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Web Chapter A

Special Circumstances Planning

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Chapter Goals

Identify many common special planning situations. Discuss divorce and remarriage requirements. Distinguish between planning for traditional and nontraditional

households. Present the needs of the affluent. Describe business owner and corporate manager needs. Isolate the requirements for people with health and aging

problems. Determine important disability and dependent care factors. Deal with elder care and terminal illness issues.

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Divorce Planning

Divorce planning: The scheduling of matters in connection with the breakup of the household.

In many states the presumptive breakup will result in an equal division of marital assets.

– Marital assets: Those that were generated or acquired during marriage.

– Nonmarital assets: Those that were developed prior to marriage or were a result of a gift or bequest during marriage.

– In general, to be considered nonmarital, assets must be kept in an individual’s name and not commingled.

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Divorce Planning, cont.

Other relevant factors in a division of assets include: – Amount of nonmarital assets: When considerable, the judge may

incorporate them to some degree in any ruling.– Needs of the individual parties: The capabilities and desires of

each party may be included.– Historical cost of living: While it is often not possible to maintain

the accustomed standard of living, in certain cases it may be used as a benchmark to start from.

– Circumstances of Breakup: Length of marriage and seemingly clear cut instances of flagrant nonmarital behavior may be reflected in rulings.

– Human Assets: Earning ability, age, and health.

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Property

Property usually refers to the tangible and financial assets owned by household members.

– Generally consists of assets developed during the marriage or commingled assets.

– The exact separation of assets may be determined by negotiation with the 50-50 rule serving as a guideline.

– Under a Qualified Domestic Relations Order (QDRO) the spouse is entitled to one-half the value of assets in a pension, and transfer requires approval.

– Upon divorce the money may be divided and the usual 10 percent tax penalty on withdrawals before age 59 ½ is waived. The money distributed from the pension may also be transferred to a rollover IRA to escape taxation.

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Alimony

Alimony (maintenance) is the ongoing payment to the former spouse upon divorce.

– Meant to provide support to the lower earning or non earning person and to make it easier for the higher earner to provide compensation when there are insufficient tangible assets to fund a lump sum payment at the time of the divorce.

– The amount paid is taxable to the recipient at ordinary income rates and is tax-deductible by the payer.

– Alimony may be non-modifiable, which means it may continue at the stated rate for the period of time indicated.

– On the other hand, it may be open-ended, which means the amount and time span for payment may be subject to review.

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Child Support

Child support is the series of payments that are made specifically for the support of the child.

– The payments often end when the child becomes 18, but can be extended to provide resources while he or she is in college.

– Payments for child support have no taxable impact on either the payer or the recipient.

– Payments may be increased by petitioning the court or the document may provide for higher costs such as those for inflation over time.

– Because of the tax benefit, payers prefer alimony to child support, and there are rules intended to uncover childcare payment that has been disguised as alimony.

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Risk Management

Risk management in divorce planning is intended to assure that agreed-upon payments are actually made.

– This is a particular problem in divorces because a large number of payers default on their obligations, and even court orders do not always rectify the problem.

– Life insurance is the most common form of risk management. A life insurance policy that is made payable to and

owned by the recipient can be established. It can provide funds to replace those from the former

spouse upon an untimely death. – Health insurance after divorce generally covers children

until age 21, even if they are not living at home.

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Tax Issues

Being married rather than divorced carries tax implications.

– Generally, being married and filing a joint return is beneficial if both spouses earn about the same amount.

– It will be disadvantageous, as compared with being divorced and filing two single returns, if one spouse earns much more than the other.

– Your marital status is determined on the last day of the calendar year or, under some conditions, when you and your former spouse are living apart.

– Legal fees for tax advice in connection with divorce are tax-deductible.

– The fees of financial planners, accountants, actuaries, and appraisers may be tax-deductible as well.

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Other Issues

A former spouse is entitled to a Social Security benefit equal to 50 percent of the higher earning spouse’s benefit, provided they were married for 10 years or more.

– The former spouse can select the greater of the amount from their current marriage, any other previous marriage of 10 years or more, or their own Social Security.

– If the former spouse dies before the age of eligibility for a full pension and the remaining former spouse is at full retirement age or above, he or she is entitled to 100 percent of the former spouse’s Social Security.

– Both parties are responsible for the debts of a spouse until the divorce decree is final. Property settlement notes and liabilities to third parties may be lifted upon bankruptcy. Child support and alimony liabilities remain after bankruptcy.

