March, 2009
by Dr. Thomas E. Bell, CMG Member, Michelson Awardee (Retired)
Tom received his Ph.D. in Management from UCLA many years ago, and was a consultant for about 25 years before he retired. He is a recipient of the A.A. Michelson award (in 1975), has served CMG as its Treasurer and its Secretary, and has repeatedly been on the CMG Board of Directors. He retired at the end of 2005.
About the Author
Dr. Thomas E. Bell
The end of your final career is usually your death. Sorry, that's how life works.
A common plan for the period between the beginning of your retirement and its ending (at your death) is to spend all the money you've saved. There is an acute problem with this plan: You don't know how much you'll need to accomplish that plan. This is because: 1) You don't know when you will die; 2) The value of your assets may change during the plan's execution (no pun intended); 3) You may have commitments to loved ones that extend after your death. The chart to the right shows the situation you face. If you have less than you need, you'll outlive your savings and end your retirement in penury. And if you have extra savings, lots of them (maybe the bulk of them) will go to taxes.
Estate planning deals with the taxation issue as well as having your remaining assets (called your "estate") allocated according to your wishes.
This article in the series on retirement provides some beginning information about the issues that need to be addressed and some initial steps to take. You need to take these steps before you die and leave a mess to your family, and those steps need to include working with an estate attorney. This article can only help you know some of the language - and urge you to get going on your plan.
Life-Style Decision: Your Loves and Your Commitments
Even if you're young (for me, that means under 50), you need to list your commitments before you take estate planning actions. Probably, this list will include offspring (sons, daughters, and grandkids), but it may include nieces and nephews. It also may include parents, brothers, and sisters. Very likely, it will also include a spouse, and perhaps an ex-spouse.
In addition to relatives, you may feel a commitment to organizations like churches, charitable groups, and schools. Extensive advertising by such organizations (especially colleges and universities) offers the promise to ease your estate planning - and leave a major part of your estate to that worthy institution.
If you have a moderate estate and are well into retirement, you may want to begin annual gifting. You can gift up to a specific amount ($13,000 in 2009) per individual without it being considered a taxable gift. My parents were good enough to do this for me when I really needed the money, and it might be a good thing for you too. This reduces your taxable estate[i], but it obviously decreases you financial flexibility.
Before seeking the "easy answer" of an estate plan from an organization with a clear interest in your decisions, both you and your spouse should make written lists of the people and organizations that you love. Then add the ones that, although you may not love, you'd like to help out. Make a guess about the portion of your estate that you'd like each of them to have, and then see how your spouse's compares with yours. Only respond to the advertisements offering help if the desires of both spouses match the organization's desires.
This all may sound kind of simple, and a lot of words about something that's really straight-forward. If only it were so. Some of the difficult issues that may need to be resolved are:
This is like making Tiger Stew. First you must catch a tiger. And dealing with these tough decisions are like wrestling with a tiger. At least if your situation is at all similar to mine.
Life-Style Decision: Your Executor
Who will make sure that your wishes will be honored and executed after you die? Your executor, of course. But who will that be? After you die (which you will certainly do), should you leave everything in the hands of your spouse (who may be dead)? Or in the hands of your oldest son/daughter (who may have her/his own problems)? The person you choose (hopefully with the agreement of your spouse) should have capabilites beyond just saying your wishes are the most important ones for your estate. Even if this is true, some other criteria are really important.
These criteria include:
Do several people come to mind? If so, I'll give you still another criterion: Getting it all done on time - even if normal work commitments must be honored simultaneously with being your executor.
My personal experience as executor of my parents' estate (after my brother died) is that this is all a huge pain. I had more attempts to divert funds to some turkey or another than I want to remember. Too often, the soothing voice on the phone only wants the money, not support for some deserving nieces and nephews who need educations. But even more enraging is the voice that tells you it can thwart any of your attempts to do the right thing because it has more power than you and will simply take the money. Does this sound like an exageration? I wish it were. Fortunately, I had a back-stop in Joe Delano who advised me in each of the cases I had to confront. The arrogance of some of these people is simply amazing.
An alternative to having a family member be executor is designation of an attorney who specializes in estate law. Of course, the same criteria apply to an attorney as to a family member. In addition, you need to be sensitive to the possibility that the attorney moves, changes orientation, or dies; this may be a bit challenging.
Maybe the answer is some large financial institution's representative who promises to honor your wishes. That's until it is merged with another institution that "forgets" the commitments of the individual making the promises (who, of course is no longer with the institution), or which now has a different set of financial objectives. One representative (who wanted to be the trustee) told me that, given the wording of a will, he felt he had total control over the assets my father had left to my mother and the kids; he planned to invest the assets as he pleased, and to charge lots of different fees. But he discovered that we could thwart his attempts to get his hands on the assets because he wasn't actually the executor (I was).
So should you select a family member to do the work? Beats me; I don't know your family. However, if you choose to have a family member (or other individual) to be your executor, you should check to make sure that individual agrees to take on the task. In addition, you should make plans in case that individual isn't available (e.g., dead).
