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Personal Finance FAQ

Papers, Please! The Important Documents in Your Life

This is part of a series. If you have not read the articles that build up to this one, I recommend that you do so first.

If you’ve ever read John Grisham’s The Testament (#aff), then you know what an entertaining read the story of a battle over a will can make. However, if you’ve had to live through family squabbles over who got Aunt Fanny’s dust bunny collection, you know that they’re no fun to go through.  The problem is that most of us don’t like to think about times when we are anything but happy, healthy, and vibrant. Monkey Brain looks in the mirror and sees Adonis or Venus, with no flaws, and no possibility of getting old. His view of you is that you’re Dorian Gray, and you’ll never get old or sick.

But, until we come up with the immortality vaccine, we’re going to get sick, get old, and eventually pass away. If you don’t do anything to prepare for this beforehand, then state laws will determine what happens to you and to your possessions. If you don’t want some random relative to wind up with your stuff, which could happen if nobody else is alive or around to claim it, then you need to take some preparatory measures.

The Important Documents You Need to Have

In this article, we’ll deal with two different categories of documents that you need to have. The first set of documents deal with what happens to you if you become incapacitated. The second set of documents deal with your wishes for what happens to your assets when you die.

Documents That Deal With Your Incapacity

There are four main documents which you need to have somewhere handy in case something happens to you and you’re no longer able to make decisions on your own.

  • Advanced Medical Directive: The Advanced Medical Directive allows you to state what sort of medical care you wish to have in the event that you are unable to take care of yourself. The common directives include resuscitation, artificial feeding, or artificial hydration. You can also specify which types of treatment to withhold. Finally, you can appoint someone to make decisions for you.

    Most states have some form of preapproved advanced medical directive text that is valid for the state in which you reside. You can also register in an advanced health care registry directory with most states. Registering with your state’s advanced health care registry will allow medical staff at hospitals to render or withhold treatment according to your wishes, particularly in the case that they cannot reach the person you have appointed to make decisions on your behalf or that person was incapacitated or died at the same time you were incapacitated.

  • Medical Durable Power of Attorney: A medical durable power of attorney is designed to allow someone else to make medical decisions on your behalf. It’s not meant to be limited to terminal conditions or a vegetative state. It can be used to make decisions such as admittance to nursing or assisted care facilities, to complete insurance forms, and to appoint a guardian for you. The power of attorney is meant to be flexible, and you can design it to include as many or as few medical decisions as you want it to.

    Again, most states have preapproved medical durable power of attorney templates. You will need to check to make sure that the power of attorney has included HIPAA release consent so that the person with the power of attorney can actually receive information from your healthcare provider in order to make an informed decision.

  • HIPAA Release Form: The Health Insurance Portability and Accountability Act (HIPAA) was designed to protect you from having just any old person come in and look at your medical records. This is great, except when you actually want someone else to look at your medical records. In most cases, this is handled through your doctor’s office. For example, when I tore my meniscus and needed orthopedic surgery, my primary care physician had me fill out a HIPAA release form to send to the VA hospital where I got my MRI and to the orthopedic surgeon who was actually performing the operation. That way, all parties involved had access to my records so that they could provide me with the appropriate care while I was being treated.

    The hiccup to this process comes when you’re not able to actually fill out a HIPAA form and you need your medical power of attorney designee to make medical decisions on your behalf. To circumvent this, you need to get HIPAA forms from your normal care providers and fill them out, authorizing your designee to see your medical records in the case that you are unable to make decisions. File these forms with your doctor, keep a copy for yourself, and give a copy to your designee. Some states have standard forms as well; you can use Google to see if your state has standard accepted HIPAA forms.

  • Powers of attorney: In a few cases, such as if you’re going to be out of country for several months, you may want to provide a limited power of attorney for paying bills, dealing with property matters if your property is broken into, or handling legal matters which may arise. Limited powers of attorney are limited in both scope of what the designated person can do and in the time that they will last. General powers of attorney give the designee the power to do anything that you can do, and in almost all instances, should be limited only to a spouse. A special type of power of attorney is called a “springing durable power of attorney,” which is meant to come into effect in the event of your incapacity. Some banks do not accept these types of powers of attorney, so check with your bank first.

Those are the primary documents meant to deal with your affairs in the event that you’re incapacitated or unable to make decisions or sign documents. However, they do not cover what happens if you pass away. That is a separate category of documents in your estate plan.

Documents That Deal With Your Death

When you die, if you do not have beneficiaries named in your payable upon death accounts or have a will, then the estate will be divvied up according to the estate laws of your state. This usually works out fine, but if you don’t want there to be a fight amongst children or siblings about some memento that someone else gets, you need to have the appropriate documents already in place. Furthermore, the goal should be to avoid probate as much as possible. Probate is an expensive, long, and public process. If you don’t want the entire world to know that you had a valuable collection of leisure suits, then you do not want them to go through probate.

