Estate plan pitfalls to avoid

Do you know who your beneficiaries are, and how your assets are titled?

Those may seem like simple questions, but over many years of accumulating bank and brokerage accounts, real estate, retirement accounts, annuities, and other assets, it’s not uncommon to forget or fail to update that important information.

Getting those bits of paperwork wrong, however, can have far-reaching consequences.

For example, failing to retitle the retirement accounts you started 30 years ago may result in the accounts going to your ex-wife instead of the two children you designated as heirs in your will and estate plan. Ditto for the life insurance policy you bought when you were married to your first wife and had expected to leave to your current wife but forgot to update the beneficiaries. Odds are these missteps would also result in a costly and public probate proceeding, where a court would end up determining who gets what.

“Unfortunately, people often don’t realize that certain assets, such as retirement accounts, life insurance policies, and annuities, pass to their beneficiaries by contract and not under the provisions of their will or trust,” says Kimberly Rosati, a trust and estate planning consultant at Fidelity. Importantly, the beneficiary designations on those assets supersede what’s in a will or estate plan.

If properly titled, however, your assets can transfer to loved ones quickly and easily upon your death, avoiding probate and perhaps even reducing estate taxes. Most people will still need a will, but proper account designations can in some situations obviate the need for a more in-depth estate plan or more complex trusts. For those with larger estates or more complex situations, however, additional estate and trust planning will likely still be advisable.

To be safe, review your beneficiary designations on all key accounts and assets at least once a year, or after any major life change, including a marriage, divorce, birth of a child, or death of a spouse. And if you do have an estate plan, align your account designations with it and your goals.

The basics: account features

Let’s start with the basics. There are three key account features that can help avoid probate while keeping costs reasonable and potentially limiting taxes on your heirs. Let’s look at each of them—and their pros and cons.

• Joint ownership
• Naming a “transfer on death” or “payable on death” beneficiary
• Naming a beneficiary on certain accounts that are outside a will

Three types of joint ownership

Joint ownership itself may be structured in different ways that may affect an estate plan. Each type of joint ownership structure offers an undivided right to the use and enjoyment of the property. However, depending on the specific classification of joint ownership, the ultimate consequences of transfer at a joint owner’s death may vary.

There are three basic ways to open a joint account, and each of them has distinct implications for estate planning depending on your situation:

Joint tenancy with right of survivorship: When one owner dies, property ownership transfers to the other owner(s) through the right of survivorship. Probate may be avoided by jointly owning an account or property with another person––often, but not necessarily, a spouse.

Tenancy by entirety: This is just like joint tenancy with right of survivorship, except that it applies only to married couples, along with same-sex couples in some states.

Tenancy in common: Unlike joint tenancy, with tenancy in common, when a joint owner dies, the joint owner’s interest in a property will become part of the joint owner’s estate and be passed on according to his or her will. A word of caution: Be careful in establishing a tenancy in common account, because it will likely lead to probate issues.

Pitfall to avoid: beneficiary designations that don’t match your will

In general, the assets in any retirement account, life insurance policy, or annuity will pass to the beneficiary named on that asset, regardless of the terms of a will. Therefore, beneficiary designations should be considered as part of an overall estate plan, and should match the goals and wishes of your will. Too many people make the mistake of having beneficiaries on some accounts that do not match those in their will, and inevitably this creates conflicts among beneficiaries that may lead to the courts.

“That’s why it’s so important to coordinate the account titling and the naming of beneficiaries with your overall estate plan to make sure your assets are passed to your heirs the way you intend while helping to reduce estate taxes,” says Rosati.

“Make sure you understand how all your assets are titled, and the effect of that title,” cautions Andrew Hamil, national manager of Fidelity’s trust and estate consulting group. “Then, review and update everything regularly.”

Pitfall to avoid: transfer on death or payable on death not matching wills

Another simple and easy way to help avoid probate is to name someone as a transfer on death (TOD) beneficiary or a payable on death (POD) beneficiary. The terms are essentially the same but apply to slightly different accounts. A TOD/POD beneficiary can be named on financial accounts, such as bank savings or checking accounts and investment accounts, vehicle titles, and––in some states––real property.

Despite their simplicity, one major issue with TOD/POD-titled assets is a lack of awareness or poor coordination with people’s overall estate planning strategies. Some might not realize that a TOD- or POD-titled asset overrides whatever is stated in a will. If a number of accounts are titled as TOD, a will can be rendered largely ineffective, and assets may not be distributed as intended.

“You could have a complex will with all sorts of trusts created for your children,” says Pamela Pirone-Benson, a Fidelity trust and estate planning consultant. “But if the assets don’t pass by the terms of the will, then the will becomes an expensive paperweight.”

Hamil describes transfer on death as a “placeholder,” rather than an estate plan. “It’s a temporary bandage until you put a larger, more effective, comprehensive plan in place.”

Consider Susan, a hypothetical client with a brokerage account worth $1 million. She names her husband as a TOD beneficiary of the $1 million account. Five years later, she does some estate planning and states in her will that the account’s assets be split evenly between her two daughters from a different marriage. Unfortunately, Susan doesn’t realize that her now ex-husband will receive the assets, because the TOD registration overrides the will.

Another problem with a TOD or POD could occur if parents name their children individually as TOD on each of two separate accounts. At the time the assets are titled, the value of the two accounts is equal. But no one tracks the value of the accounts over time. Thirty years later, when the couple dies, one child could receive a much smaller sum than the other.

And estate taxes may be due on TOD assets and payable by the recipient, depending on, among other things, how the will is drafted. “This can create an administrative nightmare for the executor of the will, who then needs to go and collect taxes from the recipients after they receive the assets,” says Pirone-Benson.

Pitfall to avoid: trusts that don’t match your situation

“For high-net-worth families, setting up a trust and placing assets in the trust may shelter assets from taxation, probate, and creditors, while integrating it all with an overall estate plan,” Hamil notes. However, not every trust is right for every situation. Beyond estate tax considerations, there are many other possible reasons to set up a trust. (Read Viewpoints: “Six reasons you should consider a trust.”) “Your child might have special needs, a problem managing money responsibly, a drug or alcohol problem, debts, or a contested divorce,” Hamil says. In these cases, the specific objective would determine the type of trust established.

In addition, the type of assets at stake must also be considered. For example, naming a trust as the beneficiary of a retirement account may have inadvertent consequences. When an individual is named as the direct beneficiary of a retirement account, the individual may stretch out the payments from that account over the expected life of the individual beneficiary. If the direct beneficiary happens to be a spouse, there are other advantages as well. However, unless the trust is properly constructed, designating a trust as the beneficiary of the retirement account may effectively eliminate these advantages and prove less beneficial to the ultimate trust beneficiaries.

In conclusion

Because this aspect of estate planning is very circumstance-driven, each situation must be considered on its own merits. While avoiding probate is important, it is rarely the only consideration, and there are numerous ways to help avoid probate.

“Overall, people shouldn’t assume too much, and they should understand that there are no panaceas or magic pills for your estate planning needs,” Hamil says. “Make sure to get reliable advice from an expert in this area, and be thorough in reviewing your entire estate plan.”

Learn more

• Read Viewpoints: "Do you need an estate plan?"
• Visit Fidelity’s Estates Planning page.