Year End Estate Planning Tip #3 – Check Your Mental Disability Plan

With the end of the year fast approaching, now is the time to fine tune your estate plan before you get caught up in the chaos of the holiday season. One area of planning that many people overlook is making sure their mental disability plan is up to date.

Three Areas of Your Mental Disability Plan That Are Likely Out of Date
If your estate plan is more than a few years old, then your mental disability plan is likely out of date for the following reasons:

1. Are your health care directives compliant with HIPAA? While the federal Health Insurance Portability and Accountability Act (known as “HIPAA” for short) was enacted in 1996, the rules governing it were not effective until April 14, 2003. Thus, if your estate plan was created before then and you have not updated it since, then you will definitely need to sign new health care directives (Living Will) so that they are in compliance with the HIPAA rules. With that said, it’s possible that health care directives signed in later years lack HIPAA language, so check with your estate planning attorney just to make sure that your estate plan documents reference and take into consideration the HIPAA rules.

2. Is your Power of Attorney stale? How old is your Power of Attorney? Banks and other financial institutions are often wary of accepting Powers of Attorney that are more than a couple of years old. This means that if you become incapacitated, your agent could have to jump through hoops to get your stale Power of Attorney honored, if it can be done at all. This could cost your family valuable time and money. Aside from this, Pennsylvania has enacted new laws governing Powers of Attorney, which become effective on January 1, 2015. If you want to increase the likelihood that your Power of Attorney will work without any hitches if you lose your mental capacity, update and redo your Power of Attorney every few years so that it doesn’t end up becoming a stale and useless piece of paper.

3. Does your estate plan adequately address mental disability? A will is something that only becomes effective when you die. With today’s longer life expectancies come increased probabilities that you will be mentally incapacitated before you die. A fully funded Revocable Living Trust is the best way to provide adequately for mental incapacity, but some older trusts do not. If you signed your Revocable Living Trust more than 8 to 10 years ago and haven’t updated it since or have assets that are outside your Revocable Living Trust, then it may well lack modern and appropriate provisions for what to do with you and your property if you become mentally incapacitated. Have your estate plan checked to ensure that it will work effectively and efficiently if you lose your mental capacity. Otherwise you and your loved ones may end up in front of a judge who will have to sort out your financial matters – at horrendous cost.

What Should You Do?
Estate planning is about much more than having a plan for who gets your stuff after you die – it should also include having a plan for what happens in case you lose your mental capacity. If your plan is more than a few years old or does not include a fully funded Revocable Living Trust, then chances are it lacks a good mental disability plan. Now is the time to meet with an experienced estate planning attorney to ensure that you have a mental disability plan that will work the way you expect it to work if it’s ever needed.

What to Do with an Inherited IRA

IRAs are among the largest assets inherited by heirs and beneficiaries. These accounts have been able to grow to such large amounts because income taxes are deferred until the owner begins to take distributions, usually after reaching age 70 ½.

Those who inherit an IRA must be very careful to follow the rules, which are complicated and often confusing. It is possible to keep an account growing tax-deferred for decades, but an innocent error can cause the recipient to lose the tax-deferred advantage and force her to pay tax now on the entire account balance. As a result, it is critical to talk with an expert before making any decision or taking any action, and to understand all available options. Here are some to consider.

Cash Out Option
Anyone who inherits an IRA can cash it out and withdraw the full amount. But because income taxes must be paid on the full amount at one time, this is not usually the best choice.

Spouse Options
A surviving spouse who inherits an IRA from his/her spouse can roll it into a new IRA or merge it with his/her own IRA. In either case, the account can continue to grow tax-deferred and the surviving spouse can continue to make contributions until he/she must start taking required distributions (after age 70 ½).

If it is rolled into a new IRA, the surviving spouse will name new beneficiaries. It is highly advantageous to name someone who is much younger (e.g., children and/or grandchildren) because after the surviving spouse’s death, distributions will be based on the beneficiary’s actual life expectancy. This will allow the account to continue to grow tax-deferred for decades. Under IRS rules, this rollover and stretch out can be done even if the original owner spouse had started taking required minimum distributions before he/she died.

