When you die, the way in which your property is handled will
depend on the type of documents (or lack thereof) you’ve set up before your
death. The following is a summary of the ways your property transfers to heirs when you pass away.
Life Insurance. At death, life insurance proceeds are passed to your beneficiaries (and in most cases, tax free). For example, if you have a life insurance policy with a face amount of $500,000, when you die, your
beneficiaries receive the $500,000 face amount tax free.
When you purchase life insurance, you name your beneficiary
or beneficiaries – those who receive the death benefit when you die. Most
married couples will name each other as beneficiaries on their respective
polices, some will name charities, and other will name other relatives,
individuals, or trusts. Life insurance contracts generally avoid probate (the
legal process of validating a will and division of property), unless you name
your estate beneficiary (a bad idea) or fail to name a beneficiary (also a bad idea).
Annuities. At death annuities operate the same way as life
insurance regarding beneficiaries. A big difference however, is the tax
treatment. Even though an annuity may pay a death benefit, in most cases it is taxable to the beneficiary. This is different from life insurance death
benefits that are received tax free. Any taxable annuity death benefits are
taxed as ordinary income.
Trusts. Trusts can be established either during your lifetime or at your death. They may also be revocable (changeable) or irrevocable (not changeable). Trusts are set up by a grantor (the person
wanting the trust) and assets are placed in the trust, managed by a trustee,
for the benefit of the trust beneficiary. When you die, the assets in the trust
are still managed by the trustee for the benefit of the beneficiary. Like
annuities and life insurance, trusts avoid probate.
Brokerage Accounts. When you have a brokerage account where
you hold stocks, bonds, mutual funds, or ETFs it’s called a non-qualified
brokerage account. The non-qualified means that it’s not a 401(k) or IRA. When you open this type of account, you are given the option to name a beneficiary on the account should you die. At death, the property passes to the beneficiary. The beneficiary also receives special tax treatment on the account. Brokerage accounts also avoid probate.
Retirement plans. When you have retirement plans such as
401(k)s and IRAs you also name beneficiaries who get the account assets when you die. The tax treatment of the assets will depend on the account (Roth or not), and what the beneficiary chooses to do with the assets (sell them all or take minimum distributions). Brokerage accounts avoid probate.
Wills. A will is a written legal document that directs how
and to whom your assets are dispersed after your death. Wills also name a
guardian(s) for minor children should both parents die. Wills also name an
executor for your estate that helps direct where assets go, what assets to
sell, and filing the final tax return for the deceased and or the estate.
As mentioned before, probate is the process of validating a will. Thus, it’s a public process, and often long and expensive. Additionally, the documents mentioned above supersede the language in a will. In other words,
if your will states that your kids get your IRA assets at your death, but your
IRA beneficiary is another person or entity, the IRA overrides the language in the will.
Dying without a will means dying intestate. Dying intestate
means that the state determines how your assets are divided, who gets them, and if you have minor children, who becomes their guardian. Different states have different laws, but be assured, the laws may differ from what your intentions are or who you think should get your assets or be guardians. Don’t risk it. If you don’t have a will, or your beneficiaries named, consider taking care of this today.
An extremely important point not to be overlooked is the
need to update your beneficiaries or documents whenever you have a life changing event. Life changes mean births, deaths, divorces, job changes, etc. For example, if you get divorced and remarry, and forget to change your beneficiary from your ex-spouse to your new spouse – and you die – your ex-spouse is still the beneficiary and gets the property. It is paramount to update your accounts, estate documents, insurance policies, and retirement plans to reflect any life changes.