Hardly a week goes by without news of a celebrity who died without a will, fracturing families and enriching their lawyers. Maybe you’re smarter than that. You have a will and appointed power of attorney for finances and health care. But unless you regularly update these documents and beneficiary designations, your heirs could still find themselves in a legal quagmire after your death or pay more than they owe in taxes (we’ll cover that too). Worse still, some of your assets could end up going to a wrongful heir.
The basic elements of an estate plan include a living will or trust (or both), a living will, and a power of attorney for finances and health care (also called a power of attorney for health care). POA designations give someone you trust the authority to manage your finances or make health care decisions in the event you become incapacitated. You can also use a power of attorney to appoint someone to manage your digital assets, such as your online and social media accounts.
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Some people use living trusts to avoid probate and appoint a trustee to manage their assets after death (see When Do Living Trusts Make Sense?). But whether your estate is simple or multi-tiered, you should review all your documents every three to five years, or more often if you’re going through a major life change, says Marcos Segrera, financial adviser at Evensky & Katz, in Miami. . We have provided a checklist on the opposite page that you can use to determine if you may need to update your estate plan.
Your beneficiaries are the key
Some assets, such as your retirement accounts and insurance policies, require you to designate a beneficiary who will inherit the account upon your death. This ensures that these assets will go directly to your beneficiaries after your death, outside of probate.
Beneficiary designations typically supersede instructions in your will or living trust, so it’s critical to make them correctly, says Letha McDowell, an attorney at the Hook Law Center and president of the National Academy of Elder Law Attorneys. You should also name contingent beneficiaries in case you and the primary beneficiary, usually your spouse, die simultaneously or within a short period of time, McDowell says. Although 401(k) plans regularly remind participants to review their beneficiaries, they rarely advise them to name a contingent beneficiary, she says.
If you don’t name a beneficiary, or if the primary beneficiary predeceases you and you don’t name a new beneficiary, the proceeds will go to the estate, which means it will be subject to probate. This could significantly delay the process of distributing assets from your estate, creating headaches and costs for your heirs.
Federal law requires that qualified plans, such as 401(k) plans, be paid to the surviving spouse, unless the spouse agrees to waive this protection. If you want these funds to go to someone other than your spouse (for example, you have remarried and you want your adult children to inherit the money), your spouse must sign a waiver waiving the right to receive funds.
This spousal protection does not apply to IRAs. In most states, you can name anyone you choose as the beneficiary of your IRA (a spousal waiver may be required if you don’t name your spouse and you live in a community property state). So while a spouse can be the default beneficiary of a 401(k), that protection disappears once the funds are transferred to an IRA.
Consider your non-retirement accounts
Although not required, you can – and should – arrange for bank and brokerage accounts to pass directly to your heirs, outside of probate. This process is commonly known as a transfer on death (TOD) or account payable on death, and forms should be available from your financial institution. You may prefer this option to a joint account, which will also bypass probate but give the co-owner an equal right to the assets in the account. With a TOD or payable on death account, you retain control of the account until you die. Beneficiaries can claim the non-estate account by producing identification and a death certificate.
As with beneficiary designations, these accounts replace your will or trust, so it’s important to make sure they’re up to date and have potential beneficiaries.
If you change a beneficiary designation, you should receive a confirmation from the account. Keep this confirmation with your other estate planning documents, McDowell says.
Marriage or Divorce
State laws vary when it comes to current and former spouses, but there have been unfortunate cases in which a life insurance payout went to an ex because the original owner didn’t update. the beneficiary of the policy. In 2013, the Supreme Court ruled that proceeds from a $124,500 federal life insurance policy taken out by Warren Hillman, who died of leukemia in 2008, should go to his estranged wife because she had been designated as the beneficiary of the policy. Hillman’s widow received none of the money.
Death of a spouse
Since most couples designate each other as beneficiaries, surviving spouses should update their beneficiary designations as soon as possible. This may not be a priority when you are grieving, but it will make probate much easier for children and other survivors after your death. (You will also need to update your will and living trust.) If you have named any potential beneficiaries, you may not need to complete this step, but you should ensure that your choice of these beneficiaries is not hasn’t changed.
Change of accounts
If you’ve transferred 401(k) plans to IRAs or opened new bank or brokerage accounts, you need to make sure the beneficiary designations (or TODs) are correct. If you are transferring a brokerage account to another company, ensure that all beneficiary designations will also be transferred. While you’re at it, make sure all accounts with beneficiary designations are up to date, including any 401(k)s you left with past employers.
How to reduce the tax burden of your heirs
Although beneficiary designations, as well as a living trust, will keep your assets out of probate, these measures will not protect your heirs from federal or state estate taxes.
In 2023, estates valued up to $12.92 million ($25.84 million for a married couple) are excluded from federal estate taxes. However, it will drop to around $6 million in 2025 unless Congress extends the estate tax provision of the Tax Cuts and Jobs Act. Additionally, 12 states and the District of Columbia have much lower estate tax exemptions. Oregon comes into play for estates valued at $1 million or more. https://www.kiplinger.com/retirement/inheritance/601551/states-with-scary-death-taxes
You can reduce or avoid federal and state property taxes by donating money while you are alive. In 2022, you can give up to $16,000 to as many people as you want without reducing your estate tax exclusion, and your spouse can donate up to the same amount.
New rules for IRAs. While even a $6 million threshold would exclude most estates from federal estate taxes, your adult children (or other non-spouse heirs) could still end up with a big tax bill if they inherit a Traditional IRA.
But under the Every Community Establishment for Retirement Enhancement (SECURE) Act of 2019, adult children and other non-spouse heirs who inherit an IRA must either take the lump sum and pay taxes on the full amount, or transfer the money to an inherited IRA. which must be exhausted within 10 years of the death of the original owner. And according to guidelines issued by the IRS earlier this year, many heirs who choose the latter approach must make annual withdrawals, based on their life expectancy, and deplete the account balance in the 10th year. (If the original owner died before taking the required minimum distributions, heirs can wait until year 10 to deplete the account.)
The 10-year rule does not apply to surviving spouses. They can transfer the money into their own IRA and allow the account to grow, tax-deferred, until they need to take RMDs, which currently start at age 72. Alternatively, spouses can transfer the money into an inherited IRA and take distributions based on their life expectancy.
The Roth solution. If you want to minimize your heirs’ tax bill, one option is to convert all or part of your IRA to Roth. Inherited Roth IRAs are also subject to the 10-year rule for non-spouse heirs, but with one key difference: withdrawals are tax-free.
When you convert money in a traditional IRA to Roth, you have to pay taxes on the conversion. But this is a case where the bear market could be your ally, as taxes are based on the value of the IRA when you convert.
Before converting funds, compare your tax rate with those of your heirs. If your tax rate is much lower, the conversion might make sense. The math is less compelling if your heirs’ tax rate is lower than yours, especially if a conversion could push you into a higher tax bracket. In addition, a large conversion could result in increased health insurance premiums and taxes on Social Security benefits.
One of the benefits of converting towards the end of the year is that you should have a pretty good idea of your 2022 revenue, which will make it easier to estimate the cost of conversion, says Ed Slott, Founder from IRAhelp.com.
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