Unless you really want to leave a mess for your heirs when you die (maybe you do, in which case you can close the article), there are some potentially catastrophic estate planning mistakes you will want to avoid to make things much easier for your family in what will already be a stressful and emotional time.

1. Wrong beneficiary on accounts

Did you intend to leave the entirety of your 401(k) to your ex-husband? Didn’t think so! But that’s what can happen if you don’t regularly check and update beneficiaries on bank accounts, retirement accounts, life insurance policies, trusts, and other assets. Assets with beneficiary designations typically pass outside of the probate process, which means even if you update your will and other estate planning documents, assets with beneficiaries may not reflect your current wishes. It’s a good idea to regularly log in to your accounts and check who the beneficiaries are and update as necessary. You may never need to change beneficiaries, which is great, but it’s always better to be safe than sorry.

2. Giving assets away before you die

There is absolutely nothing wrong with being generous while living and giving assets to your heirs, but in some cases giving assets away before you die can be a huge mistake. Investments, real estate, and other property can receive what is called a step-up in basis at death. 

Let’s say a nice couple, Bobby and Bobbina, want to give their favorite son Bobbo their treasured family vacation home. Bobby and Bobbina bought the home for $10,000 and a silver dollar in 1958, but now the home is worth almost $3 million. If they gave Bobbo the home while they are living, their basis of $10,001 carries over to Bobbo. That means if or when Bobbo sells the home, he will owe taxes on the entire sale price over $10,001 (minus any exemptions if the home becomes his primary residence).

If Bobby and Bobbina instead leave the vacation home to Bobbo in their will, he will receive a step-up in basis when he inherits the home. That means if or when Bobbo sells the home, he would only owe taxes on the amount the home has appreciated in value since he inherited it. The difference between giving assets away before you die or after you die may seem small, but it can have huge tax consequences for your heirs.

3. Not having any or enough life insurance

A large number of Americans don’t even have health insurance, much less life insurance. Not everyone needs life insurance, but if others are financially dependent on you to live, chances are you should consider your need for life insurance. A need for life insurance often exists when your assets aren’t large enough to cover your debts (like a mortgage). Life insurance can also be used to replace your income if you are worried about taking care of your family financially if something were to happen to you. If you are older and have done a great job investing for retirement, you may be able to self-insure. This means you have enough assets to pay off your debts if you were to die and your family would be taken care of. There are many different types of life insurance available, but we believe term life insurance is the best and most cost-effective solution in most situations.

4. Not having estate planning documents

Wills typically don’t cost a lot of money, and if you don’t have children or many assets, a simple will may do the job. If your estate is more complex, it would be smart to use an estate attorney to prepare your will. Dying intestate, or without a will, means the laws of your state will decide how your property is distributed upon your death. This might not be a huge deal if you don’t leave behind anything worth fighting over, but the more assets and potential heirs you have, the greater the need for a will.

Wills aren’t the only way to express your wishes when you are no longer able to do so. An advance healthcare directive gives instructions for your medical care if you are no longer able to make your own decisions. There are several different types of power of attorney that can be used to allow a person or organization to manage certain affairs on your behalf. There is medical power of attorney, financial power of attorney, and durable, limited, or springing power of attorney. Like the names suggest, a power of attorney can handle your estate, financial, and even medical decisions.

5. Worrying (or not worrying) about estate taxes

Not worrying about estate taxes can be a catastrophic mistake, but I would argue that for most people, at least with the current federal estate tax exemption, worrying about federal estate taxes is a much more common mistake. The current federal estate tax exemption is $13.99 million, or $27.98 million for married couples, which means you must have a very substantial amount in assets to be impacted by federal estate taxes. If you think you will or could be impacted by federal estate taxes, consider reaching out to a fee-only financial advisor to develop a plan for minimizing or eliminating the impact of estate tax.

Some aspects of managing your financial life can be pretty tolerable and even enjoyable. My wife enjoys managing our household budget and I really like contributing money to our retirement accounts and watching them grow. Unfortunately, I can confidently say that estate planning is rarely enjoyable and, at its best, somewhat tolerable. However, it is a vital part of planning for your financial future, and something that must be taken seriously and considered a priority.

Estate planning, and wills, are an essential part of a comprehensive financial plan. Everyone that wants their assets distributed according to their wishes should have a will. This is particularly true for people who have young children.

For people without children and with a relatively simple estate, there are online programs that can help you create a valid will. Those with minor children or a more complex financial situation should have estate planning documents drafted by a lawyer who is experienced with estate planning.

