be sought to designate a trust as an IRA beneficiary, it can be costly upfront. Drafting a trust is not cheap, and most experts would agree that because of all of the complicated rules, a separate trust should be created for your IRA; you should not use your everyday ordinary revocable living trust. And, not only may it be expensive upfront, but once the trust becomes the IRA beneficiary after the deceased owner’s death, there will be ongoing administration costs. The trust will most likely have to be professionally managed by a trustee to ensure it continues to comply with the IRC rules governing IRAs and the trust will have to file its own income tax returns each year. While these added costs may be justifiable in some circumstances, they may not be in others.

4. Spouse Loses Rollover Option

There may be reasons why an IRA owner may want to designate a trust for the benefit of his/her spouse as the IRA beneficiary instead of his/her spouse personally (e.g., in second marriage situations). However, those reasons must be weighed against the disadvantages of that designation. If the spouse is personally named as beneficiary of the IRA, he/she has the option of inheriting the IRA or rolling over the IRA into his/her own name. While there may not seem like much of a difference there, there can be many added advantages to rolling the IRA over into the spouse’s own name instead of the spouse inheriting the IRA (e.g., tax benefits, including greater tax deferral and Roth conversions). If the trust for the benefit of the spouse is instead named as the IRA beneficiary, the spouse can only inherit the IRA, and may not roll it over into his/her own name; thus, losing some of the added benefits to doing so.

5. Heirs Lose Flexibility

Individuals (a/k/a grantors) set up trusts for beneficiaries to restrict and control distributions. A trustee of a trust ensures that the beneficiaries only receive and spend the trust funds according to the deceased grantor’s wishes. A beneficiary does not have unlimited and unfettered access to the funds held in the trust. This is the way the grantor wanted it. However, if the grantor really has no reason to put restrictions on how the IRA funds are used, or is not worried about their heirs being spendthrifts or subject to creditor claims, or has no minor or disabled heirs, then why name a trust as an IRA beneficiary? Just name your heirs as the individual beneficiaries personally. They are afforded much more flexibility in stretching out the IRA balance or cashing it in to pursue other investments. Additionally, it is much less complicated and costly. While a trust as an IRA beneficiary gives the IRA owner the greatest flexibility in controlling those IRA funds beyond the grave, it leaves the beneficiary with the least amount of flexibility in later controlling and using those funds.

As you previously read in Part 1 and above in Part 2, the advantages and disadvantages of designating a trust as an IRA beneficiary can be great. The advantages can really help you accomplish your estate planning goals; but, on the flip side, the disadvantages need to be weighed against those advantages. While some of the disadvantages discussed above are unavoidable, others are caused by poor drafting and are avoidable. Designating a trust as an IRA beneficiary should never be done on the whim; but, with proper professional advice and drafting, and after fully considering the advantages and disadvantages associated with designating a trust as an IRA beneficiary, you can make an informed decision. It certainly is not for everyone, but for some it is certainly necessary.

– Attorney Matthew D. Brehmer

The Monthly 5 and 5: Trusts as IRA Beneficiaries – Part 1

In this month’s installment of The Monthly 5 and 5, I will be discussing five advantages and five disadvantages of designating a trust as an IRA beneficiary. In part one below, I will discuss five advantages; I will post part two discussing five disadvantages next week. While this post will focus on IRAs, much of it may also apply to designating a trust as a beneficiary of other kinds of retirement assets. As you will read below, designating a trust as an IRA beneficiary may allow you to achieve many of your estate planning goals; but, if the trust is drafted improperly, the results could have a substantial unintended impact on your estate plan. It should be noted that the discussion below is very summarized and only covers general rules; an experienced professional should be contacted before designating a trust as a beneficiary of your IRA (or other retirement asset).

Five advantages to designating a trust as an IRA beneficiary:

1. Stretch-Out the IRA Balance

When an individual is designated as a beneficiary of an IRA and the owner of that IRA passes away, the beneficiary becomes the owner of an “inherited IRA.” With an inherited IRA, the IRC allows the beneficiary to “stretch out” the IRA balance over their life expectancy instead of being required to either withdraw all of the IRA funds within five years of the deceased owner’s death or take required minimum distributions over the deceased owner’s life expectancy (which may be much shorter if the beneficiary is much younger, i.e., the beneficiary is the owner’s kid). If only the required minimum distribution based on their own life expectancy is withdrawn every year, the balance is left to grow, thus creating more wealth to be transferred to the beneficiary.

Likewise, if a trust is set up properly and designated as a beneficiary of an IRA, this same stretch-out is allowed. The IRC allows you to “look through” the trust and base the required minimum distribution on the trust beneficiary’s life expectancy. Thus, the trust can achieve the same stretch-out discussed above as if the individual was named personally. The added bonus that the trust provides is that the beneficiary cannot cash in the entire IRA balance immediately after the death of the IRA owner; like they could if they were named personally. The IRA balance is protected by the trust and only the trustee of such trust would be allowed to cash it in or take distributions greater than those required each year. This protects the beneficiary from squandering all of the money immediately after the owner’s death on something that may not be as advantageous as saving the money for the future, which may be what the deceased owner would have wanted.

