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Wednesday, January 4, 2012

Do I Really Need Advance Directives for Health Care?

Do I Really Need Advance Directives for Health Care?

Many people are confused by advance directives. They are unsure what type of directives are out there, and whether they even need directives at all, especially if they are young. There are several types of advance directives. One is a living will, which communicates what type of life support and medical treatments, such as ventilators or a feeding tube, you wish to receive. Another type is called a health care power of attorney. In a health care power of attorney, you give someone the power to make health care decisions for you in the event are unable to do so for yourself. A third type of advance directive for health care is a do not resuscitate order. A DNR order is a request that you not receive CPR if your heart stops beating or you stop breathing. Depending on the laws in your state, the health care form you execute could include all three types of health care directives, or you may do each individually.

If you are 18 or over, it’s time to establish your health care directives. Although no one thinks they will be in a medical situation requiring a directive at such a young age, it happens every day in the United States. People of all ages are involved in tragic accidents that couldn’t be foreseen and could result in life support being used. If you plan in advance, you can make sure you receive the type of medical care you wish, and you can avoid a lot of heartache to your family, who may be forced to guess what you would want done.

Many people do not want to do health care directives because they may believe some of the common misperceptions that exist about them. People are often frightened to name someone to make health care decisions for them, because they fear they will give up the right to make decisions for themselves. However, an individual always has the right, if he or she is competent, to revoke the directive or make his or her own decisions.  Some also fear they will not be treated if they have a health care directive. This is also a common myth – the directive simply informs caregivers of the person you designate to make health care decisions and the type of treatment you’d like to receive in various situations.  Planning ahead can ensure that your treatment preferences are carried out while providing some peace of mind to your loved ones who are in a position to direct them.



Tuesday, October 27, 2009

Estate Planning Pitfall: You plan to take a retirement distribution later this year

If you’re over the age of 70½ — or if you reach that age this year — you may be planning to take required minimum distributions (RMDs) from your IRA, 401(k) plan or other retirement accounts later this year. But you may be better off taking advantage of a tax law change that lets you skip RMDs this year.

Leaving funds in your tax-deferred accounts as long as possible often can make sense from an estate planning perspective. The longer you allow your retirement funds to grow on a tax-deferred basis, potentially the more there will be for your heirs.

Normally you must take your first distribution by April 1 following the year you turn 70½. After that, annual distributions are required no later than Dec. 31. Many people take their first RMD during the year they turn 70½ to avoid taking two distributions the following year.

In the economic downturn, the value of many investments has declined, so it’s not the best time to make withdrawals from tax-deferred accounts. Lawmakers recognized this when they enacted the Worker, Retiree and Employer Recovery Act of 2008 late last year. The act suspended RMDs for 2009.

If you reached age 70½ before this year, you can skip the distribution that would have been required by Dec. 31, 2009. And if you turn 70½ during 2009, you can skip your first RMD — which would have been due by April 1, 2010 — so you won’t have to take an RMD until the end of 2010.

The act also provides relief for people with inherited retirement accounts. The rules are a bit complicated, though, so if you’re in that situation, consult your estate tax advisor to find out whether you’re entitled to skip this year’s RMD.

Tuesday, October 20, 2009

Know the Basics of Basis

To transfer your wealth in the most cost-effective manner, it’s important to understand how an asset’s income tax basis affects your estate planning strategies. The basis that your beneficiary receives in an asset depends on how you transfer it, and this can have a large impact on the recipient’s income tax bill.

What is basis?

Essentially, basis is the cost associated with an asset. It’s used to measure your gain or loss when you dispose of the asset and, if the asset is used in your business, it’s used to determine the amount of depreciation, depletion or amortization deductions.

When you sell an asset, your gain or loss is determined by taking the sale proceeds and subtracting your adjusted basis. So, for example, if you purchase stock for $100,000 and sell it for $150,000, you’ll recognize a $50,000 gain. On the other hand, if you sell the stock for $75,000, you’ll have a $25,000 loss. 

The starting point for calculating an asset’s basis is the price you pay for it (including the amount of any existing debt you agree to assume in connection with the purchase). But depending on the nature of the asset, your basis may be adjusted to reflect changes that increase or decrease your investment in the asset.

Suppose, for example, that you purchase stock in an S corporation. Your initial basis is the price of the stock plus the adjusted basis of any property you contribute to the corporation.

Over time, your basis is increased by your taxable share of the corporation’s income, as well as by additional capital contributions or loans you make to the corporation. (Be aware that your basis isn’t increased by the fact that you guarantee a loan made by the corporation.) Your basis is decreased by items such as your share of distributions and any tax losses that are passed through to you.

Your basis in an asset has significant tax implications, so it’s important to track basis carefully and to document any events that increase or decrease it.

