Tax & Financial Strategies for Life’s
James Revels, CPA, MST, Citrin Cooperman
Estate and financial advisors are typically deemed to be the “trusted advisor” and they are frequently the first person informed of significant personal and financial events during a client’s life. It is important that advisors communicate the various significant changes made with the enactment of the Tax Cuts and Jobs Act of 2017 that will certainly have an effect on them personally. The trusted advisor provides consultations and provides recommendations at many different stages of a person’s life whether it be moving to another state, the birth of a child or terminal illness to name a few.
Trusted advisors are often confronted with client situations that require proactive and not reactive guidance in a timely fashion. Being able to respond to a client’s need is important to maintaining the relationship. There are times that they are informed of a client’s life changing event and need to be able to provide meaningful support. For example, when it is discovered that a client or someone in the client’s family is terminally ill, the emotional impact on those who care for that individual cannot be overstated.
Financial details should not be overlooked and astute planning can help everyone emotionally and financially.
Moving to Another State
Relocating to a new state requires a person to make a number of financial-related changes. Some of these changes are setting up new accounts with banks and brokerage firms or at least changing the mailing address. Various forms of new insurance policies will need to be reviewed and put into place. Existing life insurance policies will need to be updated.
Health care is sometimes never even considered. A person needs to be reminded to determine if their health care policy provides coverage in the new state of residency. Advisors should suggest that before the move occurs that steps be taken to maintain coverage (e.g., complete a new application form) or possibly change coverage. Someone with employer coverage likely is automatically covered in the new state, but they should be reminded to check with the plan administrator.
Medicare Considerations - Medicare-age individuals need to consider the type of coverage they choose. For example, the Medicare Advantage plan costs are lower when seeing doctors who are in network, this is beneficial for a person who lives in one place. Comparatively, Original Medicare is typically more beneficial for someone with multiple residences since the coverage applies in all states. Advisors that are aware a client who is relocating with a Medicare Advantage plan or Medicare Part D should inform them that there is a special enrollment period (SEP) to change plans.
Legal Issues - When a person moves to another state, all of the personal documents, including wills, trusts, powers of attorney, and health care directives and appointments, must be reviewed, changed and executed. Obviously, most advisors realize that typically wills executed in one state may not be valid in a new state of residence. In addition, many states have different laws that will necessitate the creation of new legal documents. Typically, this task is forgotten about or just pushed off until a later date which from time to time is too late. Another reason advisors should explain why these documents should be executed sooner rather than later is because the probate process in some states is more onerous than in others. This may require the use of living trusts to avoid probate and some states impose a death or inheritance tax which makes planning even more important. When a client already knows the state and city they will be moving to an advisor can make an introduction to advisors before they move to get the process started before the actual physical move occurs. This could be especially important if the clients are elderly and their mental capacity maybe declining.
Many people do not understand the significant differences in community property states - Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, and Washington (and Alaska for couples who opt in to treat their assets as community) - are states that could require significant new planning as a client moves into one of these aforementioned states. On a day-to-day basis, community property laws are invisible. However, in the events of divorce, death, and taxes, there are big differences in the results to spouses. One consideration for spouses who keep their assets separate is to consider post-nuptial agreements designed to nullify community property laws. In addition to the extent pre-nuptial agreements exist, they should be reviewed.
Advisors all have snow birds as clients they live in the North in the late spring, summer and early fall and spend winter in the South. These clients need special attention for their legal documents. The will should be written and executed in the state where the person is domiciled; only the most recent will can be probated (regardless of where it is made). An advisor should consider having durable powers of attorney drafted in each of the states that the client resides in during a typical year. They should consider an attorney in each state, or one who is licensed in all the states that the client resides.
Birth of a Child
Planning for a new child in the family can be not only stressful but expensive. According to the U.S. Department of Agriculture’s latest figures, it costs $233,610 to raise a child through age 17. There are many types of advice that should be given to expecting or new parents that typically may not be on the clients mind. Realistically they are looking at many things and the following items are potentially low on the priority list.
