The Final Plan–Thinking About The Unthinkable

38248875 - model of house made of money in male hands on gray backgroundLast week, Jeff wrote about two common concerns that retirees have: running out of money and paying for long-term care. As he explained, there are things you can do to alleviate those concerns. And, as we often say, having a plan in place is imperative to a successful retirement. Well, just as it is important to strategize for your retirement, it is important to plan for the end of your life; to have an updated, valid estate plan. And since Jeff likes to think that he will live forever, this is not a subject he enjoys talking about. So . . . he asked me to!

Estate planning is often the least understood part of the financial planning process but, for many, it is essential to obtaining that peace of mind everyone is looking for in retirement. And so every time we meet with new clients, we ask if they have an estate plan. You may wonder why we, as investment advisors, want to know about our clients’ estate plans. Well, we feel strongly that our clients have worked hard to earn everything they have, and so they should be able to design their own legacy. We also want to make sure that if our clients have an estate plan in place, that we are doing everything correctly so that their wishes are carried out as intended. For example, if their estate plan involves funding a trust at their death with a specific account, then we make sure that the beneficiary designation for that account correctly names that trust.

People are often under the false impression that they only need an estate plan if either they are very wealthy or they have a complicated family situation. This is not true. Everyone should have some sort of estate plan, even if it is a simple one. Another misconception is that an estate plan only provides for after death when, in fact, an estate plan usually also makes provisions for the possibility of incapacity. And having certain documents in place ensures that your wishes will be carried out at a time when you may be unable to speak for yourself.

Generally, a Power of Attorney grants another individual the authority to make financial decisions for you should you be unable to make them for yourself. It is important to understand that giving your Power of Attorney to a trusted individual will allow that person to pay your bills and otherwise conduct your financial affairs if you become incapacitated. Similarly, a Health Care Proxy will appoint an individual to make medical decisions for you should you become incapacitated. By having these two documents in place, your loved ones will have an easier time making decisions for you and taking care of your affairs during what will otherwise be a difficult and emotional time for them.

The other piece of estate planning, the piece that makes provisions for after your death, often involves two major components; the distribution of your assets and estate tax minimization.

First, let’s talk about the distribution piece of estate planning. Everything you own, when you die, needs to be distributed to someone else. How you own an asset upon your death will determine how it is distributed. For example, if you own an asset (such as your house) with someone as joint tenants with rights of survivorship, then when you die, your share of that asset will go directly to the joint owner. If you own an insurance policy, an annuity, or any retirement accounts, such as an IRA, that allow you to name a beneficiary, then those assets will pass directly to the named beneficiaries upon your death. (Most bank accounts and other nonretirement accounts will also allow you to name a beneficiary, but these accounts are usually called Transfer on Death (TOD) accounts.) If an asset is placed in a trust, then that asset will pass to the beneficiaries of that trust pursuant to its terms.

Any other assets that you own individually at your death, that do not either name a beneficiary or pass through a trust, are distributed pursuant to the court-supervised probate process. And any assets that pass through probate generally are distributed pursuant to the terms of your will, should you have one. If not, then those assets are distributed pursuant to the state Intestacy Laws. Those laws effectively set forth a specific formula for the distribution of a person’s assets, based primarily on his or her family tree, after all creditors’ claims and estate taxes have been paid. As I like to tell my clients, if you do not have a will, and you have assets that pass through probate, it is possible that family members who you haven’t seen in 20 years could inherit those probated assets, while your friend and neighbor, who has been shoveling you out for 20 years, could get nothing.

It is important to understand, when you think about how you want your assets distributed, that any assets with beneficiary designations will be distributed pursuant to those beneficiary designations, regardless of any instructions you have in your will. Also, it is important to understand that assets passing through probate and assets passing to a named beneficiary from a custodian (e.g., an insurance company, a brokerage house, et cetera) must be distributed within a limited time frame. If, therefore, you want certain events to happen, or time to pass before your assets are distributed to a named individual, typically the way to do that is to have those assets pass through a trust. A trust gives you “control from the grave” as we like to say. Control that you do not otherwise have after you die.

As I mentioned above, the other major component to estate planning is estate tax minimization. When you die, everything you own or control is included in the calculation of your potential federal and Massachusetts estate tax. And although the federal gift and estate tax has a significant unified lifetime credit (for 2016, $5,450,000, to be exact), the Mass estate tax exemption is “only” $1 million per person. Although it may seem like this is a figure you do not need to worry about, you may want to think again. Many people die with estates worth more than $1 million, simply when adding up the value of their home, their retirement accounts, and potential life insurance policies. A properly drafted estate plan can include the creation of trusts with specific language that will allow both spouses to take advantage of that $1 million exemption. Without that planning, a couple may not be able to take advantage of each spouse’s $1 million Massachusetts estate tax exemption, and therefore may owe significant Massachusetts estate tax when the second spouse dies.

Although each person is different, most people who we meet want to ensure that upon their death, their assets get distributed to specific people and they want to leave as much as they can to their loved ones, rather than Uncle Sam. Having a properly executed estate plan can help do both these things. And, although nobody likes to think about dying (yes, Jeff, I’m talking to you), we all need to be prepared for it.

As Jeff always says, be vigilant and stay alert, because you deserve more.