The 7 Tax Rules Of Mutual Funds

This article appeared on Liberty Investor™.

Mutual funds seem easy, and most investors believe they understand funds. But the income tax rules for funds are more involved than many people realize. Knowing the nuances of the rules is important. Taking different actions or changing their timing could improve your after-tax returns by a significant amount and preserve more of your nest egg.

Let’s take a quick trip through some key parts of the tax code to learn ways to increase your after-tax returns from mutual funds. Of course, what we’re going to discuss in this visit applies to mutual funds held in taxable accounts, not to funds held in qualified retirement plans, such as 401(k)s, traditional individual retirement accounts and Roth IRAs.

The basic rule to understand is a mutual fund itself generally isn’t taxed on its income or gains. To avoid taxes, each year a mutual fund has to pay out and pass through to its shareholders most of its net interest, dividends and capital gains. You as the shareholder are taxed on your share of these items.

While this rule prevents double taxation of the investment returns, it sometimes causes problems. Your share of the income is determined by your ownership on the day the distribution is made. That results in the inequity of a shareholder purchasing shares of a mutual fund the day before a distribution and being taxed on the full amount of the distribution.

Example: Max Profits buys 1,000 shares of a mutual fund on Dec. 29 for $15 per share. On Dec. 30, the fund makes its annual distribution of net capital gains and dividends realized for the year, amounting to $5 per share. This reduces the value of Profits’ shares by $5. He also has to include the $5 in his income for the year, though in his case it really is a return of his investment.

No. 1: Don’t invest in a fund just before a distribution.

Most funds indicate their scheduled distribution dates on their websites and to anyone who calls and asks. You need to be especially wary of making investments near the end of the calendar year and each calendar quarter. Income funds, such as bond funds, tend to make distributions at the end of each month.

When you are caught in this situation, an option is to sell the fund shares right after the distribution. In the example, Profits’ tax basis in the shares still will be his purchase price of $15 per share, and their net asset value after the distribution will be $10. He can sell right away and have a $5 loss. Of course, this isn’t a perfect solution. There might be transaction costs if he invested through a broker, and the fund might have a redemption fee for short-term holders. Plus, there’s the value of Profits’ time.

Also, under the wash sale rules, Profits can’t immediately buy back the fund shares if he wants to deduct the loss. He has to wait more than 30 days. In that time, the fund’s share price might have moved significantly higher.

Avoid these problems. Avoid month-end fund purchases and check a fund’s distribution schedule before making a purchase.

Buying the wrong mutual funds can prevent you from receiving the full benefit of tax-deferred compounding of investment returns. This is another effect of the way a fund passes through income and gains to shareholders.

Before choosing a fund, you should examine the turnover rate, or the rate at which it buys and sells investments. A fund with 100 percent turnover sells its entire portfolio and purchases other investments within a year.

The turnover rate is important because a fund distributes only its realized capital gains and other investment income. A stock fund with low turnover buys stocks and holds them for a long time, or at least longer than a year. As the stock appreciates, it is not selling the stock to realize the gains, and it doesn’t have to distribute its paper gains to shareholders. The fund shareholder can continue to own the fund shares, watch them appreciate and not have to pay taxes on the gains until he sells the fund shares.

But a fund with high turnover does a lot of buying and selling during the year. It realizes a lot of its capital gains and has to distribute them to shareholders. The shareholders have to include the distributed gains in their income for the year and lose the opportunity to let the gains compound tax-deferred.

Suppose two mutual funds have identical returns over time. But one is a low-turnover fund that makes few distributions to shareholders. The other is a high-turnover fund that distributes more than half its annual return to shareholders. After a few years, the shareholders in the low turnover fund will be much better off. Their gains compound without being reduced by taxes each year; and when they sell the fund shares, the gains will be taxed at favorable long-term capital gains rates.

Most published mutual fund returns generally are pre-tax. You can find after-tax returns for hypothetical shareholders in a fund’s prospectus and in some services and websites.

There’s another downside to high turnover funds. Most of their gains tend to be short-term capital gains, because they held the shares for one year or less. When a mutual fund has long-term capital gains that it distributes, shareholders report these as long-term capital gains on their tax returns. But a fund’s distributed short-term capital gains are reported as ordinary income on shareholders’ tax returns. They are taxed at the shareholder’s maximum marginal tax rate, plus they aren’t offset by any capital losses the shareholder has.

No. 2: Avoid funds that have high-turnover ratios or a history of distributing a high percentage of their annual returns.

If you must purchase such funds, do it through a tax-advantaged account such as an IRA.

For some people, the solution is to own only passive or index mutual funds. That’s generally a good solution, but it’s not foolproof. All index funds are not the same. While Vanguard and other mutual fund families work hard to keep expenses very low on their index funds, not all fund companies do. In addition, some funds track indexes not by purchasing the individual stocks but by using futures or options for at least part of their portfolios. These can create less favorable tax consequences.

No. 3: Examine index funds just as carefully as active funds before investing.

Check expenses, distribution histories and performance relative to the index. You’ll find a surprisingly wide variation, especially for indexes other than large company stock indexes such as the Standard & Poor’s 500 index.

When you’re a passive or index fund investor, you also should consider exchange-traded funds as well as traditional open-end mutual funds. Exchange-traded funds are able to use a few tricks to keep their expenses even lower than most open-end mutual funds. In addition, ETFs can use some tax strategies not available to open-end mutual funds.

No. 4: Compare open-end mutual funds and ETFs when considering an index or passive strategy.

Mutual funds don’t pass through their realized losses. When a fund sells an investment at a loss, the loss can offset gains realized during the year and reduce the gains passed through to shareholders. A good fund manager takes this into consideration and will look for losses in its portfolio that can be taken to offset any gains it realizes. When a fund’s losses exceed its gains during the year, as happened to most funds during 2008, the losses are carried forward and can offset future gains. That can enhance the attractiveness of a fund that’s been down. It might be a value and a turnaround opportunity, plus it could have carryforward losses to offset future gains.

No. 5: Check the prospectus for loss carryforwards.

Reinvesting fund distributions makes life easy, at first, but creates problems later. Shareholders still are taxed on the distributions, even if they don’t receive the cash. But that’s not the real problem.

Each time a distribution is reinvested, your basis in the new shares is their value on that date. Most people go for years holding a fund and reinvesting distributions. They have a bunch of shares bought at different times and different prices. When they’re ready to make partial sales of their holdings to fund retirement, they have a complicated tax picture. They have to determine the tax basis and holding period of the shares sold.

No. 6: Avoid automatic reinvestment of distributions.

Instead, let distributions accumulate in a money market fund. Then, use the account to rebalance your portfolio by purchasing new shares in funds that have lagged the others.

When you sell fund shares, you need to know three things: the net sale price, the tax basis and the holding period. Finding the last two items can be difficult when you’ve owned a fund for years, made a series of investments and had distributions reinvested.

The Internal Revenue Service issued regulations in 2008 to make this easier. The fund family or broker has to report your cost basis and whether the gain is long-term or short-term. But the calculations are required only for mutual funds purchased in 2012 and later years. Some funds voluntarily report the amounts for shares purchased in earlier years. Also, the fund family or broker can choose how to compute the cost basis, and most use the average cost method.

