If you help support others, you need life insurance and an estate plan – really

Purchasing adequate life insurance and doing your estate plan, meaning signing a will and creating a trust, are probably low on your list.

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If you help support others, I hope you will rethink your priories. I will give you two good reasons that you should:

I saw the confusion and pain a wife had to address when she lost her husband, before he bought the life insurance he had promised to obtain, and had to help her kids adjust to the massive change of lifestyle as they sold their home and downsized because they could no longer afford what their dad, the chief income earner of their family, had provided them. If they had proceeds from his life insurance, they would have only been dealing with the grief of losing him.

I saw adult children deal with the probate process so they could be appointed administrators of their mom’s estate just to be able to access bank accounts, pay funeral expenses and then sell and distribute the remainder of her assets, making their own decisions in place of knowing what she would have wanted.

If you have not obtained life insurance to replace your earning power, which helps support your family, and if you have not executed a will, along with a trust, medical directive and other documents that may be appropriate, you are not just avoiding an inconvenient imposition on your time and the payment of premiums and fees, you are failing to properly think of the consequences of not acting and the impact that could have on your loved ones.

So please think again.

Estate planning overview update – key issues to consider for your wills & more

Whether you’re updating an existing plan or starting from scratch, this overview presents the key issues to consider when designing and executing the best estate plan. The work does not stop at signing your estate plan documents; you must also complete the follow up work of beneficiary designations, memorandum to fiduciaries, etc. The goal is to avoid the pitfall of having no plan and the disaster when wills and trusts are in place but the asset ownership and beneficiary designations frustrate the plan by having assets pass to the spouse and not the trust.

If you do nothing else after reading this, write and deliver a “Memorandum to Survivors” and review asset ownership, all as described at the end of this post. A comprehensive estate plan can accomplish many goals, such as providing for survivors, ensuring your children are cared for, determining the flow of your assets upon your death, and reducing the amount of taxes your estate will pay while administering your estate. The most important goal is that you have peace of mind knowing that your estate will be administered in accordance with your wishes.

Updating an Existing Plan
If you have a plan already in place, be sure to review it every couple of years. As you grow older, your life circumstances change and these changes may affect your wishes and plans for your estate. Events such as the emancipation of your children, divorce, lapsed relationships with fiduciaries will likely affect your estate plan. Keep these matters in mind when reviewing the remainder of this post. Your change of circumstances could change your pyramid level.

Estate Planning Pyramid
Constructing a pyramid can be helpful for understanding all that goes into an estate plan, much like nutrition and investments. Each level of the pyramid addresses a new level of complexity in your family and financial situation – that is, everyone needs level one, but not all need the later, more complex levels.

Pyramid: Level One
The first level of estate planning provides the most basic protections so it is most suitable to single individuals with no children and few assets. This level of estate plan typically includes the following forms:

  • Health Care Proxy: This document allows you to appoint people to make decisions about your health care and treatment when you are not capable of doing so. You typically select the surviving spouse and then have a first and second alternate if you wish. Some states call such documents “medical directives” or “medical powers of attorney.”
  • Living Will: This makes your wishes clear as to whether or not you want to have heroic means used to prolong your life.
  • Anatomical Gift Instrument: This allows you to have a hospital use organs and other body parts for others in need of a transplant.

Pyramid: Level Two
The second level is most appropriate for individuals in committed relationships. This level includes all the forms listed in the first level, but adds a durable power of attorney. This document grants a power of attorney to the other to manage your financial affairs if you are absent or you become incapacitated.

Pyramid: Level Three
When you have children, you want to ensure that they will be both cared for and provided for in the manner you wish. To achieve this, you need a will to appoint a guardian, for the “care,” and create a trust to manage assets, for the “providing.”

  • A will is a formal document that designates your personal representative or executor, any alternates, plus a guardian and any alternates for children under age 18, then instructs your personal representative to pay off your debts, and distribute your estate per your wishes.
  • A trust is an entity that you create and can be used for many purposes. The trustee acts as the owner of what the trust holds, while the beneficiaries get all the benefits from what the trust holds. For estate planning, trusts are used to reduce estate taxes in various ways. Trust vehicles can also describe how and when assets are distributed. For example, the grantor of a trust could insist that assets not go to children until they are age thirty-five. The trust vehicle could also provide where assets flow if all family members die without issue. For example, assets could flow to a charity or educational institution.

