We live in an unpredictable time. Unexpected events happen every day. Many aspects of our lies are simply beyond our control. Even so, there are a few things in life we can be certain about. These are the things we know are going to happen to us because they happen to everyone. And, because we can’t escape these things, we need to plan for them.
The Three Certainties
So, what is certain in life? Even though we are all different, there are three certainties we can all count on:
??Life is temporary; no one lives forever.
??Time is precious; none of us knows how much time we have left.
??No matter what we have, we can’t take it with us; what’s left over will be the financial legacy we leave to those we love.
Certainty planning is a practical approach to these certainties. Many of us are looking forward to retirement. Unfortunately, we can’t assume we’ll live that long. Every day we hear about people who’ve unexpectedly passed away, often through no fault of their own. If we’re married or committed to someone, our planning needs to consider that person’s future as well as our own. Responsible adults face the certainties of life and plan for them. Certainty planning does that by addressing four important questions:
??What assets will I pass along?
??What are my assets worth?
??How will my assets be passed along?
??Who will receive my assets?
??What problems could arise?
What Assets Will I Pass Long?
It is difficult to know today what assets we’ll pass along when we die. What assets we’ll leave behind depends on many factors, including how long we live, the expenses we’ll have and how we own our assets. Because we can’t pass on assets we don’t have, the place to start is with the assets we have today. Wise people look at the assets they own and decide: (1) which ones they should use up during retirement, (2) which ones they want to pass on, and (3) which ones should be repositioned to improve their financial position.
Retirement security is about ongoing spendable income. When we retire, we can’t just go out and spend our assets. We’ll first need to convert them into cash. Converting assets to cash could trigger a variety of taxes and costs that can reduce how much we have left over to pay our expenses. How large the taxes and costs will be depends in large part on what assets we’ve used to build our retirement nest egg. In order to estimate how much spendable income we’ll have, we need to consider the taxes and costs that come with converting our assets into cash. What assets we have and the sequence in which we convert them will directly impact what assets we’ll pass on.
Some Assets Will Likely Pass On More Value Than Others
When it comes to passing on value to other family members, all our assets are not equal. Some assets have the potential to pass on more value than others. That’s because different assets can be subject to different problems and expenses when they are passed on. We need to consider:
??Fluctuations in value. Very few assets have a fixed value; most go up and down in value as the markets change over time. We can’t be certain what individual assets will be worth when we die.
??Management, maintenance and fix-up costs. Some assets need regular maintenance or generate ongoing expenses. For example, residences, vacation homes and investment real estate all require regular upkeep, else their value may diminish. This is a reason many consider property valuation services as they may recommend new additions or certain fixes to the property to increase its value. There are also regular payments for insurance and property taxes to consider. These are also often tied to the assets’ worth.
??Taxes. Some assets generate taxes as they are converted into cash. For example, family members who receive distributions from our IRAs, 401(k)s and pensions must pay federal income taxes on them. The assets we pass on can generate taxes in a variety of ways. And since Congress changes the tax rules and rates with some frequency, we can’t be sure how much net value our taxable assets will deliver to our families.
In deciding what assets to pass on, it can be helpful to see our assets from our families’ perspective (i.e., what assets would they want to inherit?). Some assets may produce more net value for them than others. Other assets may be more likely to create conflicts and disagreements. Looking at our assets from their perspective may make it easier to make decisions about which assets we should use up and which ones we should pass on as part of our financial legacy.
How Will My Assets Be Passed On?
After deciding which assets we want to pass along, we need to take the next step-making sure those assets actually get to those who should receive them. Not many people understand how assets are passed along at death. That’s because the asset transfer process can be complicated. The “how” of passing on assets depends in many respects on which assets we leave behind and how we owned them, which is why many people have turned to things like cryptocurrencies in order to organize their assets and make the transfer process quicker and less complex (click here).