For the case I dealt with, I was the executor. I retained an attorney to do the legal work and a excellent accountant to handle the tax issues. The article contributed by Joe Delano titled "What's Involved in Settling an Estate" in this issue of MeasureIT lists many of the tasks that need to be completed. I suspect that very few CMGers know about all these things; I certainly didn't. If you need to serve as executor, I strongly urge you to arrange for expert assistance so you can minimize the probability of getting into deep trouble. In doing your own estate plan, warn everyone about the need for expert help.
Life-Style Decision: Trust vs Probate
Probate is a legal process that distributes the estate (if its value is above a certain amount that may vary from state to state)[ii]. If you die and don't have a will (called being "intestate"), then the distribution will be as specified in your state of residence. The probability is high that this distribution will not be what you'd like. If you die and do have a will, your assets must still go through the process of probate. The process isn't totally unreasonable, but it is public[iii] and has to be done after you are dead and can't help.
An alternative to putting your entire estate through probate is to create a "living trust". This trust is created while you are alive, and you transfer assets to the trust (put your assets in the name of the trust). Doing this while you are alive is far easier than having your executor do it after you are dead. While alive, you can do it in a leisurely manner, and (because the assets clearly belong to you) you'll encounter a minimum of opposition from transfer agents.
A trust enables you to specify the distribution of assets sometime in the future (e.g., when children or grandchildren are going to college). This can be a distinct advantage because you have no way to determine how large the estate will be, or what amount of assets may be needed by your beneficiaries, or whether your spouse will die after you. Probably, you'd like to specify that your spouse will get your joint assets and then can give them to the kids, or provide them with the assets at the spouse's death. This disposition of assets can be handled by a living trust that is revocable while both spouses are alive, but becomes irrevocable when the first dies.
If an individual in your family is disabled (physically or mentally), you might investigate a Special Needs Trust. This type of trust exists for those who can't take care of themselves due to their special needs. If the individual qualifies for SSI[iv], a Special Needs Trust can be set up and provide income without compromising the SSI payments. For this type of trust, you should consult with an attorney that has the special expertise to deal with it; many estate attorneys do not.
Of course, a trust must have at least one trustee to manage its assets. Selection of trustees is as important as selection of an executor, and the selection criteria are generally the same. Financial institutions really like to be the trustee because of the opportunity to charge management fees and transaction fees as well as invest in things that may give them a business advantage.
There are advantages to using financial institutions and professional trustees, and they are very vocal about the advantages. The primary arguments are that they can invest more effectively than individuals, and that they can keep track of assets and file required reports. Unfortunately, significant cases of fraud have occurred over the years. Even when investments have been well-managed, problems have occurred in some cases with poor tracking of assets for individual trusts. (Investing is done after pooling of assets, and some of the IT systems were very flawed. Therefore, the quantity of assets in each trust couldn't be determined.) This doesn't mean that all such situations are bad, they may be just the thing for your situation. Just do a thorough evaluation of the alternatives.
Accumulating and Managing Retirement Funds: Credit Shelter Trusts
A common type of trust owes its existence to the Death Tax (Estate Tax). Upon a person's death, all assets can be transferred to the spouse without paying any Death Tax. However, transfers to anyone else requires payment of the tax (which may be 55% or more quite soon). Although the tax may be a high rate, there's an exemption which is implemented as a credit against the payable amount. The problem is that, without a trust, this credit will likely only be applied to the second spouse to die. A Credit Shelter Trust is designed to shelter the credit for the first person to die (along with the second one of course) so that both deductions can be used.
The arrangement involves putting your assets (community property in the State of California, but different in various states) into a trust. Then, when the first spouse dies, that spouse wills an amount of the assets equal to the exemption to Trust B (a part of the Credit Shelter Trust); the remainder goes into Trust A. There is no Death Tax to pay at this time. When the second spouse dies, the hiers have Trust B without any Death Tax, and they only need to pay the Death Tax on the assets that exceed the exemption.
Is this really legitimate? Yes it is, if all the rules are followed; you need an attorney to make sure that your effort is not in vain[v]. This attorney should specialize in estate law in the state of your residence.
Should you do this? That depends on the type and value of your probable estate. If your estate (including your home) is less than your guess at the Death Tax exemption when you die, then this holds no advantage to you[vi]. My concern is that the rate will increase and the exemption will decrease when the Federal Government decides it needs more money. If the exemption were cut, and the rate were increased to 55%, then this arrangement would pay off for my heirs; we have a Credit Shelter Trust.
Even if the value of your estate is large enough to justify a Credit Shelter Trust, your situation may indicate that other alternatives are more attractive. Your assets may reside in a tax-deferred account (like an IRA[vii]) and your heirs may also have (or are willing to setup) IRAs. In this case, a Stretch IRA may be advantageous.
Accumulating and Managing Retirement Funds: Stretch IRAs
Your retirement assets may have largely accumulated in a 401(k) that you plan to roll over into an IRA when you retire. (Your employer may strongly encourge this rollover.) In this case, you may want to keep that IRA to live on, but have it go to your children when you die.
