Checkups Are Vital in Estate Planning

How long has it been since you put your mutual funds through an estate-planning checkup?

Heirs, death, taxes and probate are not the first things most people think about when they start investing. But such factors are important.

For example, fund companies report dividends, account balances and the number of shares bought or sold. But they typically don’t list any designated beneficiaries or remind investors to update their choices.

“Nobody comes back to you and asks whether you want to change beneficiaries,” says Dennis Cronin, a spokesman for the American Assn. of Retired Persons Investment Program from Scudder in Boston.

Some investors might still have former boyfriends, girlfriends, ex-spouses, deceased parents or estranged siblings listed as heirs.

One fund company cited the case of a man who split with his wife but never divorced her, yet moved in with another woman whom he listed as the new beneficiary of his $500,000 retirement account. But he made the change of beneficiary using a form for the wrong type of retirement account, and the fund company didn’t catch the mistake. When he died, both women sought the money and both wound up with a share of it after the dispute went to court.

The most basic type of mutual fund account, involving ownership by a sole individual outside of any retirement plan or trust, is not a great estate-planning tool, as the owner cannot designate beneficiaries. Upon death, assets are transferred to heirs through the judicial process known as probate. With luck, the owner will have written a will to help the court figure out his or her intentions.

But one advantage of an individual account involves the “stepped-up cost basis” provision. This allows shares to pass to beneficiaries without requiring them to pay capital gains taxes, although they still might face estate taxes, depending on their total wealth. For this tax reason, growth-oriented stock mutual funds often make good choices in individual accounts.

Another account type is joint tenancy, which involves shared ownership with at least one other person, commonly a spouse. Upon the death of one owner, assets pass to the surviving spouse without probate.

Joint tenancy can be wise for assets where quick access is needed, such as with a home, car or money market fund that offers check writing.

But joint tenancy comes with various drawbacks and thus might not be suitable for the bulk of your investment assets. For example, each tenant has access to the account, and if any of these people is sued, some assets could be lost in a court battle.

Besides, California has a better system, known as community property with right of survivorship. It offers certain tax-saving benefits available with community property along with the probate-free transfers of property typical of joint tenancy.

Various types of trusts have become popular as ways to help people avoid probate, cut taxes and more. Trusts let you specify which beneficiaries will receive assets and in what amounts.

But you generally must register all mutual fund accounts in the name of the trustee to ensure the proceeds are distributed correctly.

“It’s outside the trust unless you list the trustee as owner or beneficiary,” says Leonard Gzesh, director of sales at Independent Advantage Financial & Insurance Services in Marina del Rey.

Individual retirement accounts make efficient estate-planning vehicles. Each IRA has only one owner, and that person gets to list beneficiaries. Compared with a trust, the paperwork is minimal. Still, it’s wise to make sure the beneficiaries for an IRA agree with what’s outlined in your will or living trust.

“Anything with a contractual arrangement by law supersedes a will and avoids probate, or supersedes a living trust,” says Gzesh.

That also holds true for variable annuities--tax-sheltered vehicles that work much like mutual funds from an investment standpoint, he says.

Gzesh cautions that it’s best to list actual people, especially spouses, rather than a trust as a beneficiary of IRAs or annuities.

“If you make the trust the beneficiary, the proceeds must be distributed, and they become taxable” upon the owner’s death, he says.

Employer-sponsored retirement programs such as 401(k) and 403(b) plans also let owners designate beneficiaries. But unlike an IRA, you can’t pick someone other than your spouse unless your spouse consents. Single owners can designate anyone of their choice.

For tax reasons, married owners of IRAs, 401(k)s and the like generally should name their spouses as beneficiaries, says Craig Wilson, senior vice president for Northern Trust Bank in Phoenix.

From an estate-planning standpoint, it probably doesn’t matter whether you stuff your IRAs and other retirement plans with conservative or aggressive mutual funds.

The best time to think about estate planning is when you open a mutual fund account. But it’s wise to review your situation as things change.

“Events that could prompt you to review your beneficiaries include marriage, divorce, births, deaths and changes in boyfriends or girlfriends,” says Cronin.