But you can choose another method to compute the basis for your sale. For example, you can specifically identify the shares being sold. That allows you to choose the shares that have the highest basis and, therefore, the lowest capital gain. Or if you have a capital loss, you can choose the shares with the highest capital gain so that it is offset by the loss.

But to change the cost basis that is reported, you have to notify the broker or mutual fund in writing before the sale. The financial firm chooses the format in which you have to make the writing.

No. 7: Plan your sales.

When you’re selling a portion of your holdings, you can choose which shares are being sold in order to achieve the best tax results. But you have to work with the broker or mutual fund firm to ensure the firm reports the basis you want.

When the broker or fund issues the Form 1099 after the year, review it carefully right away. Your tax return has to match it. If the form is incorrect, you have to notify the financial firm and have a corrected version issued.

Avoiding Hidden Threats To Your Security

This article appeared on Liberty Investor™.

Some of the most serious threats to financial independence are often overlooked. Yet a few simple actions can avoid large losses from these risks. In addition, you can reduce substantially your out-of-pocket expenses when you pay attention to these neglected issues.

The sad fact is that the insurance coverage for most people is wrong.

People are paying too much for too little coverage or for coverage they don’t need. Significant portions of their net worth are at risk from events or lawsuits. The insurance decisions during and near retirement are some of the most important and complicated in your lifetime. It doesn’t take much to turn a financially secure retirement into something far less appealing. Most people obtain insurance coverage fairly early in their adult years and don’t update it much after that. Take a fresh look at insurance as you near or are in retirement. You’ll see opportunities such as these to close gaps and reduce your cost.

Consider Increasing Your Deductibles

You aren’t a struggling young adult with a family. You don’t need a low deductible to prevent a loss from depleting your savings. When you have a healthy income and net worth, consider increasing deductibles on your home and auto policies. This will reduce premiums, usually by enough that about three years of lower premiums will make up for the higher deductible if you should incur a covered loss.

Check Discounts

You might not know all the discounts the insurer offers, and the insurer might not know all the qualities that qualify you for discounts. Often-overlooked sources of discounts in home insurance are the installation of a security system and upgrading basic systems such as electrical, plumbing and heating. The insurer or agent should be able to give you a full list of potential discounts, or you can talk with them about discounts.

Save By Bundling

There’s no doubt that bundling more than one type of insurance with one company saves money. Even when an insurer doesn’t offer the lowest premiums on each policy, bundling can shrink the gap. Don’t let premiums alone drive your decision. You want good claims service, good coverage and a financially stable insurer. After that, look for opportunities to reduce premiums.

Ensure Full Coverage For The Home

Many of my readers lived in the same homes for a long time. Often, that leads to significant insurance coverage gaps. Most likely is that the coverage limit isn’t high enough to cover a catastrophic loss. That’s because the cost of rebuilding all or most of the home exceeds the market value. Be sure your policy covers full replacement cost, not market value.

A related gap is building code updates. Localities regularly update building codes, increasing the requirements and costs for new homes. But if you have work done on an older home, because of either an upgrade or repairs after a catastrophe, large portions of the home might have to be upgraded to meet current code requirements. This can be a significant cost to fix a home after a catastrophe, especially if you have older electric and plumbing systems. Your homeowner’s policy needs to cover any changes required to meet current building codes, or you’ll have to pay the extra cost.

When you belong to a homeowner’s association, you might want significant assessments from the HOA covered. When the HOA isn’t covered for a major loss to community property, loses a lawsuit or has to upgrade a facility because the law has changed, the HOA will assess homeowners for the costs. The potential for this is especially high in condominium communities, but it’s possible for all HOAs. At times, special assessments are thousands of dollars.

Protect Personal Assets

Homes owned by older people are likely to have inadequate insurance for their contents. The standard insurance policy assumes contents are a certain percentage of the home’s value. But older owners tend to have more things than the average and more valuable things, because the average includes a lot of younger people. Your best move is to take an inventory of your home’s contents and compare that to what the insurance would pay if it were destroyed. When the gap is substantial, talk with your insurance agent about your options.

Of course, there are many personal items that are excluded from the contents coverage. These include antiques, jewelry, collectibles, furs, antiques and a lot of electronics. Make a list, obtain an appraisal of their values when necessary and buy a rider to your policy that covers them.

Some assets require special coverage. For example, if a few years ago you bought that car you drove or envied in high school, that’s now a classic car and could require a special policy instead of a standard auto policy.

Be Sure Titles Are Correct

As part of your estate plan, you might have shifted some of your assets to a living trust or limited liability company. Be sure these items are covered by your insurance. You don’t want to suffer a loss and discover it isn’t covered because legally you no longer owned the car or home.

Do You Have A New Business?

Some people turn their hobbies into businesses during retirement. That could create a new list of potential liability claims. You might be able to cover these under the personal umbrella liability policy, or you might require separate insurance. Be sure you’re covered.

Check Directors And Officers Liability

One of your activities might be to serve on the board of some organization. It might seem harmless and good community service to serve on the board of, say, a local youth sports league. But what if one of the coaches made sexual advances to some players and the parents sue the league, including the directors? Being on the board of any organization opens up the potential for personal liability suits. Even if the suit is frivolous, you need to pay a lawyer. Be sure the organization has sufficient insurance to protect its officers and directors. If it doesn’t, buy your own policy.

Cover It All With An Umbrella

Anyone with significant assets should have a personal liability umbrella policy. Your homeowner’s insurance covers you for liabilities from a range of actions by you, your family members and even your pets. But there’s a ceiling to the coverage, and it likely isn’t enough to protect you in today’s litigious world. A personal umbrella liability policy is very inexpensive. You probably should have at least $5 million of liability coverage.

The insurance coverage discussed above is in addition to the medical expense and long-term care coverage that should be basic parts of a retirement plan.

Now that most of your earnings years are past, one of the greatest obstacles to lifetime financial security is having a significant portion of your nest egg taken by a catastrophe or liability suit. Combine the cost-saving measures with the strategies for boosting coverage. The combination likely will provide you greater protection than you have for premiums that are similar to or less than what you’re paying now.

–Bob Carlson

Dealing With The Latest Turmoil In Long-Term Care Insurance

This article was featured on Liberty Investor™.

The turmoil in long-term care insurance continues. In recent years, a number of insurers raised premiums substantially on existing policies or exited the market. A year ago, it appeared things would stabilize after the shakeout, but a new round of premium hikes and policy changes is taking place.

Two of the largest and most stable LTCI carriers, John Hancock (a subsidiary of Manulife Financial) and Genworth, are seeking hefty premium increases on existing policies. Hancock sought premium increases of about 40 percent a few years ago and now is seeking an average 25 percent increase on top of that. Genworth is seeking lower increases generally but is asking for significant increases on policies sold before 2002. Genworth has 23 percent of the market, while Hancock has 16 percent. Other insurers are making adjustments to terms of new policies or stopping the sale of some policies. Industry analysts expect this won’t be the end of premium increases or other policy changes.