If you designate the children (called 1st Daughter and 1st Son in the diagram to the right) as beneficiaries, they can put the assets into their own "stretch IRAs". Although the Death Tax has to be paid for transferring the assets, this technique allows the income tax to continue being deferred. The children then have the assets in an IRA and can continue having it grow.
The same kind of transfer can occur when 1st Son dies. The transfer now goes to his named beneficiary, your Grandson for example. The lifetime of your original IRA can therefore be stretched over several generations.
Several issues arise from stretch IRAs:
If you decide to use the stretch IRA approach, you should look to a specialist in the area -- probably an estate attorney from your state or a Certified Financial Planner.
Many alternatives for structuring your estate are available, but selecting the best for your situation will probablly require a Certified Financial Planner. That person can evaluate these, including:
Life-Style Decision: Documentation
People don't like to think about death, especially their own. However, they need to grit their teeth and get documentation together for their heirs so their death doesn't result in financial chaos. Delaying that documentation until you retire (and may have a bit more time) is a good strategy only if you have certain knowledge that neither you nor your wife will die before retirement. That doesn't include many CMGers that I know, so start with something and then keep changing it until you have what you want.
Five important documents to put together are:
These documents will determine the extent of confusion and effort that your heirs will need to cope with when you die. These are not "Do It Yourself" documents; the laws vary from state-to-state, and adhering to those laws is critical. So get an estate attorney in your state who specializes in these documents to do it for you. Creating these is rather routine for these folks; they have the wording for the various alternatives all in their PCs. The fee for this varies, but it may be $1,000 to $2,000.
After having these created, my wife and I gave our birth son a copy of everything and told him where the originals were located. In addition, I provide him a CD every few months that has a directory from my PC. That directory has files identifying all our assets, account numbers, names and addresses of attorneys and accountants, and all the transactions that have occurred over the last few years. My next step is to scan in all the critical documents like deeds, wills, and so on; then those files will go into that directory too.
And In Conclusion
You really need to get an estate plan together - unless you already have one. You don't know when you may die, so you need to get going.
If you don't even have a will, then get one of the cheap programs to create wills for you and your spouse. At least you'll have something that will help in case one of you have an untimely death. JUST DO IT!
After you have SOMETHING, then proceed to identify all the assets of your current estate and what you might have when you retire. Decide where you'd like your estate to go when you die, and who should be your executor.
At this point, you can get together with a Certified Financial Planner (like Joe Delano) to see what arrangements will probably serve your needs. After that, have an attorney in your state of residence draw up the papers. Do not stop until you have the attorney's help!
If you and your spouse have IRAs or 401(k)s (or the equivalent), make sure the beneficiaries are designated properly. If you set up a trust, transfer your assets into it.
Keep the estate plan in mind as things happen. You should see whether changes are required if:
Lessons Learned
If you'd like to reach Joe Delano or me, please put [CMG] at the beginning of your Subject Line. Our e-mail addresses are:
[i] This is an especially good time for such gifting because the current value of your assets is down (and will probably go back up eventually). See!! There is something good about current economic conditions!
[ii] If you're interested in some of the issues in probate (at least in California), you can go to the following url: http://www.scselfservice.org/probate/prop/FrequentlyAskedQuestions2.htm Some states (at least 18) have adopted the Uniform Probate Code. For information about that, see the following url: http://www.law.cornell.edu/uniform/probate.html
[iii] Probably few CMGers are rich enough or famous enough to have reporters following your possible probate, but your family's privacy willstill be compromised.
[iv] SSI is the Supplementary Security Income that is administered by the Social Security Administration. An introduction to it can be found at the following url: http://www.ssa.gov/pubs/11000.html
[v] Among other things, the name on an account is important. For a Credit Shelter Trust, you might look at the following url: http://www.abanet.org/legalservices/lamp/cle/estatetaxandyourdisclaimercreditsheltertrust.pdf However, check with your attorney to get it right.
[vi] The Credit Shelter Trust may not be valuable to you, but you may want a trust anyhow. Other advantages (like limiting disputes between heirs) may still drive you toward a trust.
[vii] An individual retirement account (IRA) is a trust or custodial account set up in the United States for the exclusive benefit of you or your beneficiaries. For details, see IRS Publication 590 at the following url: http://www.irs.gov/pub/irs-pdf/p590.pdf
[viii] The Minimum Distribution Requirement applies when the original IRA holder reaches 70½. The minimum amount of distribution from the IRA is determined by dividing the assets value by the expected number of years to live (as specified by the IRS). For beneficiaries, the MDR must also be distributed, based on the beneficiary's age. A good starting point for the MDR is at the following url: http://www.irs.gov/retirement/article/0,,id=96989,00.html For a Stretch IRA, the rules are more complicated; you can see some useful information at the following url: http://moneycentral.msn.com/content/Taxes/Taxshelters/P33760.asp However, check with your Certified Financial Planner or estate accountant to get it right.