2. Defer Taxes

Another benefit of stretching out the inherited IRA over the beneficiary’s life expectancy is greater tax deferral. Since taxes on the funds in the IRA will not be paid until they are withdrawn from the IRA, that leaves more in the IRA to grow and compound, thus creating more wealth to be transferred to the beneficiary. By designating a trust as an IRA beneficiary instead of the individual personally, the trust can ensure that the beneficiary takes advantage of this tax deferral by not allowing the beneficiary to cash in the IRA immediately after the owner’s death, which the beneficiary could do if they were personally designated as the IRA beneficiary.

Additionally, suppose that the beneficiary is personally designated as the IRA beneficiary and does cash in the entire IRA immediately after the owner’s death. This may cause the beneficiary’s total income for that year to jump up into a higher tax bracket. The result: the beneficiary ends up paying more in taxes on that IRA balance than they would have had they spread it out and withdrawn it over their life expectancy instead. Again, the trust can ensure that the beneficiary does not immediately cash in the IRA and increase the overall tax liability on the IRA funds.

3. Asset Protection

If a trust is designated as beneficiary of an IRA, all of the traditional trust asset protections could apply to that IRA. This means that if the trust is properly drafted, the IRA balance may be protected from creditors, bankruptcy, and/or a divorcing spouse. While an IRA is typically afforded bankruptcy protection if the original owner of the IRA files bankruptcy, it is not afforded that same protection if a beneficiary later inherits the IRA personally and files for bankruptcy (see the U.S. Supreme Court’s 2014 decision in Clark v. Rameker). However, by properly drafting a trust and designating it as the beneficiary instead of the individual personally, the IRA could be afforded bankruptcy protection.

4. Protect Minor and/or Disabled Heirs

Another reason why individuals set up trusts is to protect and provide for their minor and/or disabled heirs. If the trust is properly drafted, it can be designated as the IRA beneficiary and those IRA funds can be protected and used accordingly to provide for any minor and/or disabled heirs. If instead the minor and/or disabled heirs are personally named as the IRA beneficiary, the IRA funds may not be managed and controlled like they would be in a trust for the minor and/or disabled heirs. Additionally, if they are designated personally as an IRA beneficiary instead of a trust, the minor heirs could get outright access to the funds at age 18 (or age 21 in some states) and the disabled heirs may lose their public benefits until they spend down the IRA funds.

5. Control Distributions

Furthermore, individuals will typically include trusts in their estate plan if they would like to have some say in, limit or completely control distributions to the beneficiaries. If properly drafted, the same can hold true for a trust that is a beneficiary of an IRA. The IRA owner may designate a trust as the IRA beneficiary because the owner wishes to control when or how the beneficiary receives the IRA distributions. This can be for a variety of reasons: to provide spendthrift protection, to transfer some of the wealth to future generations, etc. The same would not hold true if the beneficiary was personally designated as the IRA beneficiary instead of the trust.

As you read above, the advantages to designating a trust as an IRA beneficiary can be great. It can really help you accomplish your estate planning goals. However, as you will read in the second part of this post next week, there are disadvantages that need to be considered. Some of these disadvantages are caused by poor trust drafting and are avoidable, while others you are stuck with. Designating a trust as an IRA beneficiary should never be done on the whim; but, with proper professional advice and drafting, and after fully considering the advantages and disadvantages associated with designating a trust as an IRA beneficiary, you can make an informed decision. It certainly is not for everyone, but for some it is certainly necessary.

– Attorney Matthew D. Brehmer

Beneficiary Designations: An Overlooked Estate Planning Tool

While a vast majority of the population has not prepared the “staple” estate planning documents that every person over the age of 18 should have, almost everyone has prepared a beneficiary designation form of some sort. When I say “staple” estate planning documents, I am talking about a Last Will & Testament, Health Care Power of Attorney (with a Living Will and HIPAA Authorization), and Durable (Financial) Power of Attorney. It is essential that every person have at least all of these documents to effectuate their estate plan; and, most importantly, they must all work together!

In honor of Halloween, in the following scenario, I am going to use Frankenstein, Frank for short, age 40. Frank is very proactive about preparing his estate plan – he does have a pretty dangerous job creating monsters so probably a good thing he’s proactive, right? Frank discusses his final wishes with his attorney and his attorney prepares him a perfect set of “staple” estate planning documents. Per his wishes, his Last Will & Testament states that everything is to go to his wife, if she survives him, and if she does not, then to be split equally among his children (age 15 and 13). Further, if his children are under the age of 25 at the time of his death, their share of his estate shall be held in trust until they are age 25. Great, Frank thinks he is all set to go, like many people would.

However, here’s the kicker: any asset that Frank has prepared a beneficiary designation form for, will NOT pass through his Last Will & Testament at the time of his death (unless he has named his estate as the beneficiary, which in most cases is not advised). That means that whomever Frank named as beneficiary on that form will get that asset at his death (the form may have been filled out 20 years ago when he just started working, was not married and had no children). His wishes as outlined in his Last Will & Testament will not control how that asset is distributed.