Certain tax credits may now be available. A qualifying child is a person under the age of 17 by the end of the year who is a U.S. Citizen, national, or resident alien that did not provide more than half of his/her support and lived with the taxpayer for more than half a year. Advice should be given that they may want to revise wage withholding and/or estimated taxes as they may be able to benefit from the child tax credit now that the dependency exemption has been eliminated. In addition, if both spouses are working they may be able to benefit from the dependent care credit, which can have a direct impact on their paychecks if they opt to be part of an employer plan.
Now more so than ever saving for education needs to be one of the top items advisors provide guidance on. The sooner (rather than later) parents begin to invest in their child’s education the better.
According to U.S. News, the average tuition and fees for 2017-2018 are:
$34,699 at private schools
$21,632 at public schools for out-of-state students
$9,528 for public in-state students.
These amounts do not include room and board, books, transportation, and other costs of attendance.
One of the best ways parents can begin saving for education is with the use of education savings plans – 529 Plans. These plans come with many flexible benefits that many people are not aware of. Unused amounts in an account can be transferred tax free to another beneficiary. Many states allow for an income tax deduction or credit to residents on certain amounts of contributions, regardless of the parents gross income. Multiple 529 accounts can be maintained for a beneficiary, therefore allowing for further diversification of investment options. In addition, parents may set up one plan and the grandparents may set up another. One item to note to add potential future flexibility is to have dual parent approval on all forms for disbursement. This way if one parent is not able to make a distribution to an educational institution, the other has the capability to act on their behalf.
There are many important document changes that should be made soon after the birth of a child. Some of those changes include making beneficiary changes on life insurance policies and trusts, annuity contracts, retirement plans, and/or IRAs. Typically if this is the first child, it may require the creation or revision of wills and other estate planning documents. This is also the time that parents may want to name a guardian and a successor guardian for the child. Consider providing guidance to have two guardians, one to care for the child and another to handle financial matters.
Planning for the Terminally Ill
Clients that are going through serious medical issues may not be focused on asking certain questions that may help them since they are focused on taking care of themselves or a loved one who is terminally ill. Advisors should reach out to the client’s spouse, children, or other close parties to ask the difficult questions and offer practical suggestions. Planning during terminal illness falls into two different categories. One is maximizing current cash flow, to cover the medical expenses and the second is estate planning, which becomes even more urgent when death is imminent. Advisors tend to shy away from clients when they are going through difficult times mainly because they think that the client wants to be left alone to deal with their situation. This is typically not the case, this is the time they want their trusted advisor to step in and help.
It is important to inquire if there is adequate cash flow. It can make a difference if the terminally ill person was still in the work force. Group disability benefits may be available from an employer, and worker’s compensation payouts might be possible. Social Security disability benefits also could be a source of needed income. Personally owned disability insurance, instead of or as a supplement to group coverage, may be another resource that is available for needed cash flow.
Advice may be needed as to the taxation of disability benefits as they may or may not be considered taxable income. Disability insurance premiums that were paid with after-tax dollars are tax-free when distributions are made. However, if the employer pays the premiums for the disability insurance, the distributions will be taxable income. For example, disability insurance premiums paid under Section 125 employer health plans will result in taxable income if the benefit is ever needed. It is vital to know how the premiums have been paid.
When there is a cash flow issue, it is important to be able to provide advice on how to obtain alternative sources to fund the cash flow deficit. Retirement accounts usually may be used, which will in most situations trigger additional tax, but that may not be an issue for people who otherwise are short of cash flow.
Another resource for additional cash flow can be found in life insurance policies. Some life insurance policies are structured so that the death benefit can be partially paid out to the insured individual, if certain health-related tests are passed. Typically, to receive an “accelerated death benefit,” the policy will include a rider offering a lifetime payout if the insured individual has a life expectancy of less than 24 months, as certified by his or her physician. The life insurance policy could be surrendered for its cash value or money may be available to be withdrawn or the policy may allow a person to borrow against the policy. Some policies have a “disability waiver of premium” provision that allows the policy to remain in force if the insured individual becomes disabled. Policyholders may want to take into consideration that while they may be able to withdraw money from or borrow against permanent life insurance, tax-free, any excess policy loans or withdrawals could generate a tax obligation after a policy lapses.
