Advisor Insight

Leave your money to your heirs—not Uncle Sam

It's the ultimate gift to your loved ones. An airtight estate plan not only takes the guesswork out of who gets what when you pass away, sparing your family costly court battles and potential infighting, but also delineates your wishes for end-of-life medical decisions. 

"Estate-planning documents allow you to rule from the grave," said Austin Frye, an estate-planning attorney, certified financial planner and president and founder of Frye Financial Center. "You want to be sure that the assets you've worked so hard for end up in the right place and as efficiently as possible. But it's also about protecting yourself and your heirs."

Oleksiy Maksymenko | Getty Images

Parents who fail to select a legal guardian for their minor children, for example, unwittingly leave that decision in the hands of the court in the event tragedy strikes. The same is true if you fail to name a health-care proxy or financial power of attorney and illness or injury renders you unable to manage your money and medical care.

Indeed, the documents you leave behind can shelter your family from further stress at a time when emotions are already running high. Done right, your estate plan should also protect your assets from creditors, taxes and vengeful ex-spouses. 

The following list of dos and don'ts can help ensure your affairs will be handled according to your wishes.  

The to-dos

Do update your beneficiaries. With each life event, including a birth, death, divorce or marriage, you should review the designated beneficiaries to your life insurance policy and retirement accounts and amend as needed. 

Naming beneficiaries in your will is not enough, Frye said, especially if a discrepancy exists.

"The designated beneficiary of your life insurance policy, IRA, annuity and pension plan trumps whoever is named in your will, so you need to be very careful about that," he said. 

Read MoreWhen advisors' clients keeps secrets

After all, you don't want your estranged ex-spouse—and, by default, any children he or she may have from another marriage—to walk away with your individual retirement account due to an oversight. 

Do trust in trusts. A revocable living trust is a powerful estate-planning tool. Its primary benefit is that it allows you to pass assets to heirs outside of probate, the costly and lengthy legal process that is used to resolve all claims, pay off debt and distribute what remains of your property to your heirs. In many states, probate can last two years, during which time your heirs will not have access to their inheritance. 

Revocable living trusts are deemed "revocable" because you can change or dissolve the trust at any time and for any reason, as long as you are mentally competent. Generally, such trusts become irrevocable when you die, meaning that at that point, they cannot be changed. 

A backup will that reiterates your choice of beneficiaries, however, is still advised in case you leave any assets outside the trust, said Gideon Rothschild, a partner and co-head of the trusts and estates practice at New York law firm Moses & Singer. 

Do name a guardian for your minor children. If your kids are under the age of majority, which is 18 in most states, it is critical that you designate a guardian to care for them in the event you die prematurely. A judge will otherwise be forced to select the person they deem fit. And it may not be your first (or fifth) choice. 

A trustee should also be named to manage and distribute their inheritance according to your wishes. Just be sure to ask their permission first. 

How to gain control of your legal life

"I've had people say, 'What?!' when they find out they were named the legal guardian," Frye said. "You want to discuss it and have it be a positive thing. Tell them you know how loving they are with your kids and that you trust them and believe they are responsible." 

While you're at it, tell them your expectations should the unthinkable ever happen. "Ask them not to let your son buy a Porsche with his inheritance if that's what you wish," he said.

Do be specific. Estate planning is not the time for ambiguity. If you want your kids to sprinkle your ashes at sea, tell them which coast or what beach. 

Don't leave your jewelry collection to your children and let them sort it out later. Itemize your valuables, including jewelry, antiques and artwork, and name a beneficiary for each item. 

It's not the retirement assets that create the biggest conflicts, said Frye, but the sentimental items, like the prized Thanksgiving platter that you never thought to include.  

"I'm [seeing] a lot of fights with children whose mom said in her will she wanted to leave all her jewelry to her kids," Frye said. "That's not effective."  

Read MoreTales of dumb investor moves

He added: "Kids fight over who gets the ruby vs. the emerald. I've seen brothers and sisters fight over a $20 item, and their relationship fell apart over it."

Absent specificity, Frye said, valuables such as wedding rings and watches also tend to "disappear," causing accusations against the adult child who got to the house and the jewelry box first. 

"Expect that your beneficiaries will fight," Frye said. "It's all very emotional, and this is where they have their final stand regarding who Mommy or Daddy loved more. Once the parents are gone, this is where that plays out." 

