Avoiding a Major Estate Planning Pitfall

Estate Planning mistakes fall into two major categories.

Retaining too much control for too long is the first category of major mistakes. Detailed  “incentive trusts” are a sign this mistake may be in the offing. These trusts parcel money over the years only as beneficiaries achieve detailed milestones. Incentive trusts sometimes try to control a beneficiary’s choice of occupation, marital status, and more. Controls and incentives can be appropriate to avoid waste of wealth, but some estate planning strategies go too far. We’ve discussed this in past visits.

Today we’ll discuss the second major category of estate planning mistakes. We’ll call it avoiding decisions. It can lead to many problems for loved ones including a loss of wealth.

Many people find it easy to decide who in general should inherit their wealth. Often, the spouse receives all or the bulk of the estate. Children receive some of the estate initially and ultimately are slated to receive the remainder of the spouse’s share.

Unfortunately, the next decision often is not made. How should the individual property in the estate be divided among the children? Typically, the children receive equal shares, and that is fine. But most estates are not easily divided into equal shares the heirs can carry away. Failing to recognize this and to decide how the assets should be divided can lead to major problems.

Suppose you own a vacation home. You believe the children like the home, have pleasant memories of time spent there, and want to keep it in the family. Your estate planning strategy is to leave it to the children equally for them and their families to enjoy.

This arrangement raises an array of questions. How much time should each heir and his or her family be able to spend at the home alone? Who’s in charge of ensuring repairs and maintenance are done? How will the costs of owning the home be divided? What if a sibling cannot afford the expense? Suppose one sibling wants to expand or modify the home? What if one sibling lives far away and can visit once a year at most while another lives nearby? What if one sibling needs cash and wants to sell the home, but the others cannot afford to buy his or her share? Suppose one sibling wants to maximize the value of the home someday while the others want to donate it for conservation or some other cause?

The easy solution for an estate owner is to ignore these issues and the potential for other issues. You can leave the children equal shares of the estate and let them and the executor work out the specifics of how the assets will be divided so each has an equal monetary share. In some families, the siblings will be able to work out the issues outlined above and reach an amicable solution. In other families they won’t find a solution, and that will escalate problems in the family.

The issues of division or co-ownership can arise with almost any asset. With less valuable personal assets the conflicts can be worse. Someone may have an emotional attachment to an asset and fixate on it.

For these reasons you need to decide not only how much of the estate each child will inherit but also which property will make up that share. There are several ways to solve these problems. You should consider which you think is most likely to work for your family.

? An easy solution is to direct the executor to sell all the assets and distribute the cash to the beneficiaries. An heir who wants a particular asset can offer to buy it the same as anyone else can. Potential pitfalls with this approach are that the process might not maximize selling prices because of poor timing of the sales or an urge to sell quickly so the estate can be closed. The executor can hold out for prices close to estimates of the true value of assets, but that could mean heirs don’t receive proceeds for some time, and some assets may not be marketable. Another problem is that children who want a certain asset might not be able to afford it.

? A related solution is to direct that charitable contributions be made with the assets that would be most difficult to divide or sell. This assumes you would leave part of your estate to charity.

? With major assets ? such as real estate, a business, or a collection ? you should give careful thought to ownership. Leave the asset to someone who wants it and will be a wise owner. You may decide someone outside the family would be the best owner. In that case, arrange the sale during your lifetime or leave the executor directions for selling the property.

If you decide to name siblings as co-owners of such property, give some thought to how they will manage the property and resolve differences. Allow them to change the rules, but set up the initial sharing mechanism.

You could decide it is best to leave a major asset to only one of the children. Then, you’ll have to leave the other children assets to equalize the value of their shares. In some cases, life insurance is used to equalize inheritances.

? Personal assets can be more even more difficult to divide than major assets. The personal assets tend to be difficult to sell or even give to charity. It is not practical to designate an heir for each in the will. The personal assets also are most likely to have more sentimental or emotional value to heirs than monetary value, and the value to an individual may not be clear until the estate is being settled.

One recommendation is to informally designate the heir of each asset, or at least most of them. You can write a letter to your executor directing who receives which items. Similarly, you can put labels on items naming their inheritors, such as on the backs or undersides of art or furniture. These methods are not legally binding, but people generally will follow your wishes. You won’t be able to cover everything through these methods, but many key items will be determined.

In the past, we’ve suggested selecting a lottery system to decide how personal assets are allocated. Some examples of these are in the Estate Watch section of the Archive on the members’ web site.

? Some people name a non-family member as executor and give the executor discretion to distribute individual assets as long as the monetary value of each heir’s share is equal. While practical, this method may not seem fair or objective to at least some of the heirs and does not have the imprimatur of representing your specific choices.

The right way to divide property depends on your estate and family. In every estate, however, the owner should decide at least the method for distributing the assets instead of giving the children the same shares and expecting them to work out the details.

February 2010. RW