It’s no secret why insurers are asking for premium increases. The cost of long-term care is at all-time highs and rising; insurers are earning much lower returns on their investments than anticipated; and Americans are living much longer than expected. A result of those three factors is insurers are paying more in claims than projected and, therefore, are not making their expected margins.

In reaction to the rate increases, insurers say most policyholders are still keeping their policies. They’re adjusting policy terms to reduce premium increases. For example, you can reduce a policy’s daily benefit or rate of inflation increase. I’ve discussed these and other policy terms that can be changed to make the policies more affordable, and these articles are available in the Archive of the members’ section of the Retirement Watch website. But making such adjustments means you’re paying the same or higher premiums for less coverage.

Unfortunately, most American’s will need long-term care at some point in their lives and need a plan to pay for it. Of those 65 and older, six in 10 men will need long-term care, and eight in 10 women will need it.  You can’t count on your spouse to be there to provide care, because if you are 65 or older, you have a 71 percent chance of being widowed for five or more years; 46 percent of that group will be widowed for at least 10 years.

Long-term care can be expensive. If you live in California, for example, the average cost of a semi-private room is $83,950. If you want a private room, plan on spending at least $97,820 per year. That’s in today’s dollars. You can try to save money with in-home care, but that still runs more than $52,000 per year. So you need a plan for covering LTC expenses in case you or your spouse needs the care.

One way many are dealing with the crisis in LTCI is to opt for one of the new Hybrid Combo LTC policies. These can be used to supplement an existing policy or be an alternative to the “use it or lose it” proposition of traditional LTCI.

A combo policy is an annuity or life insurance policy that has an LTCI rider. Benefit payments are triggered under the rider when you meet the requirements for needing LTC (usually not being able to perform two of the six activities of daily living, or becoming cognitively impaired).

Let’s take a detailed look at a new and attractive life insurance/LTC combo policy, the Nationwide CareMatters. My insurance expert, David T. Phillips, says the policy is one of the most attractive new entries in the market. As he puts it, “It scorches the competition for non-medical exam plans.” The policy is approved in most States.

You buy the policy with either a lump-sum deposit or a series of deposits over five years or 10 years. It is set up to allow for transfers from individual retirement accounts to fund the policy.

Your deposit buys both life insurance and LTC benefits, both of which are greater than your deposit. If you never use the LTC benefits, your beneficiaries receive the life insurance benefit. The LTC benefits are available to you immediately after the policy is in force. There’s no waiting period. You select the payout period for your LTC benefit, which is tax-free, from a range of two to seven years. When you use the LTC benefits, they reduce the life insurance benefit; but beneficiaries will receive a life insurance benefit of 20 percent of the policy’s initial face amount even if you exhaust the policy through long-term care benefits.

The amount of your LTC coverage depends on your age at the time of the deposit. The table nearby gives estimates of the death benefit (life insurance benefit) and LTC benefit for men and women of different ages who deposit a single sum of $100,000 into CareMatters and select a six-year LTC benefit period.

Sample   Benefits – $100,000 Deposit

Issue Age





MaleDeath Benefit





LTC Pool





FemaleDeath Benefit





LTC Pool






There are other benefits to the policy. There’s no medical exam required to qualify, only a telephone interview. Also, this is an indemnity policy, not a reimbursement policy. Once you qualify to receive the LTC benefit, monthly payouts begin with the amount based on the amount of your deposit and the payout period you selected. With a reimbursement policy, you’d have to wait to be billed by the long-term care provider, submit receipts to the insurer and wait for reimbursement. Another benefit is this policy will pay for LTC received outside the United States.

CareMatters also provides immediate 100 percent liquidity. Your deposit earns interest, but you can receive all or some of it back for the asking while the policy is in force.

Combo policies overcome the No. 1 complaint of those who shy away from stand-alone LTC policies: You and your heirs receive nothing if you never trigger the LTC benefits. With combo policies, you or your heirs receive something when the LTC benefits are unused. The combo policies also are attractive to some who can’t meet the medical qualifications for stand-alone policies, because the combo policies tend to accept some people who don’t qualify for stand-alone coverage.

Longtime readers know I haven’t been a big fan of the combo policies. Most don’t offer adequate benefits for the costs. But I try to identify the exceptions. I’ve also long recommended that potential LTC expenses be covered with a combination of strategies instead of relying only on one insurance policy or not having any coverage.

An annuity/LTC combo is attractive to someone who has conservatively invested money that primarily is for either emergencies or heirs. Putting that money in the combo policy can provide more income if LTC is needed but is available for the other purposes if LTC isn’t needed.

In the past, I’ve said that you should buy a life/LTC combo policy only if you need the life insurance. The Nationwide CareMatters policy is an exception. It has substantial benefits if you trigger the LTC rider, and the LTC benefits actually are better than the life insurance benefits. In addition, the interest on your deposit and 100 percent liquidity provide the same cash-reserve benefits of an annuity/LTC combo.

To learn more about the Nationwide CareMatters life insurance/LTC combo policy, contact David T. Phillips at 888-892-1102 or

Protect Yourself From ID Theft

This article was featured on Liberty Investor™.

Identity theft isn’t making the headlines it did a few years ago. Yet it’s still a problem. The Federal Trade Commission estimates that annually about 9 million Americans have their identities stolen, and this costs consumers about $5 billion. The FTC says fixing your credit after a theft takes about 175 hours and costs $1,173. In addition, a bad credit report can cause you to be denied a mortgage or auto loan or even a job.

The baby boomers and those older are big targets for ID theft. They tend to have money and good credit ratings. Plus, they’re vulnerable from a number of sides, such as anyone who helps around the home.

Credit card companies have tightened their protections for customers. Their computers are programmed to identify unusual transactions, and the companies quickly contact the cardholder or freeze an account. But that doesn’t stop people from applying for new cards or loans in your name or taking other actions.

If you really want to prevent ID theft, consider these steps.

Check credit reports. You’re entitled to an annual free copy of your credit report from each credit reporting firm. You should exercise this option annually to see if there are any errors or any activity you didn’t initiate. But this is a weak step. You would be learning about unauthorized credit applications well after the fact. The real benefit of this step is to correct any mistakes in the report, such as having someone else’s history incorrectly applied to your report.

Destroy all debit cards. Many people like debit cards because, unlike credit cards, they draft the amount directly from your checking or other account. You aren’t borrowing money, so interest and finance charges aren’t imposed.

The downside is that you don’t have all the protections of credit cards. Losses from improper use of your credit card are limited to $50. There’s no limit on debit card losses, unless the card issuer voluntarily establishes one. If someone gets your debit card and PIN, they quickly can drain your bank account.

Debit cards also are less attractive after the Dodd-Frank financial regulation law. The law reduced the fees card processors can charge retailers on each transaction. As a result, the card issuers generally eliminated rewards programs and other bonuses. Because of the ID theft potential and lack of benefits, some advisers say to cut up debit cards.

Sign up with credit monitoring services. There are a number of services that track the activity on credit reports by one or more of the credit reporting firms. You can sign up free with these services, and they will inform you of any new activity in your credit report.

