A CFP® Explains: Wills, Health Proxy, Power of Attorney, & Trusts

When we are constructing financial plans for clients, we inevitably get to the estate planning portion of the plan, and ask them “Do you have updated wills, a health proxy, and a power of attorney in place?”  The most common responses that we receive are: 

• “I know we should have but we never did”

• “I did but it was over 10 years ago”

• “I have a will but not a health proxy or a power of attorney”

• “I have heard about trusts, should I have one?”

The Will, Health Proxy, and Power of Attorney are the three main estate documents that most people should have.  In this article I will review: 

• How Wills work and items that you should include in your Will

• Why you should have a Health Proxy and how they work

• Power of Attorney

• The probate process

• Considering a testamentary trust

• Assets that pass outside of the Will

• Revocable Trusts & Irrevocable Trusts

• Estate planning tips

• How much does it cost to establish a will, health proxy, and a power of attorney

Establishing A Will

The most basic estate document that most people are aware of is a written Will.   The Will provides specific guidance as to who will receive your assets after you have passed away.  The Will also establishes who would be the guardian of your minor children should you pass away prior to your children reaching the age of majority.  Without a Will, state laws and the court system that know nothing about you, will decide who receives your assets and who will be the guardian of your minor children; not a situation that most people want. 

The Will can be a very simple document.  If you are married and have children, the Will may state that if you pass away everything goes to your spouse but if both you and your spouse were to pass away simultaneously, the assets go to the children.  For individuals or married couples without children, or for married couples that have been divorced, it’s also critical to have a Will to provide direction as to what will happen to your assets if you were to pass away. 

You can engage an estate attorney to complete a simple Will or if your Will is very simple and straightforward, you may elect to use a do-it-yourself option through a platform like Legal Zoom.   We typically encourage clients to meet with an estate attorney because when it comes to estate planning many people don’t know what questions to ask to get the right documents and plan in place.  If you are married with minor children, and you and your spouse were to pass away leaving all the assets to the kids, with a simple Will, they would have access to their full inheritance at age 18.  An 18 year old having access to large sums of money may not be an optimal situation.   In those cases, you may want to include a testamentary trust or revocable trust in your estate plan to put some restrictions in place as to how and when your children will have access to their inheritance. 

Probate

I'm going pause here for a moment and explain what probate is and the probate process. When someone passes away, all of the assets included in their estate go through what's called a “probate process”.  The probate process is a legal process of accounting for all of your assets, debts, and transferring your assets to the beneficiaries of your estate.  The person listed in your will as the “executor” is responsible for coordinating the probate process.  Depending on the size of the estate, your executor will usually work with an attorney, an accountant, and possibly appraiser, to: 

• Value the assets in your estate

• Work with the courts to process your estate

• Pay outstanding expenses or debts

• Coordinate the transfer of assets to your beneficiaries

Since the probate process is a legal process involving the courts, the process often takes longer than beneficiaries expect.  Individuals will make the incorrect assumption that when you pass away, they just read the will, and your beneficiaries receive the assets within a few days or weeks; unfortunately that's not that case.  It’s not uncommon for the probate process to take 6 to 12 months and there are expenses involved with probating an estate.  If it’s a complex estate, it could take over a year to complete the probate process. 

For these reasons, it’s a common goal with estate planning to find ways to avoid the probate process and pass you assets directly to your beneficiaries.  I will explain more about these strategies later on.  But circling back to our discussion about the Will, if all you have is a Will, when you pass away, the assets in your estate will pass through this probate process. 

Testamentary Trusts

There are a lot of different types of trusts within in estate planning world. One of the most basic and common trusts, especially for individuals with children under that age of 25, is a testamentary trust. A testamentary trust is a trust that is built into your will.  With at testamentary trust, you are not establishing a trust today , but rather, if you pass away, a trust is established during the probate process and you can direct assets to the trust.  Building a testamentary trust into your Will gives you some control over how the assets are distributed to the beneficiaries after you have passed away. 

It's common for individuals or married couples with children under that age of 25, to build these testamentary trusts into their Wills.  I will illustrate how these trusts work in the example below. 