Do get help. A do-it-yourself mentality is all well and good when it comes to home improvement, but estate planning is one area where failure to secure expertise can cost you more in the end. The more complex your estate, the more valuable professional counsel becomes. (Perhaps one of your children helps to run your family business, or your new spouse and children don't get along.) 

"It's the same as providing yourself with your own medical care," said Rothschild at Moses & Singer, noting horror stories abound involving parents who inadvertently disinherit one child. Others leave their financial legacy, and their kids' inheritance, vulnerable to creditors and taxes. 

"There are dozens of stories of litigation among family members because Mom and Dad didn't plan for all the possibilities," Rothschild said. "It inevitably ends up in court, the brother and sister don't talk anymore, and only the lawyer got rich." 

The don'ts

Don't name your estate. The biggest no-no when it comes to estate planning is naming your estate as your IRA beneficiary. Your assets would, as a result, be subject to claims and creditors during probate. 

Thus, when you die, the proceeds from your IRA would be used to pay off any debt in your name. Whatever money remains, if any, is then distributed to your heirs. 

The better bet by far is to name a live person or group of people, such as your children, as your IRA beneficiary, allowing those assets to pass outside of probate and protecting the proceeds from creditors, according to Bill Dendy, an estate attorney, CFP and president of Elite Financial Management. 

The other perk to leaving your IRA to a loved one? It's more valuable to your heirs. Non-spouse heirs can normally either liquidate an inherited IRA and pay taxes within five years of the owner's death, or "stretch" their required minimum distributions (and tax bite) out over their lifetime. But your heirs lose that ability to stretch if you leave your IRA to your estate, Rothschild said.

Your children may know that you have a safe deposit box at the bank, but if they don't know which bank, what branch and where the key is, how can they find it?
Austin Frye
president and founder of Frye Financial Center

Don't keep it a secret. All the estate-planning documents in the world won't do you or your loved ones any good if you forget to tell your beneficiaries where the paperwork is kept. 

"Your children may know that you have a safe deposit box at the bank, but if they don't know which bank, what branch and where the key is, how can they find it?" Frye said.

For assurance, you may want to consider leaving a copy with your attorney, keeping one in your fireproof home safe and even giving a copy to your heirs. Otherwise, your family won't know what your burial wishes are, or that you intended to leave the pearl necklace to your granddaughter, until it's too late. 

"I've had situations where kids came to me later and said, 'We finally found the burial instructions, and Dad wanted to be cremated,' but they had already buried him," said Dendy at Elite Financial Management. 

Read MoreWorst marriage money mistakes

Don't tilt trouble. It's not sufficient to create a revocable living trust. To fulfill its purpose of keeping your assets out of probate, you need to actually transfer assets into the trust. 

"Yes, living trusts can avoid probate, but unless you transfer every single asset you own into the name of the trust, anything you forget to include must still go through probate," Rothschild said. Be sure, too, he said, that if you leave assets to your spouse in a trust and he or she has children from a prior marriage, the language clearly indicates that upon your spouse's death, any remaining assets should pass exclusively to your own children. 

Don't get stuck in the TOD trap. Another common misstep is over-reliance on "transfer on death" accounts, an easy and (sometimes) effective alternative to a trust that avoids the need for probate and clarifies how your investment assets will be divided among your children. Such accounts, however, are not immune from creditors or angry ex-spouses should your child's marriage end in divorce. 

"TOD accounts have no ability to protect those assets once the person who created them passes away," Rothschild said. "The only way to protect your child's inheritance is to set up a trust to retain those assets." 

Another warning: Beware of joint TOD accounts if your spouse has children from another marriage. If you die first, your spouse would gain control of those assets and could legally change the beneficiaries to his or her own kids, thereby disinheriting yours. 

Don't forget a backup plan. You must also look out for yourself, of course. That's where the living will, or advanced health-care directive, comes in. Such documents outline your end-of-life preferences regarding medical treatment, including surgery, organ donation and cardiopulmonary resuscitation. Essentially, it tells them whether to pull the plug or not should you become critically ill.  

You'll need a durable financial power of attorney, too, to manage your estate according to your wishes in the event you become mentally ill or incapacitated.  

"This is very important as life expectancies rise, because of the increased incidence of dementia and other disabling illnesses," Frye said. You don't want to leave your children guessing over who should make decisions on your behalf and what you would choose.  

No one can predict how long they will live, but a carefully crafted estate plan can preserve your financial legacy and protect your family even in the event of sudden tragedy. Better yet, it can all but eliminate opportunity for conflict among those you love most.  

—By Shelly Schwartz, special to