Each of the free services generally monitors only one credit reporting firm, usually is owned by the credit reporting firm and tells you which reports it covers. They also want to upgrade you to a fee-paying service. Usually the free reports are issued at a fixed date, so activity could occur in your account some time before you know about it.

There are other services that will monitor your credit for a fee, such as Lifelock. These firms say they are proactive and will know as soon as there is new activity in your account. They also look for a wider range of activity, such as requests to change your address, and let you know immediately of any changes. This proactive approach can stop someone who’s stolen your identity from receiving loans or other credit in your name.

Most of these firms also will help you restore your credit record and reclaim your identity if it’s stolen.

Freeze your credit identity. Probably the most effective way to avoid ID theft is to freeze your credit reports. You can contact each of the three major credit reporting firms and direct them to freeze your credit status. Then, they won’t be allowed to release your information to anyone. With your credit status frozen, even someone who obtained all the details of your identity won’t be able to receive approval for new loans.

You periodically might need someone to have access to your credit reports. You might apply for a new job or seek a mortgage or auto loan. In that case, you can ask the services to unlock your account for a set time period. Usually each time you do this, it costs $5. Unfortunately, you can’t authorize release of your credit report only to certain people or firms.

When you freeze your credit status, you establish a password or PIN. You need this to unfreeze the account. If you lose the PIN, a process that can take months is needed to verify your identity and unfreeze the credit.

Secure your information. Identity usually is stolen through unsophisticated methods. Thieves can enter a home or steal a wallet, cellphone or personal computer and find all the information they need. In general, someone who has your name, address, birth date, and Social Security number can cause a lot of damage.

People often leave access to this information exposed. They enter key information in their smartphones or computers. They’ll leave sensitive documents accessible in their homes. Even if there are no valuable objects in your home, it pays a thief to break in and grab blank checks, old financial statements and your passport or birth certificate. You can go on a short vacation and have all this information stolen while you’re gone. Documents with this information should be shredded and thrown away or securely locked.

This step is especially important for snowbirds or other second home owners.

The three major credit reporting firms are TransUnion, Experian and Equifax. The Federal government mandates, where you can obtain a free credit report from each firm annually. Note that obtaining your credit report is not the same as seeing your credit score. The details of credit scores are considered proprietary, and apparently lenders can determine how the score is computed for them.

These steps won’t completely eliminate vulnerability. There are other ways your Social Security number can be obtained, and a thief can use that to file a false tax return in your name and claim a refund. But the Internal Revenue Service doesn’t hold individuals liable for false refunds (though it isn’t as generous with employers who are victims of ID theft). These are the strongest measures you can take and will greatly reduce your risk.

–Bob Carlson

Curbing The High Cost Of Retirement Medical Care

This article appeared on Liberty Investor™.

The cost of retirement medical care continues to rise and to be the wild card in retirement plans. Reports and studies update the estimates of the cost of retirement medical care each year. They show the cost to be high and also very unpredictable for individual retirees and couples. The studies focus on average or median costs. In your planning you have to be aware that individual costs vary greatly because of differences in personal health, geography and insurance coverage. Your retirement medical costs can be substantially higher or lower than the overall forecasts.

We’re talking about out-of-pocket costs, those expenses that aren’t covered by Medicare. People on average incur higher medical costs than these estimates, but Medicare picks up some of the costs. These estimates are of what you’ll have to pay.

A couple retiring in 2013 and incurring median drug expenses during retirement would need to save $151,000 to have a 50 percent chance of covering their lifetime costs for prescription drugs only, according to the latest study from the Employee Benefit Research Institute (EBRI.) Those who incur among the highest medicine expenses are likely to need more than $220,000. The good news in the report is that the prescription drug expense estimates are lower than last year’s because of a reduction in the rate of growth of medical and drug costs.

Remember those estimates are only for prescription drug costs. To have a high probability of paying all uncovered medical costs after age 65, EBRI estimates a couple age 65 today with a high level of medical expenses will need savings of $360,000. (You can see that for the average person prescription drugs is the largest medical expense not covered by Medicare.)

How will these costs be paid? EBRI estimates that Medicare covers about 62 percent of medical costs for beneficiaries. (I’ve seen other reports estimate that Medicare pays only about 50 percent of costs.) Another 13 percent comes from private insurance and about 12 percent is paid by the retirees. The rest is paid by State programs, employer retirement benefits and other sources.

Of course, there are steps you can take to reduce both the out-of-pocket costs of retirement medical care and the uncertainty of your exposure to the medical costs.

  • Those not already retired should take steps to establish good health habits, including participating in any employment or community wellness programs.
  • When you’re eligible for a health savings account, take advantage of the option and fund it with the maximum amount each year. Contributions to HSAs are deductible if made by you and excluded from gross income if made by your employer. Earnings on the account compound without taxes, and all amounts withdrawn from the account are tax-free when withdrawn to pay for qualified medical expenses. It’s a good way to build a tax-advantaged retirement fund for medical expenses.
  • Enroll in Medicare when first eligible. For most of us that’s when we turn 65. You pay a penalty for life if you decide later to sign up for Medicare Part B or the Part D Prescription Drug Coverage after your initial enrollment period expires.
  • Sign up for Part D Prescription Drug Coverage. This is private insurance that is partially subsidized by the government. Prescription drugs are the largest medical expense for most of those age 65 and older. A good policy reduces your out-of-pocket costs and the uncertainty of how much you’ll pay should you have an above-average or catastrophic need for medicine.
  • When you don’t have much need for prescription drugs at the start of retirement, sign up for a bare-bones, low-cost policy. You always can switch to a more robust policy during a future open enrollment period if you need it and will avoid the premium penalty for signing up for Part D late.
  • Consider a Medicare Supplement policy. When you’re in traditional Medicare (not Medicare Advantage), there are a number of deductibles, copayments and coverage gaps. A Medigap policy will cover some of them and reduce your uncertainty. There are 10 different Medigap policies to choose from, so you can look for the right trade-off for you between premiums and better coverage.
  • Shop around. I can’t stress this enough. Recent studies have found that retirement medical care premiums for identical coverage for the same person can vary by 100 percent. There are people paying twice as much for Part D and Medigap policies than they should because they didn’t shop around. The insurance industry counts on a combination of inertia and people disliking insurance shopping. It costs people a lot of money.
  • Have flexibility. A retirement plan needs a cushion and some flexibility because of the uncertainty of medical expenses. You should minimize fixed expenses so that spending changes can be made in case uncovered medical expenses arise.
  • Plan for long-term care (LTC). Medicare won’t cover much of any long-term expenses you incur, and most of you won’t qualify for Medicaid. You probably don’t want to rely on Medicaid for long-term coverage anyway, because the level of care by facilities accepting primarily Medicaid usually is considered to be of lower quality than at others.

I recommend most people plan on using several sources to pay for LTC. Part of the cost can be funded from savings. There probably are expenses you incur now that you won’t if you need LTC, and that money also can be used to help pay for LTC.