Providing for Survivors: You need to address how your assets and any life insurance flow after your death in order to ensure that your resources allow those who survive you to maintain the same standard of living, during their life expectancies, that you all had during your life. If your investments are not sufficient, even after making liquid certain kinds of personal property (e.g., a second home), then there is a need for life insurance.

Life Insurance: Term insurance, providing only a death benefit, funds the shortfall between assets required to maintain the lifestyle of the survivors and actual assets available. Whole life, variable or other types of insurance should only be used when permanent insurance is required, as in the case of maintaining estate liquidity throughout your lifetime.

Flow of Assets: After you determine the assets required to support the lifestyle of the survivor, you determine to whom the assets flow. For example, at Levels One and Two, you can leave everything directly to survivors, while at Levels Three to Six, you use a trust, and at Level Six you may even separate some portion of the assets by gift now.

Control Over Assets: In Levels One and Two, the survivors have complete control over the assets. At higher Levels, trust vehicles are used for the estate tax savings. However, you also gain a heightened level of attention on the assets: you have engaged a trustee to focus on providing for the surviving spouse, maintaining his or her lifestyle, while still attending to the interests of other beneficiaries, such as children. In this way, the trustee will try to preserve the trust assets in the best way possible for the longest duration. Finally, the trustee must distribute the assets per your instructions; if assets went to a survivor, they are not bound in any way to follow your wishes, so you may not achieve your estate planning goals.

Fiduciaries: In designing the estate plan, many choices revolve around the fiduciary that you select for a particular role.

  • Personal Representative or Executor: This is the person who “marshals” all assets of the estate together, pays death expenses and transfers ownership of property to the surviving spouse or trust. This is approximately a nine-month task.
  • Guardian: This is the person whom you select to love and care for your children in your absence. The spouse selects the surviving spouse and then a second or third choice beyond that. This job lasts until each child has reached majority (age eighteen).
  • Trustee: This person has potentially the longest-term job because he or she must manage the trust assets and make distributions of income and sometimes principal to the surviving spouse, children and even grandchildren. Depending on the terms of the trust, this job could last until the children are young adults.
  • Beneficiary Designations and Ownership: ownership and how life insurance proceeds and retirement plan assets flow is described below.

Pyramid: Level Four
This level of planning addresses state taxes. When the potential combined estate of a husband and wife exceeds $1 million, and they have other beneficiaries for whom they want to maximize the estate after taxes, then trusts are typically used. States such as Massachusetts impose an estate tax over $1 million. Other states have similar amounts, but many are increasing, such as New York which will match the federal credit in 2019. Therefore, additional planning is required if you reside in a state with an estate tax.

Pyramid: Level Five
The fifth level contains trusts that address federal estate taxes, as well as state. Congress has retained the unified gift and estate tax credit, now at approximately $5.34 million (inflation adjusted) with a 40% estate tax rate (up from 35% last year). In addition, the unused portion of the estate tax credit of a deceased spouse is “portable”, allowing it to pass to the estate of surviving spouse.

With the trust structure, sub-trusts can be created so that both the credit and the marital deduction are used. This structure takes advantage of the credit at the first and second deaths. In contrast, wills that pass all assets outright to the surviving spouse would only take advantage of the credit at the second death. The total tax savings for an estate of $10 million or more is excess of $1.75 million for the combined estates.

  • Life Insurance Trust: You can also make an irrevocable trust the owner of any insurance on your life to exclude all proceeds at death from both estates, avoiding estate taxes. That is, the proceeds are completely estate tax free. However, this requires an irrevocable transfer to the trust; you cannot get the insurance back out. You can use this trust to receive insurance proceeds that can pay for estate taxes, thereby preserving more of your estate after taxes without increasing the taxable estate.

