Estate Planning Disasters (Unintentional Disinheritance)

You have probably heard or read about estate planning disasters involving many of our well-known celebrities.  We often ask ourselves how someone could be so irresponsible or careless. The truth is there are many ways to make estate planning mistakes. They can be made by people with estates of all size and we see it firsthand every day.  It is important to understand that smaller estate sizes can still have costly and significant consequences. Most importantly, it may not reflect a person’s wishes.  One of the potential mistakes is commonly known as unintentional disinheritance of your children.

Leaving assets to a spouse seems normal and the right thing to do.  What could possibly go wrong by leaving assets to your spouse?  Probably nothing as long as the surviving spouse does not have a previous marriage or remarries.  So what is a scenario someone could easily overlook upon remarriage, you ask? Here are some common ways children can be left out of an estate plan unintentionally.

IRA Example-  John and Jane are each other’s first spouse, have two children, and have been married for 40 years.  They both have an IRA and are each other’s primary beneficiary if the other were to die.  If John were to pass away first, his retirement account would be transferred to Jane’s IRA.  So far so good.

Let’s say a few years had passed and Jane met Tim, who was divorced and had children from a previous marriage.  If they got married, it is likely that Jane, at some point, would change the primary beneficiary on her IRA to Tim, her new spouse.  Upon her death, her IRA would get transferred into Tim’s IRA, assuming Tim survived her. Now let’s assume that Tim never updated his own IRA beneficiary to include Jane’s two children. Upon Tim’s death, his IRA would then go to his children.  Jane, without realizing it, has disinherited her two children from what may be the most valuable asset her and John owned.

What could Jane have done differently? There are multiple strategies she could have made to preserve her and John’s assets for their two children. Here are a couple:

  1. Include her two children as primary beneficiaries along with Tim.  An IRA owner can name several primary beneficiaries.  She can indicate a percentage or dollar amount to the children.
  2. Purchase a life insurance policy naming her children as primary beneficiaries as an offset to the IRA transferred to Tim.
  3. Change the primary beneficiary to a trust with Tim as the income beneficiary and her children as the remainder beneficiaries. Tim would have access to the income and principal depending on how the trust is governed, but guarantee that any remaining amount went to Jane’s children.

Let us dig a little deeper into another scenario.

Will Example-  Bill and Betty were each other’s second spouse and both of their previous spouses died in their 60′s.  Both Bill and Betty had multiple children from their first marriages.  When they were married for 10 years and Bill reached the age of 75, they sought the direction of an estate planning attorney to draft relatively simple wills.  Bill came into the marriage with more assets than Betty and his goal was to leave $50k to each of his children upon his death, with the remaining to Betty.  In her will she did not leave any of her assets to him since “he had enough.”  However, over the next 10 years until he reached age 85, Bill’s investment account dramatically increased.   Since the will specified a fixed amount to each child and not a percentage of his estate, the amount for his children as a percentage of the overall value significantly decreased.  From the time the wills were drafted until his death, the value of his estate increased from $400,000 to $1,200,000.

It was never Bill’s intent to not provide for Betty.  However, she did not really use the $1 million Bill left for her, and upon her death, the account had grown to $1.4 million.  This account along with her separate assets were left to her children through her own will.  Bill essentially gave Betty’s children $1.4 million, while leaving only $50,000 to each of his three children.

What are some strategies Bill could have used to protect his estate vision?

  1. Periodically update his will. We recommend that clients review their estate plan every couple years and evaluate any changing circumstances. In this case, Bill and his attorney would have noticed that his estate had grown significantly and that his wishes were no longer being carried out.
  2. Purchase a life insurance policy, naming his children as beneficiaries as an offset to what he left to Betty.
  3. Draft language in the will to establish a trust for Betty as the Income Beneficiary and his children as the Remainder Beneficiaries.  See explanation below.

Bill could have had his attorney draft language to create a trust upon his death.  A trust created on death is known as a testamentary trust. It has both an Income Beneficiary and a Remainder Beneficiary.  The Income Beneficiary has the right to the income from the account, while the Remainder Beneficiary gets whatever is left over upon the death of the first beneficiary.  In addition, many times the income beneficiary also has the ability to take portions of principal for Health, Education, Maintenance, Support, etc.  As the income beneficiary, Betty also could have been allowed to withdraw a generous amount for her personal needs.  The remaining value she did not withdraw would then go to Bill’s children as Remainder Beneficiaries.

No matter the type of account, whether it is an IRA or a taxable account, it is very important to update your wills, keep your beneficiary arrangements current and confirm they match your objectives.

In Bill and Betty’s case, they had a stock broker and an attorney who drafted the will.  Unfortunately, they did not collaborate to confirm the estate documents remained current and accurate.  Estate planning assistance is not a service that stock broker’s typically provide.

We at Haberling Financial Group do not practice law or draft estate planning documents.  However, we do review our clients estate planning documents and work with their attorney to confirm goals are properly documented.  We also review them periodically to confirm accuracy as circumstances and objectives change.  If changes are needed, we assist the client in communicating the desired changes to the attorney.

Even though you may not have a celebrity-sized estate, it is still important to us that your nest egg is protected and your estate vision is carried out.  Do not let your children be the victim of unintentional disinheritance.

■ Stephen Palm

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