Last month, I was at a networking breakfast enjoying a cup of coffee with fifty of my closest business friends and chatting with a young woman I hadn’t met before. As happens at these things, the conversation led to the inevitable question about what I do. My answer – estate planning – led to an equally inevitable response from my new friend. “I don’t have an estate, so I don’t need a plan.”
I would bet good money that she is wrong, and here’s why. Everyone has assets and everyone will die. I know that sounds a little harsh and you might doubt the truth of the first statement, but the second assertion should be no surprise. To illustrate my case, let’s look at two examples: (1) a married couple with young kids and (2) a widower with a bank account, an investment account and adult children.
Example 1: Married couple with young kids
The married couple owns a house with a big mortgage on it, one spouse works, and one spouse stays home with the kids. The couple knows that if something happened to either spouse the family would be in dire straits, so they have life insurance policies large enough to cover the mortgage and provide living expenses for the surviving spouse (they are young and in good health so the premiums are cheap). The primary beneficiary on each policy is the other spouse and the successor beneficiaries are their children. The couple goes out for their monthly date night and are hit by a drunk driver and both tragically die.
- Who will take care of the children? Without a will or other valid document nominating a guardian, the choice is left to the courts. Yes, the fate of these children now rests with a local district court judge. In the best case scenario, a loving family member will file a guardianship case and no one will challenge it. A less ideal outcome is that family members will fight over guardianship and they will be embroiled in a long, expensive custody battle. The worst case scenario is that no family member is suitable or willing to be a guardian and the children are placed in the foster care system.
- What will happen to the house? The bank will most likely foreclose on the property.
- What will happen to the life insurance proceeds? Under most state laws, the insurance company cannot write a check to a minor child. Before the proceeds can be released, a custodian of the money must be appointed by a court, otherwise the insurance company will hold the funds in a special account until the children reach the age of majority.
The couple could have avoided these outcomes with some basic estate planning. At the minimum they could have signed wills nominating a guardian for their children and a custodian for the insurance proceeds, and changed their beneficiary designations to the custodian for the children under the Oklahoma Uniform Transfer to Minors Act (there are traps here for the unwary so consult an attorney). The best option would be to set up a living trust to own the house, designate a guardian and a trustee, receive the insurance proceeds, pay off the mortgage, transfer the house to the children when they reach the age of majority, and establish strict rules on how money can be spent by the trustee.
Example 2: Widower with a bank account, an investment account and adult children
The widower doesn’t want his kids to mess with probate (the court process to transfer property to your heirs). I don’t blame him; probate is expensive, complicated, and can take a long time. A good friend of the widower told him to just add his oldest daughter to the bank account and the investment account as a joint tenant with a right of survivorship. That way, when the father dies, everything automatically transfers to the daughter. The father did this and his daughter assured him that she would share everything equally with her three siblings. The father lives a long a prosperous life and does not die until several years after retitling the accounts. What could possible go wrong?
- Really bad outcome number 1: The daughter is at fault in a car wreck and is sued. The judgment against her is above the limits of her insurance policy. The judgment creditor collects from the daughter’s assets, which include the father’s accounts. Because she is a co-owner of the accounts, they are subject to her debt.
- Really bad outcome number 2: Father dies and daughter does not honor his request that she share equally with her siblings. Because she has a right of survivorship, upon the father’s death the accounts transfer outright into her name. She has no legal obligation to share and the probate courts have no jurisdiction over non-probate assets. The siblings have no recourse against their sister.
- Really bad outcome number 3: Father dies and the daughter honors his wishes that she share equally with her siblings. The investment account has grown to a substantial amount. Because the account passes to her under the right of survivorship, it is not subject to estate tax. However, when she transfers money to her siblings she is transferring assets from herself (not from her father) to her siblings. This type of transfer is considered a gift by IRS and anything over $14,000 is subject to gift taxation. Although there are ways to reduce or avoid the gift tax, you need to talk with both a CPA and an attorney.
As in example one, the widower could have avoided these outcomes with some simple estate planning. First, he could have used a power of attorney so that his eldest daughter could assist him in managing his accounts without subjecting them to her liabilities. He could have designated all of his children as beneficiaries in equal shares and avoided the gift tax issue entirely. If he had established a living trust, he could have shielded his children’s inheritances from their creditors.
In either example, bad outcomes result from no planning or poor planning. Even the smallest and simplest estates need a solid plan. Talk to an estate planning professional to learn more about how you can protect your loved ones.