Debts and Death

Dear Garden State Trust Company:

What happens to my debts when I die?

—STILL PAYING THE MORTGAGE

 

Dear Still:

According to a study by the credit bureau Experion, released in December 2016, some 73% of consumers have debts when they die, including mortgage debt.  Some 68% have credit card debt; 37% have mortgage debt; 25% have car loans; 12% have personal loans, and 6% are still paying off student loans.  The average total debt at death for these consumers was $61,554.

That does not mean all these people died virtually bankrupt.  The study does not include an assessment of how large the estates were. Most likely, most estates were large enough to retire the debts.

At your death, your debts pass to your estate, just as your assets do. Your executor will be responsible for paying off those debts. All debts and taxes must be paid before any inheritance is distributed to your heirs.  

If there are not enough cash or life insurance proceeds in the estate to meet the debt and tax obligations, some assets may have to be sold to raise the money. This could include the family home.  If there is a mortgage on the house, the heirs may be able to take over the responsibility for paying the mortgage, to avoid a forced sale.

If you should die without any assets at all, your debts die with you.  But try not to let that happen.

Do you have a question concerning wealth management or trusts?  Send your inquiry to contact@gstrustco.com.

© 2017 M.A. Co.  All rights reserved.

The Trouble with Powers of Attorney

Reportedly the incidence of Alzheimer’s disease among those 85 and older is about 47%.  This population needs help with financial management.  Perhaps the most common tool to permit a family member to assist with handling an elderly person’s assets is the power of attorney.  Unfortunately, the power of attorney can also be an avenue that leads to financial abuse of the elderly.  Attorneys Martin Shenkman and Jonathan Blattmachr outlined steps that may be taken to head off such problems without compromising flexible financial management for the elderly person (“Powers of Attorney for Our Aging Client Base,” published in the July 2015 issue of Trusts & Estates magazine).  Among their recommendations:

  • Joint agents.  Checks and balances for the power of attorney may be created if more than one person must sign off on the exercise of the power. Although this may limit quick decisions in the event of an emergency, the tradeoff for greater security may be worthwhile.
  • Care managers.  An independent care manager may be hired to evaluate the elder periodically to report to the elder’s health care agent.  The care manager can determine whether the appropriate care is actually being provided to the elderly person.
  • No more gifts.  In the usual case, one who holds a power of attorney cannot make gifts of the elderly person’s property.  However, the power of attorney may be drafted to specifically allow for such gifts, if that is desired.  In the days when the federal estate tax kicked in at much lower levels, some estate planners routinely advised that gifting powers be included in a power of attorney, so as to begin putting an estate plan into effect and to control death taxes.  The authors make a persuasive case that, given today high federal estate tax exemption, such gifting powers should no longer be routinely included in powers of attorney.  The income tax benefits of holding property until death are far greater than the potential estate tax savings for all but the largest estates. What’s more, gifting powers have been a specific source of elder abuse.
  • Living trusts.  It is becoming more and more common for elderly clients to outlive their spouses, siblings, and friends. That creates a dilemma if there are no children nearby.  The authors suggest, “The use of a funded revocable trust that names an institutional co-trustee or successor trustee can provide a viable solution for clients fitting this profile.”

We are that “institutional co-trustee or successor trustee.”  It’s always nice to receive recognition of the value of our services from experts in estate planning.  We’d be very pleased to tell you more about how our services may benefit you and your family over the generations.  Please arrange for an appointment with one of our officers at your convenience.

© M.A. Co. All rights reserved.

 

Tax Reform Stalls

There has been surprisingly little progress on tax reform, given the high hopes that so many had last January.  On May 17 Republicans and Democrats from the Senate Finance Committee met with Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn.  The key takeaway seemed to be that the Senators want to pursue tax legislation on a bipartisan basis.  That means committee hearings and, most likely, a very protracted process.  Many already have suggested that tax reform can’t happen until 2018.  However, enacting major tax reform in an election year would be unusual, because so much attention must be invested in campaigning.

