What Capacity Is Required To Change Beneficiary Designations?

grandfather-506348_640Dear Liza: Can someone with stage four Parkinson’s change the beneficiary on their life insurance? My answer is: it depends. That’s a pretty lawyerly answer, I know, but the thing is that whether or not someone has legal capacity is fact-dependent and unique to each individual, and, in addition, it depends on what kind of legal document a person is signing.

Changing a beneficiary designation is changing a legal contract, and for that act, a person must have what’s called ‘contractual capacity.’  As a practical matter, this means that someone must have the capacity to understand the meaning and effect of the words in the contract that they’re signing.

In a more formal sense, under California law (that’s where I’m licensed to practice, but all states will have a definition in their Probate Code), someone who has a deficit in one or more of a long list of abilities that include such things as long and short term memory, the ability to understand and communicate with others, and the ability to understand and appreciate quantities, would be considered someone without contractual capacity.

So, a person may have Parkinson’s, but still have the capacity to understand what they are doing when they are changing a beneficiary designation.  Being sick, all by itself, doesn’t determine capacity. It gets down to what that person could understand at the time that they made the change in the contract. And being able to understand and communicate that understanding is what’s required. If that person can’t physically sign their name, for instance, an Agent, acting for them under a Durable Power of Attorney, could make such a change at their direction, as long as such an act was authorized under that Durable Power of Attorney.

If someone with a serious illness wants to change their beneficiary designations on a life insurance policy, and wants to avoid a challenge to that change in the future, they could have a doctor state, in writing, that they still have the capacity to contract, and could sign the beneficiary change form in front of witnesses who could verify that, in fact, the person knew what they were doing and why they were doing it.

 

Should We Create a Living Trust?

houseDear Liza: We are a married couple in our early and mid 30s with a one year old son living in Southern California. I have been looking at setting up a trust and/or will for our little family but not sure what is needed in our scenario. My husband and I each own a home in our name (bought before we got married). 

 My husband and I plan to create a living trust for each of us and transfer the property in our respective name into the trust to avoid probate and create a will for everything else. Since both properties still have outstanding mortgage, how do we go about changing the title to a trust and will the lender allow this? Is the living trust the best way to go about with estate planning or do we need to look at another type of trust? Aside from the two properties, what else should be included in the trust? Do we need to create an ILIT for the life insurance policy to avoid estate tax and inheritance tax? What is the exemption limit in California? It sounds like you are thinking about all the right things (and on your way to owning a real estate empire). Yes, a living trust is a great idea for your family for these three reasons:
  1. A living trust will allow you to transfer your assets to your son without a probate proceeding.
  2. A living trust will allow you to set up a trust for your one-year old son so that an adult can manage his inheritance until your son is an adult.
  3. The transfer of your properties into a living trust will not affect your mortgage–there’s federal legislation that says such a transfer does not trigger any due on sale clause. Your lender doesn’t need to be notified, you just record a deed transferring your property to the trust.

You probably don’t need an insurance trust. That’s what people use to exclude the value of their insurance payouts from their taxable estate. But today’s exemption levels ($5.43 million in 2015) are so high, that most of us won’t have to pay any estate tax, even if our life insurance policies are included in our taxable estates.

Paying Credit Card Debt as Trustee

debtsDear Liza, My father passed away recently, and all of his and my mom’s assets are held in a living trust (except an individual checking account), of which I am now the Trustee.  A few collection agencies are now contacting me about collecting on some credit card balances, which are fairly significant.  From what I’ve read online, it sounds like debt collectors might not be able to lay any claims against the trust, but they can collect from the personal estate of the deceased (i.e. checking account or other assets held in the individual’s name).Is that understanding correct?  In case the debtors try to collect against the trust, I want to know our rights in that situation.  As Trustee, you are, actually, obligated to pay the debts of the Grantors (the people who created that trust) that you know about before you can distribute assets to the trust’s beneficiaries. That includes taxes and, in this case, credit card debt. If there are sufficient assets in the trust to pay those debts, you have to pay them. If there are insufficient assets in the trust to pay those debts, often you can, as Trustee, negotiate a lower payment with the companies — because that debt is not secured by anything (in contrast, say, to a house that secures a mortgage), the companies will often settle for less than the full amount rather than writing off the entire balance. If you don’t pay these debts and distribute the trust’s assets to the beneficiaries, these companies could, theoretically, go after the beneficiaries for payment from their inherited assets. Here’s an article that you might find helpful, too.