Pyramid: Level Six
The final level is for complex estate planning that minimizes federal and state estate taxes through multiple generations. An example of this is a generation-skipping trust. These trusts transfer assets from the grantor’s estate to his or her grandchildren. This is what allows the grantor’s estate to avoid taxes that would apply if the assets were transferred directly to his or her children. The grantor’s children can still enjoy financial benefits of the trust by accessing any income that is generated by the trust while leaving the assets in trust for grantor’s grandchildren.

  • Other entities: Separating assets by gift now would be important if you wanted to ensure some minimum funding for children, such as guaranteeing coverage for their college expenses.
  • 529 Plans: you can use 529 plans or trusts for gifting to cover college costs of a child.

After the Plan has been Executed – Ownership and Beneficiary Designations
Once the documents and insurance are in place, make sure to review and complete the following:

Qualified Plans (IRA’s, 401k plans, etc.):

  • Primary Beneficiary – to the surviving spouse (so he or she can roll over the proceeds to an IRA and thereby defer income taxes); and
  • Secondary Beneficiary – to your children (or your own revocable, depending on whether you want the assets controlled or available to children).

Life Insurance and Annuities:

  • Primary Beneficiary – when not owned by an irrevocable trust, such as group term, to your own revocable trust (for estate tax benefits, e.g., using credit at first death); and
  • Secondary Beneficiary – to the surviving spouse (in case of trust has been terminated for some reason).

Other Assets
Consider changing ownership of any jointly held assets to ownership by one of you. Any assets held as joint tenants with rights of survivorship will go to the survivor by operation of law and never get to your revocable trust. (You want to be sure that you have sufficient assets going to the trust to realize the full tax reduction effect.)

You may even want to fund your trusts, moving investment accounts over to your own revocable trust. This has no impact on your income taxes. You can also choose to fund your revocable trust now. This will save a significant amount of time for the executor, and the attorney he or she hires, as this will need to be done after your death otherwise.

Memorandum to Survivors
Compile a reference book or add to your financial plan book photocopies of important papers, identifying where the originals are, then adding a list of important contacts, instructions to your executor and trustee and other important notes for family and friends. You would update this at least annually with new asset statements (consider this as you gather information for preparing your taxes). To be more specific, the list (and copies) should include:

  • Location of original will, trust, etc.;
  • Location of health care proxy and durable power of attorney;
  • List of professionals with contact information: doctor, attorney, CPA, etc.;
  • List of fiduciaries with contact information: health care proxy, guardians, executors and trustees, attorney-in-fact for durable power of attorney, etc.;
  • Location of insurance policies and valuables such as original titles, etc.;
  • Location of safe deposit box for valuables and items in #5 or 7;
  • List of all bank and investment accounts and location of any stock certificates or other documentation for investments;
  • List of all mortgages, loans and credit card accounts;
  • Any appraisals or other listing of items by value;
  • All automatic debits that need to be addressed (stopped, changed); and
  • List of all password protected accounts (e-mail, on line banking and credit cards, etc.) and where to locate the passwords… and the password to access the password.

Please see planning-for-the-inevitable-end-of-life-services for more ideas on such memoranda. Also, after you review this overview, let us know how we can help you get your estate plan in order.

Ignore Most Financial Planning Rules

General rules of thumb for financial planning rarely work. Here are some with my critiques:

“Stocks minus your age should equal 100” – Bad rule – your investment allocation depends on your risk tolerance, the rate of return required to achieve your goals, when you add to investments from annual savings or stock option exercises and when you remove investments to fund lifestyle needs.

“Life insurance must equal six times compensation” – Bad rule – your spouse or partner would use all of your resources, including insurance, to fund lifestyle needs after you die. If you review this and determine a short-fall, that is the amount to be funded by insurance. It could be more or less than the six-fold multiple but ensures that your survivors have adequate resources to be protected.

“Save 10% of income annually” – Decent rule – however, some may need to save even more and others may have no savings need. As with life insurance, the question is whether the return from assets plus annual savings over your life expectancy will fund your lifestyle.  