Why does basis matter?

From an estate planning perspective, basis is important because it affects the amount of taxable gain your beneficiary will recognize should he or she sell the asset. And your beneficiary’s basis in an asset depends on the manner in which you transfer it.

The general rule is that, when you transfer an asset at death, your beneficiary receives a “stepped-up” basis equal to the asset’s fair market value on that date. If you transfer an asset by gift, however, your adjusted basis in the asset “carries over” to your beneficiary.

At first glance, it would seem that transfers at death are preferable because a stepped-up basis minimizes the gain on a sale of the asset. But it’s not that simple. To determine the best strategy for transferring assets you need to look at the big picture.

First, consider your basis in an asset. If the asset’s value hasn’t appreciated significantly — so that its fair market value isn’t substantially higher than your basis — then the manner in which you transfer the asset won’t have a big tax impact on your beneficiary. Also, if your beneficiary plans to hold onto the asset rather than sell it, the income tax implications may not be a significant factor.

Case in point …

It’s important to balance any negative income tax consequences against potential transfer tax savings. For example, Todd, whose net worth is well above the $3.5 million estate tax exemption, wants to transfer $1 million in publicly traded stock to his daughter, Rebecca. Todd’s adjusted basis in the stock is $200,000, and he’s already used up his $1 million lifetime gift tax exemption.

If Todd gives the stock to Rebecca, he’ll owe $450,000 in gift tax (assuming a 45% rate). His basis carries over to Rebecca, and she also gets to increase her basis by virtue of the fact that he paid gift tax.

The increase is determined by a formula of the gift tax paid and the appreciation gifted. In this instance, she increases the basis by 80% of the $450,000 gift tax paid. Thus, her adjusted basis is $560,000. So if she sells the stock she’ll recognize a $440,000 gain, resulting in a $66,000 federal capital gains tax liability (at the current rate of 15%). (For illustrative purposes, it’s presumed that Rebecca lives in a state that has no income tax.) The combined tax on the transfer (assuming Rebecca sells the stock immediately) would be $516,000.

It seems that a transfer of the stock at Todd’s death is preferable because Rebecca would receive a stepped-up basis and avoid the $440,000 gain. That would be true if Todd were to die tomorrow. But what if he dies 10 years later and the stock’s value grows to $2 million? Rebecca wouldn’t inherit any built-in capital gains, but Todd’s estate would owe $900,000 in estate tax (assuming no change in the estate tax rate).

As you can see, determining the best strategy can be a challenge. Are Todd and his family better off paying $516,000 in taxes now or $900,000 in 10 years? Will the stock’s value actually double in 10 years? The answers depend on the time value of money and Todd’s best guess of the stock’s performance and value in the future.

Bear in mind that, if Todd had not previously used his lifetime gift exemption, there would be no gift tax paid on the gift and, consequently, no adjusted basis for Rebecca. If she were to sell the asset immediately, her gain would be $800,000, and she’d owe a capital gains tax of $120,000.

What does the future hold?

Complicating matters further, as of this writing current law calls for the estate tax to be repealed in 2010 and to be reinstated in 2011. During 2010 only, assets transferred at death won’t be entitled to a stepped-up basis, except for a limited amount of property.

It’s likely that Congress will pass legislation this year that preserves the estate tax, but it’s not yet clear whether such legislation will modify the basis rules. So it’s important to keep track of your income tax basis in various assets and to evaluate its potential impact on your estate plan.

Thursday, August 20, 2009

If you don't have a succession plan

Estate planning pitfall:
You don’t have a succession plan for your estate plan

Some of the most important estate planning decisions involve naming people to act on your behalf after you die or, in the event you become incapacitated, during your life.

You’ll want to select people you trust and who possess the skills, experience and temperament necessary to carry out your wishes. You should also choose at least one, and preferably two, successors for each of these representatives. If you don’t, and one of them dies or is otherwise unable to serve, a court will make the decision for you (usually with some input from your family).

Common estate planning documents that should include successor designations include your:

  • Will. Your will should designate a successor executor, especially if you’ve named your spouse as the executor, because he or she might decline the burden of administering your estate while grieving your death. Further, if you have children who are minors, the will is the place for you to designate guardians for those children.
  • Trusts. Trustees often have considerable discretion to distribute funds and make decisions in accordance with your wishes, so selecting their successors is just as important as selecting the original trustees. Another option is to create a mechanism for the current trustee or beneficiaries to name successor trustees.
  • Health care documents. A health care power of attorney authorizes another person to make medical decisions for you, including decisions on life-sustaining treatment, when you’re unable to make them yourself. Your spouse will probably be your first choice, but it’s critical to choose one or more successors in the event he or she is unavailable or otherwise unable to make the decision.
  • Power of attorney. This document authorizes your spouse or another representative to manage your financial affairs. If he or she is unable to act, you need to have a successor ready to take over at a moment’s notice.
To avoid having a court make these decisions for you, review your executor, trustee, agent and proxy designations periodically to be sure you have replacements who are ready, willing and able to step in should the need arise.