President Trump’s tax proposals rolled out at the end of April, included the elimination of the federal estate tax, so that remains a possibility.  In a statement accompanying the presentation of the one-page proposal, economics adviser Gary Cohn said: “The threat of being hit by the death tax leads small business owners and farmers in this country to waste countless hours and resources on complicated estate planning to make sure their children aren’t hit with a huge tax when they die. No one wants their children to have to sell the family business to pay an unfair tax.”

Cohn clarified that the repeal of the estate tax would be immediate, not phased in over a period of years.  Democrats are likely to resist changing or eliminating the federal estate tax.

We are no closer to knowing the fate of the federal gift tax or the generation-skipping transfer tax, however.  It has been argued by some observers that the gift tax must be retained so as to protect income tax revenues.  No indication as of May on the fate of basis step-up, or the possibility of taxing unrealized gains at death.

What’s the hold-up?

One of the major stumbling blocks to getting to tax reform is the issue of “revenue neutrality,” the idea that all tax cuts must be offset by tax increases elsewhere in the Tax Code so that net federal tax collections remain unchanged.  That was the model for the Tax Reform Act of 1986; it was not the approach used for the Economic Recovery Tax Act of 1981, which helped to break a long period of stagflation.  In fact, ERTA turned into a bipartisan stampede once the ball got rolling.

The cause of tax reform may have been set back when Senate Majority Leader Mitch McConnell (R-Ky.) announced in May that only a revenue-neutral tax bill could pass the Senate.  He did not identify any “pay-fors” to offset tax breaks expected to foster better economic growth.  The proposal put forth by President Trump, even though it lacks critical details, has been judged to “lose” as much as $7 trillion over its first ten years.  

What happens when the stock market bulls realize that corporate tax reform is not in the cards this year?  Wait and see.

© 2017 M.A. Co.  All rights reserved.

Tapping Retirement Funds to Pay for College

Dear Garden State Trust Company:  

Should I withdraw or borrow from my 401(k) plan to help pay for my child’s college expenses?—PUZZLED ON FUNDING

Dear Puzzled: 

As a general rule, impairing your retirement savings to meet current spending needs is not a good idea, even for higher education expenses.  There are other sources of funds for education needs—in contrast, in retirement, when one is on a fixed income, borrowing to meet expenses is problematic. 

What you take out of your plan now can be hard to replace later.  It’s been estimated that it can take six to ten years to fully restore a retirement account that has been tapped to meet four years of college expenses.  In part, that’s because one misses out on the compounding of investment income during the period.  For longer time frames, the stock market has produced higher total returns than the interest rates on student loans.  The other part is that it can be hard to get back into the saving habit.

The better approach is to save for higher education early, separately from retirement savings, so as to put time on your side and minimize the need for loans when the college years arrive.

Do you have a question concerning wealth management or trusts? Send your inquiry to contact@gstrustco.com.

© 2017 M.A. Co.  All rights reserved.

Living Trusts & Financial Privacy

Remember when “hidden treasure” resided in chests buried by pirates? Today’s precious assets may be invisible to the naked eye until retrieved from a hard drive.

Case in point, Pirate Latitudes, an adventure yarn set in Jamaica in the 1600s, found in computer files left by author Michael Crichton.

Although Crichton is best remembered for Jurassic Park and other techno-thrillers, in 1975 he wrote another historical adventure, The Great Train Robbery. HarperCollins published Pirate Latitudes in November 2009, more than a year after the author’s death.

Crichton died in 2008 of throat cancer. Five times married, he left a prenup and a living trust. Here is what is known at this date about the John Michael Crichton Trust:

It was a revocable living trust created in May 1998.

It has been amended three times.

That’s all.

We have no indication of the size of the trust or the identities of the beneficiaries.

Crichton’s will was filed with the probate court, but one lawyer observed: “The main significance of this probate is really to nominate who’s going to be in charge.  There are really no assets in this estate; it’s all in the trust.”

Among the many reasons for having a living trust, financial privacy is likely the one most important for celebrities such as Crichton.  However, there are more advantages to considered.

You remain in charge

When our clients place investable assets in flexible trusts, they give us their instructions in an attorney drawn trust agreement. Under the terms of that agreement, they retain the right to cancel the trust or change their instructions. Nothing’s tied up.