Example: Jim and Sarah have two children, Rob age 14 and Wendy age 8.  Between the value of their house, life insurance policies, and other assets, their estate would total $1.5M.  Jim & Sarah realize that if something were to happen to them tomorrow, they would not want their kids to inherit $1.5M when they turn age 18 because they might not go to college, they may try to start a business that fails, buy a Corvette, etc. In their Will they establish a Testamentary Trust that states that if both parents pass away prior to the children turning age 25, all of their assets will flow into a trust, and that Sarah’s brother Harold will serve as the trustee. Harold as the trustee is able to distribute cash from the trust for living expenses, education, health expenses, and other expenses deemed necessary for the well being of the children. The children will receive 1/3 of their inheritance at age 25, 30, and 35. 

You can design these testamentary trusts however you would like. In the Will you would designate who will be the trustee of your trust and the terms of the trust. 

IMPORTANT NOTE: Testamentary trusts do not avoid probate like other trusts do.  The trust is established as part of the probate process. 

Revocable Trusts & Irrevocable Trusts

It's also common for individuals and married couples to consider establishing either a Revocable Trust or Irrevocable Trust as part of their estate planning.  These are separate from Testamentary Trusts.  Revocable Trusts and Irrevocable Trusts are being established today and assets owned by the trust pass in accordance with the terms set forth in the trust document.   There are material differences between these two types of trusts but some primary reasons why people establish these types of trust are to: 

• Avoid probate

• Protecting assets from a long term event

• Control how and when assets are distributed beyond the date of death

• Reducing the size of the estate

• Advanced tax strategies

Assets That Pass Outside of The Will

There are certain assets that pass outside of the Will.  Many of these “other assets” pass by “contract”, meaning there are beneficiaries designated on those accounts. A common example of assets that pass by contract are 401(k) accounts, IRA’s, annuities, and life insurance.  When you set up those accounts you typically designate beneficiaries for each account and your Will could say something completely different. The assets that pass by contract do not have to go through the probate process unless the beneficiary listed on the account is your estate which is usually not an advantageous election for most individuals. 

Transfer On Death Accounts (TOD)

One of the estate planning strategies that we use with clients is instead of holding an individual investment account in the name of the individual, we will register the account as a “transfer on death” (TOD) account.    If you have an individual brokerage account and you pass away, the value of that account will have to go through probate.  By simply adding the TOD feature to an existing individual brokerage account which lists beneficiaries similar to a 401(K) or IRA account, that account now avoids probate, and passes by contract directly to the beneficiaries.

Depending on the assets that make up your estate, you may be able to setup TOD accounts as opposed to going through the process of setting up trusts but it varies from person to person. 

Power of Attorney

Let’s shift gears now over to the Power of Attorney document.  A Power of Attorney document is important because it allows someone to step into your shoes and handle your financial affairs, should you become incapacitated.   Some common examples are: 

Example 1: If you're in a car accident and end up in a coma, for accounts that are held only in your name, such as a checking account, investment account, or credit card, they will only speak to you.  Being married does not give your spouse access financially to those accounts while you are still alive but your spouse may need access to them to continue to pay your bills or get access to cash to pay expenses while you're incapacitated.   Having a power of attorney document would allow your spouse or trusted individual named as your “agent” to act financially on your behalf. 

Example 2:  Having a power of attorney in place is key for Long Term Care events.  If you have a spouse or parent and they have a stroke, develop dementia, or another health event that renders them unable to handle their personal finances, you could step in as their agent and handle their personal finances.  In long term care situations that can often mean paying a nursing home, applying for Medicaid, paying medical bills, or shifting the ownership of assets to protect from a Medicaid spend down. 

The Power of Attorney can also be built so your agent is not given that power today but rather it would only be given if a triggering event happened sometime in the future.   With this document you really have to name someone you 100% trust.   As financial planners, we have seen cases where there is abuse of the Power of Attorney powers and it’s never pretty.  It's not uncommon for a power of attorney to allow the agent to make gifts as a planning tool, but that might also include gifts to themselves, so you have to fully trust your agent and the powers that you provide to them. 

Health Proxy

The health proxy is usually the least fun estate document to complete but is equally important.  In this document you are naming the individual that has the right to make your health decisions for you if you are incapacitated.  This document spells out what you want and don’t want to have happen if certain health events occur. While it's not uncommon for individuals to be a little uncomfortable completing this document due to the nature of the questions, it's a lot better to complete it now, versus your family members trying to determine what your wishes would be when a severe health event has already occurred. 

The health proxy will list items like: 

• Would you be willing to be put on life support?

