Big Mistake: Failing to Update Beneficiaries

I make a point of reminding my clients to review their beneficiary designations on their employer based retirement plans, life insurance, IRA’s and accounts with transfer on death assignments. The same could be said of beneficiaries outlined in their wills (you have a will, don’t you?). I was happy to see that the February 2013 issue of Consumer Reports listing this as the number one mistake in their article, 7 Money Stumbles to Avoid.

Why is this so important? It’s because huge unintended consequences could happen if you fail to review this on a periodic basis. For example:

• Many people have trust arrangements set up within their estate planning but many people fail to change the beneficiary designations on accounts when the trust is established, potentially ruining the whole estate planning strategy they wanted to employ.

• It is not uncommon for former spouses to still be listed as beneficiaries on an individual’s life insurance or retirement plans.

• If you have an ERISA based retirement plan like a 401(k) or 403(b) and remarry, did you know your new spouse is automatically your 100% primary beneficiary? This may be the intent of the person, but it may not necessarily be that way if children from a former marriage are involved. And by the way, prenuptial agreements don’t work here.

• I’ve seen parents still listed as beneficiaries even though their child has long been married and has a family of their own that they need to financially support.

• Listing an estate as a beneficiary of a retirement account can have the unintended consequence of having the funds disbursed (and taxed) even if the beneficiaries didn’t need the funds and would opt to defer the receipt of these funds (and the tax consequences) to a later date.

• Having a child who has special needs lose their government assistance because they were improperly named as a direct beneficiary rather than a special needs trust.

• Not only beneficiaries, but the designation of guardians for your children, executors and trustees are good to review as well within your estate planning documents.

On an annual basis, it’s a good exercise to go through this to make sure that all of this is still aligned with your goals. And I would confirm any beneficiary designations directly with the financial service firm that you are working with rather than assuming they have the latest paperwork that you filed on hand. In the end, this is a very simple exercise that can save your family a lot of grief later down the line.

Be Ready for Changes in Our Income Taxes

On January 1st, 2011 the largest tax hike in history will take place if Congress does nothing. This came into play because the tax legislation in 2001 and 2003 had the support to be enacted, but not permanently. Now Congress in a quandary; I’m sure they would love the tax revenue to reduce the federal deficit (hopefully). However raising taxes at the height of a growing anti-incumbent sentiment with mid-term elections coming up isn’t the best for job security. I suspect some sort of legislation will get passed that will at least temporarily extend the tax breaks for taxpayers in the lower tax brackets so our representatives have something to bring with them on the campaign trail. I also suspect some sort of permanent resolution to the federal estate tax code will occur by year end (although I’m surprised Congress let the estate tax die this year).

My primary concern is beyond the above. Raising taxes in a weak economic environment historically has been an effective recipe for economic slowdown. The powers that be have not declared that we ever exited the recession and raising taxes may create a rare double dip. Solely taxing the higher tax brackets isn’t a solution either. The problem is that many of the people who are in the higher tax brackets fall into the category of the small business owner. These are the people that are the engine for job growth in our country. With the entrepreneur already dealing with the anti-business political dialogue coupled with higher taxes from the healthcare legislation, increased tax hikes may further curtail job growth and Washington could be shooting themselves in the economic foot. Extending the current income tax rules for an intermediate time period (3-5 years) is much better economic stimulus than Congress can conjure up. A one year extension is not a solution; it will just prolong the uncertainty which means business will hold onto its wallet. It would be a gimmick like the rebate checks we got a few years back which did nothing to stimulate the economy.

Despite the uncertainty, these are the things that you can do now that will still be effective no matter what ends up happening in our tax world:

-Accelerate Income: Normally you don’t want to do this, but if you have the ability to accelerate your income into 2010 rather than waiting until 2011, you should be poised to take action if the current tax rules are not extended.

-Accelerate Deductions: If the tax rules are not extended and if your personal exemptions and deductions were phased out in the past, then it may be likely to see this come back into play in 2011. Some deductions are non-discretionary and the only thing you can do is accelerate moderate amounts (such as paying real estate taxes due in 2011 or paying your January mortgage or home equity payment in December). But if you are subject to the phase outs above and are charitably inclined, you may be better off accelerating donations this year

-Tax Gain Harvesting: Financial folks like to talk about accelerating losses, but I would be thinking about harvesting some gains, especially long term holdings that have very low cost basis that you were reluctant to sell because of the tax implications. If legislation isn’t extended, the capital gains rate goes from 0% to 10% for lower tax brackets and from 15% to 20% to higher tax brackets. It seems Washington would like to see the higher tax brackets even pay more if they could. Even if you have a holding you want to keep, you may want to sell at a gain and repurchase to step up the cost basis. If you are potentially subject to the healthcare tax surcharge, it may be wise to start working on this now before the tax becomes effective. You may want to consider gifting appreciated assets to your children and having your children sell and recognize the gain if they fall into the 0% tax bracket (just be aware of gift taxes).

-Roth Conversions: There are many reasons why a Roth conversion may make sense and when to avoid it that goes beyond the scope of this entry. But with potentially higher taxes in the future, it is something that should be considered. For those who have a lot of investment income from taxable investment holdings and appear to be subject to the healthcare surcharge in a few years, it may make sense to convert and pay the tax out of the taxable holdings. On the front end, converting and incurring the taxes when they are lower makes sense. On the back end, shrinking the taxable assets and the investment income created by it may help avoid or reduce your taxes subject to the future healthcare surcharge.

-Be Ready for Estate Planning: If you have a heightened concern about estate taxes, you should be ready to review your strategy once the federal estate tax legislation is passed and adjust if necessary. Also don’t forget about the estate taxes your state imposes. States usually react to what the federal government does so this should be addressed as well.

With the above, everyone has a unique set of tax circumstances. You will need to do your due diligence to see if this makes sense for you and get help if you aren’t an expert. Some tactics above may create unintended consequences as many deductions and credits can be subject to phase-outs; higher amounts of your Social Security benefits could be taxed. Also you have to be careful to avoid the alternative minimum tax (AMT), which is in legislative limbo as well. Also keep in mind that it’s not about avoiding taxes; often more problems occur by trying to avoid taxes. It’s about managing taxes efficiently. But by being proactive of your tax situation, you will be better off in the long run.