 

Paying Capital Gains on Appreciated Assets

houseDear Liza, My father passed away in 2002 when the federal estate tax limit was $1million. At that time my mother chose to put their home in the Bypass Trust.  She has now passed and the home is worth $1.4 million.  Do we inherit tax free or pay taxes on the amount over $1million?  It’s nice when I get a question that has a clear-cut answer AND an answer that most people would be happy to recieve. And this one’s got both, sort of: you will inherit the assets held in the Bypass Trust free of estate tax, even on the appreciation since 2002. That’s in fact why your mother put the house in the Bypass Trust, to take it (and its appreciation) out of her taxable estate.

However, here’s what you aren’t going to get: a step-up in basis to the date of death value of the house ($1.4 million). Capital gains are calculated on the difference between what you bought an asset for (the basis) and what you sold it for (called gain, if you sold it for more money than you paid for it.) So, a step-up in basis reduces the capital gains taxes that will be due when that asset is sold. A step-up in basis is a good thing if you own appreciated assets that you plan to sell.

When your Dad died, in 2002, your Mom got a step up in basis for the house — if, for example, they’d bought that house in 1953 for $25,000, she would have gotten a new basis of $1 million for that house in 2002, since that’s what it was worth when he died. If she’d decided to sell the house after your father’s death, she would only  have had to pay capital gains on the post-death appreciation. (I’m assuming the house was community property because I live and work in California. In other states, the survivor only gets a step up on the assets owned by the deceased spouse.)

But the way the tax code works is that if an asset is held in the Bypass Trust, you don’t get to take another step-up in basis at the second death. It’s kind of a good-news/bad-news story: you don’t have to pay estate tax on the assets (and all of the appreciation) on the assets held in the Bypass Trust. This is why Bypass Trusts exist, they shelter assets and appreciation from the estate tax. But if you sell the house now that your mother’s dead, you will have to pay capital gain taxes on the gain ($400,000) earned since your father’s death.

When does a Will Make Sense?


pot of goldDear Liza: A friend of mine is considering a living trust.  The only property he has is a coin collection maybe worth around $15,000.  He has an adult daughter who he doesn’t communicate with and does not want her to get anything.  He would like to leave the collection to me.  Is a living trust a good way to go listing me as the trustee or the beneficiary?  Or is doing a Will just as good? If the only property that your friend has is a coin collection, a simple Will should accomplish his goals.  A Will allows your friend to clearly state who should receive that collection upon his death. Assuming that $15,000 falls below the probate threshold in his state (called the “Small Estates Limit”), no probate would be required upon his death to transfer the collection to you. A living trust is just a way to avoid probate, but really serves no purpose in an estate that’s below the probate limit anyway. To determine the probate threshold in your friend’s state, start here.

Who Inherits When There’s No Beneficiary?

IRA moneyDear Liza: My dad named his mother as his beneficiary, but she passed away in 2004.  My dad died in 2013 but didn’t change his beneficiary. I am my father’s only child and he has no wife, so who gets the money ? When a person dies and there’s no surviving beneficiary named for an account, the assets would go that person’s “estate.” You don’t say what kind of account this is, but the most common kind of account with beneficiary designations would be a retirement account, so I’ll make that assumption (though most beneficiary accounts work the same way).

What that means is that, if your father left a Will, the assets in the account that you are describing would pass to the beneficiaries under that Will. If he had no Will, and you are his only child, you would be the beneficiary under the laws of the state that your father lived and died. (These are called “intestacy” laws, and they spell out who inherits if there’s no Will.)

But here’s the thing, your father’s estate may have to go through probate before the assets can be transferred to you. This depends on the size of your father’s estate, and where he lived and died. All states have what’s called a “small estates limit,” and if an estate falls below that limit, no probate is required.  I can’t tell from your question how big or small your father’s estate was, or where he lived. But that’s the relevant question for you to ask. If you don’t need to go through probate, there’s a way for you to request that the account be transferred to you without a court order; if you do need to go through probate, you’ll need a court order (which is how probate ends) to have the assets transferred to your name.  To find out the probate small estates limit in your father’s state, and how to transfer assets if his estate is under that limit, start here.

Reporting Foreign Gifts

gift packageDear Liza: Does a person receiving a gift from a sibling in another country have to pay gift tax on that gift in the United States? In the United States, gifts are not considered ordinary income, so you don’t have to report them or pay income tax on the amount you’ve received. (If a US citizen, the person who gave the gift, called the donor, has to report all gifts over $14,000 per person per year, and will have to use up some of their lifetime exclusion from gift and estate tax for gifts over this amount. If they are super generous and give more than the amount excluded, currently $5.43 million, they would have to pay gift tax on those gifts.)

But, if you have received a gift from someone who is not a US citizen, then you may have to report to the IRS, even if you don’t owe gift tax. Here’s the rule, copied from a helpful IRS article:

“You must file Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, if, during the current tax year, you treat the receipt of money or other property above certain amounts as a foreign gift or bequest.  Include on Form 3520:

  • Gifts or bequests valued at more than $100,000 from a nonresident alien individual or foreign estate (including foreign persons related to that nonresident alien individual or foreign estate);

or

  • Gifts valued at more than $13,258 (adjusted annually for inflation) from foreign corporations or foreign partnerships (including foreign persons related to the foreign corporations or foreign partnerships).”

The IRS may recharacterize certain distributions from foreign partnerships, corporations, or trusts as not gifts, and then subject these to income tax or additional reporting requirements.

Capital Gains Taxes on Appreciated Property

houseDear Liza: My mother gave her house to my sister just before she passed away.  My sister is going to sell the house. Do we have to pay taxes on that? If your mother’s house had appreciated in value between the time your mother purchased it, and her death, then the answer is yes. I can’t answer even a fraction of the questions that people send to me, so I try to pick ones that I think will have value to many people. Your sister is going to owe capital gains taxes on the difference between what your mother paid for that house and what your sister sells it for. Capital gains taxes are levied on the difference between what someone paid for an asset (that’s called the basis) and what they sell that asset for later (they’re taxed on the gain, or difference between the basis and the sale price.)

Because your mother gave the house to your sister before her death, your sister received that gift with your mother’s original tax basis. For example, if your mother purchased her house in 1976 for  $65,000, and your sister sells it in 2015 for $365,000, your sister is going to owe capital gains on the $300,000 in value that the house gained between 1976 and 2015. (There’s a $250,000 exclusion from this tax for the sale of a primary residence if you’ve lived there for 2 of the last 5 years, but I don’t know if that applies to your mother’s house here. It could, I suppose.)

If your mother had instead gifted that house to your sister upon her death, via a Will or a trust, your sister would have inherited it with a stepped-up basis, which means that her basis in that house would have been the value the house had at your mother’s date of death. In the example I just used, if your sister inherited the house with a value of $365,000 (as shown by a qualified appraisal) and then sold that house for $365,000, she would have owed zero in capital gains taxes. That’s the difference between lifetime gifts (donor’s basis) and gifts made as a result of death (date of death value basis).

Amending a Survivor’s Trust

grandfather-506348_640Dear Liza: My parents have a revocable Trust that is very outdated and we want to make amendments to it. I understand most of the Trust but am having trouble with the Survivors Trust. I was surprised to see that upon the death of one spouse a Survivors Trust may be established. Is this really a necessary part of a Trust. Isn’t being the Co Trustee basically the same thing? A Survivor’s Trust is often created for tax planning. It’s common.  Many living trusts, especially those drafted prior to 2012 (when tax laws changed) are designed to minimize the estate tax at the second death. Trusts like that typically divide the trust estate into two trusts when the first spouse dies: one trust holds the decedent’s assets and is often called the Bypass Trust (or the Credit Trust); the other trust holds the survivor’s assets, and is called the Survivor’s Trust. Usually, the survivor can use assets in both trusts, but, to the extent that they don’t use up all the money in the Bypass Trust, that money passes estate tax free to the beneficiaries.  If your parents don’t have more than $10 million (like MOST people), their trust can most likely be simplified to just hold all of the assets in one, revocable trust after the first death. This trust is still often called the Survivor’s Trust. But this is all completely separate from who manages the trust, whatever it is called. That person is the successor Trustee, or, if appointed during your parents’ lifetimes, a co-Trustee. If you are helping your parents take care of their finances, and they’d like to help them manage their affairs, they can appoint you to serve with them now as a co-Trustee, or even resign, and let you take over as sole Trustee now.

How to Store That Plan

punch-402558_640Dear Liza: I’ve just completed my estate planning documents using the latest edition of WillMaker Plus, including the will, health care documents, power of attorney, final arrangements, etc. I think all totaled it comes to over 65 pages. I’d like to leave all the documents well-organized so they’re not just a pile of papers that would overwhelm the executor. I’d like to put the documents in a three-ring binder with a table of contents and tabbed for the different sections. Is it legal to hole-punch these documents, either before or after they’re singed and notarized? Would that vary by state? I have never heard of any law that would invalidate documents that were otherwise valid because there are physical holes in the paper. Sometimes my clients make a copy of their documents, hole punch those, and put the copy in a binder, then put the originals in a safe deposit box or safe in their house. It’s great that you are trying to make things easier on your loved ones. Here’s a few other things you could put in the binder: a list of your passwords to online accounts; a list of your accounts, life insurance policies, and other assets; contact information for your heirs and beneficiaries; and a list of people that you work with, if any, such as tax preparers and financial advisors.