Top 7 Estate Planning Mistakes

For many people, estate planning falls under the same category as going to the dentist: deal with it as seldom as possible or only when absolutely necessary.Top 7 Estate Planning Mistakes
by Mark P. Cussen, CFP®, CMFC ( Biography)For many people, estate planning falls under the same category as going to the dentist: deal with it as seldom as possible or only when absolutely necessary. In addition, those with low incomes and low net worth often feel that estate planning is unnecessary, and is a process reserved for the rich. However, what most people don't know is that proper estate planning goes beyond allocating money or other assets. There are a number of common estate planning errors that can be avoided by arming yourself with adequate knowledge about estate planning. In this article, we'll examine seven of the most common estate planning errors.

No Estate Plan
Many individuals do not realize that estate planning includes the preparation of documents such as living wills, which include provisions for touchy situations like when one should be taken off life support, as well as traditional wills, which makes provisions for the disposition of property and the guardianship of minor children. Preparing these documents helps to ensure that a person's wishes are clearly documented. Regardless of the size of the estate, preparing a will can help to prevent quarreling and bitterness among beneficiaries, who may otherwise feel that they are the rightful benefactors of a decedent's assets. (For more insight, read Getting Started On Your Estate Plan.)

Ignoring the Sunset Provision
As of 2008, estates benefit from an exemption from federal estate taxes, for amounts up to $2 million. This amount will increase to $3.5 million in 2009, be repealed in 2010, and is scheduled to be increased to $1 million in 2011. While it may be optimistic to hope that a more favorable provision will be passed for 2011 and after, it may not wise to bank on such changes. Therefore, those with more than $1 million dollars in assets should stay abreast of any future changes so that they can be prepared to alter their estate plans accordingly, if necessary. (For more on this topic, see Get Ready For The Estate Tax Phase-Out.)

Being Unaware of the Gift Tax Impact on Joint Ownership
One method that many individuals use to avoid probate is to title assets in joint names with a friend, relative or other individual. However, unless an exception applies - as is the case when the joint owner is the owner's spouse - this can generate a taxable gift in the current year if 50% of the value of the asset is worth more than the annual gift tax exclusion amount.

For example, if Bill Jones puts his friend Fred's name on the title of a $50,000 car that Bill owns, Bill will be liable for gift tax on $13,000 of the car's value. The annual gift tax exclusion is $12,000 for 2007 and 2008. This means that one can give cash or assets of that amount or less to another person each year without paying gift tax. But because the car is valued at $50,000, half of the value of the car ($25,000) will legally become Fred's property; therefore,  Therefore $13,000 will be taxable. (To learn more, read Skipping Out On Probate Costs.)

Failure to Use Unified Credit
Failure to use unified credit is a costly error committed by an astonishing percentage of affluent households. When the first spouse passes away, generally all of his or her assets pass to the surviving spouse. However, if the deceased spouse had assets valued over the unified credit limit ($5 million as of 2008), then the exclusion for those assets will be lost if they are transferred directly to the spouse, who will then only have his or her exclusion to count against assets distributed to heirs when he or she dies. As such, a credit shelter trust should be established that shields the assets of the first spouse to die and allows his or her unified credit limit to be used as well. (See Tax Efficient Wealth Transfer for more on this strategy.)

Failure to Gift Assets Before Death
One of the easiest ways to reduce one's taxable estate is to gift assets to friends or relatives each year within the gift tax exclusion limit. This is a convenient way not only to reduce the taxes your estate may have to pay after you're gone, but also to see whether your beneficiaries are capable of using your assets wisely. If they squander the gifts you give them during your lifetime, then you may want to consider leaving your assets to them in an incentive trust that rewards them for fiscally responsible behavior. (Interested in incentive trusts? Read Encouraging Good Habits With An Incentive Trust.)

Failing to Ensure Retirement Plans Have the Correct Beneficiary Designations
The beneficiaries of retirement accounts will sometimes change, particularly if the primary beneficiary predeceases the account owner. However, the account owner must usually complete a new beneficiary designation form, indicating the new beneficiary. Otherwise, the beneficiary might be determined under the default terms of the account agreement. Consider also that the payout options under most retirement plans often depend on whether the beneficiary is a spouse of the owner. Further, these options may be irrevocable after the beneficiary's initial payout election. There can be nasty tax repercussions for those who are not careful in this matter, and beneficiaries should be educated on how their elections could impact the taxes on their inherited amounts. (See Update Your Beneficiaries for more on this topic.)

Make Sure You're Covered
Regardless of your income bracket, having adequate life insurance coverage is vital in most cases. Low-income households can benefit from term insurance coverage to replace income lost as a result of the death of the primary breadwinner, while affluent families may need the proceeds from insurance to  provide liquidity upon the death of the insured. However, it may be important that those in the latter category transfer ownership of the policies to an irrevocable trust in order to avoid estate taxation on the death benefit. (To learn more, read Shifting Life Insurance Ownership.)

Conclusion
These are just some of the errors that individuals often make with their estates. The good news is that many of these can be easily and quickly rectified, providing the corrective steps are taken before death. Consult with professionals who can help to ensure that your estate planning is on track. These individuals may include your financial or estate planner and your tax attorney.

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