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Financial Planning for Divorce

There are a number of strategies and issues that should be reviewed when divorce is contemplated.

– Inflation adjustments.– Where there is some uncertainty, higher alimony payments can provide greater

net benefits than child care when tax deductions and taxable income are combined.

– Negotiations for property settlements should include probable tax treatment subsequent to divorce.

– Mediation, arbitration, and sometimes direct negotiations over settlement terms.– The ability of each party to financially maintain the assets preferred should be

taken into account. – Planning for the period beyond divorce for the non earning spouse or the one

unfamiliar with financial and other operating matters should begin as soon as it is feasible.

– Property settlements should be emphasized where feasible.

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Financial Planning for Divorce, cont.

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Remarriage

Second marriages often involve assets brought to the marriage that remain in each person’s name rather than being fully integrated, due to:

– Wariness after an unsuccessful or costly first marriage. – Separate obligations from a previous marriage. – A more cautious attitude as one gets older.– Sizeable assets that have been accumulated.

By second marriages: – One or both parties may bring to the new marriage children

from a previous one. – An elderly man or woman whose spouse has died later may

remarry for companionship and sharing of household duties. The children may lose part or all of the inheritance to their parent’s new spouse.

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Remarriage, cont.

The following planning strategies may be considered:

– A frank discussion of the issues that are likely to cause friction after the marriage. When the parties differ in how they wish to use their capital, each may hold back assets so that they can fund their obligations or wishes separately.

– Postpone consideration of controversial issues. When a marriage progresses well and the relationship deepens, many issues can better be solved later on.

– Use a prenuptial agreement.

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Prenuptial and Postnuptial Agreements

Prenuptial agreements provide, before marriage, for financial and other terms upon the divorce or death of the asset holder.

– Provides for permanent separation of assets when one or more parties want to leave their money to someone else.

– Must be voluntary. Terms cannot be so one-sided that if there is a divorce, there are insufficient funds for the second spouse.

Postnuptial agreements are entered into after marriage and provide the terms upon breakup due to death or divorce.

– They can be used when both parties agree on what is a fair settlement in the event of divorce.

– The judiciary may believe that a party, when married, can be subject to intimidation, the courts may require a higher standard for recognition of the postnuptial.

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Nontraditional Families

Nontraditional families: Adults other than single or married persons who live together in a relationship intended to be permanent.

– Distinguished from traditional families by marriage. – The rights and requirements of marriages are established by

federal and state regulations and judicial rulings, and are statutory.

– The rights of unmarried cohabitants have grown in recent years in many municipalities and corporations. But substantial differences between marital and non marital couples remain in this country with varying views by governmental and business organizations.

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Retirement Planning, Nontraditional Families

An unmarried person who lives with a partner receives no social security benefits, and does not receive death benefits from the partner’s Social Security or from an employer.

The cohabitants can purchase an insurance policy on the working partner’s life, payable to the worker’s cohabitant.

Unmarried couples who have retirement assets in joint name would have to prove that they contributed their monies.

Otherwise, assets received during their lifetime could be considered a gift which could subject it to the combined estate gift tax.

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Insurance Planning, Nontraditional Families

Some life insurance companies may reject a payee for a life contract on the basis that he or she would not suffer a financial loss if a partner died.

Homeowners insurance may only cover the individual whose name is on the deed. Thus, a cohabitant who is not so listed may want to take out separate renter’s insurance.

Automobile insurance companies will not generally issue joint coverage for unmarried couples. Therefore, two policies should be obtained or, if applicable, the second party should be added on as occasional driver.

An increasing number of companies provide medical coverage for both parties in an unmarried relationship.

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Estate Planning, Nontraditional Families

Unmarried couples are not entitled to a marital exemption which, on the death of the first spouse, eliminates estate taxes on assets that are transferred to the surviving spouse.

Leaving IRA monies to a non spouse will allow that person to inherit the money with mandatory taxable withdrawals taken over time based on the beneficiary’s life expectancy with the balance remaining in the IRA compounding tax-free.

– Converting an IRA to a Roth will allow the beneficiary to inherit the money income tax-free.

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Estate Planning, Nontraditional Families, cont.

The surviving spouse of a person who dies without a legal will by law receives part or all of the proceeds. An unmarried partner will often receive nothing.

– Even when the blood relatives who will, by law, receive the proceeds recognize the unmarried spouse’s rights and transfer the money to him or her, difficulties with the gift tax arise.

