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In this episode, podcast host and author of “Control Your Retirement Destiny”, Dana Anspach, covers Chapter 13 of the 2nd edition of the book titled, “Estate Planning.” If you want to learn even more than what there is time to cover in the podcast series, you can find the book “Control Your Retirement Destiny” on Amazon. Or, if you are looking for a customized plan for your retirement, visit us at sensiblemoney.com to see how we can help. Chapter 13 – Podcast Script Hi, this is Dana Anspach. I’m the founder and CEO of Sensible Money, a fee-only financial planning firm. I’m also the author of Control Your Retirement Destiny, a book that shows you how to align your finances for a smooth transition into retirement. In this podcast episode I cover the material in Chapter 13, on “Estate Planning.” If you like what you hear today, go to Amazon and search for Control Your Retirement Destiny. And, if you are looking for a customized plan, visit sensiblemoney.com to see how we can help. ----- Even if you have never been to an attorney or drawn up a will or a trust, you have probably still done some type of estate planning- and not even known that’s what you were doing. How could that be? If you have ever opened a bank account or named a beneficiary on a retirement account or life insurance policy, that’s estate planning. It’s a legal document that specifies where your assets go when you pass. For example, if you open an account titled jointly with a spouse, friend or child, when you pass, that account belongs to them. It doesn’t matter what your will says – the titling of that account overrides any other documentation. The same thing occurs with beneficiary designations on retirement accounts. The financial institution must disburse the funds to the beneficiaries you have listed – it doesn’t matter if you have a trust or will that says something else. Many people don’t know this. And it can get you in trouble. I saw this first-hand with George and Faye. George was referred to me shortly after Faye passed away from pancreatic cancer. This was a second marriage and Faye had two children from a previous marriage. When Faye was diagnosed, they had wisely visited an attorney and had a trust drawn up. Faye wanted 1/3 of her assets to go to each of her two children and 1/3 to George, so that is what the trust said. However, nearly all of Faye’s assets were in her company retirement plan. And Faye never changed the beneficiary designation on this plan to the trust. George was named as the beneficiary. Unfortunately, George and Faye thought the trust document would take care of this. They did not realize the trust has no legal authority over her retirement plan unless she took the next step of filing updated beneficiary paperwork. Now, George was in the awkward position of inheriting the entire account. Luckily, George is a good guy, and continues to honor Faye’s wishes by taking withdrawals and then sending the appropriate after-tax amounts to Faye’s children. However, this has unfortunate tax consequences for George, forcing some of his other income into higher tax rates. Overall though, this case has a happy ending because George is doing the right thing. But not everyone would. The type of estate planning error that happened to George and Faye could have been avoided if the estate planning had been coordinated with the financial planning. Many attorneys don’t ask clients for a detailed net worth statement. I’m not sure why. They should and they should look at the types of accounts that someone has so they can make recommendations that will work. An attorney can draft the best documents in the world, but if they don’t make sure the client follows through on all the other paperwork that is needed, those documents can become pretty ineffective. In this podcast, I’m going to cover a few basic things you need to know about estate planning. However, I am not an attorney. Nothing I say should be considered legal advice. Rules vary by state and you will always want to get advice that is specific to your situation. With that in mind, the four topics I want to cover are titling accounts, setting up beneficiary designations, trusts, and I’ll briefly touch on the topic of estate taxes. First, account titling. You have retirement accounts, and pretty much everything else. When I say retirement accounts, I mean IRAs, Roth IRAs, 401ks, 403bs, SEPS, SIMPLE IRAs and any other type of company sponsored retirement account like a pension or deferred compensation plan. Retirement accounts must be in a single person’s name. We are frequently asked by married couples if they can combine their retirement accounts, or title an IRA in a trust. The answer is no. A retirement account must be owned by one individual. The way you specify where your account goes upon your passing is by the beneficiary designation you put on file. With non-retirement accounts you have more choices. Most people open bank accounts in their name or jointly with a spouse or partner. If an account is titled only in your name, upon your death it will need to go through probate. When you add a person to the title or add a beneficiary to the account, then the account can pass directly and avoid the probate process. One of the first things we do when bringing on a new client is review account titling. Many people are not aware that you can add beneficiaries to a non-retirement account. This is accomplished through something called a P.O.D. or T.O.D. registration. P.O.D. stands for payable on death. T.O.D. stands for transfer on death. And some financial institutions have their own term for this type of account. For example, Schwab calls it a DBA or designated beneficiary account. Let’s look at an example. Assume you add your daughter as a joint tenant on your bank account. Your will (or trust) specifies that your money should be split evenly between your children. At death, what happens? Legally that entire bank account belongs to your daughter regardless of what the will (or trust) says. A financial institution must pass assets along according to how the account is registered or titled. There are three key things to know. First, if the account is registered only in your name, and you have a will, then the will controls how the account is disbursed. However, because there is not a direct beneficiary named or