To pay for the bulk of the coverage, you should consider obtaining either a stand-alone LTC policy or an annuity or life insurance policy with a long-term care rider. Or you can combine both types of coverage. Tapping the equity in your home through either a reverse mortgage or a sale can be a good way to plan for extended long-term care expenses. By using all these tools, you’ll have a solid plan to cover any LTC you need.

I’ve covered all these strategies and more in detail in past issues of Retirement Watch. You also can find strategies in my books, including Personal Finance for Seniors for Dummies.

–Bob Carlson

10 Basic Rules Of Every Estate Plan

This article appeared on Liberty Investor™.

Most people still believe that estate planning is all about tax planning. Since the tax law now exempts most estates, they think they don’t really need an estate plan. But they do, and many people need an estate plan more than ever.

An estate plan involves a lot more than tax planning. And for most people, the non-tax elements of a plan are more important than the tax issues.

There are basic rules and guidelines that apply to every estate plan, whether it is taxable or not. Draft an effective plan by paying attention to these guidelines, regardless of what the tax law is or might become. You always can make adjustments if the tax law changes.

Get Started And Do Something

Too many people use uncertainty as an excuse not to have a plan. Some people can’t resolve issues such as who should be the executor, trustee or guardian of their children. Some can’t decide how much to leave to charity. Or perhaps the estate planner is proposing a strategy they don’t quite understand or aren’t comfortable with yet.

Don’t let these issues leave you with no estate plan or an out-of-date plan. If you can’t pull together a complete plan, at least do the minimum necessary, such as a basic will and powers of attorney. You can do an estate plan in installments. Assemble a simple, basic plan now that covers the essentials. Then, work toward a more robust plan as you learn more about the tools available, refine your goals and resolve disagreements.

10. Keep Track Of Your Estate

There’s a story that W.C. Fields didn’t think banks were safe, so he diversified by stashing his money in relatively small amounts in banks all over the country. He didn’t keep a master list of the banks, and his heirs never were sure they found all the money — though they spent resources trying to track down all the accounts. Fields probably knew how to find everything, but he didn’t give anyone else all the information.

Different variations of this story occur remarkably frequently in estates of all sizes. The estate owner doesn’t have a master list or file of all the property and debts, and the files aren’t in great shape, at least not for someone who doesn’t know the system. In those cases, all the property might not be located or the estate spends a lot of time and money trying to locate it. Your estate planner also can’t deliver the best advice without an accurate list of your assets and liabilities.

At a minimum, you should update a complete list of your assets and liabilities once a year and share this with the person (or persons) named as executor in your will. And make sure your executor knows where to find all the documents to back up the financial statement. Even better is a complete list of all your key financial items, including online accounts. For help compiling a list, use my report, To My Heirs.

9. Estimate Cash Flow

Many people overlook cash flow when developing an estate plan. But the cash flow and sources of cash are important. Debts must be paid.
Attorney fees and other expenses will be incurred. The expenses of running and maintaining the estate’s property must be paid, and the survivors have their regular living expenses to pay. Of course, if taxes are due, they must be paid with cash.

Estimate how much cash the estate will need before it is settled and where it will come from. If the estate won’t have enough cash, reconsider the plan. You can sell some assets now, provide that some people will get property instead of cash, buy life insurance or give the executor instructions on how to sell property. Many estate planners advise limiting specific cash bequests to only a few special cases.

8. Choose Executors And Trustees

Most people spend a lot of time on their plans, then select the executors and trustees as an afterthought, often automatically choosing the estate-planning lawyer or oldest child as executor and the bank recommended by the lawyer as trustee. Those might or might not be the best choices for you. Unfortunately, a good estate plan can be ruined if the wrong people implement it. Give a lot of thought to who should execute your plan.

7. Anticipate Conflicts And Reduce Them

Many estates have built-in conflicts that could have been resolved. For example, if kids don’t get along now and if you are always mediating their disputes, then they aren’t likely to amicably manage assets or decide how to divide them. Perhaps they should be given separate ownership of assets or different voting rights, or maybe someone else should help make decisions about the property.

Other times, the roles of an individual create conflicts. A classic conflict is when a spouse is made trustee, receives income from the trust, and the children get the trust property after the spouse dies. Often, the children end up believing that the spouse invested for maximum current income at the expense of earning capital gains for the future. Your estate plan should avoid such built-in conflicts. At best they lead to hard feelings and at worst lead to expensive litigation.

6. Don’t Search For A Perfect Solution

An estate plan is a balancing act. It strikes a balance between your goals, the needs of your family, the tax law and perhaps other factors. You also have to decide whether to leave assets to your heirs directly or with some restrictions, such as through a trust.

A good estate planner will present you with several alternative plans. Each will handle the trade-offs in different ways. You choose the alternative that strikes the balance you prefer.

5. Don’t Be A Control Freak.

Some controls can be a good idea, such as when a beneficiary doesn’t have good judgment or experience handling a meaningful amount of money. In such cases, property should be put in a trust.

But some people go a step further and dictate in detail how wealth is and is not to be invested and distributed. There are trusts saddled with restrictions that require them to be invested in Treasury bills, gold stocks or the stock of certain companies, to name just a few examples. Trustees, executors and heirs need to be able to adapt to changing circumstances.

4. Make Your General Plan Known

If you don’t tell heirs your plans, they will develop expectations. Feelings tend to be hurt when they are surprised after your death. That can lead to anger or bitterness that will be taken out on others in the family. Also, heirs might plan their finances with certain expectations about your estate plan and be in difficulty when their expectations aren’t realized. You should let people know generally how they’re affected by your plan. For example, if you aren’t going to treat heirs equally, will leave money to charity or know that someone is expecting certain property, it is important to let the affected people know ahead of time.

3. Don’t Circulate Your Will

While you want the general outline of your plan known among those affected, don’t circulate the will. You likely need to update it every few years, and any change in the details gives someone a reason to be upset. Also, having different versions of a will circulating over the years makes an expensive will contest more likely.

2. Things Change

Your estate plan never is final. The property you own and the values change. The members of your family change through births, deaths, marriages and divorces. Your goals might change. You might be inclined to leave more or less to charity or specific heirs over time. You need to meet with your planner at least every two or three years to review changes in your financial picture, family and goals as well as the tax law.

1. Keep It As Simple As Possible

Some people and their attorneys get so wrapped up with the latest estate-planning tools that they overlook simpler strategies that will accomplish their goals. Be sure complications are necessary to meet your goals before putting them in your plan.

Remember that any mistakes in your estate plan will live long after you. Follow these rules and you’ll end up with an estate plan that works well for you and your heirs.

–Bob Carlson

Using Protection Trusts To Help Heirs

This article appeared on Liberty Investor™.

“Great Fortunes Lost” was the title of an article in Fortune magazine some years ago. It described how various individuals, usually heirs, lost or squandered very large fortunes. Some of the individuals lost more than money. They lost their health or wasted their lives because of the effects wealth had on them.

Many people I hear from are concerned about that happening in their families. They worked hard for their wealth and want to leave some of it to help their children and grandchildren. Yet, they are concerned that the wealth might be wasted or would have negative effects on their loved ones. They don’t want their wealth to be more than their heirs can responsibly handle, or so much that it makes them idle or wasteful. You also probably don’t want to risk having your money end up with ex-spouses, creditors or drug dealers of your progeny.