However, many people think their wills will distribute their remaining assets. Often this isn’t the case. In fact, it’s quite possible our wills will have no impact at all on some important assets. Many people are surprised to learn there are three separate asset transfer systems that can impact how leftover assets are distributed. Many of us will leave behind some assets that will be transferred under each of the separate systems. Which system applies to a particular asset can depend both on the types of assets we own and how we own them. There are three general ways in which we can own our assets:
??Solely in our own names. These are the assets our wills should distribute (or our state’s intestacy law will distribute if we don’t have a valid will). These assets are handled under our state’s probate process. The probate process is designed to settle our financial affairs by paying off our debts and making sure our remaining assets are delivered to the people we’ve selected.
??Jointly with someone else (joint tenancy) with a right of survivorship. Assets owned in this manner are transferred to the surviving joint tenant by operation of state law. Many people own their homes, vehicles and bank accounts in joint tenancy with a right of survivorship. The terms of our wills generally don’t apply to these assets; state laws distribute our interest to the surviving joint tenant(s).
States that have adopted community property laws generally reserve for a spouse a 50 percent interest in community property assets (those acquired during t he course of a marriage and not subject to pre-nuptial or separate property agreements). Generally, wills only distribute the portion of community property assets that aren’t reserved for the surviving spouse.
??Under a written contract. Assets subject to the terms of a written contract are often transferred through written beneficiary designations. Examples include: IRAs, Roth IRAs, 401(k) accounts, annuities, life insurance policies and assets held in trust. When we die, the asset is distributed to the beneficiaries we’ve named.
The Asset Distribution Worksheet
To really see how our assets will be distributed, it can be helpful to organize our assets on a three column worksheet, one column for each of the three ways we can own our assets (solely, jointly or under a contract). In each column we’ll list both the assets we own in that manner and its approximate net value. Then we’ll follow these three steps:
?1.?Add up the net values of the assets listed in each column to determine the total net value of the column’s assets.
?2.?Add the total values of the three columns together to determine total net worth.
?3.?Divide each column’s value by total net worth to compute the percentage of total net worth in each column.
Our worksheet will show us what percentage of our assets will be transferred under each of three wealth transfer systems if we died today. We’ll see which assets our wills will pass on under the probate process, which assets will pass automatically by state law to surviving joint tenants, and which assets will be distributed through beneficiary designations. The illustration shows a sample Asset Distribution Worksheet.
After completing the worksheet, it’s important to step back and analyze the information it reveals. Which column has the most assets? Which column has the least? Look down the road five or ten years. What’s likely to happen to the assets in each of the columns? Which columns will likely have assets that grow in value, and which columns are likely to have assets that lose value or will be sold to pay expenses?
The Asset Distribution Worksheet may show us some things we hadn’t expected. Many people will have their highest percentage of assets in the “contract” column. Often the column with the smallest percentage is the “solely owned” column-the one in which assets are transferred by will. Many expect this column to transfer the most assets, not the least. It can be a surprise to learn that our beneficiary designations may pass on a larger portion of our wealth than our wills.
The Beneficiary Knowledge Gap
Beneficiary designations are often the weakest link in our certainty planning because they are easy to overlook. We set up our beneficiary designations when we open one of these accounts; then we often forget about them. Many of us spend less than five minutes deciding who to name as beneficiaries, and we may not review those decisions for many years. We aren’t aware of how important those decisions can be to our families in passing on our remaining assets.
Many people don’t have written copies of their beneficiary designations. In addition, they may also not know:
??Which assets allow them to name beneficiaries.
??That they may be able to name two kinds of beneficiaries (primary and contingent).
??That different beneficiaries can be taxed differently.
??That their beneficiary designations should be reviewed every two to three years.
??How to change outdated beneficiary designations.
??That their designations should be coordinated with their wills and trusts.
Who Will Receive Our Assets?
To know for certain who will receive our assets, we need to have the right paperwork. We can know what documents we will need by looking at our Asset Distribution Worksheet:
??Solely owned assets. These assets are transferred through the probate process. We’ll need an up-to-date will to distribute them.