• If you could not eat, would you allow them to use a feeding tub

• Resuscitation preferences

• Willingness to accept blood transfusions

Again, not fun things to think about but by you making these decisions while you are of sound body and mind, it takes away the difficult situation where your family members have to decide in the heat of the moment what you would have wanted.  That situation can sometimes tear families apart. 

Keep Your Estate Plan Up To Date

All too often, we run into this situation where a client will acknowledge that they have estate documents, but they were established 20 years ago, and they never made any changes.  It makes sense to meet with your estate attorney and revisit your estate plan: 

• Every five years

• If you move to a different state

• When Congress makes major changes to the estate tax rules

The estate laws vary state by state.  If we have clients that are planning to move and they plan to change their state of domicile to another state, we will often encourage them to meet with an estate attorney within that state once the move is complete.    Congress has also made a number of changes to the federal estate tax laws over the past few years, with potentially more in the works, and not revisiting the estate plan could end up costing your beneficiaries tens of thousands of dollars in estate taxes that could have been avoided with some advanced planning. 

Cost of Estate Documents

The cost of establishing a Will, Health Proxy, Power of Attorney, and Trusts, often varies based on the complexity of your estate plan.   A simple Will may cost less than $1,000 to establish through an estate attorney.   Establishing all three documents: Will, Health Proxy, and Power of Attorney may cost somewhere between $1,000 - $3,000.  While it's not uncommon for individuals to be surprised by the cost of setting up these estate documents, I always urge people to think about the cost of not having those documents in place.  The probate process with professionals involved could cost thousands of dollar, your beneficiaries could lose thousands of dollars in taxes that could have been avoided, not to mention the emotional toll on your family trying to figure out what you would have wanted without clear guidance from your estate documents. Revocable Trusts and Irrevocable Trust

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Should You Put Your House In A Trust?

Should You Put Your House In A Trust?

When you say the word “trust” many people think that trusts are only used by the uber rich to protect their millions of dollars but that is very far from the truth.  Yes, extremely wealthy families do use trusts to reduce the size of their estate but there are also a lot of very good reasons why it makes sense for an average individual or family to establish a trust.   The two main reasons being the avoidance of probate and to protect assets from a long-term care event.  This article will walk you through: 

• How trusts work

• The difference between a Revocable Trust and an Irrevocable Trust

• The benefits of putting your house in a trust

• How to establish a trust

• What are the tax considerations

What Is A Trust?

When you establish a trust, you are basically creating a fictitious person that is going to own your assets.   Depending on the type of trust that you establish, the trust may even have it's own social security number that is called a “tax ID number”.  Here is an example.  Mark and Sarah Williams, like most married couples, own their primary residence in joint name.  They decide to establish the “Williams Family Trust”.  Once the trust is established, they change the name on the deed of their house from Mark and Sarah to the Williams Family Trust. 

Revocable Trust vs. Irrevocable Trust

Before I get into the benefits of establishing a trust for your house, you first have to understand the difference between a “Revocable Trust” and an “Irrevocable Trust”.   As the name suggests, a revocable trust, you can revoke at any time.  In other words, you as the owner, can take that asset back. You never really “give it away”.   Revocable trusts do not have a separate tax identification number.  They are established in the social security number of the owner.  A revocable trust is sometime referred to as a “living trust”.

With an Irrevocable Trust, once you have transferred the ownership of the house to the trust, it’s irrevocable, meaning you are never supposed to be able to take it back. The trust will own that house for the rest of your life.  Now that sounds super restrictive but there are a lot of strategies that estate attorneys use to ease those restrictions and I will cover some of those strategies later on in this article.

In both cases, in trust language, the owner that gave property to the trust is called the “grantor”.  I just want you to be familiar with that term when it is used throughout this article.

So why would someone use an Irrevocable Trust instead of a Revocable Trust?  The answer is, it depends on which benefits you are trying to access by placing your house in a trust.

The Benefits Of A Revocable Trust Owning Your House

People transfer the ownership of their house to a revocable trust for the following reasons: 

• Avoid probate

• They have children under the age of 25

• They want maximum flexibility

Avoid Probate

From our experience, this is the number one reason why people put their house in a revocable trust. Trust assets avoid probate.  If you have ever had a family member pass away and you were the executor of their estate, you know how much of a headache the probate process is.  Not to mention costly.

Let’s go back to our example with Mark & Sarah Williams.  They own their house joint and they have a will that lists their two children as 50/50 beneficiaries on all of their assets.