Individuals and investor groups may offer to buy it, and pay the required premiums. This will provide more money to the seller than the other alternatives. Some life insurance policy sales are known as viatical settlements. (Viaticum, in Latin, refers to the provisions furnished to a Roman official going on a journey). Selling an insurance policy on one’s own life involves more than cash flow and taxes. The seller must be comfortable that unknown investors will collect a benefit at his or her death. Viatical arrangements usually take place when the seller has less than two years to live. Typically, funds received from a viatical settlement are not subject to federal income tax. People who are chronically rather than terminally ill can avoid tax on these transactions if the money received is used to pay for qualified long-term care. In order for the proceeds to be tax-free, the buyer generally must be a licensed or registered viatical settlement company.
Sales of life insurance policies that do not qualify as viatical settlements are known as life settlements which may generate a tax obligation. For example: a life insurance policy is sold for $500,000 of which $200,000 of premiums were contributed and the cash value of the policy is $325,000. Under this scenario, this sale will result in a gain of $300,000 which will be part ordinary and part capital gain. The $125,000 gap between the premiums paid ($200,000) and the policy’s cash value $325,000 will be subject to taxations as ordinary income. The remaining $175,000 of gain would be taxed as a long-term gain. In addition, the 3.8% surtax on net investment income also may apply. This outcome is a result of the Tax Cuts and Jobs Act of 2017 reversing Revenue Ruling 2009-13.
Purchasers of life insurance policies typically want to know the seller’s life expectancy, as indicated on medical reports, which are usually required to be submitted. Buyers usually prefer policies held by people who are age 75 or older. People who are below this age will need to show a severe medical condition exists in order for them to be able to sell their insurance policy. Cash value policies (whole life, universal life, and variable life) generally are preferred by buyers. Term life policies may be acceptable if they’re convertible to some form of cash value policy.
Advisors should emphasize a thorough estate plan review as this can help to put the terminally ill person and the family’s mind at ease. The new exemption of $11,180,000 means relatively few people will leave an estate that is subject to federal estate tax. Consequently, people who are terminally ill, below those asset levels, may ignore estate planning. Nearly half of all states impose estate or inheritance taxes which means that planning is still necessary. Without appropriate estate planning, assets might wind up in the wrong hands, after death, and there could be unnecessary costs as well as delays in wealth transfer.
Advisors should communicate that a comprehensive estate plan consists of more than a will. Assets as joint tenants with right of survivorship (JTWROS), those assets will pass directly to the surviving co-owner after the first death. In some situations, there are good reasons to title property as JTWROS. Assets held in this manner will go to a surviving co-owner without going through probate. Avoiding probate can save time and money. Assets such as IRAs, employer retirement plans, and life insurance policies often will not go to the heirs under a decedent’s will and will generally pass under a beneficiary designation. Assets held in trust may pass under the terms of the trust, without going through probate. Moving assets into a trust, not only can avoid probate but, this tactic might reduce the threat of a will being contested.
Very often critical thoughts are left silent as it is very unlikely that anyone will be able to cover everything in a will or transfer everything to a trust. Where can valuable papers be found? Who will care for a beloved pet? A terminally ill individual might create a letter of instruction to supplement other estate planning documents. Financial details can be described: savings and investment accounts, location of real estate deeds and life insurance policies, contact information for accountants and attorneys and other advisors, etc. The letter can also include computer user names, passwords, PIN numbers and other information necessary for access to electronic records. A letter of instruction also can supplement a will by providing details about how the terminally ill person would like personal possessions to be distributed. This letter might specify that a valued watch will go to grandson, a particular bracelet to granddaughter, and so on. Generally, the terms of a letter of instruction are not legally binding. The letter is more of a roadmap to help survivors locate and distribute assets based on the deceased wishes.
These are only three of the life events where advisors can make a significant impact in the planning process of a client. As mentioned these are only a few of the life changing events that a person goes through and there are many others that advisors need to be able to help provide advice, support and recommendations as a client continues through their family life cycle.
James A.J. Revels, co-practice leader of Citrin Cooperman’s Trust and Estate Group, is a tax partner with more than 25 years of experience in the areas of income tax, trust, gift, and estate planning. He advises a broad range of clients including high net worth individuals, executives, entrepreneurs, owners of closely held entities, foreign individuals, early stage corporations, foreign corporations, bio-tech companies and not-for-profit organizations.