From a practical standpoint, then, our trust clients maintain exactly as much investment control as they wish, just like the clients who have their personal investment accounts or IRAs with us.

Typically, we provide professional management or guidance tailored to each trust client’s needs and preferences. 

Always, our role as trustee is to do exactly what our trust clients have instructed us to do. There’s no doubt whatsoever about who’s in control. If any client ceases to be satisfied with our services, he or she is perfectly free to terminate the trust or employ another trustee.

Put our experience to work for you and your family

If you would like to learn more about our personal trust services and how they might help you do more with your financial assets, we invite you to meet with us in person.

We look forward to discussing your goals and requirements.

© 2015 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2015, are not reflected in this article.

Emotional Investing

We like to think that since the advent of modern portfolio management practices, investing in stocks and bonds has become a cerebral, analytical process with no room for emotion. The truth is that most investors, even institutional investors, are buffeted by emotional turbulence from time to time, and that truth is reflected in the volatility of the financial markets.

But if a little emotionalism when it comes to investments is unavoidable, too much emotion can be hazardous to your wealth. Here are four symptoms of problem emotions, financial behavior that is inconsistent with sound investment practice.

Fear of loss.  Investors are generally motivated by fear or by greed. Behavioral scientists have learned that, for many people, the pain of loss is larger than the sense of satisfaction from a gain of the same size. Similarly, some investors will accept larger risks in order to avoid a loss than they will in seeking a gain.

Taken to an extreme, fear of loss leads to investment paralysis.  An excessively risk-averse investor may park funds in ultra-safe, low-yielding bank deposits or short-term Treasury securities until a decision is made, accepting long periods of low returns. Or winning investments may be sold off too quickly in an attempt to lock in gains, while losing investments manage to stay in the portfolio indefinitely.

Following the herd.  It’s difficult to be a contrarian, to find value that everyone else has overlooked. Many people find it easier to go with the crowd, to own the current hot stock or hot mutual fund. At least that way, if the investment does poorly, one has plenty of fellow sufferers with whom to commiserate.

But when “crowd” is defined as one’s family and friends, the crowd’s investment goals may be very different from one’s own.

Hair-trigger reflexes. Markets move on news. In many cases, the first market response is an overreaction, either to the up side or to the down. Sometimes “news” is only new to the general public, and it’s already been reflected in the share price through trading by those with greater knowledge. The true importance of any news event can only be discerned over the longer-term.

Generally, it’s better to watch the market react to news than to be a part of the reaction. Remember that market dips may present the best buying opportunities but they’re also the toughest times, emotionally, for making a commitment to an investment.

Betting only on winners.  Some 85% of the new money going into domestic equity mutual funds goes to funds with MorningStar ratings of four or five stars, according to one estimate. This may be one reason that the government requires this disclosure for investment products: Past performance is no guarantee of future results. The disclosure is required because it is true.  High returns are usually accompanied by high risks; ultimately, those risks may undermine performance.

Abnormal returns, whether they are high or low, tend to return to the average in the long run. Investing on the basis of the very highest recent returns runs a significant risk of getting in at the top of the price cycle, with a strong chance for disappointment.

The alternative approach

To avoid impulsive decisions that may be tainted with emotion, one needs an investment plan.  The best way to moderate the impact of stock and bond volatility in difficult markets is to own some of each. Assets do not move up down in lockstep. When stocks rise, bonds may fall. Or at other times, bonds also may rise when stocks do. The movements of each asset class can be mathematically correlated to the movements of the other classes. Portfolio optimization involves the application of these relationships to the investor’s holdings.

Expected returns need to be linked to the investor’s time horizon. Longer time horizons give the investor more time to recover from bad years, more chances to be in the market for good years.

© 2017 M.A. Co.  All rights reserved.

Home Office Deductions: The Easy Way & The Hard Way

Beginning in the 2013 tax year, the IRS gave taxpayers a choice when it comes to the home office deduction.  To avoid the necessity of detailed recordkeeping, a new “safe harbor” deduction was created for home offices.  The simplified deduction was set at $5 per square foot of the home office space, up to a limit of $1,500 (300 square feet).

