Mistakenly, many believe that they do not have enough assets to worry about estate planning. With today’s $5.6 million exclusion per individual and simplified portability that raises a couple’s exclusion to $11.2 million, estate taxes may not be an overbearing concern. But there are many estate planning steps everyone with heirs and assets should take. A financial plan would be incomplete without a review of the basics of estate planning. As a fiduciary, your advisor should cover this important topic. Just be sure to work with a fee-only advisor to avoid being sold high commission and high expense insurance products you might not need under the guise of estate planning.
How Assets Transfer After Your Death
Transfer by Will
Assets that transfer by will are assets you specifically list in your will to any designated beneficiary. If you don’t have a will, the state you reside in has one for you. While the state's method of distributing your assets may not be what you would wish for and could lead to serious problems for your heirs, your assets will be distributed to someone.
Without a will an asset could be passed under state law to your heirs as an undivided interest in a home or other real estate. This presents a problem if the asset needs to be liquidated to evenly divide and title the property. Because all parties must agree to the terms of any sale and beneficiaries may have differing opinions as to the value, holding an undivided interest can make final disposition very difficult. Sometimes sentiment will stand in the way of liquidating the asset, causing friction among family members and leaving some susceptible to emotional blackmail or simply leaving all with a claim to property that in essence has no remainder value.
Another common mistake in drafting a will is to misunderstand how some assets transfer and the hierarchy of the transfer. If an asset transfers by contract, that is, if there is a named beneficiary of an IRA or insurance product, the contract takes precedent and that asset will not be available to transfer through your will.
It is inappropriate to transfer certain retirement plan assets through your will. IRA and 401k type assets lose their tax advantaged status and result in needless income tax leakage for your estate.
Items transferred through your will are also subject to the delays and costs of probate. Probate costs vary from state to state but it is the delay that is often the problem. If there is not enough liquidity in the estate, heirs could be hard pressed to carry the expenses of maintenance and taxes while the probate process proceeds.
Another drawback to transferring assets through your will is that wills are all a matter of public record and must be filed with the county where the decedent last lived. That means your estate and its’ disposition is not a private matter. Anyone who is curious can learn about matters that you may have preferred to be private.
Transfer by Contract
You can also transfer assets to your heirs via contract. Contracts are private agreements and thus can preserve privacy. Assets that transfer by contract also will avoid the delays of the probate process. For example, the beneficiary of a life insurance contract will receive any funds soon after the required paperwork is completed and processed. IRA and other retirement accounts may also have a named beneficiary. Once the death certificate is presented to the custodian the distribution of those assets will begin. For this reason, it is important that you keep the beneficiary designations on assets that transfer by contract up to date. You should review your beneficiary forms regularly and any time there is a life changing event.
A revocable living trust is another type of contract often used to transfer assets. Investment accounts, real estate, collectibles, and many other items can be owned by a revocable living trust. RLCs are a very popular alternative to wills. These trusts protect the privacy of your estate and your heirs and avoid the delays of probate. A common mistake in the use of a revocable living trust is forgetting to title assets in the trust name. Maybe you buy a vacation home, or you open a new investment account and forget to have it titled to the trust. You should regularly review your estate assets and be sure they are titled correctly.
If you do not want to go to the expense and trouble of setting up a revocable living trust there are other tolls you can use to transfer assets via contract rather than through your will.
An often-overlooked tool is called Transfer on Death (TOD). Many states have adopted laws that enable individuals to transfer assets by contract rather than by will, which greatly simplifies final distributions for heirs.
For investment accounts the TOD designation allows you to specify beneficiaries for each account you may have that is registered in your name. You may specify a different percentage ownership for each beneficiary. Upon your death the assets in the TOD account will transfer to the named beneficiaries without the delay of probate and separate from other items in your will. You can make changes to the beneficiaries and their percentage participation whenever you choose. There is usually no additional charge for having the TOD designation added to your account, but not all institutions may offer this type of account, so be sure to ask.
For banking accounts you should know about the Pay on Death designation which works in a similar fashion, and also avoids probate. Ask your banking institution if they offer this type of account.
Per Stirpes is a Latin term meaning "per branch". It indicates how property should be distributed in the event of a named beneficiary is deceased.
For example let's say you have a son and daughter who each have two children of their own. You have an IRA which you wish to leave to your children in equal shares. If you have indicated this on the IRA beneficiary form you may think all is well. However, suppose your daughter is traveling with you when you both die in an automobile accident. What will happen to the assets in the IRA?
Without the per stirpes indication the IRA will transfer Per Capita, meaning your son will inherit all the assets in the IRA, leaving your grandchildren from you daughter with no share. If, however, you included the per stirpes designation on the beneficiary form, your surviving son would inherit his half of the IRA, and your daughter’s heirs (the branch) would inherit the other half of the assets. This dramatic difference is due to those two small words - per stirpes.
Durable Power of Attorney
A Durable Power of Attorney is another estate planning must have. Many of us worry, with good reason, that we might one day become incapacitated and unable to attend to our own affairs. How can we be sure our bills are paid, our investments are managed, or our property sold if the need arises?
A power of attorney is a document that delegates legal authority to another person. You may be familiar with a limited non-durable power of attorney from attending a property closing when one of the parties is absent. The Power of Attorney allows the principal (person granting the Power of Attorney) to name an Attorney in fact (the person to whom the legal authority is being delegated) to sign documents to effect a property closing on their behalf.
Non-Durable Powers of Attorney can be granted for a wide variety of tasks, and they remain in effect until canceled by the Principal or until the Principal becomes incompetent or dies.
A durable Power of Attorney is often granted between spouses or between a parent and a trusted child or other relative. The durable Power of Attorney as the name implies enables the Agent to act on the Principals behalf even if the Principal becomes mentally or physically incompetent. This is an important distinction. Should the Principal become incompetent through disease such as Alzheimer's or as the result of an accident or illness, there is someone in place who can make legal decisions, access funds, and pay bills on behalf of the Principal. As with non-durable POAs a durable Power of Attorney ends when revoked by the Principal or when the Principal dies.
If you have not executed a Durable Power of Attorney and you become unable to handle your own affairs your family will probably have to go to court to have you declared incompetent - a very public airing of a very private matter. The court must then appoint someone, maybe not the person you would choose to handle your affairs. Sometimes a bond must be posted, an attorney or CPA hired to prepare detailed financial reports that must be filed with the court, and the court must give permission for certain transactions like the sale of real estate. All of this can be a long and expensive undertaking that can easily be avoided with proper planning.
Healthcare Power of Attorney
The healthcare power of attorney, sometimes called a healthcare proxy, is another estate planning necessity. It names an individual to make healthcare decisions on your behalf when you are incapable of making those decisions for yourself. Not to be confused with a healthcare directive, this document works much like a durable power of attorney except it is for medical care rather than financial assets. Usually it is granted to a spouse or close relative to grant them the authority to make healthcare decisions on your behalf.
While not a legal document a healthcare directive does inform your family of your wishes for end of life care. You should not subject your family to the agony of having to guess under what circumstances you would like medical care withheld. You should spell out the conditions under which you would like to not be revived or the treatments you would not want to be subjected to. If you do not want to be kept alive by feeding tubes or respirators at some point, you should spell out those circumstances and spare your family any potential guilt or heartache of having to make such hard decisions at what will be for them a very horrible time.
Letter of Instruction
Another non-legal document you should prepare is a simple letter telling your heirs who they should contact if you die and where they can find documents they will need as they close out your estate. Some of the items you should include are: