If you (or a loved one) are entering hospice or close to life's end, you may need to act quickly to prevent unnecessary legal, tax and other costs on your estate. Planning is also critical to provide peace of mind for both you and your family. Here are some of the key concerns to consider.
1. Prepare for Incapacity
Immediately effective durable powers of attorney for financial matters are needed to be sure that the plan can be implemented without the necessity of obtaining a doctor's letter later. The person handling your financial affairs under a power of attorney is called your attorney in fact. If you trust your attorney in fact to handle your affairs if you are incapacitated, then you should be confident in their actions while you are competent. Note that you can monitor your attorney in fact if you are competent. On the other hand, you cannot monitor them if you are incapacitated.
2. Avoid Probate and Complete Any Required Funding
Planning to avoid probate upon death may require a revocable trust. In order to be effective, the trust must not only be put into effect, but it must also be funded by transferring record title of real property, bank accounts and investment accounts into the trust. Failure to fund may result in a full or summary probate proceeding such as a petition to transfer the assets into the trust. In California, this is called a Heggstad Petition.
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You should confirm that all beneficiary designations for life insurance, retirement and all annuities are completed. Failure to complete beneficiary designations for retirement accounts such as IRAs, 401(k)s, 457s and 403(b)s are particularly problematic as that may trigger unnecessary probate costs, accelerated income tax and cause income to be taxed at a higher rate due to a bunching of income into a shorter period of time.
3. Consider Swapping Assets
Consider transferring appreciated assets with a low income basis to obtain a step up in income tax basis upon your death and transferring depreciated assets away to avoid a step down in income tax basis. Care should be taken to insure that such a transfer or swap will not subject the assets to claims for expenses or Medi-Cal liens. In California, the maximum tax rate for residents for capital gains is 37.1% (federal and state combined). The swap or transfer of appreciated assets can provide a substantial tax benefit to your heir or beneficiaries.
4. Make Charitable Gifts
Consider implementing any desired charitable gifts during your lifetime if your estate is not subject to estate tax. Your lifetime exemption for estate tax purposes is $5.45 million, if you're single, and $10.9 million for a married couple. Charitable gifts at death provide no estate tax savings for smaller estates. On the other hand, charitable transfers or gifts made during your lifetime may yield a substantial income tax savings even for the smaller estates.
5. Identify and Review Existing Life Insurance Policies
Confirm that all life insurance policies are paid and that policies have not lapsed. Reinstatement may still be possible prior to death. For a taxable estate (in excess of $5.45 million for singles or $10.9 million for married couples), consider selling the life insurance policy to an irrevocable life insurance trust (ILIT). You may even be able to stop or reduce payments due to life expectancy if the cash value is adequate.
6. Plan to Avoid Income in Respect of the Decedent (IRD)
For taxable estates, you may be able to avoid income in respect of a decedent (IRD) items, which include wages, individual retirement account distributions and other income that may be paid after death. IRD items are subject to both estate tax and income tax. While a deduction is available for income tax purposes, estate tax paid does not provide dollar for dollar protection. Note also that the estate tax deduction for the calculation of the income liability is often overlooked.
The steps taken to avoid income in respect to the decedent depend upon the type of income or item. For example, a Roth conversion or even an accelerated distribution from a retirement account may be appropriate if the decedent’s marginal income tax rate is lower than the beneficiary’s marginal tax rate. IRD may be avoided by transferring the IRD asset to the surviving spouse. Deferring receipt of retirement benefits will postpone receipt and tax of the IRD income. Careful planning may allow the beneficiaries to stretch the receipt of the benefits over the beneficiary’s life expectancy. Estate tax can be avoided by transferring the IRD asset to a charity in the estate plan. Careful planning is needed which should include the financial advisor and the tax advisor.
This is not intended to be an all-inclusive list of the issues to be considered for planning at the end of life. Each person's situation in unique. Planning when you're at death’s door is different. The estate plan is not an abstract idea of something that may happen very far into the future.
John M. Goralka is the founder of The Goralka Law Firm, an estate planning, trust administration, business and tax firm.
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