For most people, becoming a parent is the first time estate planning comes into the picture. Do you need a Will? How do you designate guardians? How do you preserve your assets for your child?
Here’s the full rundown on estate planning considerations for new parents. (This article addresses married couples — stay tuned for an upcoming article on single parents.)
The Pitfalls of Intestacy
Let’s start where everyone starts: without a Will. If you die without a Will — known as dying “intestate” — then your state’s default distribution scheme dictates who receives your assets. That may be fine if you’re single (assets typically go to your parents) or married without children (assets go to your surviving spouse).
If you have minor children, however, problems arise because many states distribute assets to both the surviving spouse and the children. In New York, for example, the surviving spouse receives the first $50,000 plus half the remainder, and the children split everything else. (Be sure to check your state's intestate succession laws.)
Since a minor cannot directly own substantial assets, the child’s inheritance enters the dreaded property guardianship (also known as conservatorship), a burdensome and often expensive proceeding whereby a court-appointed guardian manages a minor’s assets under ongoing court supervision. And when the child becomes an adult — the age of 18 in New York — the child receives all of the assets outright. Vegas trip, anyone?
Fortunately, there’s an easy solution: put in place a Will directing that your assets pass to your spouse, not to your children.
Designating Guardians for Minor Children
It’s rare for both parents of minor children to die, but it happens. Part of estate planning is envisioning the worst and tackling it head-on for the sake of your loved ones.
If you have minor children, your Will should designate a guardian or co-guardians (along with backup options) to care for your children in the event both parents have passed. Otherwise, a court will pick someone, which may not reflect your wishes or values and can cause family conflict at the worst time.
Testamentary Trusts for Minor Children
The passing of both parents of minor children also poses a financial problem: absent proactive planning, the children will inherit substantial assets. Even worse than the burden of property guardianship, each child will receive all assets outright upon turning 18 — which, including life insurance proceeds, can easily total millions.
Your Will thus should not leave any assets directly to your minor children, but instead to a testamentary trust (i.e., a trust created only upon death) for the benefit of your children. In the event both parents have died, a trusted family member or other individual will step in to manage the trust to support your minor children and distribute the assets responsibly over time.
Non-Probate Assets: Joint Accounts, Life Insurance, and Retirement Accounts
If you have a Will, you can rest easy that all your assets will pass according to its terms, right? Wrong. Certain assets (called “non-probate assets”) pass according to separate rules. Here are three of the most important:
Joint accounts. Most joint bank and brokerage accounts come with a right of survivorship, meaning if one owner dies then the other becomes the sole owner. For spouses, this is generally a good thing, as these assets avoid probate (the court procedure following one’s death). But be wary of having joint accounts with others — such as one’s children — as unintended consequences can result, such as a minor receiving funds outright.
Life insurance. Life insurance proceeds are paid to the policy’s named beneficiary, regardless of what one’s Will says. In general, a minor child should not be named as a primary or contingent beneficiary, as the life insurance proceeds would enter property guardianship and be distributed outright at 18. For most married couples with minor children, a good approach is to name the spouse as the primary beneficiary and the testamentary trust for one’s children as the contingent beneficiary.
Retirement accounts. Upon the account-holder’s death, retirement accounts (such as IRAs and 401(k) accounts) are paid to the named beneficiary, if any. Inheriting a retirement account can confer significant income tax advantages, so be sure to name beneficiaries — but not minor children. Again, for most married couples with minor children, a good approach is to name the spouse as the primary beneficiary and the testamentary trust for one’s children as the contingent beneficiary. (Caution: Do not attempt to designate a testamentary trust as a retirement account beneficiary without attorney guidance. Doing this improperly can create income tax problems.)
The federal estate tax exemption is higher than ever — $11.2 million per person as of 2018 — so hardly anyone has to worry about it. State estate taxes, however, may be a different story.
As of 2018, twelve states (and the District of Columbia) impose an estate tax, and many have exemptions well below the federal level:
(Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania also impose an inheritance tax.)
Some of these exemption amounts are still lofty, but once you include life insurance proceeds — part of the insured’s estate as a general rule — a couple’s assets can quickly approach these levels. Add in the fact that hardly any states allow couples to share the exemption amount (a feature known as “portability”) and thus, without proper planning, the exemption of the first spouse to die will be wasted, then state estate tax considerations come into play.
How do you know if you need estate tax planning? If you and your spouse’s combined net assets plus your combined life insurance death benefits begin to approach either the state or federal exemption amounts noted above, tax planning should be considered. Even relatively simple planning can go a long way in providing the flexibility to avoid estate taxes.