Here’s how you can minimize what goes through probate.

  • Naming beneficiaries in Payable On Death (POD) and Transfer on Death (TOD) accounts: The first category that you need to ensure is set up properly is your POD/TOD accounts. These are the highest priority directives and will supersede what is set forth in your will. The most common of these accounts are bank accounts and brokerage accounts. If you have a joint account with a POD directive for your spouse, then, if you pass first, the account will become your spouse’s account in your spouse’s name only. These cannot be used to avoid creditors, but they do avoid probate.

    Another set of TOD assets is property – real estate and automobiles. There are two types of joint ownership which trigger the TOD and avoid probate.

    • Tenants by entirety: This is applicable for real estate and is only available for married couples.
    • Joint tenants with rights of survivorship (JTROS): This is applicable for both real estate and vehicles and can be used for non-spouses. For example, if you and your brother jointly owned a house and you passed away before he did, then he would get full fee simple ownership of the house.

The final type of account which has beneficiaries is life insurance. When you name a beneficiary and have an active life insurance policy in force, upon your passing and notification to the insurance provider, they will pay out the claim directly to the beneficiary. In most cases, this is a tax-free event.

It is important that you do not name your estate as the beneficiary on these accounts. If you do so, then your estate will have to dispose of the assets – meaning distribute them according to your will or to state estate laws – and they will go through probate. I cannot emphasize enough that probate is costly and time-consuming, and it’s public. The whole world gets to see your affairs exposed. Avoid it where possible.

  • Wills: A will is the legal documentation of your wishes for the distribution of your assets upon your death. Remember that if you have debts or expenses which you were not able to pay while living, your estate will be required to pay; the estate stands good for the debts.

    Typically, wills are written and comply with the laws of the state in which you reside. They must be signed by you at the end and witnessed. Some states allow handwritten wills, and, while it may be common to see the dying exclamation in movies, they’re limited in the legal strength that they possess. It’s best to go with a prepared, typed will.

    If you are married, it is common to use what is known as a “sweetheart will,” where all assets pass to the remaining spouse. If there are specific assets which you wish to go to someone else, these can be outlined in the will as well.

    In the will, you will name an executor, who is the person responsible for carrying out the wishes of your will. The executor will represent the interests of the estate and will distribute the assets according to the terms of the will.

    There are a few clauses within the will which you should know about when you prepare it:

    • Bequest clauses: these are the clauses where you specify specific assets to go to your stated recipients, e.g. “I leave my prized dust bunny collection to Bill Gates” or “I donate all $100,000 to the Red Cross.”
    • Residuary clause: this is the clause which states who receives whatever is not specifically allocated in the bequest clauses, e.g. “I leave all remaining property owned by me and not previously provided for in this document to my husband, Robert Davis Smith.”
    • Guardianship clause: this is the clause which identifies the individual(s) who are to raise minor children or dependents. You will want to identify successor guardians in case the original guardians are unable or unwilling to accept the responsibility, e.g. “In the event that my child is a minor at the time of my death, I appoint my husband, Robert Davis Smith, as guardian of our child. In the event he is unable or unwilling to serve as guardian, I appoint my brother, William Jennings Bryan, as guardian.”
    • Tax/debt appointment clause: this is where you specify how estate taxes (if any) and debts (if any) are paid. They usually come from the residuary estate.
    • Simultaneous death clause: this is a clause which is used to avoid disputes between potentially competing heirs if it’s medically impossible to determine who died first. Let’s say that husband and wife have no kids, and each has a sibling. Husband’s brother hates wife’s sister. If husband and wife die after falling into a vat of syrup and drowning, the medical examiner may determine that the wife lived one minute longer than the husband. According to the laws of the state, all of husband’s assets would go to the wife, and then on to the wife’s sister. The husband’s brother would probably go to court to fight the finding and try to find that the wife died first. A simultaneous death clause solves this problem. In it, each person would assume that the other died first. In this case, by having a simultaneous death clause, husband’s brother would get husband’s assets, and wife’s sister would get wife’s assets. An alternative to the simultaneous death clause (and usually a better choice) is the…
    • Survivorship clause: In a survivorship clause, the approach is the same as in a simultaneous death clause, but the surviving spouse must live a certain amount of time. For example, if, in the syrup incident above, if wife had been in a coma for a week and then died, using a simultaneous death clause would have been irrelevant, and wife’s sister would get the entire estate. If they use a survivorship clause requiring the surviving spouse to live for, say, three months before receiving the estate, then the estate would be split. Be careful in using this clause, as it can tie up assets that the surviving spouse needs to live. Make sure that there would be enough money available in a POD/TOD account to allow the surviving spouse to continue to meet expenses in the intervening time period.
    • Disclaimer clause: this clause is meant to remind heirs that they don’t have to receive everything that is bequeathed to them. Let’s say that Bob and Sue own a timeshare. They bequeath the timeshare to their daughter Laura in the will. Laura is savvy and realizes that timeshares are terrible to own and doesn’t want it. She can disclaim the timeshare. To disclaim the timeshare, she must:
      1. Not benefit from the property itself
      2. Not say who else receives the property instead of her
      3. Disclaim it within nine months of the death of the person(s) bequeathing the timeshare to her, and
      4. Do so in writing
    • Contingent legatee clause: this clause is used to determine in advance who should receive property in the event that the original intended recipient has died. This can either be to an entirely different recipient, or to the original recipient’s heirs. If to the original recipient’s heirs, the contingent legatee clause needs to specify:
      1. Per stirpes: this means that the assets flow proportionally. Let’s say that you designate your two children Sally and Bill as recipients of $100,000 total. Sally has two children, Biff and Bob. Bill has one child, Jill. If Sally predeceases you, and you designate the heirs per stirpes, then Bill gets $50,000 and Biff and Bob get $25,000 each.
      2. Per capita: this means that the assets are divided amongst the remaining heirs. In the previous example, if you decided on a per capita distribution among contingent legatees, Bill, Biff, and Bob would all get $33,333.33 each.
    • No contest clause: this is a clause designed to create an incentive for a potentially upset party not to contest the will in court. In order for this to be effective, it has to give something to the person who would otherwise contest the will, and if that person (or those people) contests the will in court, the money is forfeited. A good example would be an estranged child who receives a small inheritance compared to the other children. A no-contest clause would create a situation where the estranged child could lose the inheritance he did receive if he challenges the will in court and loses. Sometimes this won’t work, because people are apt to forego economically beneficial arrangements if they feel they are wronged – a phenomenon called altruistic punishment,[1] so they will sue regardless simply for the principle involved. But, it can work in other cases. The applicability of a no contest clause depends on the state of residence.