Non-Spouse Options
If the original owner died before beginning to receive required distributions, a non-spouse beneficiary can establish a Beneficiary IRA and start taking annual distributions based on his/her own life expectancy, with the option to take a lump sum at any time. (This is called the “life expectancy option.”) This must be done by the end of the year following the original owner’s death. If the first distribution is not taken by then, all of the IRA must be withdrawn by December 31 of the fifth year after the owner’s death. (This is called the “five year rule.”)

If the original owner died after beginning to receive required distributions, a non-spouse beneficiary must take a distribution equal to the owner’s required minimum distribution for the year he/she died if one had not been taken. For subsequent years, distributions can be based on either the new owner’s life expectancy or the original owner’s remaining life expectancy (whichever is longer).

The original owner’s name must be listed on the title, but the inheriting beneficiary will name new beneficiary(ies). A non-spouse beneficiary cannot roll an inherited IRA into his/her own IRA or make contributions to an inherited IRA, as a spouse can. But when distributions are stretched out over a longer period of time, the tax payments are also stretched out. And by keeping more money in the IRA for as long as possible, the tax-deferred growth can be maximized…which will result in a much larger balance.

Thinga to Consider:

  • cashing out an IRA is generally always going to be the wrong choice because of the potential for disastrous tax consequences – consider not leaving this choice up to your heirs (who are likely to cash it out); rather, consider the continued tax deffered growth potential if that IRA is held in trust for your beneficiaries
  • spouses can roll over IRAs, but have the ability to name new beneficiaries when they do – in a second marriage situation, this could accidentally disinherit children from the first marraige if the surviving spouse rolls the account over and names new beneficiaries
  • Using a stand alone IRA trust for large IRAs can give your beneficiaries use and enjoyment of those funds while adding asset protection and retaining the tax deffered growth within such plans

For more on IRAs a beneficiaries of Trusts and Standalone IRA Trusts, See the previous post on Naming a Trust as Beneficiary of an IRA, andDiscretionary Trusts – How to Protect Your Beneficiaries from Bad Decisions.

Eight Reasons – NOT – to have an estate plan.

If this one is too long for you, by all means, skip directly to number 8!!

1. You enjoy paying taxes. Maybe you believe that giving 40+% of your life savings to the government is a good use of that money. Your family can probably live on the fraction of your money left over.

Most people have heard that the federal estate tax exemption is over $5 million ($5.34 in 2014 and $5.43 in 2015). So, if your estate is comfortably under that there will be no tax consequences, right? Pennsylvania has an inheritance tax that is separate from the federal estate tax (see #2 below for more on this)*. Also, if you have a appreciated assets or a retirement plan and your heirs cash it out, it could have disastrous capital gains and/or income tax consequences.

2. You believe that State representatives know how to plan your estate better than you do. You voted to elect these officials, so why not let them make laws that will distribute your estate.

In Pennsylvania, if you’re married with children and you die without your own estate plan, the government has decided how your estate will be distributed. So, let’s say your two kids are 3 years old and 1 years old, respectively. Under the law, the first $30,000 goes to your spouse. Then the balance is divided 50/50 between your spouse and your children. You want your minor children to get 50% of the balance of your estate immediately, right?

*The 50% that passes to your children will be subject to Pennsylvania Inheritance Tax. There will be no inheritance tax owed on the first $30,000 and 50% of the balance that goes to your spouse. Wouldn’t it be better if 100% of your estate was not subject to inheritance tax, which would give your spouse that much more money to take care of your children?

3. Your minor children will be in good hands with a state agency.   You don’t need to name a guardian for your children. The Department of Children and Youth Services will be fine.

Avoid this. If for no other reason, make an estate plan to name guardians for your children.

4. You don’t want to have any say in how your spouse and children use their inheritance, they can just have it and enjoy it.

Your spouse and children will enjoy their inheritance a lot more if you have a plan to preserve assets for them and protect those assets from creditors, predators, and the heirs themselves. With an estate plan, you can protect your assets from the bad things in the world and make sure they are available to your loved ones.

