Potential Problems When You Fail to Plan Properly

Sometimes, a person intentionally disinherits an adult child or other relative by making no provision for the individual in a will or trust or by beneficiary designation.

More often, the disinheritance is accidental. Because a person either failed to execute estate planning documents or had an improperly-designed estate plan, property was not distributed as intended. Following are some examples which, with the exception of the invented names, are based on actual occurrences.

Daddy wanted me to have the house

George, a widower, wanted to leave his entire estate in equal portions to his two daughters, and he executed a will with such a provision. Wanting to simplify the conveyance of his residence, he decided to transfer title to himself and his older daughter as joint tenants with right of survivorship. He died soon afterwards, and his other estate assets, then valued at $500,000, were divided equally between the daughters as provided in the will. Ownership of the residence, then valued at $600,000, passed to the older daughter. The younger daughter assumed that her sister would sell the house and give her one-half of the net proceeds, but her sister allowed that their father had intended for her to have the residence, which is why he had put it in her name.  She said he had done this out of appreciation for the fact that she lived closer to him and assumed more care-giving responsibilities. Sadly, the two sisters still do not speak to each other.

Many individuals, like this father, fail to coordinate what passes under a will and what passes outside of it. He incorrectly assumed that the will governed everything he owned, whereas in fact it did not govern property in joint tenancy or any proceeds from a life insurance policy or retirement plan where an individual, rather than the estate, is named as beneficiary.

I want to provide for my kids but not hers

When John and Carol were married, they each had two adult children from previous marriages.  They sold the homes they owned individually and purchased a new one in joint tenancy with right of survivorship, but they maintained their separate investment accounts and shared expenses. They intended that when the first of them died, the survivor would be able to live in the house and receive income from all of the investments, and that when the surviving spouse died that person’s estate would be divided equally, one-half to John’s children and one-half to Carol’s children. John executed a will leaving everything to Carol if she survived him. If she did not, his estate would be equally divided between his children and hers.

Not too long afterwards, he had a heart attack and died, and Carol as a joint tenant became owner of their home and inherited all of John’s assets.  She fully intended to execute her will as they had discussed, but unlike John, she procrastinated, and still had not done so when she died.

According to the laws of intestacy in the province where she lived, her entire estate passed to her two children, and John’s children received nothing. Not only had John unintentionally disinherited them, but all of his wealth went to two people he did not particularly like.

John could easily have provided for Carol by establishing a spousal trust with his personal assets, whereby Carol would receive the income and the remainder would pass to his children. He could also have arranged for Carol to be able to occupy the house with his one-half interest in the house then passing to his children.

If he had taken these steps, neither the gain in their residence nor the gain in his investment portfolio would have been taxed on his terminal income tax return. When property passes to a spouse, either outright or in a spousal trust, any tax on the gain can be deferred until the spouse or trustee sells the property, or until the death of the spouse if the property was not sold earlier.  Furthermore, the gain in a principal residence is exempt from taxation.

Could total strangers get my property?

Suppose that, following John’s death, Carol met and married Tom, who had three children by his previous marriage. Carol continued to procrastinate about completing her will, and when she died she was survived by Tom. According to the laws of intestacy in her province, one-half of her estate passed to her children and one-half to her surviving spouse. In his will Tom then provided that his entire estate be given to his three children. Thus, assets that had belonged to John wound up in the hands of total strangers.

A carefully-designed estate plan is important in all circumstances but especially when there are children by previous marriages.

I would like to leave a legacy, but I want to be smart about it

Roger appreciates the positive impact the Winnipeg Symphony Orchestra has had in his community, and in gratitude he wants to make a gift that supports the orchestra. That is motivating him to include in his estate plan a gift of $200,000 to the Winnipeg Symphony Orchestra with the stipulation that the money be used specifically for educational programming. Included in his estate is a portfolio of securities, some quite highly appreciated, a residence, two rental properties, and an RRIF with a balance of about $800,000.

One possibility is for Roger to provide a bequest of $200,000 to the Winnipeg Symphony Orchestra. This would result in a tax credit on his final income tax return that would reduce the total amount of income tax due with that return. Another possibility would be to name The Winnipeg Symphony Orchestra as a beneficiary of $200,000 of funds remaining in his RRIF. Assuming that at least this amount remains in the RRIF at the time of his death, the programs would be funded, and again a tax credit could be claimed on his final income tax return. The Winnipeg Symphony Orchestra may issue a donation receipt when it receives funds via a beneficiary designation.

The best alternative from a tax standpoint would probably be to empower his executor to select securities equivalent in value to $200,000 and contribute them to the Winnipeg Symphony Orchestra. The tax credit would be the same as with the other options, and the capital gain in the contributed securities would be exempt from taxation. If he had chosen either of the first two options and given everything else to his children, they would have received less because the includible portion of all of the gain would have been taxed. This illustrates that failure to plan properly can result in unnecessary taxes being paid.

Difficult Choices

Sometimes giving money away is more difficult than earning it. That is especially true for parents with complex family situations. Or for any wealthy individual with children, who wants to provide children with a good quality of life but not destroy self-esteem and incentive.

Suppose Bill and Pam have three children. One is a physician, who has a relatively high income, lovely home, and many luxuries. Their middle child, a daughter, is a public school teacher, recently divorced after a difficult marriage, and struggling to make ends meet. Their youngest, a son, dropped out of school, has never settled on a career, has some substance-abuse problems, and normally contacts them only when he needs money. Bill and Pam are now in process of updating their wills.

Do you think they should leave equal amounts to all of the children? Perhaps more to the daughter because she is having a difficult time? Less to the younger son because he would probably waste it? Interestingly, when most people are asked such a question, they declare that in their estate plan they would leave equal amounts to the children because they don’t want their final testament to imply that they loved one more or less than the others. However, they acknowledge that during life, they are more likely to give them unequal amounts because of different needs and circumstances.

Another question that parents confront is the structure of legacies for children.  In some instances, where a child has demonstrated prudence with money, a large lump sum may be perfectly appropriate.  In the case of Bill and Pam’s younger son, it would probably be much better to establish a trust from which he would receive regular income and have only limited access to principal.

For affluent families, the question isn’t just how to divide estate assets among the children but also how much, overall, to give the children. Some parents transfer essentially everything to their children, reduced by as little tax as possible, but other parents calculate how much a child would need to have a good lifestyle and opportunity for self-realization, and then give whatever remains to other individuals and charitable institutions.

Many consider that a healthy community is part of their legacy to children, so they leave bequests for education, health care, the environment, social services, the arts, and other causes. By setting such examples, they are transmitting values as well as money. One person commented: “We have four children, and we are adopting a fifth whom we call charity. We will give 20 percent of our each to each of our four biological children and also 20 percent to our adopted child.”  This person has only a modest estate, but he believes he has a responsibility to the wider community as well as to immediate family, and wants his children too to live by this principle.

When you engage in estate planning, you will confront these difficult questions. You will, of course, have to make decisions about investments and tax strategies, but you will also have to think about family dynamics, values, and meaning. Because these subjects are daunting, the temptation is to put them aside. However, you will have peace of mind when you have a completed plan that expresses who you are and properly provides for the people and institutions that are important to you.

For further guidance of developing an estate plan that is right for you, please contact us to request a complimentary copy of the brochure, An Estate Plan That Expresses Your Intentions. Remember that we are also available to meet with you in person to respond to your questions.