Fortunately, you can leave enough assets to make your children and grandchildren comfortable and do so in ways that avoid or minimize these problems. To do this, you generally want to leave money and property in a trust or trusts, with a reliable friend, family member or professional as trustee or co-trustee. It’s important to have the right terms in the trust. Discuss your goals and concerns with your estate planner to ensure the trust will have the right provisions to meet your goals. Here are the key provisions to consider for your trusts.

Spendthrift Clause

This is standard for most trusts as creditor protection. It generally provides that creditors of the beneficiary can’t force payouts from the trust or be paid directly from the trust. Even if the beneficiary is bankrupt, the creditors still can’t invade the trust.

It isn’t complete protection. The creditors might be able to lay claim to any money or property paid to the beneficiary from the trust. In addition, some States don’t allow the spendthrift clause while others put a ceiling on the value of assets that can be protected, such as $500,000. So, while you should have the spendthrift clause, it is not the only trust control you need.

Discretionary Clause

This clause gives the trustee discretion to pay or not pay income and principal to the beneficiary, and to decide how much to pay. This provision can work when the trustee knows your wishes well and you developed written guidelines for the trustee to follow. The trustee also needs to keep up with what’s happening in the lives of the beneficiaries.

Even so, the clause has disadvantages. It can leave the trustee and beneficiary as adversaries. That could lead to major problems if both are family members. Also, you can’t anticipate all possibilities ahead of time and give the trustee guidance on each possibility. You are relying on the trustee’s judgment. A corporate trustee who is not familiar with your family also might not be able or willing to use the discretion effectively. So it is a clause to be used carefully.

Milestone Or Incentive Trust

This provision is intended to prevent a beneficiary from becoming a wastrel or dependent on the trust. Instead of providing that income and principal will be paid on a schedule, this clause says payments are made when a certain milestone is met. The milestone can be reaching a certain age, graduating from college, being employed for a certain number of years, or virtually any milestone you want to set.

It is designed to protect against giving money to an heir before he can handle it or has established himself as a productive adult.

Often in these trusts before the beneficiary reaches the milestone, the trust will pay out only the income or a fixed dollar amount as an allowance, or it will pay for specified expenses such as education and medical care. That way the beneficiary’s basic needs are met, but there’s an incentive for him or her to be productive or meet the other goals that are important to you.

Stepping Stone Trust

This is a variation of the milestone trust. The trust pays some or all of the income or a fixed amount each year for a period of time. The difference is that instead of giving the beneficiary all the principal upon reaching a certain milestone, the principal is paid in stages upon reaching different milestones. That allows the beneficiary to learn over time how to handle the money instead of receiving it all at once. Some people believe this approach also encourages the beneficiary to be useful and productive over a longer period and establish it as a lifestyle before receiving enough from the trust to destroy incentives.

For example, a trust could provide that one-third of the principal is paid when the beneficiary reaches age 25, one-third at age 30 and the rest at age 35. Or you could have smaller percentages or specific dollar amounts paid in the early years and large percentage or amounts for the later dates. Some people have a trust pay a certain percentage of the trust or a lump sum after the beneficiary graduates college and another amount after graduation from professional school, and further distributions are made after the beneficiary stays employed for certain periods of time.

Matching Trust

This is another clause designed to pay out trust principal only when the beneficiary has some maturity and responsibility. The trustee makes payments to match income earned by the beneficiary. The payments can match the beneficiary’s income dollar for dollar or be a multiple of it, such as three times the salary.

But the matching trust can be a bit unfair if there are several heirs, or it might give the beneficiary the wrong incentives. An heir who is attracted to a relatively low-paying occupation, such as teaching, will receive less than a sibling who is drawn to a higher-paying profession, simply because of different interests and aptitudes. Also, the trust might cause an heir to seek employment in a high-paying field rather than one he enjoys the most. So the matching trust must be used carefully.

Escape Clause

This clause is called by a number of different names, but the substance is the same. No matter how carefully you choose from and draft the provisions already mentioned, the time the money is scheduled to be distributed might turn out to be a bad time to give it to the beneficiary. Or annual income distributions might be going to waste or harming the beneficiary, even before the principal is distributed. Perhaps the beneficiary drifted into substance abuse, gambling or high-risk business ventures or is going through a nasty divorce, bankruptcy or a lawsuit. There are a number of possible scenarios.

To prevent distributions under such circumstances, you can add the escape clause to the trust, in addition to any other clauses. The escape clause can override any other trust terms. In its simplest form, it allows the trustee to withhold payments when the trustee determines that doing so is in the best interests of the beneficiary. Some people spell out the circumstances under which payments should be withheld. Others realize they cannot anticipate everything, so they give the trustee a broad, general power to withhold distributions.

Under the clause, the payments to the beneficiary resume when the trustee decides it is in the best interest of the beneficiary.

Withholding payments under the escape clause doesn’t have to be all or nothing. You can empower the trustee to make payments that seem in the beneficiary’s best interests, such as paying for basic living expenses, but not more.

Emergency Clause

Some of the saddest estate-planning stories are those involving a trust that was created with certain situations in mind, but the trustee and beneficiaries are confronted with situations that weren’t anticipated. It’s not unusual for a trust creator to focus on the circumstances under which distributions are to be made and overlook other possibilities, such as situations in which distributions should be accelerated or increased.

For example, you probably would want the trust principal to be used if your grandchild developed special medical needs or wanted extended education. If you’d thought about it, in such circumstances you wouldn’t want the money sitting in the trust waiting for the grandchild to reach a certain age or be employed for a number of years.

It’s a good idea to add a clause that allows the trustee to make distributions under special circumstances.

Marital Agreements

Would you like a big part of your estate to end up in the hands of someone you never knew? It might if money is given to a child or grandchild whose marriage doesn’t last. The spouse could receive some or all of the wealth in a divorce. The assets in the trust might be protected, but the trust can’t protect money that’s already been distributed or is distributed in the future.

The best solution is for your children and grandchildren to have valid premarital or postmarital agreements. These agreements are very flexible, and the couple can put in whatever terms they like. But the basic clause you want is that any gifts or inheritances from you or trusts you create are not considered marital property to be divided in the case of a divorce but are the separate property of the spouse who was the beneficiary.

For a marital agreement to be valid, each party should have separate legal counsel, there must be full disclosure from each party and there must be enough time taken to contemplate the agreement.

Some people write their trusts so that they serve in place of marital agreements. The bulk of the principal never is distributed to beneficiaries unless they have valid marital agreements with the terms discussed above. Instead, the beneficiaries receive income and principal to meet their needs. But otherwise the principal remains in the trust and is safe from being divided in a divorce.

You can’t plan for all contingencies to protect your wealth. You can plan for the ones that have caused problems for people in the past by using trusts with time-tested clauses.

Be careful about using some of these clauses. Some people write such detailed conditions under which principal payments will be made that they cross a line from protecting the wealth to controlling and micromanaging their beneficiaries for life. They don’t allow for different circumstances or changing interests of their beneficiaries. You estate planner should be able to help you find the balance.