The existence of the new safe harbor and relief from recordkeeping does not change the other requirements for taking the home office deduction.  The office must be used regularly and exclusively for business.  The office should either be the principal place of business or used for administrative or management activities when the taxpayer has no other office for handling those chores.  An office kept for the convenience of the employer, such as a salesman who lives away from company headquarters might have, also will qualify.

In many cases, the actual expenses for the home office will be greater than the safe harbor.  These may include, for example, a share of utilities and insurance costs. For example, the IRS reported that for the 2010 tax year, the average home office deduction was $2,600, so many people will find the safe harbor limit too low.  The taxpayer may choose the traditional route of actual expenses instead of the safe harbor. What’s more, that choice may be made for each tax year, without regard to the choices made in earlier years. Thus, the taxpayer may alternate between methods, choosing the one most favorable each year.

The somewhat harder way

With the traditional method of calculating the deduction, a proportionate depreciation deduction is permitted for the office space. The amount of the depreciation is recaptured and taxed as income when the house is later sold.  The safe harbor alternative does not generate depreciation recapture.

The deduction for the home office may not exceed the net income of the business.  If the business is showing a loss for the year, the loss may be carried forward when the traditional method of calculating the deduction is used.  However, the carryover is not permitted with the safe harbor approach. What’s more, any carryover loss created from the actual home office expense calculations may not be deducted in years in which the safe harbor is elected.

Although the simplified deduction was intended to make life easier for taxpayers, the reality is that many taxpayers will have to figure the deduction both ways to decide which is the better way to go.

The IRS reports that the number of taxpayers claiming the home office deduction has held steady over the last six years, at roughly 3.4 million.  The aggregate value of the deductions claimed has dipped, falling from nearly $11 billion in 2010 to $9.5 billion in 2014 (most recent available data).  Most of the reduction in deductions occurred in 2013 and 2014, suggesting that there was, in fact, a significant shift to the easier way of claiming the home office deduction. The IRS does not break out those figures.

© 2017 M.A. Co.  All rights reserved.

401(k) Protection Programs

Dear Garden State Trust Company:

When I retire in about a year, I’m expecting a six-figure distribution from my employer’s 401(k) plan.  The success of my retirement turns on what I do with this money, and I’m more than a little unsettled by the prospect.  What should I do to keep my all my options open?

—LOOKING AHEAD TO FINANCIAL INDEPENDENCE

Dear Looking: 

I have two words for you: IRA Rollover.  With this arrangement, you can continue the tax deferral that your 401(k) account has enjoyed so far.  Be sure that you use a “trustee-to-trustee” transfer of the funds to avoid the 20% tax withholding that otherwise would apply to your distribution.

Will your distribution include shares of stock in your employer?  If so, you should consider not rolling those shares over, but accept them for your taxable portfolio.  Income taxes on “net unrealized appreciation” in those securities may be deferred in this manner.  Your accountant can give you more details.

You’ll also need an investment plan for your retirement money.  When you undertake this, consider your taxable and tax-deferred funds as part of one large portfolio.  The plan that you or your investment advisors come up with needs to take all of your resources into account, as well as your retirement income needs.  You are wise to be looking into these questions a year before you retire.  We can help you with all of these questions if you wish.

Do you have a question concerning wealth management or trusts? Send your inquiry to contact@gstrustco.com.

© 2017 M.A. Co.  All rights reserved.

The Problem of Faithless Trustees

There’s been quite a bit of press coverage of “fiduciary duties” when it comes to professionals giving financial advice.  Bank trust departments and trust companies always have been held to the fiduciary standard, and are proud of it.  Unfortunately, there are some documented cases when individuals with such duties simply ignored them.

Special needs

Lawrence and Millicent Stream, a successful professional couple, had an autistic son, Larry.  Although Larry’s condition was not severe, his parents saved for a trust to provide for him for the rest of his life after they had died.  They accumulated about $2 million in that trust for Larry.

The trustee of Larry’s trust was Layton Perry. We don’t know how the couple knew Mr. Perry, why they chose him as trustee, and why they did not choose a bank trust department or trust company for this important job.  We do know that Perry was a disbarred lawyer.