another person on the account title, this account will have to go through probate. Second, if you title an account in the name of a trust, then the terms of the trust control how the account is disbursed. Assets and accounts titled in a trust will avoid the probate process. And third, if you add a joint tenant, or some other formal account registration such as tenants in common, transfer on death, or payable on death, then that account registration takes precedence over the will or trust. Let’s say we have Joe and Mary who have two children. They have a jointly titled account, which means if either Joe or Mary passes the account belongs to the survivor. However, if Joe and Mary both pass, the account will have to go through probate. To avoid this they can add their two children as designated beneficiaries to this account, so if both pass, the account goes seamlessly to the children without all the red tape. This type of titling can be accomplished with real estate also. You can file a transfer on death deed or a beneficiary deed for a minimal filing fee. Now, some people prefer to add their children to an account or to the title of their home while they are alive. Please, don’t do this without understanding the potential consequences. When you add another person to the title, that account is now subject to their creditors. If they get in trouble, your assets could be at risk. It could also cause a tax mess. Particularly when it comes to how capital gains taxes work upon death. On a capital asset (such as a home, a stock, or a mutual fund) you have what is called your cost basis; what you paid for the asset. Upon your death, your heirs get what is called a “step-up” in cost basis, which means their cost basis for tax purposes is the value of the asset at your date of death. Let’s look at an example using your home. Assume you bought your house many years ago for $100,000. You’ve done no major improvements so this $100,000 is your cost basis. Today the home is worth $400,000. Upon death, your heirs inherit the house worth $400,000 and immediately sell it. How much do they have to pay in capital gains taxes? Assuming they sell the home for $400,000, they pay no capital gains taxes on the $300,000 of gain because their cost basis was stepped-up to the date of death value. This step-up in cost basis can be voided by titling your property inefficiently. This happens with the common practice of adding an adult child to the title of the house. For example, let’s say after your spouse passes, you add your son to the title of your home. Technically you have gifted him half the value of your home, and instead of the home passing to him at death, he co-owns it with you now. This means he does not get that entire step-up in cost basis upon your death; only the interest attributed to you gets a step-up. Let’s walk through the numbers. Assume the same facts: you paid $100,000 for the home, and upon your death it is worth $400,000, and your son sells it for that amount. Your half of the asset gets a step-up in cost basis, so your share of the house has a basis of $200,000. Your son’s share, however, would have a basis of $50,000 (half your original basis). He now owes tax on $150,000 of gain. At a potential 20% capital gains tax rate, that is $30,000 in taxes owed. This could have been avoided by having the asset transfer to him on death rather than using joint ownership. This example applies to investment accounts such as stock and mutual funds as well as property. This situation can easily be avoided by titling accounts more effectively. What you can do with a property is either set up a beneficiary deed or transfer on death titling. Or if you have a trust, title the property in the trust. This way the house or account remains in your name while you are alive and automatically passes upon your death. If you want one or several of your children to have control of the asset now, with a trust structure you can add them as a co-trustee. This means they could make decisions about the asset, but they would not be an owner of the asset for tax purposes. There can be significant tax and legal implications to how you title accounts. That’s why I call it the hidden form of estate planning that everyone does, but no one knows they are doing it. I understand as you get older you may want a relative to have access to an account to assist with bill paying. What can you do in that situation? Many banks also offer a designated signer account. This designated signer can write checks on the account, but they are not a co-owner. This means their creditors cannot go after the asset. It also means it is easy to remove them if that becomes necessary. The designated signer registration doesn’t spell out what happens to the account upon your death, but it does allow someone other than you to pay bills and write checks on the account while you are alive. Overall there are four things that can be impacted by your account titling. One is taxes. Two is a creditor’s ability to go after the asset. Three is who the asset goes to when you pass. And four is who can make decisions about the asset now. All four of these need to be considered when you add or remove someone to an account title or property deed. The next topic I want to cover is beneficiary designations. Many people name beneficiaries and never update them. This applies to life insurance policies and retirement accounts. There are numerous cases every year where someone gets divorced, passes away and their ex-spouse gets the retirement accounts and life insurance. Any time you get married or divorced, you need to update everything. If you haven’t checked your beneficiaries in awhile, it’s time to do some homework. List all your accounts, how they are titled and who the current beneficiary is. If you need to change a beneficiary, it’s pretty easy. Call the financial institution and fill out a new form. In many cases, you can now do this online. If you are married, this is your first marriage, and there are no children outside of the marriage, then naming beneficiaries can be simple. Ideally your spouse is named as the primary beneficiary on all IRAs and retirement accounts. Assuming your children are functioning adults, they can be named as contingent beneficiaries. The legal concern with this structure is that upon your passing your spouse could remarry, leave everything to their