A top estate-planning attorney shares advice.
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By Christine Benz | 02-19-10 | 06:00 AM | Email Article

There's a lot about the estate tax that's up for grabs right now, as I discussed in this article. At the same time, many aspects of estate planning are crucial no matter what the tax code says, such as creating a living will, naming individuals to act on your behalf if you die or become disabled, and choosing beneficiaries of your investment accounts. To discuss some of these important concepts, I interviewed H. Susan Jones, a top estate-planning attorney based in the Chicago suburbs. In the interview, Susan discussed some of the most common pitfalls of estate planning and how to avoid them, as well as some underutilized estate-planning maneuvers. An excerpt from our interview is below.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz.

Christine Benz: What are the big mistakes you see people making when it comes to estate planning?

Susan Jones: The biggest mistake is a misunderstanding of beneficiary designations. Many assets today are transferred at death through a beneficiary designation. Good examples of these assets are IRA rollovers, Roth IRAs, life insurance policies, annuities, any kind of plan that we call a qualified plan, meaning they're qualified for favorable income-tax treatment, such as a 401(k).

People don't understand that getting those designations right is extremely important. One thing I see, and I'll give this a name, is unintentional disinheritance. It's very typical to see a beneficiary designation that says, "To my spouse if he or she is living, otherwise to my then-living children."

Benz: What's wrong with that?

Jones: If you say, "I give this to my then-living children," and one of your children predeceases you, what happens to the share that would have gone to that predeceased child? If your beneficiary designation reads "to my then-living children," it goes to your true surviving children. The share that would have gone to your grandchildren through your child who is deceased is cut out. You may be disinheriting your grandchildren.

That's probably not what most people want. If I ask them that question, "If a child isn't living, where do you want those assets to go?" they typically say, "Well, I want it to go to that child's children." The Latin term for this is per stirpes, to the descendants. So that would send it down the bloodline to the deceased child's children.

Benz: Say you have a beneficiary designation form for your 401(k) or some other asset, and it doesn't allow for this level of detail. What should you do?

Jones: Go to your plan administrator. I've seen documents that specifically allow you to say if you want your assets to be distributed per stirpes, and some of them have a box you have to check. Unfortunately, there's no consistency within the financial-services industry. If the plan administrator doesn't know how to handle it, you need to write your own beneficiary designation that says "to my then-living children in equal shares, except that if a child of mine is not living, the deceased child's share is distributed, per stirpes, to that child's then-living descendants."

Benz: What are the other pitfalls associated with beneficiary designations?

Jones: Something I see among younger people is that they name their spouse the beneficiary of their 401(k) plan, and when they have the first child they change it to read, "And if my spouse isn't living, I give it to little Suzie." But then comes little Johnny, and little Sally � and they don't change that beneficiary designation. So, 20 years down the road, Suzie, the firstborn child, gets the entire account, because you haven't said, "I give to my then-living children per stirpes." You've given it to the person who's in your life at that time. So even if you have only one living child at the time you make a beneficiary designation, you can still write it to encompass future descendants.

And there's something else to be aware of in this situation: You're naming little Suzie, who's two years old, the beneficiary of your assets. That's a big issue in that someone who's two years old legally cannot own assets. The solution if someone who's under 18 inherits assets is to have a court-appointed guardian. But the minute you hear "court-appointed guardian," you should see dollar signs. It's expensive to go to court to get a guardian appointed and then have the court oversee those assets until the child is 18 years old.

Instead of naming your children as beneficiaries if they inherit assets and your spouse isn't living, maybe you would pay it to a trust. And when it's paid to a trust, then the trustee takes over, and there is usually no court accounting. And furthermore, you don't have to give it to children at age 18 under the trust. You might get the kids through college and working a few years before you start to give them money.

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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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