When the first spouse passes away, there is no issue because the house is owned joint, and the ownership automatically passes to the surviving spouse.  However, when the surviving spouse passes away, the house is part of the surviving spouse’s estate that will be subject to the probate process.  You typically try to avoid probate because the probate process: 

• Is a costly process

• It delays the receipt of the asset by your beneficiaries

• Makes the value of your estate accessible to the public

The costs come in the form of attorney fees, accountant fees, executor commissions, and appraisal fees which are necessary to probate the estate. The delays come from the fact that it’s a court driven process. You have to obtain court issued letters of testamentary to even start the process and the courts have to approve the final filing of the estate. It’s not uncommon for the probate process to take 6 months or longer from start to finish.

If your house is owned by a revocable trust, you skip the whole probate process. Upon the passing of the second spouse, the house is transferred from the name of the trust into the name of the trust beneficiaries.   You save the cost of probate and your beneficiaries have immediate access to the house.

The Difference Between A Trust and A Will

I’ll stop for a second because this is usually where I get the question, “So if I have a trust, do I need a will?”  The answer is yes, you need both.   Anything owned by your trust will go immediately to the beneficiaries of the trust but any assets not owned by the trust will pass to your beneficiaries via the will. Trusts can own real estate, checking accounts, life insurance policies, and other assets.  But there are some assets like cars and personal belongings that are usually held outside of a trust that will pass to your beneficiaries via the will.   But in most cases, people have the same beneficiaries listed in the will and the trust. 

Children Under The Age of 25

For parents with children under the age of 25, revocable trusts are used to prevent the children from coming into their full inheritance at a very young age.  If you just have a will, both parents pass away when your child is 18, and they come into a sizable inheritance between your life insurance, retirement accounts, and the house, they may not make the best financial decisions. What if they decide to not go to college because they inherited a million dollar but then they spend through all of the money within 5 years?  As financial planners we have unfortunately seen this happen.  It’s ugly. 

A revocable trust can put restrictions in place to prevent this from happening. There might be language in the trust that states they receive 1/3 of their inheritance at age 25, 1/3 at age 30, 1/3 at age 35.  But in the meantime, the trustee can authorize distributions for living expenses, education, health expenses, etc.  The options are limitless and these documents are customized to meet your personal preferences.

Maximum Flexibility

The revocable trust offers the grantor the most flexibility because they are not giving away the asset. It’s still part of your estate, it’s just not subject to probate. At any time, the owners can take the asset back, change the trustee, change beneficiaries of the trust, and change the features of the trust. 

The Benefits Of An Irrevocable Trust

Let’s shift gears to the irrevocable trust.  The benefits of establishing an irrevocable trust include: 

• Avoid probate

• They have children under that age of 25

• Protect assets from a long-term care event

• Reduce the size of an estate

As you will see, the top two are the same as the revocable trust. Irrevocable trust assets avoid probate and are a way of controlling how assets are distributed after you pass away. However, you will see two additional benefit listed that were not associated with a revocable trust. Let’s look at the long-term care event protection benefit. 

Protect Assets From A Long-Term Care Event

When individuals use an irrevocable trust to protect assets from a long-term care event, it’s sometimes called a “Medicaid Trust”.    If you have ever had the personal experience of a loved one needing any type of long-term care whether via home health aids, assisted living, or a nursing home, you know how expensive that care costs.  According to the NYS Health Department, the average daily cost of a nursing home is $371 per day in the northeastern region.  That’s $135,360 per year.

For an individual that needs this type of care, they are required to spend down all of their assets until they hit a very low threshold, and then Medicaid starts picking up the tab from there.  Now the IRS is smart.   They are not going to allow you to hit a long term care event and then transfer all of your assets to a family member or a trust to qualify for Medicaid.  There is a 5 year look back period which says any assets that you have gifted away within the last 5 years, whether to an individual or a trust, is back on the table for purposes of the spend down before you qualify for Medicaid.  This is why they call these trusts a Medicaid Trust.

Medicaid Will Put A Lien Against The House

Now, your primary resident is not an asset subject to the Medicaid spend down.  If your only asset is your house and you have spent down all of your other assets that are not in an IRA or qualified retirement plan, you can qualify for Medicaid immediately.  So why put the house in an irrevocable trust then?  While Medicaid cannot make you sell your primary residence or count it as an asset for the spend down, Medicaid will put a lien against your estate for the amount they pay for your care.  So when you pass away, your house does not go to your children or heirs, Medicaid assumes ownership, and will sell it to recoup the cash that they paid out for your care. Not a great outcome.  Most people would prefer that the value of their house go to their kids instead of Medicaid.