Check out the video below if you’d like to learn more about how a will compares to a trust and the pros and cons of both.

When deciding if you need life insurance, it’s important to first understand what purpose the insurance would be serving. The most common use of life insurance is to provide an immediate pool of assets that can replace the insured’s income or savings potential to meet the needs of the survivors. These needs could be living expenses, outstanding debts like mortgages, education expenses and any other financial needs or goals. The bottom line is, if you aren’t here tomorrow, will your family’s quality of life continue or grind to a halt?

If you decide you do have a need for life insurance, here are some simple rules-of-thumb to use as a starting point.

• How much should I get? A common starting point is 10 times your annual income. If you want to get more comprehensive, you can add the items listed above like mortgage balances, college education costs and other expenses you would want to take care of for your family. There are also circumstances where it makes sense to insure the life of a spouse who does not earn income, but provides critical support for the family and household.
• How long will I need it? You may want coverage until your projected date of financial independence or when the needs listed above no longer exist. For many, this will line up fairly closely with retirement.

I think I need life insurance, but what is the difference between term and whole life?

Term Life is a life insurance contract with a pre-defined expiration date. Designed to serve a temporary need, these policies typically cover a period between 5 and 30 years, which creates a lot of flexibility for their use within your financial plan. The concept is relatively straightforward. The insurance company agrees to pay a death benefit for a certain length of time (the “term”), as long as you pay the premiums. The amount of the premium will be based on your age, health and the term. Similar to home and auto insurance, when you cancel the policy or stop paying the premiums, the contract ends.

Whole Life is a type of permanent insurance that will pay a death benefit regardless of your age as long as the policy is in-force. The premiums are usually much higher with this type of policy because the premiums paid during early years are used to build cash value and subsidize the cost of insurance for the later years. When you are young, the cost of insurance is very cheap. When you are old, the cost of insurance is very expensive. If you average out the cost over your “whole life”, you get the cost of permanent insurance. The benefits of these types of policies include a permanent death benefit and access to the cash value that is built up within the policy.

Which type of insurance is right for me?

Focus on the why! Are the reasons you need insurance temporary or permanent in nature? Temporary needs would be expenses that are expected to be reduced or go away completely over time, such as replacement of income to cover debts, living expenses or education costs. Permanent needs would include potential future health issues that would prevent insurability, estate tax/liquidity needs (less so now that the combined estate tax exemption is over $22M!) or legal agreements that require insurance that never goes away. The purpose that the insurance is serving will determine the type of insurance that should be purchased. A person’s life insurance needs will typically diminish over time, so it often makes sense to purchase an inexpensive term policy while directing more of your savings to building your army of dollar bills. This is especially true during your precious early years of savings where your Wealth Multiplier is so powerful!

Here is a clip that goes into detail on the differences between term and whole life.

Video: The Best and Worst Types of Life Insurance!

Video: How to Pick the Perfect Term Life Insurance Policy

Video: When Is Whole Life Insurance a Good Idea?

Before making any decisions about your future plan, it may be worth sitting down to think about what you envision for your kids – pre-paid education, a house/car down payment, retirement savings, disability needs funding, etc.

Each of these goals has a different strategy, as discussed below. If you have several goals in mind, one important thing to consider is that you do not have to pick one single option and can utilize a combination of planning strategies.

We like to compare saving for your children to an oxygen mask when you are on an airplane. It is important to save for yourself first (Check out the Financial Order of Operations). Your children can always take out loans for school or save for themselves, but you cannot take out loans to fund your retirement later on. Just remember, you are actually doing them a favor this way because you will not end up living in their basement one day.

Education

There are a few tax-advantaged ways to save for your child’s education. The most popular option today is a 529 plan, which allows tax-deferred savings to be invested and used tax-free toward qualified education expenses (i.e., K-12 tuition, college tuition, room & board, books, laptops, etc.). Some states even allow a state income tax deduction for contributions to their 529 plan. Anyone can open a 529 for a beneficiary, including family friends or grandparents. For parents wanting to save for a child before they arrive, they can even open an account naming themselves as beneficiary and then update that to name their child later. If a 529 is not needed (received scholarship, did not attend college, etc.), the account beneficiary can be renamed to a qualified beneficiary. When picking where to establish a 529 plan, it is important to consider your home state’s tax advantages and the investment options (and their costs) available within the plan.