A will may be contested by blood relatives, and in some jurisdictions probate court may not be receptive.

– Placing assets into named beneficiary accounts like insurance policies, IRAs, joint accounts, bypasses probate. Living trusts bypass probate as well. You can name a cohabitant as trustee as well as beneficiary.

– Under assets in joint name the presumption may be that all of the assets are in the estate of the first to die which can result in higher estate taxation. Carefully kept records can overcome that presumption.

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Child Rearing, Nontraditional Families

In marriage there is the presumption of equal rights and responsibilities for a child.

In nonmarital households that responsibility falls to the blood relative or to the person who adopted the child.

In those circumstances, joint adoption where allowed could be undertaken to avoid the possible absence of rights by the partner if the couple should separate or the person who adopted the child should die.

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Advantages of Nontraditional Families

The household members can engage in income shifting, thereby reducing taxes on the earnings on the assets shifted.

There is no liability for repaying the debts of the non marital partner, while in some cases there may be one for a spouse.

If the two unmarried partners make about the same income, their income tax will be higher.

However, if they have a wide disparity in income they will pay a lower amount.

One member may more easily qualify for federal aid, say, for Medicaid, than if for eligibility purposes combined household income were to be counted as it is in marital joint income.

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Domestic Partnership Agreement and Other Legal Arrangements

A domestic partnership agreement is a personal contractual document that relates somewhat to a pre- or postnuptial agreement.

– The financial arrangements are set out in the event that the two people separate.

– May call for arbitration or mediation. – The household roles of both partners may be specified. – Most recognize that the relationship is long term and that both parties will

live together in an exclusive relationship, sharing financial resources and basic maintenance expenses and are responsible for the well-being of the other party.

– Not all states or municipalities recognize this document. Powers of attorney and medical powers can provide valid

documents so that a partner can be recognized to act on the partner’s behalf.

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Summary of the Differences Between Married and Unmarried Couples

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Summary of the Differences Between Married and Unmarried Couples, cont.

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Wealth Planning

Affluence: Being financially independent with a high standard of living.

– Those who are affluent can focus on Maslow’s higher levels of needs.– The affluent person’s risk tolerance may be greater, though some

affluent investors may take a less aggressive investment posture to reduce personal stress.

– Affluent individuals sometimes open up family offices: in-house, self-contained entities that hire full-time people and advisors to handle investments and other financial matters.

– Family partnerships for family businesses, gifting, charitable foundations, and trusts of all types are used in greater abundance by the affluent.

– For affluent people, preservation of wealth over succeeding generations can often be the financial goal that replaces maximization of standard of living.

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Business Owners

A closely held business is one in which one or a few individuals own a business. May be an individual proprietorship, partnership, or corporation.

Risk management strategies: – Diversification of assets. Whenever feasible, financial assets

should be established. – Insurance: Life, disability, medical, property, liability, accident,

and malpractice.

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Business Succession and Estate Planning

Will the business or business interest be sold or retained for future generations?

– Under a buy-sell agreement the provisions of sale are established in contractual form.

– The contract generally provides for the mandatory purchase by one partner or stockholder of another’s interest at a predetermined rate or standard in the event of an owner’s death, disability, or retirement.

– The terms of appropriate operations that trigger the buy-sell are often standard.

Life insurance payable upon death of an owner may fund the purchase by one partner or corporate stockholder of another owner’s family interest.

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Business Succession and Estate Planning, cont.

Tax planning considerations may be incorporated in the sale of the company.

– Upon an owner’s death, a large estate tax may be due on a business with considerable value.

– There are special estate tax provisions that provide for taxation of a closely held business.

– In addition, the estate has the option of deferring taxation for ten years under these provisions, which are intended to prevent the forced sale of the business to raise funds to pay estate taxes.

– The business or individual owner may provide life insurance to fund estate taxes as well.

– There are many methods to effect transfers of business in a tax efficient way, including an employee stock ownership plan and a family limited partnership.

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Corporate Managers

Common enhanced benefits for corporate managers include greater life insurance coverage, a broader disability benefit, access to deferred compensation, an expense account, a special bonus plan, and a potentially lucrative stock options program.

It also includes access to special perks including financial planning and legal advice.

– The financial planner must determine the extent to which these benefits are tied to the company as opposed to the manager’s ability to take them to a new company or into retirement.

– The likelihood that a manager will stay at the company for the remainder of his or her career must also be assessed.