If you transfer the ownership of the house to an Irrevocable Trust, you can live in the house for the rest of your life, and as long as the house has been in the trust for more than 5 years, it’s not a spend down asset for Medicaid and Medicaid cannot place a lien against your house for the money that they pay out for your care.

So if you are age 65 or older or have parents that are 65 or older, in many cases it makes sense for that individual to setup an irrevocable trust, transfer the ownership of the house to the trust, and start the 5 year clock for the Medicaid look back period.   Once you have satisfied the 5 year period, you are free and clear.

Frequently Asked Question

When I meet with clients about this, there are usually a number of other questions that come up when we talk about placing the house in a trust.  Here are the most common:

If my house is in a trust, do I still qualify for the STAR and Enhanced STAR property tax exemption?

ANSWER: Yes

If my house is gifted to a trust, do my beneficiaries still receive a step-up in basis when they inherit the asset?

ANSWER:  As long as the estate attorney put the appropriate language in your trust document, the house will receive a step up in basis at your death.

What if I want to sell my house down the road but it’s owned by the trust?

ANSWER:  It depends on what type of trust owns your house and the language in your trust document.  When you sell your primary residence, as a single tax filer you do not have pay tax on the first $250,000 of capital gain in the property. For married filers, the number is $500,000. Example, married couple bought their house in 1980 for $40,000, it’s now worth $400,000, which equals $360,000 in appreciation or gain in value. When they sell their house, they do not pay any tax on the gain because it’s below the $500,000 exclusion.

If a revocable trust owns your house, you retain these tax exclusions because you technically still own the house. If an irrevocable trust owns your house, depending on the type of irrevocable trust you establish and the language in your trust document, you may or may not be able to utilize these exclusions.

Many of the irrevocable trust that we see drafted by estate attorneys that exist for the purpose of avoiding probate and protecting asset from Medicaid are considered grantor trusts. The estate attorney will often put language in the document that protects the assets from Medicaid but allows the grantor to capture the primary residence capital gains exclusion if they sell their house at some point in the future.  But this is not always the case.  If you establish a irrevocable trust for your primary residence, it’s important to have this discussion with your estate attorney to make sure this specific item is addressed in your trust document.

Now, here is the most common mistake that we see people make when they sell their house that is owned by their irrevocable trust.  You put your primary residence in an irrevocable trust six years ago so you are now free and clear on the five year look back period.  You decided to sell your current house and buy another house or sell your house and put the cash in the bank.  At the closing the buyers make the check payable to you instead of your trust.  You deposit the check to your checking account and then move it into the trust account or issue the check to purchase your next house.  Guess what? The 5 year clock just restarted.  The money can never leave the trust. If your intention is to sell one house and by another house, at the closing they should make the check payable to your trust, and the trust buys your next house.

Does the trust need to file a tax return?

ANSWER: Only irrevocable trusts have to file tax returns because revocable trusts are built under the social security number of the grantor. However, if the only asset that the irrevocable trust owns is your primary residence, the trust would not have any income, so there would not be a need to file a tax return for the trust each year.

Are irrevocable trusts 100% irrevocable?

ANSWER: There are tricks that estate attorneys use to get around the irrevocable restriction of these trusts.  For example, the trust could make a gift to the beneficiaries of the trust and then the beneficiaries turn around and gift the money back to the grantor of the trust. Grantors can also retain the right to change who the trustees are, the beneficiaries, and they can revoke the trust.  Bottom line, if you really need to get to the money, there are usually ways to do it.

How To Establish A Trust

You will need to retain an estate attorney to draft and execute your trust document. For a simple revocable or irrevocable trust, it may cost anywhere from $2,000 – $5,000.  Before people get scared away by this cost, I remind them that if their house is subject to probate their estate may have to pay attorney fees, accountant fees, appraisal fees, and executor commissions which can easily total more than that.

In the case of a long-term care event, I just ask clients the question “Do you want your kids to inherit your house that you worked hard for or do you want Medicaid to take it if a long-term care event occurs down the road?”  Most people reply, “I want my kids to have it.” Putting the house in an irrevocable trust for 5 years assures that they will.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.