The Bogleheads' Guide to Retirement Planning (43 page)

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Authors: Taylor Larimore,Richard A. Ferri,Mel Lindauer,Laura F. Dogu,John C. Bogle

Tags: #Business & Economics, #Investing, #Personal Finance, #Business, #Business & Money, #Financial, #Non-Fiction, #Nonfiction, #Retirement, #Retirement Planning

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List each insurance policy and annuity contract, the policy or contract number, the issuing company, and the contact information of the company. Either include the policy/contract or provide directions to where each policy or contract can be found.

Advisers

Include in this section contact information for your attorney, accountant or tax preparer, insurance agents, investment adviser, spiritual leader, and any other person you desire to be notified in the event of your death or disability.

Wills

Your will must meet the technical requirements for a will in order to be valid. The consequence of not meeting those requirements is that you will be considered to have died intestate, and parties other than those you intend may end up inheriting your assets. In some states, a will must be in writing and must be signed at the end and in the presence of two witnesses, who also sign.

Wills typically contain an introductory paragraph, a paragraph directing payment of debts and expenses, a paragraph identifying family or perhaps identifying the beneficiaries, a paragraph naming the personal representative (executor), a paragraph specifying the powers of the personal representative, and one or more paragraphs directing the ultimate disposition of the estate. There may also be paragraphs establishing trusts for minor beneficiaries and a paragraph allowing the personal representative to pay the bequest to any minor or disabled person to a fiduciary or to set up a Uniform Gift to Minors Act account.

If your estate plan includes a living trust, you will have a special kind of will, known in the will-drafting trade as a pour over will, which directs the personal representative to distribute your assets to the trustee of your trust. The trust (more on trusts later) will then control the ultimate distribution of your assets.

There are some common misconceptions regarding wills. The following is a summary of those misconceptions:

•
Wills and Probate:
“If I have a will, does that mean my estate will not have to go through probate?” Despite the common belief, it is not true. Wills are administered through the process of probate, and there is no way to avoid it unless one uses a trust or pay-on-death account or the asset is one that by statute is not subject to probate, such as an annuity.

•
Disclaimers:
Suppose Auntie Edna leaves you all of her $100 million fortune. You are her sole heir. The only problem is, you just sold your Internet start-up company for $475 million, and you really don’t need the money. What do you do? Well, you could accept the inheritance and just pass it on to your son when you die. But if you do that, your son will end up paying estate tax on his inheritance. Assuming the maximum estate tax rate will be 60 percent, he could lose 60 percent of the $100 million to taxes when you inherit and another 60 percent when you die and he inherits. A lightning-quick calculation on your part reveals the loss could be $60 million on the first inheritance and another $24 million on the second inheritance, a total of $84 million lost to taxes. Ouch! What do you do? You go to your attorney’s office and explain the situation. “Don’t worry,” says he, and he explains that under the federal tax code, you can disclaim an inheritance by filing a qualified disclaimer, and by doing so, you will be treated as if you died before Auntie Edna and never received the inheritance. He further explains that since Auntie Edna left the money to you per stirpes, a quaint Latin phrase translated “by the roots,” the property descends in the family line. If you file the disclaimer, young Jake will inherit Auntie’s fortune. Since you did not inherit, the estate tax due on your death will be avoided. Jake will be $24 million richer than he would have been, had you taken the inheritance for yourself. There are many other potential uses for qualified disclaimers—too many to go into here—but their use should always be considered in planning and administering taxable estates. Qualified disclaimers must be filed within nine months of the date of creation of the interest disclaimed and must meet the requirements of the Internal Revenue Code.

Trusts

A trust is an arrangement in which one party agrees to manage assets contributed by another party for the benefit of a third party. Under common law, all the parties had to be separate individuals. By statute, they can now be the same individual, creating a convenient legal sleight of hand that conveys many benefits.

Trusts accomplish three main objectives. First, the assets transferred to a trust during life avoid probate and hence potentially reduce the cost of administration of an estate after the death of the person who originally established the trust. Second, trusts provide a means of providing for the orderly administration of a person’s assets when that person, or the person designated to receive the benefits of the assets, is unable to administer the assets for themselves. Third, trusts provide a means of protecting assets and conserving them for the benefit of those designated to receive the benefit of the trust.

The People Involved

The person who contributes the assets to the trust is known as a settlor, grantor, or trustor. The person who manages the assets is known as the trustee. The person for whom the assets are managed is known as the beneficiary or, much less commonly, the
cestui que trust.

Revocable versus Irrevocable

When a settlor decides to establish a trust, he or she must first decide whether to reserve the power to terminate the trust and, hence, recover the assets from the trustee on demand. If the settlor reserves the right to terminate the trust, the trust is a revocable trust. If the power to terminate is not reserved, the trust is irrevocable. The rule cited is the rule under common law.

In some states, trusts are considered to be revocable unless the trust document specifically states the trust is irrevocable. Irrevocable trusts are often structured to hold life insurance policies on the life of the grantor. Such trusts, known as irrevocable life insurance trusts or ILITs, can be used to pass large sums to beneficiaries free of estate tax if correctly structured.

If the settlor decides to name herself or himself as initial trustee, the trust document is known as a declaration of trust. If the settlor names a third party as the initial trustee or as joint trustee with the settler, the trust document is known as a trust agreement.

A trust in which the settlor is the source of the assets contributed is known as a self-settled trust. That term is not used when the source of assets is a third party. In most states, a self-settled trust provides no protection from creditors’ claims, but there are exceptions. Consult an attorney for details.