–Bob Carlson

Why A Living Will Is Not Enough

This article appeared on Liberty Investor™.

Every few years, the media latch on to a case of someone in a coma or similar medical distress. The family members and doctors don’t agree on what the next step should be and the confusion generates conflict, controversy and story. The lesson from the media always is: Be sure you have a living will.

The answer isn’t that simple. Often in these situations, there is a living will. It isn’t enough.

Medical care documents are essential to an estate plan. I’ve even recommended that these documents be finalized while decisions about other parts of the estate plan still are deliberated. But you need to consider more than one document. Let’s take a look at the choices.

Living Wills

Most States now authorize living wills and adopted sample forms that are easy to use. Often you can download one from your State’s web site. The approved living will forms for each State also are located at Caring Connections (

A living will in its basic form articulates whether you want certain levels of care in certain circumstances or not. The basic, traditional living will states: “If I have a terminal condition, and there is no hope of recovery, I do not want my life prolonged by artificial means.”

Though a simple idea, it isn’t so simple to put into practice. There are areas of possible disagreement and uncertainty.

Often, it can’t be determined with certainty that someone has no hope of improvement or is terminally ill. There also is debate over whether feeding and hydration tubes (and other forms of care) are artificial means of life support or means of providing comfort.

The response of estate planners is to draw up custom living wills. They work through detailed questionnaires with their clients, sometimes totaling 60 pages or more. The questionnaires give different scenarios. The client decides the decision to be made in each circumstance. You might have seen an example on an episode of “Seinfeld.”

Even this approach has drawbacks. Technology and medical knowledge change. The situation that was hopeless five years ago might not be today. Also, we don’t really know what a person is feeling or experiencing in all these circumstances. Of course, even a questionnaire of 60 pages or more cannot cover every possible scenario. Finally, there still can be disagreements over the facts and certainty of the prognosis.

Another caution about living wills is some studies found they simply aren’t effective. Treating doctors and nurses might not see the documents until after treatment has been administered. Some ignore the documents because they are afraid of lawsuits. At other times, doctors interpret the documents as approving treatment when others have a different interpretation. Finally, if one or more key family members ask for treatment, doctors normally comply even if the living will says otherwise.

Often unsaid is that the intent of most living wills is to stop or remove care. You, on other hand, might want to draft a living will that says you want care in all but a few circumstances.

Healthcare Power Of Attorney

A living will is fine, but because of its limits, everyone should appoint a healthcare proxy instead of or in addition to a living will. The appointment is made through a healthcare power of attorney or proxy. The name of the document varies from State to State.

A healthcare proxy gives one or more people the authority to make medical decisions when you are unable to. The persons with the power of attorney need to be available to the care providers, so you might not want to name someone who lives a sizable distance from you, travels a lot, or doesn’t have some flexibility. You ease the burden on others by naming more than one person. Some people appoint only family members. Others believe that the decision can be less emotional if at least one trusted non-family member is named. You also set the default decision with the voting rules. For example, you can say the default is to provide treatment unless all the proxies agree to withhold it.

The power of attorney can be supplemented with a living will or other document that expresses your philosophy and wishes under at least some circumstances. The combination of a power of attorney and living will often is called an advanced healthcare directive.

Do Not Resuscitate (DNR)/ Do Not Hospitalize (DNH)

DNR and DNH orders for older patients are quite common, especially for those who are frail. Research indicates CPR rarely helps these individuals recover and instead makes their passing violent rather than peaceful. The reasoning for the DNH is that at some point people do not benefit from hospitalization for every new ailment or development. Instead, they should be kept comfortable wherever they are residing.

Someone who agrees with those sentiments can decline in advance CPR or hospitalization or both.

HIPAA Authorization

This simple document authorizes medical providers to release medical information about you to the named persons without violating the privacy provisions of the Health Insurance Portability and Accountability Act of 1996. It can be incorporated into the other forms. Many medical providers won’t even give details to spouses and family members now without the authorization.

If you spend time in more than one State, check with an attorney to be sure that your documents will be effective in all States involved.

Your documents also can include non-medical instructions. You can give instructions regarding music, grooming, fresh flowers  and other aspects of your environment you’d like when you are receiving care.

Of course, all of your doctors should have a copy of any documents you execute and know how to get in touch with the proxies named. Each of the proxies should have a copy. Some family members also should have copies.

Making Health Directives Work

You can take steps to increase the probability that your instructions will be followed.

  • Put it all in one document. A complete plan involves at least a healthcare power of attorney and living will. You also can include other instructions discussed above. Consider compiling all this information in one document instead of in separate documents. Sample all-in-one documents are available, as Five Wishes, from Aging with Dignity (; 888-5-WISHES) and some other sites. These organizations charge modest fees for the documents and say they have versions for each State.
  • Be sure it is valid. Some States require two witnesses for the documents to be valid. Others require three witnesses. A few require the documents to be notarized. Be sure the documents are valid in your State.
  • Don’t forget about travel. The law of wherever you are when healthcare is needed determines whether a document is valid. If you regularly live in or travel to other States, produce a document that is valid in the most restrictive State or prepare different documents that meet the requirements of different States.
  • Don’t keep it to yourself. To reduce disagreements and misunderstandings among those around you, it makes a lot of sense to discuss details with the people you designate as proxies and also general beliefs with your loved ones. Remember that a document, no matter how detailed, can’t cover every possible situation. Your proxies need to know your general beliefs so they can make decisions in specific circumstances that reflect your wishes.
  • Consult different sources. Web sites and books have sample forms. Estate planning attorneys have their own forms developed over the years based on personal experiences and philosophies. Consult several sources to get a taste of the available options.

Though I list a number of sources for forms and documents, I don’t recommend that most people complete this on their own. This is part of an estate plan and should be finalized with the guidance of an estate planner.

None of these tools provide a perfect solution. In most cases, difficult decisions will have to be made by loved ones. But you can ease the burden and provide a framework for making the decisions.

Keep in mind that most States allow a doctor or hospital to refuse to follow the instructions for reasons of conscience.

Most of us need help in thinking about the difficult treatment decisions, whether for ourselves or others. A useful guide is a booklet written by a former chaplain at a nursing home. The booklet discusses the pros and cons of different choices and includes summaries of the scientific research on different treatments. You probably could benefit from Hard Choices for Loving People, by Hank Dunn (A&A Publishers, Inc., 43608 Habitat, Circle, Lansdowne, VA 20176-8254; $6.00; 855-232-4365; Fax: 571-333-0167);

–Bob Carlson

Estate Planning For Modern Families

This article was featured on Liberty Investor™.

Traditional estate plans don’t work well for many families these days. A traditional plan is for couples who are in their first and only marriage and have only kids from that marriage. Different plans, tools and strategies might be needed for people with other life stories.

Let’s start with planning for the single person. Many people now are unmarried for a substantial part of their adult years. They might be widowed, divorced or never married. They might be in relationships that don’t include legal marriage.

Several issues are the same for all of them.