General Needs Trusts, Special Needs Trusts, Retirement Trusts, Generation Skipping Trusts, Asset Protection Planning, Charitable Planning, and Business Succession Planning can all be accomplished by putting a comprehensive estate plan in place.

5. You’ll just make all your accounts and real estate joint with your kids. Why should you have an estate plan when you can just do this?

Adding your children as joint owners of bank accounts and real estate can cause serious issues such as: gift tax consequences, capital gains tax issues, and subjecting all of your assets to your children’s creditors. This is also problematic with regard to Pennsylvania’s Inheritance Tax laws.

6. You made a will 20 years ago and just wrote in the changes you wanted to make.

Making any marks on your will can invalidate the will or make it inadmissible in whole or in part to probate. At the very least, it will complicate matters with the probate court and could lead to disharmony in the family.

Avoid probate altogether with a living trust. Probate is a very public affair. Anyone can get a copy of your will from the probate court. The probate process takes at least 12 months to complete, and can incur hefty legal fees.

Maintain privacy and family harmony by having a trust in place that passes your property outside of the probate court.

7. You don’t have a lot of money and own very few assets, so why bother?

Estate planning is not just for the rich. Estate planning is not just about death. Estate planning is as much about lifetime planning as it is about wealth transfer on death:

  • Incapacity/Disability Planning
  • Health Care Powers of Attorney
  • Durable General Powers of Attorney
  • Living Wills
  • HIPAA Authorizations
  • Guardian Designations

8. You don’t plan on dying anytime soon.  

I hear this one a lot. Here’s my counteroffer: Estate planning is not about dying; it’s an act of love. You make an estate plan because your loved ones need you to. Put a plan in place for your loved ones. You’ll feel good about doing it and they’ll be taken care of.


Estate Planning for Young Families

Many young families put off estate planning because they are young and healthy, or because they don’t think they can afford it. But even a healthy, young adult can be taken suddenly by an accident or illness. And while none of us expects to die while our family is young, planning for the possibility is prudent and responsible. Also, estate planning does not have to be expensive; a young family can start with the essential legal documents and term life insurance, then update and upgrade as their financial situation improves. A good estate plan for a young family will include the following:

Naming an Administrator
This person will be responsible for handling final financial affairs—locating and valuing assets, locating and paying bills, distributing assets, and hiring an attorney and other advisors. It should be someone who is trustworthy, willing and able to take on the responsibility.

Naming a Guardian for Minor Children
Deciding who will raise the children if something happens to both parents is often a difficult decision. But it is very important, because if the parents do not name a guardian, the court will have to appoint someone without knowing their wishes, the children or other family members.

Providing Instructions for Distribution of Assets
Most married couples want their assets to go to the surviving spouse if one of them dies. If both parents die and the children are young, they want their assets to be used to care for their children. Some assets will transfer automatically to the surviving spouse by beneficiary designations and how title is held. However, an estate plan is still needed in the event this spouse becomes disabled or dies, so that the assets can be used to provide for the children.

Naming Someone to Manage the Children’s Inheritance
Unless this in included in the estate plan, the court will appoint someone to oversee the children’s inheritance. This will likely be a friend of the judge and a stranger to the family. It will cost money (paid from the inheritance) and the children will receive their inheritances in equal shares when they reach legal age, usually age 18. Most parents prefer that their children inherit when they are older, and to keep the money in one “pot” so it can be used to provide for the children’s different needs. Establishing a trust for the children’s inheritance lets the parents accomplish these goals and select someone they know and trust to manage it.

Reviewing Insurance Needs
Income earned by one or both parents would need to be replaced, and someone may need to be hired to take over the responsibilities of a stay-at-home parent. Additional coverage may be needed to provide for the children until they are grown; even more if the parents want to pay for college.

Planning for Disability
There is the possibility that one or both parents could become disabled due to injury, illness or even a random act of violence. Both parents need medical powers of attorney that give someone legal authority to make health care decisions if they are unable to do so for themselves. (You would probably name your spouse to do this, but one or two others should be named in case your spouse is also unable to act.) HIPPA authorizations will give doctors permission to discuss your medical situation with others (parents, siblings and close friends). Disability income insurance should also be considered, because life insurance does not pay at disability.