An overlooked estate planning strategy: Disclaiming inheritance

Not everyone wants an inheritance. 

Popular reasons for rejecting a windfall include avoiding tax hits,  preserving government benefits, managing family dynamics, giving to charitable causes and using generation-skipping estate planning strategies.

Those instances, and the process involved with taking the counterintuitive step of disclaiming assets that might otherwise flow to a surviving spouse or the next generation in an estate plan, require documentation, frequent family discussions and alternatives in the event of an unexpected death or illness, said Miklos Ringbauer, founder of Los Angeles-based MiklosCPA.

But the "why" and "how" of turning down that wealth in order to aid clients' long-term estate goals often get less attention in the frequently complex planning for their future. If the family and their financial advisors or tax professionals fail to codify their wishes in wills and other estate-planning documents, the wealth could end up stuck in lengthy, expensive probate cases.

While "everybody loves to get stuff," there are "some unique circumstances where it may not make sense," Ringbauer said. "What a lot of people don't talk about is, if you've had a chance to discuss the wishes of the decedent and the trust has not been updated."

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The details behind disclaimers in estate planning

Within the estimated $124 trillion in wealth expected to flow to spouses, heirs and other beneficiaries in coming decades, the avoidance of estate taxes, the implications to family businesses or relatives with varying financial circumstances and some strict guidelines related to government benefits for veterans, student loan recipients, people with disabilities and other groups could loom large. 

But families face an important time crunch, if they're going to create a disclaimer refusing the inherited asset, according to a guide by advisor lead generation and matchmaking service SmartAsset. Most beneficiaries must disclaim the assets in writing within nine months of the deceased person's death and understand that, while they will be forfeiting their rights to an inheritance or certain parts of it, they won't retain the right to say where that wealth ends up.

"Your inheritance disclaimer specifically says that you refuse to accept the assets in question and that this refusal is irrevocable, meaning it can't be changed," according to SmartAsset. "Aside from that, you also have to follow any guidelines set by your state to disclaim an inheritance. For example, your state might require that a disclaimer be notarized or witnessed, filed with the probate court or shared with the executor of the deceased person's estate or the trustee in charge of distributing assets from a trust."

At a basic level, families must create estate plans reflecting their current state of residency and a "plan B and plan C" in the case that anyone involved dies or suffers debilitating illness, said Ringbauer, who recommended revisiting the documents every three to five years. Many of the problems with inheritances stem from the misperception among clients and even professionals who "think that estate planning is once and then done," he said.

"All of us and our clients think we will live forever, but the problem is, we wait too long to start planning together," Ringbauer said, noting that many wait until their 50s and 60s to begin the process. "In some cases, that's too late and/or they forgot to update the documents."

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That could prevent them from preparing adequately for regulatory changes that have affected, say, the timing of required minimum withdrawals of inherited 401(k) accounts and individual retirement accounts or the levels of exemptions from the gift and estate taxes. A strategy aimed at skipping a generation, setting aside assets for a charitable organization or diverting them from one beneficiary in the highest tax bracket to those in another often leads to a requirement that one family member must formally disclaim the assets.

What many high net worth families and their advisors must steer clear from is a "communication breakdown" in which "everything falls apart" with an estate plan, Ringbauer said. And that problem often arises with family businesses in particular.

"The kid says, 'Dad, I saw you work 12 or 15 hours a day, this is not something I want to do,'" Ringbauer said. "Noncommunication and not understanding the people and the beneficiaries' wishes and desires will result in disclaiming most of the time as a result."