new spouse, and bypass your children. If this is a concern, you may need a more complex structure (a trust) to address this. Consider a more complex structure if you are in a second marriage and have children from previous marriages, have minor children, or have an adult child with dependency issues or special health needs. That brings us to the topic of trusts. A trust is a legal document that provides instructions on how the assets in the trust are to be handled, and by whom they are to be handled. There are three main parties to a trust. There is the grantor, which is the person or people whose property is going into the trust. There is the trustee or trustees, which are the people in control of the trust assets. And there are the beneficiaries – the people who will benefit from or inherit the remaining assets one day. With the most common type of trust, called a revocable living trust, the grantor, trustee, and current beneficiary are the same set of people. For example, let’s say Wally and Sally Sample, the couple we follow in the Control Your Retirement Destiny, set up a revocable living trust. The title of their trust is “The Sample Family Revocable Living Trust, dated August 9, 2018.” The trustees are Wally and Sally, so they can easily sign for and make decisions about any property in the trust while they are alive. They manage accounts titled in the trust the same way they always have. No restrictions apply. They are also the current beneficiaries of the trust, but upon their death, or in the event they are incapacitated, the trust names the successor trustees, people who can then make decisions, and it spells out what is to happen to the property in the trust, who it goes to, and over what time-frame. Let me explain how this comes together with the case of Ellen. Ellen’s husband passed away several years ago and she is now in her 80’s with one daughter, Sara. She always invited her daughter to join our meetings. As the years passed, I could see that Ellen’s cognitive abilities were changing. She asked me to take instructions from Sara; however, legally, I could only take instructions from Ellen. Ellen was the trustee and she was not technically incapacitated, so although the trust named Sara as a successor trustee that provision only became effective if Ellen was seriously incapacitated. I encouraged them to visit their estate planning attorney and add Sara as a co-trustee to Ellen’s trust. They did this and a few years later when Ellen entered an assisted living facility it allowed for Sara to seamlessly continue to manage Ellen’s affairs. One of the key benefits of a trust is that is spells out who is to step in when you can’t make decisions on your own. You can do that through a successor trustee or add a co-trustee. Another benefit of a trust is that the assets that pass via trust avoid the probate process. However, setting up a trust document alone is not enough. Once a trust document is completed, assets must be moved into the trust by changing the account registration and/or property titles. Once you have a trust, instead of your name on an account, it should list the trust as the account owner. It is astonishing to me the number of people who set up a trust, but don’t change their account registrations or property titles. In this situation the trust can become a nearly useless document. It may be sitting there, on the shelf, but if no assets are ever titled in it, what exactly does that document apply to? Not much. There is something called a pour-over will, which can be used to fund a trust after your death, but those assets must now go through probate. And if you are incapacitated, and an account is not titled in your trust, your co-trustee or successor trustee will have difficulty managing that asset. Much easier if you move the appropriate assets into the trust while everyone is healthy. While you are titling assets into your trust should you also name the trust as the beneficiary on your retirement accounts? Only if your attorney advises you to. Retirement accounts have some unique tax characteristics when passed to a spouse or to a real person. A trust is not a person – it’s an entity and sometimes when the trust is the beneficiary of a retirement account it can void some of the tax benefits. There are special trusts, called conduit trusts, that can be set up to avoid this. Overall, having the trust be the beneficiary of a retirement account is complicated. When it’s part of a strategic plan designed by an attorney, it can be good. The last topic I want to cover is estate taxes. In 2019, most people won’t be subject to the federal estate tax. That’s because current law says you can pass along $11.4 million in assets and no estate tax applies at the federal level. If you’re married that means jointly you can pass along $22.8 million. However, 12 states implement a state-level estate tax. And in many of those states the amount that is exempt from this tax is much lower than the federal level. For example, Massachusetts and Oregon have a $1 million exemption amount. In Oregon, amounts over a million are taxed at a rate that can range from 10% – 16%. Then there are states like New York, where they say that you can exclude up to about $5.5 million – however it is what is called a “cliff tax” so if your estate value is too much more than that $5.5 million, then the entire estate will be subject to the estate tax, with rates as high as 16%. Depending on what state you live in, planning techniques that can help reduce state-level estate taxes could be quite applicable to you. I’ve now covered the basics on account titling, beneficiary designations, trusts and estate taxes. And, I must remind you, none of this is legal advice and I am not an attorney. Getting your affairs in order is a great feeling. I think it’s worth it to find a good attorney and do it right. ----- That wraps it up for this podcast on Chapter 13, on “Estate Planning” and for our initial recording of the Control Your Retirement Destiny Podcast, which covers the material in the printed book. We plan to update the material as major changes occur, and we plan on future episodes of the podcast to cover additional topics. You can always get a copy of the book on Amazon in either hard copy or electronic format. And you can always visit sensiblemoney.com, to see how a staff of experienced retirement planners can help.