You may have held long discussions with your heirs about how you want your assets to be distributed after your death, but a discussion does not make a legal document. And if you never set pen to paper to devise an estate plan, your survivors fall prey to the highest fees and taxes in the system: fees from lawyers and probate proceedings, and taxes from federal and state governments. If familial ties are already weak, the state's method of distribution can completely fray the lines of communication. If you've been putting off making your estate plan, read on to find out what this omission could cost you and your family.
1. No Control Over Who Manages Your Asset Distribution
If you die without a will (dying intestate), fail to name an executor in your will, or the executor named in your will refuses to act as executor for the estate, a probate court will appoint someone to administer the estate. The administrator must locate your financial documents, determine the value of your estate, contact your heirs and properly distribute your assets. State law will generally determine the "proper" distribution of your assets based on the state's definition of your heirs. For instance, whether you were survived by a spouse, child, grandparent, or other descendant may determine the order in which your heirs are identified.
State law usually determines who can be an administrator. However, in some cases, anyone can be designated an administrator as long as the beneficiaries agree and sign a testament to their agreement.
For some administrators, the complexity of settling the estate can make it a part-time job. They may be forced to relocate for an extended time in order to handle estate matters. State law usually allows the administrator to charge a fee for the work. Often the fee structure is similar to that of the probate lawyer's fee, such as a percentage of the entire value of the estate. The fee can be sizable, and may cause friction among heirs who feel the administrator is getting an inequitable share of the estate pie.
2. Interim Estate Finances
The administrator will handle the finances of your estate and may shoulder unexpected monetary burdens as a result. This may include taking on an additional mortgage payment as the family decides what to do with real estate, negotiating with creditors, paying down debts and as paying income and property taxes.
While all of these payments and debts can be delayed as the estate is settled, any delay comes at the cost of additional interest. The money the administrator may have to fork over is reimbursed when the estate is settled unless an account is earmarked for covering such expenses, and there's no guarantee that an estate will settle quickly. A proper estate plan will provide a means to protect your executor and heirs from creditors by establishing a source of funds to cover bills and debts.
3. Assets for Undesirables
Without a will, state law determines how your assets are divided. Money in your bank accounts, items you've collected and your house could be passed along to an unintended beneficiary or be dispersed in amounts that might make you roll over in your grave.
Say you are survived by your two children: a son who remained close to you and a daughter who hasn't spoken to the family in a decade. You may have promised your son that he could sell your house to fund his children's college education. But if you die intestate, state law may determine that your assets must be distributed to the first living relatives along a specific line of succession, beginning with your spouse and children, then your grandchildren, your parents and your siblings. In the case above, your estranged daughter would have rights to the proceeds from the sale of your home and every other asset you left behind.
The situation gets even stickier when current families and different generations collide. Depending on the laws of your state, if you divorced and remarried, your surviving spouse and children may have to evenly divide assets with children of an earlier marriage. If one of your children predeceases you but is survived by his or her children, your grandchildren may inherit their parent's share of the assets.
4. The Cost of Probate
Estates in which property is inherited must usually go through probate, although small or modest estates - as defined by state law - may be exempt. Strategies in estate planning can help you avoid probate or decrease the fees. For instance, establishing a living trust will generally negate the need for probate. But with intestacy, your beneficiaries must face the court. If your estate is complex, with debts, creditors, real estate, securities and other tangible and intangible assets, you may need a probate lawyer to guide them through the rules and regulations.
Fees for probate lawyers and court proceedings vary widely, but a probate lawyer typically earns a percentage of the gross estate - the value of the estate before expenses and creditors take a bite. Therefore, if an estate is valued at $500,000, a lawyer can charge as much as $25,000 where the cap is 5%. State law usually determines the maximum amount that can be charged by a probate lawyer, and may permit the fee to be negotiable. If most of that money is tied up in a house or other property, beneficiaries may need to sell the property to pay the lawyer.
5. Surprise Taxes
The only advantage to all those fees is that they reduce the amount of the taxable estate. If you set up an estate plan, there are a variety of devices - from payment-on-death accounts to trusts - to reduce the taxable estate. If you fail to set this up, you could be leaving a large portion of your wealth to the tax man.
Both the federal and state government can dip their fingers into an estate. While each year the estate size climbs to higher limits before the federal government can flirt with your money, as evidenced by the seemingly ever-changing estate tax rules that have ranged from astronomically high to nonexistant in recent years.
These taxes on the estate decrease the amount of money heirs may receive. But certain taxes may come to your heirs unexpectedly. If you did not specify a beneficiary for your life insurance or an annuity, then the money is split among the people in your line of succession when the estate is settled. Unlike an executor, the administrator cannot shelter beneficiaries from taxes by timing the distribution of assets.
6. Government Grab
The worst-case scenario for someone who dies intestate is that the state cannot find a rightful heir - no spouse, no kids, no parents, no siblings, or no descendants. If that's the case, you'll forfeit everything to the state; that is, your estate is escheated to the state. The state must make an effort to search for a legal heir, and if one is found, the cost incurred for that search is charged to the estate.
You can avoid the bulk of grizzly taxes and fees that shrink your legacy by establishing a proper estate plan, including drafting a will. Death and money can bring out the worst in people, but by doing a little preparation you can save your family from the angst that could be created when you leave the disposition of your estate to your state.