Mortality: a topic that few enjoy ruminating, but nonetheless an important component of financial planning. What happens to your estate should you become ill, incapacitated or (gulp) die?
If you have been reading the “Thrive” series this year, you know we’ve covered debt management and cash flow; investments and retirement; and making the most of employee benefits — all with the underlying message of working with a certified financial planner to build your estate. And while the stereotypical “wealth management” image is of nice possessions or someone swinging in a hammock without a worry in the world, the time when a solid financial plan truly shines is in the event of tragedy.
If you are diagnosed with an illness or have an accident, financial planning is the last thing you want to deal with (or make your family or loved ones deal with) when all energy should be focused on recovery and health — or love, connection or loss.
A financial power of attorney, or POA, is a legal document that gives someone the authority to act on your behalf in financial matters. Most POAs are issued in cases of illness, disability or if you are simply not present to sign important paperwork, such as with travel abroad during which you cannot physically execute important transactions or decisions. You can choose to grant power of attorney to a trusted person you know (called “the agent”), and the power can be very broad or quite restrictive, depending on your preference.
“It’s important that you designate someone to have this authority in the event that you become ill, disabled or otherwise unable to execute on important financial matters,” says certified financial planner Ben Smith, founder of Cove Financial Planning in Milwaukee, Wis. “Otherwise the courts may appoint a conservator over your finances, which often is a lengthy and costly process.” Plus, neither a court nor a conservator will know you or understand your wishes as well as somebody you trust and with whom you have discussed these matters.
“Make sure your financial planner has a copy of the power of attorney paperwork along with your agent’s contact information,” adds Smith. “And remember that financial POA typically expires upon death, so it’s essential to have a will in place.”
Unless your financial planner is also an attorney, it’s not likely they would be directly involved with writing your will; however, your planner can advise on considerations as you create your estate plan. “For example, you might discuss how certain accounts are taxed at death and their impact on your estate plan. This may involve the creation of trusts, which your attorney would take the lead in creating,” says Smith.
You also can talk with your financial planner about reviewing and updating your beneficiary designations. Beneficiaries can be designated on investment accounts, insurance policies, annuities and other accounts. The designation assigns your assets or death benefits to one or more people or an organization upon your death. “You can name primary beneficiaries to receive the entire asset,” says Smith, “as well as secondary beneficiaries, who will receive the entire asset if your primary beneficiary passes away or is otherwise unable to accept the inheritance.”
One of the oft-asked questions is: How is debt paid and could my family be left holding the bag? In short, when you die, your bills are paid out of your estate and any leftover assets are distributed through a process called probate. Some states have “community property” laws that make spouses liable for any debt accrued during the marriage, but beyond that, the people typically responsible for the debt of an individual who has died are co-signers on a loan and joint owners of a credit account. If your estate does not have enough assets to cover your debts, depending on where you live and the conditions of the loan agreement, a loved one could be liable — which is another reason to speak with a financial planner.
If you are on the receiving end of an inheritance, there are considerations with which to become familiar. For example, a cost basis is essentially the amount of money one originally paid for an asset. If the asset increases in value over time, when it is sold, it may be subject to a capital gains tax. This is especially important for taxable assets [those not held in a retirement account like an IRA or 401(k)].
“When you pass away, your assets generally receive a ‘step up’ in cost basis,” says Smith. “That means if the person who inherited the asset sells it right away, capital gains tax may not be required.”
If you inherit a retirement account, keep in mind that Congress updated rules related to required minimum distributions, or RMDs, for retirement accounts. Anybody other than a spouse who inherits a retirement account has a finite time period to deplete it — and those withdrawals are taxed.
“It’s always a good idea to properly prepare your own accounts prior to incoming inheritance,” says Smith. Often, the money you receive from an inheritance will need to be transferred to a “like” account, such as an IRA to an inherited IRA, or a taxable brokerage account to another taxable brokerage account. “Taking care of these logistical items as early as possible can make the estate settlement process go much more smoothly, particularly while dealing with the emotional impact of losing a loved one.”
Finally, Smith encourages asking your financial planner and lawyer (and accountant if you have one) to work as a team. “With your permission, these professionals involved with your financial life can coordinate together to create the best possible estate plan based on your needs,” says Smith. “Don’t feel like you should have to be the intermediary in getting all of this done.”
Anticipating tragedy is not a pleasant thought but having a solid financial plan in the event of illness, accident or death offers peace of mind for you and your family — and that can make the good times so much greater.
Follow and tweet Ben on Twitter at @BenSmithPlanner.