Charitable Trusts

Trusts can be classified by the objective of the trust. A trust is known as a charitable trust if the primary objective is to benefit a charity. There are two common types: charitable lead trusts and charitable remainder trusts.

Trusts in which the charity receives the initial stream of payments from the trust, and after those payments have been distributed, whatever is left is distributed to some third party, are known as lead trusts. The charity leads the way in receiving payments from the trust.

Trusts in which the charity benefits only after one or more intermediate parties benefit are known as charitable remainder trusts. The charity gets the remainder only after a specified series of payments have been paid to the initial beneficiaries.

Two types of remainder trusts are commonly used; the grantor retained annuity trust (GRAT) and the grantor retained unitrust (GRUT). The difference between the two lies primarily in how the stream of payments is determined. In a GRAT, the grantor gets a fixed amount of money over a fixed period of time, usually in payments paid annually or more often. In a GRUT, the grantor receives a fixed percentage of the trust assets for a fixed period of time. The amount to be paid is determined annually.

Charitable remainder trusts are useful when one desires to receive income from an asset during life and wishes to receive a charitable contribution income tax deduction as well. It is even possible to use the money received, and perhaps the tax savings, to fund a separate ILIT to provide additional money to beneficiaries, free of estate taxes. Chapter 17 provides more detail.

Special Needs Trust

A special needs trust is established for a person suffering from some disability, such as a severe physical or mental disorder. The trust serves as the repository for the assets because, if the disabled person received the assets directly, the receipt of the assets might disqualify the disabled person from receiving public benefits. Special needs trusts must be constructed very carefully, so consult an attorney with experience in these types of trusts.

Powers of Attorney

The power of attorney allows the person you name, known as an agent or attorney in fact, to act for you and to take the actions authorized in the power of attorney. Powers of attorney are of two types: regular and durable.

A regular power of attorney is suspended if the principal, the person writing the power of attorney, becomes disabled. By statute in most states, disability will not suspend a durable power of attorney.

A durable power of attorney will allow the attorney in fact to take any action the person making the power of attorney could do if personally present. Typical powers granted—and this is by no means an exhaustive list—include the power to initiate banking and securities transactions, the power to demand and receive, the power to sue or defend lawsuits, the power to apply for government benefits, the power to fund a trust or perhaps even create a trust, the power to make transfers for Medicaid qualification, and the power to make health-care decisions.

Designating a Health-Care Surrogate

The designation of health-care surrogate (DHCS) is an alternative to a durable power of attorney. A DHCS contains health-care provisions and allows a person you name to step in and make medical decisions for you, if you become incapable of making them for yourself. The DHCS form allows the person you name to do anything in regard to your health care that you could do yourself, were you able to do so.

The powers granted in a DHCS usually come into play only after the maker has been declared incapacitated by one or more physicians. Examples of things a person designated as health-care surrogate can do include hiring and firing doctors, selecting health-care facilities, consenting to operations, authorizing other necessary treatment, and consenting to the administration of antibiotics and other necessary medications.

Advance Directives/Living Wills (AD/LW)

A living will prevents you from receiving medical care when your death is inevitable. People typically desire to be allowed to die without the application of heroic measures to prolong the dying process. In rare cases, a living will is structured to require medical care even if the situation appears to be hopeless.

The agent you name in your living will has the power to discontinue treatment measures designed to prolong your life or to prevent those measures from being taken. Before that happens, your physician and one other doctor must agree that you are in a terminal condition, an end-stage condition, or a persistent vegetative state.

Business Buy-Sell Agreements

Failure to plan for a key person leaving a business can result in loss of control by the remaining participants, admission of an outsider to the business, forced curtailment of expansion plans, or even the forced liquidation or sale of the business. Buy-sell agreements allow for the orderly transition of ownership in a business when a participant leaves the business for ill health, retirement, death, or other reasons.

The first thing to decide is who will purchase the business if someone leaves. Among the available choices are all or some of the remaining members of the business, the business itself, or an outsider.

Funding Alternatives

Many buy-sell agreements are drafted with the thought that a key participant in a business might die, and so they are funded with life insurance. If a whole life policy is used (admittedly, an expensive way to go), the policy will build up a cash value over time that can also be used as the basis for a loan to fund a buyout if someone leaves the business for a reason other than death. It may also be possible to fund the purchase with a loan from a third party, but consideration should be given to the likelihood that the death or departure of a key person may affect the ability of the remaining members to obtain a loan or may affect the terms on which a loan would be offered. Finally, the remaining members of the business can personally assume the obligation to buy out the departed member. When they have the obligation to do so, the agreement usually provides for a down payment and the purchase of the departed party’s interest over time at a stated interest rate. The departed party usually retains a security interest in the interest sold (which may be released as payments are made) to secure payment for the interest.

As the great Texas football coach Darrell Royal said about passing the football, “Three things can happen when you pass the ball, and two of them are bad.” (This quote has also been attributed to General Robert Neyland when he coached at the University of Tennessee, Coach Duffy Dougherty of Michigan State University, and others.) Likewise, many things can happen when one fails to plan for business succession, and most of them are bad.

ADDITIONAL RESOURCES

The following books on wealth preservation are recommended:

• James E. Hughes Jr.,
Family Wealth—Keeping It in the Family
(rev. and expanded ed.). Bloomberg Press, 2004.

• Gerald M. Condon,
Beyond the Grave
(rev. ed.). Collins Business, 2001.

• Kathryn G. Henkel,
Estate Planning and Wealth Preservation.
Warren Gorham & Lamont, 1998.

CHAPTER SUMMARY