The first focus of a single adult’s estate plan should be to ensure that someone competent will manage the property and other matters if the individual is unable to. The best solution usually is a durable financial power of attorney or a living trust or both.

You also need a medical directive, which can include a medical power of attorney, a living will and other instructions. These documents designate one or more people to make decisions about your medical care when you aren’t able to. We don’t have space here to discuss these in detail. Detailed discussions are on the Retirement Watch members’ website.

These tools also are important for traditional couples, but they are more important for others. State and Federal law often provide some protection and presumptions for married couples but not for others. As with married couples, the key to making these tools work is naming the right people to make the decisions for you and being sure the documents properly empower them.

Surprisingly to many people, you’re also likely to need a document naming people who can visit if you are in a hospital or other facility. This might be in the medical directive or a separate document. Many medical providers now interpret Federal privacy law to restrict access to only family members unless there is a clear statement from the patient.

Long-term care insurance or some other plan for long-term care might be more important for an unmarried person than for a married couple. A single person doesn’t have a spouse who might be able to assist him. While Medicaid will pay for nursing-home care while allowing you to retain some assets, a married couple usually is allowed to retain more assets than a single person. In addition to a single person’s being able to retain fewer assets for a legacy, the assets of any partner of the single person might be endangered under Medicaid, especially if the assets are owned jointly.

Those are common issues for all single persons and others in non-traditional families. Now, let’s look at different situations they might face.

If You’re Single

Unmarried estate-planning candidates fall into three categories: those who have children from a previous marriage or relationship, those who never had children and those who are part of a couple but won’t be getting married or whose State doesn’t recognize their marriage. The categories can overlap, but each category has some unique challenges.

As with a married person, a single person who dies without a will has the disposition of the property determined by State law. If there are biological children, in most States the property will be divided equally among the children. If there are no children, the disposition can be very unexpected, depending on the State and which relatives are alive. The property could go to half-siblings, cousins or nieces and nephews. Single adults, especially those without children, are more likely to have nonfamily and charities as objects of affection and so prefer a disposition different from that offered by State law.

Issues about children from more than one relationship and nonbiological children are discussed later with patchwork family issues.

With a traditional couple in these situations, the solution is to draft a will; but single people might prefer having most assets pass through a revocable living trust. Depending on the State, the probate process for a will might require notice to everyone who would have been eligible to inherit if there had not been a will. For an unmarried person, especially one without children, that can mean constructing a family tree and proving the demise or divorce of extended family members.

Property in a living trust avoids probate, and the terms of the trust determine who inherits the property. A will still is needed because it might not be possible to transfer all property to the trust, but the living trust might minimize delays and costs.

Another key issue for singles is the choice of an executor or successor trustee when there is no spouse or adult child to take the role. There might be friends or family members who are able and willing to handle the position. Otherwise, a trusted adviser, such as an accountant or attorney, might be the best choice.

There are a number of assets that aren’t covered by a will or living trust. These assets include individual retirement accounts, retirement plans, annuities and life insurance. Singles need to decide who they want to benefit from these assets, complete their beneficiary designation forms, keep copies of the forms and update the documents when appropriate. The executor of your estate needs to know about these assets and where to locate your records.

Taxes are an interesting planning issue. The income tax law can be more generous for unmarried people, but the estate tax is less generous to singles than to married couples.

Often, a married couple pays higher income taxes than two single people with the same incomes. Partly for that reason, some seniors choose to live together without getting married. Staying unmarried allows them to file separate returns, and a couple might be able to shift some deductions to the one in the higher tax bracket.

Under the estate and gift tax, singles do not have the advantage of the marital deduction. An unmarried person still can use the annual gift tax exclusion, make unlimited gifts for education and medical expenses and use the $5.34 million lifetime estate and gift tax exemption. The lack of a marital deduction now matters only to fairly wealthy unmarried seniors, but for them it does limit the after-tax amount that can be left to noncharitable beneficiaries. For them, life insurance might be more attractive than it is for married couples.

The annual gift tax exclusion can be used to benefit anyone. Those without children often use it to benefit nieces, nephews and other relatives.

Care must be taken when using the lifetime gift tax exemption amount. It often is better to make gifts early as long as sufficient assets are retained to support the standard of living. Yet the objects of affection might change over time, especially in nontraditional families. So if the exemption is used early, be sure the recipients of the largess are likely to be permanent objects of affection.

For many single seniors, especially those without children, a legacy of charitable giving is more important than it is for marrieds. The singles’ estate plans might contain more charitable gifts than others. In addition, they might make more lifetime use of strategies such as charitable trusts to generate current income tax savings and income during their lifetimes, reduce the size of their taxable estates and leave charitable gifts.

Social Security and pensions leave few options. Social Security does not allow designation of a beneficiary other than the spouse, and a number of employer pension plans have the same restriction. The main options to replace this income for a surviving loved one who is not a spouse are to buy life insurance or have other assets to leave the person. Another possible strategy is to place assets in a charitable remainder trust that pays income to a beneficiary for life or a period of years, and then the remaining assets go to charity.

The population of single adults is increasing, and it faces unique estate-planning challenges. These individuals should be sure to work with an estate planner who understands their special situations.

If Yours Is A ‘Patchwork Family’

Another type of nontraditional family often is called a “patchwork family.” These are families in which at least one spouse is in a second or later marriage and there are children from one or more of the marriages or other relationships.

Estate planning issues generally are important in these families. The spouses usually want to provide for each other. But they might have different objectives beyond that.

A common situation is that a spouse wants his assets to provide for the surviving spouse during her lifetime, but wants any remaining assets eventually go to his biological children. There often is a concern that if property is left outright to the surviving spouse, the assets ultimately might not be distributed among the children as desired. Also, when there are children from more than one relationship, there might be a preference to favor one set (such as the younger children) over the other. Some people want to provide for stepchildren, while others don’t.

For patchwork families, trusts are the usual way to resolve these issues. The primary goal of the trusts isn’t tax reduction. Instead, the trusts are used to control how the property is managed and distributed over time. The terms and number of the trusts vary based on the family situation. There might be one family trust or separate trusts that filter down to different members or branches of the family. The estate owner needs to determine his goals and have the estate planner write a plan that best meets those goals.

The downside to using trusts is that you probably can’t make full use of both spouse’s lifetime estate and gift tax exemptions. That’s not an issue for most families, because of the $5.35 million individual exemption, but can result in trade-offs for wealthier families.

Patchwork families also seem to have more will contests and other disputes than do traditional families. This risk can be reduced if the spouses sign a premarital or postmarital agreement. Otherwise, if you have only a will, it is easier for your spouse or even your spouse’s children to challenge the terms. Also, let your children know generally how you intend to distribute the assets between the families. If you state this at the outset, it becomes much more difficult for one of them to challenge the plan.

When it’s a second or later marriage, the spouses almost certainly should have separate attorneys for their estate plans. There are just too many potential conflicts for one attorney to serve the two spouses. In addition, to avoid potential conflicts and suspicions, many estate planners recommend that you give your durable power of attorney, healthcare proxy or living will to one or more adult children or other people instead of your spouse.

–Bob Carlson