??Jointly owned assets. For these assets we’ll need copies of the documents that establish the right of survivorship. With real estate, we’ll need our deed. Cars, boats and other vehicles we’ll need a state issued certificate of title.
??Contract assets. For each of these assets, we’ll need a copy of the beneficiary designation. That’s the only way to be certain who we’ve named as the primary and contingent beneficiaries.
The Beneficiary Folder
Although many people will pass on a significant part of their net worth through beneficiary designations, very few will have copies of them. Without copies, we can’t be sure who our beneficiaries are. Sometimes companies lose, misplace or never receive the beneficiary information. We may need to show written documentation to prove who we’ve named as beneficiaries. Lack of these records could create some difficult financial problems.
Considering the percentage of our wealth that will be transferred through our beneficiary designations, it’s surprising how little information most of us retain about them. An excellent way to have this information readily available is to keep a beneficiary folder. This is a file, notebook or other paper storage device with all our beneficiary information. For each contract asset listed on our worksheet, we should have a copy of our latest primary and contingent beneficiary designations.
Why Use An Advisor?
Our financial advisors should be able to help us build and manage our beneficiary folder. Many of them have experience with beneficiary designations. They may be able to suggest ways we could improve our designations. They may also be able to identify some assets we have that allow beneficiary designations we may have forgotten about. Working with an advisor to build our worksheet and beneficiary folder can save us time and strengthen our working relationship.
Also, if we can’t find copies of some of our beneficiary designations, the financial advisor could help. An advisor should be able to:
??Contact the asset provider on our behalf to get copies. We need to give them written authorization to get that information; or
??Prepare and file new beneficiary forms and make copies for our beneficiary folder. This alternative may be faster and easier than trying to track down and get copies of old designations. When properly executed and filed, a new beneficiary designation generally replaces and supersedes an older beneficiary designation. Before filing a new beneficiary designation form, it may be wise to check with an attorney or tax advisor to make sure the new designation is coordinated with wills, trusts and other documents.
What Problems Could Arise?
Planning for the certainties in life is all about being ready for the unexpected. An accident or illness can turn our carefully designed financial plans upside down. The best way to deal with the unexpected is to prepare for it in advance. Death may trigger a number of problems that could seriously impact people we love and care about. No one wants to leave behind a legacy of problems or cause family divisions. In our certainty planning we should consider these potential problem areas:
??Will there be enough left for my spouse/partner and my children? Will they be financially secure?
??Do I have any “problem assets” that could be difficult to deal with? Things such as:
?? ?Business interests
? ?Home or vacation home
?? ?Collections
?? ?Family heirlooms
??Do I have any heirs with special problems or concerns?
?? ?Special needs children
?? ?Children with emotional, marital, legal or dependency problems
?? ?Children deeply in debt
??Are there likely to be any conflicts between some of my family members?
?? ?Poor relationships between my current spouse/partner and my children
?? ?Strained relationships between children
?? ?Children born from different relationships
?? ?Children who have different amounts of financial resources
??Do I have causes or charities to which I would like to contribute?
??How much of my financial legacy might be lost to costs and taxes?
?? ?Income taxes on IRAs or qualified plan accounts
?? ?Estate/inheritance taxes
?? ?Administration costs, sales commissions or management fees
One financial vehicle that might be useful in dealing with some of these problems is life insurance. Policy death benefits (which are generally income tax-free under IRC Section 101) could provide funds to solve some financial problems. Life insurance could add flexibility to certainty planning and help solve problems which could arise.
Conclusion
We live in a rapidly changing world. Time and time again we’ve had to adapt to the unexpected. Still, even during times of continuing change, there are three certainties we need to acknowledge and plan for: (1) life is temporary; we will all pass away some day; (2) time is precious; we don’t know how much time we have; and (3) we can’t take our assets with us. None of us wants to leave our family with a legacy of conflict and division. Certainty planning helps us prepare for the certainties we all face and gives us an opportunity to improve the lives of the people we love.