– When an executive decides to leave, the benefit package to be received from the new employer is typically an important part of the negotiations and the ultimate decision.

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Stock Options

Stock option: The right to buy a stock at a specific price for a specific period of time.

– Stock options are often used by companies to align the employee’s goals with the profit- maximizing goals of the business and to maintain employees within the company.

– They provide a form of compensation that is tax-deferred, and if guidelines are followed stock options can be partially or fully taxable at favorable lower capital gains rates.

– Stock appreciation rights broadly serve the same function. – They provide employees with compensation equivalent to the

gain in the price of the stock without their actually possessing the stock option’s right to buy shares.

– There are two types of stock options: incentive stock options and nonqualified stock options.

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Incentive Stock Options

Incentive stock options: Options that are not taxable to the recipient when the option is granted. They receive special favorable tax treatment.

– Moreover, there is no tax when the option is exercised and the shares are purchased.

– The proceeds when sold, less the option price, are subject to tax at long-term capital gains rates if the shares are held for at least one year after exercising the option and two years after the option is granted.

– If the shares are sold within one year of exercising the option, the gains are taxable as ordinary income.

– The difference between market price and option price on exercising the option may be subject to alternative minimum tax rates.

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Nonqualified Stock Options

Nonqualified stock options: Options that are not taxable to the recipient when the option is granted, but are taxed when the option is exercised. They don’t receive special favorable tax treatment.

– The difference between the option price and market value of the stock at date of exercise is taxed at ordinary income rates.

– When the stock is sold, the difference between the sales price and market value at exercise date is taxed at long-term capital gains rates.

– Nonqualified plans can grant options at prices significantly below market prices.

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Other Issues for Corporate Managers

The tax benefit from deferred compensation must be weighed against the default risk.

Often corporate managers have a concentration issue, as a large portion of their wealth is tied up in their company.

Typically, the response to the concentration problem is to reduce it by exercising options of worth and selling of shares.

Diversification strategies extend to policies for 401(k) and other pension plans under the investment control of the employee.

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Disability and Special Needs Planning

Disabilities make it difficult or impossible for a person to function normally in society.

Dependents with special needs present a related difficulty.

Having a disability either as a child or an adult can prevent a person from working or limit his or her earning capacity.

– When a disability gradually worsens, the power of attorney may be a springing one: i.e., will take effect at a defined point of time in the disability.

– A standby trust may also be established and funded, with a trustee ready to take over management of financial affairs, again at a point to be defined in the document.

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Disability and Special Needs Planning, cont.

Those who qualify may apply to Social Security for disability payments.

– A person who is disabled may be entitled to an income tax credit subject to income and other limitations.

– Those people who are able to work cannot be discriminated against because of their disability.

When a disability occurs , an assessment is made of income capabilities combining personal assets, disability payments, and perhaps financial assistance from relatives. Then the maximum standard of living is developed.

– Often the investment policy for those with permanent full disabilities is tempered by care that it not be too conservative, particularly for people disabled at a young age.

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Special Needs Planning for Dependents

Special needs planning usually concerns dependents who often have permanent disabilities that eliminate or limit their income-earning abilities.

Planning for dependents carries both a financial and an emotional burden.

– In some cases the costs of care can exceed $100,000 a year. This precludes all but the affluent from handling such care without government assistance.

– Emotionally, there are questions about how to divide limited resources among parents, the incapacitated child (or spouse), and other healthy children.

– In personal terms, the question can be how much is enough time and care devoted to the individual in need.

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Special Needs Planning for Dependents, cont.

Sources of aid: – Two sources of government aid are Supplemental Security

Income (SSI) and Medicaid. – SSI provides a modest income for food, clothing, and shelter.

Medicaid provides medical payments of all types. – Social Security disability payments, another form of government

aid, handles children whose parents are eligible for Social Security coverage and adults.

– Household financial aid by relatives, friends, or others must support and not replace governmental SSI aid.

– A popular way to do this is through a special needs trust. A special needs trust provides a mechanism for presenting supplemental aid to dependents with the objective of not compromising governmental aid.

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Special Needs Planning for Dependents, cont.

A principal issue under the special needs trust is who should be the guardian, conservator, and trustee for the incapacitated.

– The guardian handles financial and personal affairs for the incapacitated. The guardianship can be partial or full, depending on the degree of incapacity.

– A conservator is sometimes employed who may be principally concerned with financial affairs and assets.