Good thing Frank was advised of this. Frank takes heed of this advice and updates his beneficiary designation forms to carry out the same wishes as under his Last Will & Testament. However, typically this is not as simple as just updating the names on the form. Frank needs to ensure that the form is prepared properly, which includes drafting to make sure that any shares his children may receive will be held in trust until they are age 25, identical to his wishes under his Last Will & Testament.

It is important to remember that if he had not updated his beneficiary designations, his “real” final wishes would not have been carried out after his death; his $200,000 IRA may have gone to his ex-girlfriend that he named as beneficiary when he was 20 years old. On the other hand, if he had updated his beneficiary designation but done so improperly, again, his “real” final wishes may not have been carried out after his death; his $200,000 IRA may have gone outright to his two financially immature children, then age 18 and 20, instead of being held in trust until they were 25.

Now Frank was proactive, think about all the people who have not had the “staple” estate planning documents prepared or had their beneficiary designations reviewed to ensure that they are correctly filled out; is their estate going to be distributed as they really intended? Further, Frank’s estate plan was relatively simple; most people’s circumstances and wishes are much more complicated than his. This makes conjunctive planning even more so important – attorneys must advise clients as to both their Last Will & Testament (or Trust) and any beneficiary designations that they may have made to ensure that they are all consistent and carry out the client’s final wishes.

Types of Assets

If you have any of the following assets, you have most likely prepared a beneficiary designation form at some point:

Any retirement accounts, including 401(k)s, IRAs, pension plans, profit sharing plans, etc.;
Life insurance;
Brokerage accounts; and/or
Annuities.

In addition, most States now allow owners to name a beneficiary for any real estate property they own (i.e., transfer on death designation) and any bank accounts they have (i.e., payable on death designation). Now, think about all of the assets you have or may have at death. For most people, besides your tangible personal property (e.g., household goods, automobiles, etc.), the above list of assets covers a majority of your estate. That is why beneficiary designation planning is ESSENTIAL to estate planning today.

Non-Probate

A Last Will & Testament directs how and to whom your executor or personal representative should distribute your probate property. However, if you have prepared a beneficiary designation form for one of the types of assets listed above, that asset will not go through probate and therefore, the distribution of that asset will not be controlled by your Last Will & Testament. The distribution of that asset will be controlled by the beneficiary designation form that you filled out, possibly haphazardly and without much thought and advice.

While avoiding probate is great news and on the top of most people’s estate planning goals, the beneficiary designation form must be filled out correctly in order to properly effectuate your final wishes. This is something that should be discussed with an attorney so you can ensure that it is done correctly and that when fully considering the big picture, your final wishes are carried out. The big picture includes all of your assets and how and to whom they will be distributed to at your death, whether that distribution is controlled by beneficiary designations, your Last Will & Testament, and/or your Living Trust.

Naming Your Beneficiaries

Depending on your estate plan, you may choose to name an individual, trust, estate, charity and/or any combination of these as the beneficiary to one or more of the assets listed above. However, this decision is not as easy as just filling in a blank on a beneficiary designation form. There are numerous considerations to contemplate and discuss with an experienced attorney before making any final decisions. Some of the issues that may arise depending on your estate plan include (all of which will be discussed in future posts):

How to effectively and efficiently leave the asset to multiple beneficiaries, whether the asset should be split up immediately among the multiple beneficiaries, held in trust for some or all of the multiple beneficiaries, spread out over future generations, etc.;
How to protect the asset from the beneficiary, whether the beneficiary is too young, financially immature, disabled, has creditor/divorce concerns, etc.;
How to minimize the tax consequences, whether it is the impact of estate tax, generation-skipping transfer tax, income tax, deferring tax, etc.;
How to comply with the complex IRA (or any asset listed above) rules, whether you are naming an individual, estate, trust and/or charity as a beneficiary and the different consequences of naming each; and/or
How to prepare and implement an estate plan that considers the big picture and ensures that your estate is distributed effectively and efficiently, according to your final wishes, with the least amount of time and cost involved.

Conclusion

With beneficiary designations possibly controlling the distribution of a majority of a person’s estate, estate planning must include beneficiary designations and how they affect the person’s final wishes as outlined in their Last Will & Testament and/or Living Trust. This is why both the long trusted “staple” estate planning documents and beneficiary designation forms are important and required for every person today. This will, in many cases, inevitably lead to attorneys and financial advisers being required to work together to ensure that the client’s estate plan is carried out correctly. The issues that may arise are complex and the consequences may be severe, therefore, you need to seek professional advice before finalizing your beneficiary designation forms.

– Attorney Matthew D. Brehmer

Crummey Estate Plan

All Things Estate Planning – Putting You "In the Know"

beneficiary designation

The Foundation – Part 2: Probate Avoidance

The Monthly 5 and 5: Trusts as IRA Beneficiaries – Part 2

The Monthly 5 and 5: Trusts as IRA Beneficiaries – Part 1