Tuesday, August 18, 2009

A "Principle Trust" can help achieve your estate planning goals

For many, an important estate planning goal is to encourage their children or other heirs to lead responsible, productive lives. A popular tool for achieving this goal is the incentive trust, which conditions distributions on certain “acceptable” behaviors. But is this your best option?

Rigid distribution rules problematic
An incentive trust attempts to shape your beneficiaries’ behavior by conditioning distributions on specific benchmarks that are readily understandable and achievable. Examples include obtaining a college degree, maintaining gainful employment, or refraining from unacceptable behaviors such as drug or alcohol abuse or gambling.
In an effort to quantify acceptable behavior, some incentive trusts provide for matching distributions based on a beneficiary’s salary or charitable donations. Unfortunately, this approach can lead to unintended consequences.
For example, if your trust conditions distributions on gainful employment or matches a beneficiary’s salary dollar-for-dollar, it may discourage heirs from becoming stay-at-home parents, doing volunteer work or pursuing less lucrative but worthwhile careers, such as teaching or social work. If the benchmark is graduating from college or obtaining a graduate degree, the trust may unfairly penalize family members with disabilities or who simply lack the temperament or capacity for higher education.
One potential solution is to design a detailed trust document that attempts to cover every possible contingency or exception. Not only is this time-consuming and expensive, but, even with the most carefully drafted trust, there’s a risk that you’ll inadvertently disinherit a beneficiary who’s leading a life that you’d be proud of. Or, the trust may reward a beneficiary who meets the conditions set forth in the trust but otherwise leads a life that’s inconsistent with the principles and values you wish to promote.
Principles trump incentives
If you’re comfortable giving your trustee broader discretion, consider using a principle trust, instead. By providing the trustee with guiding values and principles rather than rigid rules, a principle trust may be a more effective way to accomplish your objectives.
A principle trust guides the trustee’s decisions by setting forth the principles and values you hope to instill in your beneficiaries. These principles and values may include virtually anything, from education and gainful employment to charitable endeavors and other “socially valuable” activities.
By providing the trustee with the discretion and flexibility to deal with each beneficiary and each situation on a case-by-case basis, it’s more likely that the trust will reward behaviors that are consistent with your principles and discourage those that are not.
Suppose, for example, that you value a healthy lifestyle free of drug and alcohol abuse. An incentive trust might withhold distributions (beyond the bare necessities) from a beneficiary with a drug or alcohol problem, but this may do very little to change the beneficiary’s behavior. The trustee of a principle trust, on the other hand, is free to distribute funds to pay for a rehabilitation program or medical care.
At the same time, the trustee of a principle trust has the flexibility to withhold funds from a beneficiary who appears to meet your requirements “on paper,” but otherwise engages in behavior that violates your principles. Another advantage of a principle trust is that it gives the trustee the ability to withhold distributions from beneficiaries who neither need nor want the money, allowing the funds to continue growing and benefit future generations.
Not for everyone
Not everyone is comfortable providing a trustee with the broad discretion a principle trust requires. If it’s important for you to prescribe the specific conditions under which trust distributions will be made or withheld, an incentive trust may be appropriate. But keep in mind that even the most carefully drafted incentive trust can sometimes lead to unintended results, and the slightest ambiguity can invite disputes.
On the other hand, if you’re comfortable conferring greater power on your trustee, a principle trust can be one way to ensure that your wishes are carried out regardless of how your beneficiaries’ circumstances change in the future.

Friday, September 26, 2008

Not Using a Trust When You Should

Estate Planning Pitfall: Not using a trust when you should

Determining if a trust is appropriate for you depends on your objectives and your needs. Suppose, for instance, you have adult children in whose ability to handle the financial responsibility of inheriting your estate you have complete confidence. You’re unsure whether the idea of keeping assets in trust for them after your death is appropriate.

It would still make sense to use a trust during your life, as doing so will allow for the seamless transition of control of the assets at your death. And assets held in your trust prior to your death will pass to the beneficiaries without being subject to probate, which can be expensive and always is a public process.

In deciding whether to keep assets in trust after your death, though, you need to weigh the disadvantage of burdens — and, more important, the idea of having the assets “tied up” rather than going outright to your children — against the potential estate tax benefits down the road. 

Your circumstances will help to determine whether the assets should remain in trust. For instance, depending on the size of your estate, the trust can provide a means of keeping assets outside of the estate tax system forever or, at a minimum, for at least a generation.

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