– A trustee is the person (or persons) responsible for the operation of the special needs trust.

All three are fiduciaries - that is, they must act in the best interests of the incapacitated.

One appointed person may handle more than one function.

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Letters of Intent

Special needs planning involves taking care of people who, in many instances, can’t take care of themselves.

One document that helps with this process is the letter of intent. It can detail many factors involved with the supervision of a dependent child or adult.

These include:– The operational factors involved with the care of the person.– An explanation of what is wrong with the incapacitated.– A list of all professionals and family members with addresses,

telephone– numbers, and email information.– A financial breakdown of asset and governmental benefits.– Private information on pleasurable activities, religious affiliation,

medical problems.

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Financial Planning

Financial planning for dependents with special needs includes:

– Reviewing documents: It is very important that a person who is receiving SSI and Medicaid payments, not be a beneficiary or contingent beneficiary of assets.

– Providing for a guardian, conservator, or trustee.– Spend down dependent’s assets: It is often best to spend down

assets in the dependent’s name since $2,000 or more of assets can result in ineligibility for SSI..

– Beginning to plan early.– Obtaining qualified assistance. It is important to hire an experienced

attorney who is familiar with the laws on assistance in that particular state. An accountant, an investment advisor, or financial advisor familiar with investment and tax matters is also helpful.

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Elder Care Planning

Elder care planning is financial planning that involves actions taken on behalf of people, often our parents or grandparents, who are unable to adequately handle normal living matters without assistance.

– Elder care is classically part of the life cycle that comes after active retirement. Caring for the elderly often falls to their children or a close relative or friend.

– For children this period can have emotional overtones as they experience role reversal.

– Because adult children have many other responsibilities and often live far from their parents, they may question whether they are handling their needs properly.

– Since parents often wish to maintain their independence, the assistance of their children may, in some cases, not even be met with appreciation.

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Elder Care Planning, cont.

Cash flow planning ensures that day to day household expenses are met.

– May include financial support to the parents when funds have run out, the sale of assets such as the home to create liquidity, or a reverse mortgage.

Investment planning for the elderly differs in its time frame and risk tolerance.

– The tolerance for risk should be reduced since large declines in asset values can have direct material effects on the standard of living of the elderly. A greater mix of bonds and less aggressive stock mutual funds is called for.

Long-term care insurance can offset the cost of assistance needed within the home or at a care facility.

– In some cases, it can also protect a person from being financially impoverished due to the disabilities of their spouse.

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Elder Care Planning, cont.

Medicaid and related state and municipal aid is government assistance for the poor.

– Medicaid pays for medical care, and care at home and underwrites the cost of nursing home care.

– An alternative that is practiced is intentionally transferring or working down assets to qualify for Medicaid.

– Transferring assets to beneficiaries, often to children, in order to qualify for Medicaid can assure that part or all of the parents’ assets will go to their children.

– The government is attempting to limit this planning procedure by implementing specific requirements.

– Transfers of assets from parents to others will be subject to a 36-month “look back” period.

– When monies have been transferred to or from a trust, a 60-month look-back period will be in effect.

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Terminal Illness Planning

Terminal illness planning involves accommodating the wishes of the dying person in a way that retains as much of the financial resources as possible for the remaining household members and other intended beneficiaries.

Affected areas of financial planning include:Estate Planning The WillLiving Will and Healthcare Proxy TrustsLetters of Instruction Durable Power of AttorneyGifting Burial arrangementsTax and Investment Matters InsuranceCash Flow Planning

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Chapter Summary

Divorce typically involves one or more types of payments incorporating alimony, child care or lump sum outflows.

Remarriage differs from first marriage in complexity which can give rise to his, hers and theirs issues.

Non traditional households often must provide substitutes for the legal contract of marriage to protect one or both individuals.

Planning for the affluent can have less to do with retirement and more with estate planning and may allow greater risk taking behavior.

Business owners require specialized planning in such areas as diversification of assets owned, insurance owned, and business succession and estate planning.

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Chapter Summary, cont.

Corporate managers often have issues connected to asset concentration, scope and portability of benefits, and analysis of stock options.

Disability and special needs planning incorporate maximization of governmental aid while utilizing existing assets and private aid sources.

Eldercare mandates involvement by children or friends to assist in helping people who may not be operationally independent any longer.

Terminal illness planning provides legal, tax and other financial practices so as to maximize the monies and minimize the difficulties in the last stages of life.