You will also need to attest to the will and that you are of sound mind and body, and get the will notarized so that there is no need for a witness’s testimony in probate court that it was indeed you who wrote and signed the will.

  • Living Trust: If you have a significant amount of property that you wish to pass on to heirs without going through probate, then you could create a living trust. You transfer the assets of your estate to the trust, which is revocable and for your benefit during your lifetime. When you pass, the property in the trust is passed on to your beneficiaries. Since the trust handles the management of the property, the probate court does not need to be involved. A living trust will generally cost between $1,000 and $1,500 to create and a couple hundred dollars a year to maintain. There are tax issues associated with improperly created trusts (namely trust income), so you will need to consult with a trust attorney if you decide to create a living trust.
  • Trust for Minors: If you have minor children and wish for them to be beneficiaries of your life insurance policy in the event that both parents (or the one responsible parent) die, you can create a Section 2503 trust, otherwise known as a trust for minors. Most insurance agencies will allow you to name a trust as a beneficiary of the life insurance policy; however, the trust needs to be in place before you die. The basic steps are to identify a custodian, fund the trust, and outline provisions for the restriction of the use of funds in the trust. You need to consult with an estate planning attorney to set this up.

Can I Get These Documents Online?

 In most cases, you can use an online form providing company like LegalZoom or Nolo to get the basic documents. Here are some examples where I would actually use an attorney rather than getting a form off of the Internet:

  • You would be subject to estate taxes. Federally, in 2020, the limit is $11.58 million dollars; however, many states have lower thresholds. Don’t just look at the federal limit when considering whether or not you’d be subject to an estate tax. Assets passing from one spouse to another are exempt from federal estate taxes, as long as they are both U.S. citizens.
  • You’re creating a complicated will or complicated medical directives. As long as what you’re doing is pretty straightforward, then you will be fine using standard forms.
  • You’re creating a trust. You definitely want to get the documentation right if you’re creating a trust, because you want the trust to stand up to legal scrutiny, and you want it to be properly set up if you’re using it for legal tax avoidance. Get it wrong and you’ll either subject your estate or you’ll subject your beneficiaries to unwanted taxes.

Dealing with incapacity or death is not an easy subject, but it’s one that we must take responsibility to address.

 

Now that we’ve looked at how to protect yourself, let’s go on offense. The next couple of articles will deal with other ways you can grow your nest egg. First, we’ll focus on investing in real estate.

 

Related articles:

If You’re Waiting for an Inheritance, You’re a Sick, Entitled Teat Sucker

Estate Planning and Trusts: An Interview with Attorney Ben Grosz

Stuff Tore a Family Apart. What a Shame.
 

[1] http://www2.unine.ch/files/content/sites/ethol/files/shared/documents/Fehr_Gaechter_altruistic_punishment.pdf

The next article in this series is “Getting People Who Live in Houses to Pay You.”

By Jason Hull, CFP®

Jason Hull, CFP®, was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business.

You can read more about him in the About Page.

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