There are a few downsides to saving to a 529 plan. Tax-free withdrawals are subject to qualified withdrawal rules, which do not include travel expenses, extracurricular activities, or health insurance. Also, for those who are taking advantage of the American Opportunity Credit, you cannot “double dip” to take the tax deduction for expenses paid from a 529. Finally, if you have unused 529 funds (received scholarship, did not attend college, etc.), and you need to withdraw the savings, the earnings portion of your non-qualified withdrawal would be taxed as income, along with a potential 10% penalty (depending on your situation).

Because of the limitations of the 529 plan, some parents find that they prefer to save for college within a brokerage account, whether it be their own or a custodial account. While brokerage assets are not tax-advantaged, they are accessible at any time, and are not penalized if not used for qualified education. The downside to using brokerage assets as a savings vehicle for education is that when it comes time to file a FAFSA and qualify for financial aid, a higher proportion of the assets are included as available for education spending.

Video: The Best Ways to Save and Pay For College

Personal Goals

For more personal goals (future cars, weddings, home down payments, etc.), you may want to consider a custodial account. Custodial accounts, such as UTMAs and UGMAs, allow you to act as custodian of a brokerage account/after-tax assets for a minor child. The difference between UTMAs and UGMAs lies in what investments are available – UGMAs can hold traditional investments (cash, stocks, bonds, etc.), and UTMAs can hold traditional investments, along with real estate. Both accounts are easily accessible to investors and provide a lot of investment flexibility because there are no qualifying rules for contributions or withdrawals like there are on other accounts. Accounts can be opened at banks (similar to a savings account), but brokerage institutions, such as Schwab, Fidelity, or Vanguard, may allow you to grow savings for longer-term goals.

There are a couple things to think about when investing a custodial account. First, the account legally becomes the child’s asset once they hit the “age of majority”, usually 18 or 21 (state-specific law). Second, if income is high within the account, it could be subject to Kiddie Taxes, which are higher than standard tax rates.

Retirement

It is no secret that The Money Guy team LOVES Roth assets, so we love the use of Custodial Roth IRAs when possible. Contributions are taxed before they are invested, but continue to grow tax-free until retirement. Having the opportunity to take advantage of so much tax-free, compounding growth can be a game-changer for your children. If you think 88x over is impressive, check out this resource that shows the power of compounding growth for kids. One strategy Brian likes to use to incentivize saving is a dollar-for-dollar match with his daughter. For every dollar his daughter saves, Brian also invests a dollar (up to the eligibility limit).

To qualify for Custodial Roth IRA contributions, children must have taxable, earned income. For example, an earned paycheck from working as a lifeguard would count, but non-taxed cash earned from chores would not.

Keep in mind that Roth IRAs are intended for long-term saving and investing. If you are saving for a specific need pre-retirement, you may want to revisit your options to ensure you will have full access to your savings.

Disability Savings

If your family needs require saving for a child’s disability, you may want to investigate an ABLE account. ABLE accounts are intended for the Maintenance, Health, Education & Support of those with disabilities. If eligible, an individual can have one account (tied to their SSN) opened through a state. Contributions are limited to $15,000 annually from outside sources, but can grow tax-free if used for their intended purpose. A beneficiary with earned income can save their earned income to the account, as well.

If someone eligible for the ABLE was the beneficiary of a 529 account (intended for education expenses), and that account is no longer advantageous, 529 assets can be rolled into the ABLE. Also, ABLE accounts do not disqualify beneficiaries from governmental programs such as Medicaid and SSI. To qualify, a person must be diagnosed with a disability before age 26.

Check out Brian & Bo’s thoughts!

Video: How to Be Young Money Millionaires! (By Age)

Video: What are the Best Ways to Save Money for Kids?

You may have heard us use the analogy: paying for your children’s education is like putting on an oxygen mask on an airplane; make sure yours is secured first!

Your children have decades of compounding growth ahead of them, and will likely have extra capacity to pay that debt off later down the road. That’s not to mention scholarships and other financial aid they can receive. Make sure your financial future is on solid footing before worrying about your children. After all, your kids do not want to be your retirement plan.

We like to use the College Boards National Averages to get a figure on long-term education planning. Ultimately, a good funding goal to have is covering 50-75% of education costs due to the likelihood of additional resources from financial aid, scholarships, and student loans if needed.

You may want to analyze expected future costs as a whole and see what annual funding is adequate. As a reminder, savings for education expenses would not be included in your overall savings rate for retirement and is considered Step 8 (pre-payment of future expenses) in the Financial Order of Operations (FOO).