Married Couple with Children

Henry and Wanda are married 60 year-olds. They have two children, Brent (age 25) and Jake (age 23).  Jake has run into a bit of a drug problem lately and is currently in rehab. During the course of their marriage so far, Henry and Wanda have accumulated the following assets:

1.  4 bedroom house-Joint tenancy (with a $200,000 mortgage)  Approx. value: $750,000

2.  Retirement Plans:

• Henry’s IRA (beneficiary – Wanda)  $100,000
• Wanda’s 401K (beneficiary – Henry)  $150,000

3.  Brokerage Accounts holding stock in various companies (Joint tenancy)  $200,000

4.  Life Insurance:

• Henry owns a $500,000 term policy (Beneficiary Wanda) $500,000
• Wanda owns a $250,000 term policy (Beneficiary Henry) $250,000

5.  Joint Bank Accounts:

• Savings $10,000
• Checking $10,000

6.  Automobiles:

• 2005 Honda Civic (Wanda holds title) $10,000
• 2006 Chevy Truck (Henry holds title) $10,000

7.  Jewelry, furniture and furnishings, etc.  $10,000

Total Estate Value Less Debt:                        $1,800,000

(Probate Value: $2,000,000: Note that the probate value of an estate used to determine filing fees and attorney’s fees does not take into account debts such as mortgages, loans, credit card bills, etc., so for probate cost purposes, we can assume the items above — ie: the house — are owned outright).

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•  If Henry alone died tomorrow without any estate planning whatsoever, the above items would be distributed as follows:

1.  The home, brokerage account and bank accounts are held in joint tenancy. This means that these items pass automatically to the surviving joint tenant (Wanda) without the need for a formal probate proceeding. The IRA and life insurance also pass directly to Wanda as the named beneficiary without need for probate. The truck passes through a DMV non-probate procedure.

2.  Therefore, without a Will, Trust or any other estate planning, the estate passes on to the surviving spouse because of how these assets are titled (joint tenancy). This situation seems to work out okay if one spouse predeceases the other and Henry does not want anyone outside of his wife and children to inherit any of his property.

3.  The main issue to remember is that the system is set up to make easy transfers at the first spouse’s death. But, don’t be fooled because at Wanda’s death, this estate will have to be probated unless Wanda sets up a Trust or some other probate avoidance vehicle following Henry’s death.  And placing property in joint tenancy with one’s children is problematic in that it exposes the parent to the child’s spouse and creditors, not to mention the tax implications.

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Assume instead that Henry and Wanda both die simultaneously in a car accident. Now what are the implications of not having prepared any estate planning?1.  Cost: The entire estate ($2,000,000 of probate value) will need to be probated at an approximate cost of $35,000 for attorney’s fees alone! This does not include court filing fees and other expenses of transferring Henry and Wanda’s assets to their children. Although having a Trust would not eliminate expenses entirely, this document would considerably lower the costs of transferring this estate.

2.  Time and Hassle: A probate takes a minimum of a year in most cases (and many times it’s even longer). Furthermore, court oversight of the handling of your estate is a big burden for whoever is trying to do this work on your behalf. Note: A Trustee following the terms of a Trust could have consolidated assets and managed them for the benefit of children in much less time.

3.  Who will become the Administrator or Executor of the estate of Henry and Wanda?

An Executor is chosen by the drafters in a Will beforehand to distribute cash and assets. Here, however, if no decision is made, then the court will have to determine who inventories and distributes the estate. This can also lead to problems if the families of the deceased couple don’t see eye-to-eye.

4.  What about Jake?  Without a Trust naming someone to manage Jake’s share of the money until he is healthy and back on his feet, the Court will likely order an outright distribution of estate assets to Jake. Do you think it’s a good idea to give someone with a history of drug problems access to $1,000,000 outright? If Henry and Wanda had prepared a Trust ahead of time, then they could have had Jake’s share distributed to a subtrust so a Trustee could distribute the money using his or her discretion after checking on Jake’s day-to-day health.

5.  Beneficiary Designations: Just a note that the retirement plans in our scenario above would be probated as well. This is because many young parents often don’t choose a “backup” or “secondary” beneficiary when they initially complete these forms and down the line they never update the forms. If there’s no backup, then the plan usually pays to the decedent’s “estate.”

a.  Who are the backup beneficiaries on your retirement plans?  Remember, you can’t name your children or grandchildren individually if they’re minors.

6.  Health Care Decisions: Finally, assume that Henry is hospitalized in a coma immediately following the accident and Wanda is deceased. Without a Power of Attorney for Health Care, the children (if they’re adults) or Henry’s parents face an agonizing decision about Henry’s final wishes. This decision can lead to family difficulties when loved ones disagree about the incapacitated individual’s final wishes.

7.  Taxes: Remember, there are two types of taxes to consider:

a.  Estate taxes: No estate tax worries as of 2015 because the estate tax exemption is $5,430,000 per person and this amount is increased with inflation annually. Therefore, you can transfer your entire estate without paying any estate taxes if it is worth under $5,430,000 in 2015.

b.  Income taxes: But, remember that the IRA and 401K distributions would be taxable as income to the eventual beneficiaries because those assets were tax deferred during Henry and Wanda’s lifetimes.

8.  Worst Case Scenario: The above explanations assumed the children Brent and Jake survived their parents. What if something happens to the whole family? How is the estate distributed in that case? Well, California law provides for a distribution scheme for decedents in the event someone dies without a Will. This scheme may or may not be similar to your desired outcome, which could have been followed if you had drafted a Will or a Trust.

As you can see, avoiding necessary estate planning may work out for you initially. However, in the case of dire circumstances, you may leave your grieving family with a considerable burden and a major expense to pay if you avoided planning during your life.