Fortunately, Perry was not named Larry’s legal guardian.  That job fell to Carolyn Crepps, who had worked as a legal assistant.  She investigated Perry’s management of the trust, and she found that he and his wife had used the assets to buy new cars for themselves, had made mortgage payments on their own home, and had made many personal withdrawals from the trust with no documentation or explanation.  The $2 million fund had been reduced to $200,000.

Crepps asked the probate court to remove Perry as trustee, and he was removed.  The court ordered the sale of the Perrys’ cars and home, with the proceeds returned to the trust.  However, that did not bring the trust fund back to its full $2 million balance.

Larry Streams was not stupid, but he was much too trusting of other people.  As were his parents.

Old Money

James Stillman, onetime Chairman of the National City Bank of New York (which years later would be renamed Citibank), was very rich.  At his death in 1918, his fortune was estimated at $1.8 billion in today’s dollars.  His son Chauncey used a portion of that fortune to create a family retreat, which he named “Wethersfield.”  He purchased art, built a mansion suitable for displaying it, and installed gardens in the style of 17th-century Italy.  A family foundation was created to manage the family’s money and implement their philanthropy.

In 1998 the family foundation was worth $103 million.  Unfortunately, there were no family members on the board of trustees to provide proper oversight.  The trustees made grants to institutions that had nothing to do with the Wethersfield Estate, including their own alma maters, and the ex-president directed over $700,000 for his personal benefit.  By April 2015 the value of the foundation had shrunk to $31 million, after 14 straight years in which grants made by the foundation exceeded its revenue.

The heirs finally woke up and brought suit against the trustees, and eventually, they won a settlement of $4.4 million.  The trustees were replaced, and the board now includes family representation.  The legal settlement won’t be enough to save the Wethersfield Estate, so now the heirs have agreed to sell some of Chauncey’s art collection, including works by Degas and John Singer Sargent.  They are hoping to raise $12 million.

There is a saying: Rags to rags in three generations.  The saying is usually interpreted to mean that the first generation creates wealth; the second conserves it, and the third squanders it.  In this case, it was the untrustworthy managers who squandered the fortune, but the third generation did their part by failing to supervise their advisors properly.

© 2017 M.A. Co.  All rights reserved.

The Wrong IRA Beneficiary?

Sometimes mistakes in an estate plan can be repaired after death. Sometimes not.

Charles Sukenik executed his will on November 4, 2004. His estate was to be divided between his surviving spouse, Vivian, and the couple’s private foundation.  His revocable trust was restated at the same time, giving Vivian certain real property and the balance to the foundation.

Roughly five years later, in 2009, Charles designated Vivian as the beneficiary of his IRA, worth some $3.2 million. 

When Charles died in 2013, the heirs discovered that the estate plan was not very tax efficient. Vivian was looking at potential income taxes of $1.6 million on the IRA distributions.  She proposed to reform the estate plan, giving the IRA to the private foundation in exchange for other estate assets of equal value.  The charity was not opposed to the plan.  Being tax exempt, the new plan would make the income tax obligation that comes with an inherited IRA disappear.  Certainly, this approach would more effectively implement Charles’ testamentary intentions.

The Court couldn’t swallow this one, because “the reformation requested here is prompted by neither a drafting error nor a subsequent change in law. Several years after executing his will and trust, decedent himself thwarted the tax efficiency of his own estate plan by making [Vivian] the beneficiary of the IRA. There is nothing in the record indicating why, after executing these estate planning instruments, [Charles] chose to leave additional assets to his wife in this manner or why, in the four years before his death, he did not take steps to cure the unfavorable tax consequences of his choice of IRA beneficiary.”

The Court concluded that if reformation were allowed in these circumstances, the decision “would expand the reformation doctrine beyond recognition and would open the floodgates to reformation proceedings aimed at curing any and all kinds of inefficient tax planning.”

Did Charles have any understanding of the tax time bomb that he included in his estate plan?  It appears probable that he did not consult his attorney before designating his wife as his IRA beneficiary, which is an ordinary, everyday occurrence.  But he should have.

© 2017 M.A. Co.  All rights reserved.