You’re wrapping up your will signing ceremony – you feel satisfied; you have executed a flawless ceremony. Your clients are relieved to be able to put this entire affair behind them – for now; they are happy to have their affairs in order and are grateful to have been guided through such a difficult process by a confident and capable attorney. But should you feel satisfied? Are your clients’ affairs actually in order? Did your estate plan contemplate non-probate assets? Non-probate assets are those assets that do not pass under the provisions of a person’s will, but pass according to a beneficiary designation card or other contract. Examples of non-probate assets include insurance policies, employment benefits, and survivorship accounts.
Non-probate assets are an often overlooked part of drafting a comprehensive estate plan. Clients will typically believe that the will controls the disposition of their entire estate. As attorneys, we must endeavor to plan for these typically forgotten assets, and we cannot rely on our clients to bring these matters to our attention. Some clients may know whether their bank accounts are designated as joint tenants with right of survivorship, other may not; some clients may know if their investment accounts are pay-on-death, other may not; some clients may readily know the beneficiaries of their life insurance policies and retirement accounts, others may not have the slightest idea. In my practice I would estimate that only approximately twenty-five percent of my estate planning clients know these answers.
The issues and pitfalls here are myriad – did the client name beneficiaries, if so who? Who are the primary beneficiaries? The contingent? Has there been a death? A divorce? Are you crafting an estate plan for a blended family where the spouses may have children together, and they may also have their own children to consider? For many people, an overlooked or unaddressed beneficiary designation can thwart an otherwise well-designed estate plan. This is especially true in an environment where, for many, their IRA is one of their largest assets, and due to the income tax deferred treatment of a traditional IRA, a failure to consider the asset and its beneficiary designations could be catastrophic for a client’s estate plan.
Imagine this scenario: a client begins contributing to a traditional IRA at the beginning of their career; perhaps they name a spouse as the primary beneficiary; perhaps the client does not have children at this point in their life, so there are no contingent beneficiaries. Years later, the client’s spouse dies; the client never changes the original beneficiary designation. Perhaps by this point there are children. Under most account policies, if the original beneficiary designation was never changed, the primary designation would fail, and the funds held within the IRA would be payable to client’s estate. If the client were to die without rectifying this situation, the funds would be paid to the estate, and as such would be subject to the five-year push out rule, causing all deferred income tax to be due and payable within five years of the date of death. If even the overall tax effects are ameliorated somewhat by distributing the proceeds of the IRA directly out of the estate and to the beneficiaries in the same year, the beneficiary loses the ability to spread the payments out over a longer period of time. If the beneficiary designations had been addressed, the children could have been named as primary beneficiaries, and assuming the client was not yet receiving the required minimum distributions, the funds could have been paid out to the children, over their life expectancies, vastly reducing the overall income tax effect of this asset.
The scenario set forth above is but one in which an otherwise effective estate plan can be thwarted by not taking into account non-probate assets. Imagine if there were trust planning involved. Would the client want to have the trust operate as a conduit – paying out the required minimum distributions but restricting the beneficiary’s ability to elect to take the funds in a lump sum? Perhaps there are circumstances that would lead the client to prefer that the funds pay into an accumulation trust; thus, sacrificing the tax position to provide for the beneficiary’s well-being. The possibilities are vast, and a good estate planner will not leave this stone unturned. Michael P. Repp