“You only need 70% of income in retirement” – Bad rule – in fact, many people spend more in the first years of retirement as they travel more while spending far less in their 70’s and 80’s as their needs become fewer. This can be further complicated by estate planning goals of gifting to children or charities.

“Hold six months after-tax income for a rainy day” – Decent rule – however, this depends on liquidity, borrowing ability (e.g., home equity line) and cash flow. If annual income permits substantial savings, such that you could pay for a new roof without affecting lifestyle, your “rainy day” reserve can be much less.

“Monthly payments on debt should not exceed 20% of income” – Decent rule – in fact, the rule is somewhat irrelevant in that most lenders apply rules to limit mortgage payments plus home insurance and property taxes to a percentage of income. As with the savings rule, your level of debt may be more or less depending on assets available, risk tolerance and lifestyle costs.

“Do not refinance until rates drop 2%”– Bad rule – the test is simple: how soon will the cost of refinancing be recouped by lower payments? With no points/no closing cost loans, this can a year or less. Buying down a rate by paying points will make sense if the pay-off is in 12 to 24 months and if you plan to stay in the residence for seven years or more.

“Delete collision coverage on a car more than 7 years old” – Decent rule – as with the “rainy day” reserve, this depends on cash flow and other resources. It also depends on whether the car is your “antique.”

“Do not spend more than 7% of income on long-term care insurance”– Uncertain rule – some people may have sufficient assets to self-insure. Some people will not risk nursing care due to bad family health history; they will want to pay for full insurance.  

Are you going to break the rules?

While breaking rules may or may not work for you, creating and sticking to a financial plan will!

Planning for the inevitable – online end-of-life services

What would happen if today were your last day? How would your survivors know how to administer your estate? Even if you have a will, would the personal representative or executor of your will know where to find your life insurance policy, estate documents, and the passwords to your accounts? There are many ways you can plan for this inevitable event and provide your survivors with the support they need to carry out your wishes.

In recent years, new websites have been created for end-of-life planning and documents storage like www.AfterSteps.com and www.principledheart.com. These websites provide a one-stop solution where you can store all your end-of-life documents, from wills and trusts to instructions for basic matters like cancelling your cellphone plan, or to lists storing all you passwords. These websites also organize your asset information and communicate relevant information to your beneficiaries at death.

Of course, whenever you store sensitive information online, you have to be able to trust that the service provider will keep your information secure. Generally, these websites provide bank-level security and encryption services, but as you well know, even the most “secure” websites can be vulnerable. You have to weigh the convenience these websites provide against the risk of having your account compromised.

If an online solution does not work for you, you can always choose a more traditional route. There are resources available, such as the “What if…” workbook that can help you formulate your plan. Alternatively, you can compile a binder with all of your instructions, passwords and estate documents and store your binder in a secure location, either in paper form or as an encrypted document (and be certain to communicate that location).

Whatever you choose, it is important to discuss with your estate planner to determine the best solution is for you. In the end, you want a choice that provides peace of mind for you and clarity for your survivors.

Whole Life is not a great “Investment Alternative” – use the death benefit when age becomes a factor

Whole Life is a poor “investment alternative.” Consider what an insurance company may say, annotated with our comments:

1) Tax Deferred
Does not make up for fees and poorer returns. The mortality fees alone can bring the total fees up over 2%, which compares poorly to a stock index bought via an ETF, were the fees are below .1%
2) Attractive returns compared to bank alternatives
Yes, to a bank, but NOT to your own portfolio of stocks or funds
3) More than initial deposit guaranteed in early years
Only at first and at some cost
4) Strong dividend history
Dividends are only a part of the return on investments – whole life is far worse than a good variable life policy let alone stocks purchased directly or via mutual funds, over time
5) Death benefit (DB) income tax free
Always true of life insurance because it is subject to estate taxes
6) Returns very high if DB paid in early years
“so what?” This is intended to be a long-term purchase
7) Beneficiary can be changed easily without having to redo wills and trusts
Meaning that proper estate planning is not being done
8) Annuitization of other assets easier to do, which can lead to higher retirement income
“Easier” means you pay them to do it instead of doing it yourself, which means shifting the allocation of your own portfolio depending on cash needs