Major Changes Under Duress Not a Good Idea

It’s not uncommon to panic under extreme pressure. And there’s no pressure like when a loved one is very sick or near death. There’s a temptation to “tie up loose ends” and to direct our financial advisors and attorneys to make “last minute adjustments” before it’s too late.

Resist that temptation, especially if you’ve recently updated your planning.

I’ve seen families make irrational decisions that can be attributed to a lack of understanding about their estate plan. In many married couples’ estate plans, for example, there are two trusts, one for the husband and one for the wife. The reason that two trusts exist is to take advantage of both spouse’s estate tax exemptions.

Sometimes there is a misperception that when one spouse dies then that spouse’s trust will be distributed to the surviving spouse. But that’s usually not what really happens. In most cases, the decedent spouse’s trust continues on as a separate trust for the surviving spouse’s benefit for the rest of his or her life. Often, the surviving spouse will become the trustee of the decedent spouse’s trust as well.

The reason that the decedent spouse’s trust is not distributed outright is that doing so would defeat the estate tax planning that has been put into place. By making a distribution outright to the surviving spouse, then all of the estate would be taxed when he or she dies. So that is why the husband/wife trusts are typically held for the surviving spouse rather than being distributed outright to him or her.

Not understanding this fact, panicked families will collapse the trust before the sick spouse dies and put everything in the well spouse’s name. As I pointed out in the preceding paragraph, doing this will likely defeat the estate tax planning and balancing of assets that was put into place to take advantage of the tax exemptions.

Other times families will reposition assets between the trusts just before the sick spouse dies. This can also lead to problems related to capital gains taxes. Normally, when a person dies holding appreciated assets, the assets receive a “step up” in tax cost basis equal to the date of death value. If I purchased Coca Cola Company stock at $1/share and when I died it was worth $10/share, then my beneficiaries will normally inherit the stock at the step-up value of $10/share. If they sold it shortly after my death for $10/share, then the capital gains tax that would have been realized had I sold the stock the day before my death disappears.

But if the family tries to transfer appreciated assets into a dying person’s name in an effort to receive the step-up in tax cost basis, they have an unpleasant surprise. The tax law anticipates people trying to take advantage, so there’s a rule that disallows step-up if the asset was transferred within one year of death. So making last minute changes here could actually do harm to the family.

Should a family therefore not worry about last minute planning if a loved one is gravely ill? Certainly if that person’s documents haven’t been updated in quite some time it makes sense to review them with competent counsel. But the family would be wise to carefully think through any choices that they have, and consider the time it would normally take to implement those choices successfully. If the health and mental stability of the sick person isn’t expected to hold out for long, then it makes sense to “triage” the strategies in such a way as to take care of the most important things first.

Another important thought in late-stage planning includes the fact that any significant changes might be subject to challenge. If a sick person suddenly disinherits someone in favor of another family member, undue influence and competency issues might arise.

If this is a possibility, the family might want to ask attending physicians for statements regarding the sick person’s competency, carefully document all of the medications that are being administered (with an eye towards whether any might affect decision making) and take steps to ensure that the sick person visits alone with counsel rather than having family members who might be or become beneficiaries present at the meetings.

Dealing with the loss of a loved one is almost always stressful. No one wants to compound the stress by having to deal with legal, tax and financial issues at the end of life. The best way to avoid that problem is to take care of things well ahead of time. But if you or a loved one find yourself in this situation, be very careful that you don’t cause more harm than you solve.

©2012 Craig R. Hersch

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