Skeletons in Your Estate Plan: Five Issues That Could Come Back to Haunt You

Halloween is a good time to consider what may be lurking in the dark corners of your estate plan. The biggest planning problems are often not dramatic drafting failures. Instead, they are quiet issues that can go unnoticed until a death, disability, or a change in the law brings them to light. Here are some common estate planning “skeletons” worth looking for.

The Unfunded Trust

A revocable trust generally controls only the assets that are actually transferred to it or otherwise directed to it at death. If you signed your trust agreement but never retitled your accounts or real estate, those assets may still have to pass through probate. Assets such as retirement accounts and life insurance require separate attention because they generally pass according to the beneficiary designation on file rather than under the dispositive provisions of your trust. As a result, carefully designed tax planning, continuing trusts for beneficiaries, and other provisions of your estate plan may not work as intended, and your executor and trustee will be left to sort it out, often under court supervision. A periodic funding and beneficiary-designation review can help ensure that your assets and estate planning documents are working together.

Funding Formulas That Ignore State Estate Tax

Many married couples’ estate plans divide assets at the first spouse’s death using a formula tied to the federal estate tax exemption. But federal estate tax planning is only part of the equation. A number of states impose separate estate taxes with exemptions far below the federal amount, and some do not allow spouses to carry over an unused exemption. Depending on the applicable state law and the terms of the estate plan, a formula tied solely to the federal exemption could produce an unintended state estate tax at the first spouse’s death. Formula provisions written years ago should be reviewed against today’s federal law and the estate tax laws of any relevant state.

The Ex-Spouse Still Named as Beneficiary

A divorce may change more than your marital status. Although the laws of many states automatically revoke certain provisions benefiting a former spouse, these rules vary considerably and may not govern every asset or beneficiary designation. Federal law can affect the treatment of certain employer-sponsored retirement benefits. In addition, life insurance, IRAs, and transfer-on-death accounts may pass according to the beneficiary designation on file, making it particularly important to review those designations after a divorce. A beneficiary designation completed years earlier may deserve just as much attention as your will or trust agreement. Following a divorce, marriage, birth, death, or other significant family change, review your wills and trusts along with beneficiary designations on retirement accounts, life insurance policies, and other assets.

Outright Distributions at Staged Ages

Estate plans commonly provide for a child to receive assets in stages, such as one-third at 25, half of the remainder at 30, and the balance at 35. Although this approach may prevent a young beneficiary from receiving a large inheritance all at once, each outright distribution can sacrifice the protections that might otherwise be preserved through a continuing trust. Depending on how the trust is structured, retaining assets in trust for a child may provide greater protection from creditor claims and divorce. If properly structured, holding assets in an ongoing trust for a child may also keep those assets out of the child’s taxable estate, potentially allowing them to pass to later generations without additional estate tax. A beneficiary can still be given significant control and access to the trust property, including by serving as trustee or co-trustee.

Out-of-State Real Estate

A vacation home in another state can create added probate risk. If the property is titled in your individual name at death, a court process may be required in the state where the property is located, as well as in your home state. Properly transferring the property to a revocable trust during life can help avoid that result. Property owners should also consider whether the state where the property is located imposes its own estate tax. Even if you are not a resident of that state at the time of your death, and even if you own your second home in a revocable trust, an estate tax might apply. Owners of out-of-state real estate should consult with an estate planning attorney to discuss property titling and relevant estate tax exposure.

A Treat, Not a Trick

Fortunately, most of these issues can be resolved with careful planning, and most are straightforward to fix when addressed before a crisis brings them to light. A periodic review, ideally every few years and after any significant change in family, assets, or applicable law, is the most reliable way to make sure your plan does not contain any spooky surprises.

Want to make sure there are no “skeletons” hiding in your estate plan? Reach out to Mari Berlin, Ariana Katz, or another member of LP’s Trusts & Estates Group.