Big Mistake: Failing to Update Beneficiaries

I make a point of reminding my clients to review their beneficiary designations on their employer based retirement plans, life insurance, IRA’s and accounts with transfer on death assignments. The same could be said of beneficiaries outlined in their wills (you have a will, don’t you?). I was happy to see that the February 2013 issue of Consumer Reports listing this as the number one mistake in their article, 7 Money Stumbles to Avoid.

Why is this so important? It’s because huge unintended consequences could happen if you fail to review this on a periodic basis. For example:

• Many people have trust arrangements set up within their estate planning but many people fail to change the beneficiary designations on accounts when the trust is established, potentially ruining the whole estate planning strategy they wanted to employ.

• It is not uncommon for former spouses to still be listed as beneficiaries on an individual’s life insurance or retirement plans.

• If you have an ERISA based retirement plan like a 401(k) or 403(b) and remarry, did you know your new spouse is automatically your 100% primary beneficiary? This may be the intent of the person, but it may not necessarily be that way if children from a former marriage are involved. And by the way, prenuptial agreements don’t work here.

• I’ve seen parents still listed as beneficiaries even though their child has long been married and has a family of their own that they need to financially support.

• Listing an estate as a beneficiary of a retirement account can have the unintended consequence of having the funds disbursed (and taxed) even if the beneficiaries didn’t need the funds and would opt to defer the receipt of these funds (and the tax consequences) to a later date.

• Having a child who has special needs lose their government assistance because they were improperly named as a direct beneficiary rather than a special needs trust.

• Not only beneficiaries, but the designation of guardians for your children, executors and trustees are good to review as well within your estate planning documents.

On an annual basis, it’s a good exercise to go through this to make sure that all of this is still aligned with your goals. And I would confirm any beneficiary designations directly with the financial service firm that you are working with rather than assuming they have the latest paperwork that you filed on hand. In the end, this is a very simple exercise that can save your family a lot of grief later down the line.

Long Term Care Insurance Market in Flux

Recently John Hancock raised premiums on many of its existing long term care insurance (LTCI) policies in force with increases ranging from approximately 20% to 90%. These were primarily focused on policies written over five years ago. This comes on the heels of Prudential and Berkshire both exiting the LTCI market over the past year. Insurance companies making less on their reserves in this low interest rate environment, fewer policy owners letting their policies lapse than expected and inadequate premium pricing in the past have all contributed to the flux in this marketplace.

All of this has made it even more difficult for people to protect the financial risk of needing long term care. What can you do to protect yourself? Here are some tips:

• For financial planning projections, you should make the assumption that LTCI premiums will go up with inflation over time if you currently hold or are purchasing a LTCI policy. Given the flux of the long term care insurance market and the fact that premiums will be variable over time, I suspect it will be a while before the insurance companies become effective of adequately pricing out the risk and underlying premiums needed to support this type of insurance.

• If you are one of those individuals who have insurance and received a significant price hike, I would caution you against dropping the policy altogether without thorough consideration. If you can’t afford the increase in premiums, the insurance company may allow you to reduce your benefits to keep premiums at affordable levels. It may not be ideal, but you still have some level of protection. Even with the premium hikes, many currently held policies still look attractive compared to what you can purchase new on the open market today.

• There are many riders and options available in the insurance marketplace to address long term care needs. There are a new slew of hybrid life insurance products which provide long term care benefits if needed. Traditional LTCI can have riders that protect against inflation and pays back the premium if no claims are ever made. There are options where the LTCI buyer can fully pay off their premiums in several payments in the early stages of owning the policy. These provisions all protect against the current flux of the LTCI market and are very attractive to someone shopping for LTCI. However I would be careful as everything that reduces risk comes with a cost. Insurance companies do a very good job of profiting on areas where the consumer has a heighted level of fear so I would weigh out if the benefit is worth the cost.

• Many people are resistant to buying long term care insurance because they may never use it. For those who fall in this camp, just keep in mind that most of us go for years without ever having a claim on their homeowners insurance. Somehow we continue to pay premiums on this type of insurance.

• In the end, I still continue to think shopping for this insurance in your early 50’s is the ideal time to consider this, buying a policy that covers the average daily cost in a nursing home care in the area you intend to live with a 5% compound inflation rider with a three to five year period is the best baseline place to start as far as shopping for a LTCI policy. From there you can adjust this accordingly to meet your personal circumstances.

• Finally, determine if LTCI is right for you. This type of insurance tends to be a perfect fit for those who have the financial means to pay the premiums over the long haul, but not enough in financial resources to absorb a long term care need. In some cases, people who can both afford the premiums and a long term care need buy it to increase their chances of leaving a legacy to their heirs. But LTCI is not universally the best fit for everyone.

When addressing my client’s retirement planning needs, the financial risk of needing long term care is always a built in assumption within my planning work. The state of the LTCI marketplace certainly isn’t making things any easier. But I urge that everyone should consider this risk and if LTCI fits you’re your needs regardless if you do this yourself or have professional guidance with your financial affairs.

(Tentative) Tax Deal Highlights:

Although the tax deal isn’t a done deal yet, I expect an accord to be reached prior to year end. The below is a brief synopsis of the tentative tax deal in place. Just keep in mind that this may be tweaked a bit depending on the political wrangling between now and when it is signed into law:

Tax Rates: Tax rates instituted during the Bush era will be extended for two years (through 2012). The big question over the past several weeks was whether these rates would be extended to all taxpayers or just the lower tax brackets.

Long term capital gain and dividend rates: Current long term capital gain and qualified dividend rates will be extended for two years (through 2012).

Alternative Minimum Tax Patch: The exemption within the AMT calculation will remain at similar levels in 2010 and 2011. This patch has been pushed through for several years now and has prevented millions of taxpayers from being subject to this tax. Over the past few years it has been the end of the year tax drama to see if the patch will be continued. So it’s nice to see that we won’t have to worry about this next year at this time.

Payroll Taxes: Amounts paid toward Social Security from employees will lower from 6.2% to 4.2% in 2011.

Estate and Gift Taxes: The top rate will be 35% (it was set to go to 55%) and an exemption of $5 Million per individual (where it would have reverted to $1 Million). This is the primary bone of contention within the political parties and may have a higher likelihood of change than other aspects of the legislation.

Extenders: These continue to allow for contributions directly out of an IRA for charity for those over age 70 ½, the state and local sales tax deduction as an itemized expense, the extra real estate tax deduction for those who do not itemize and the deduction for teacher’s expenses for 2010 and 2011.

Credits: The child credit of $1,000 is maintained for two years as well as higher education credits and expands the earned income tax credit.

Unemployment Benefits: These are extended at their current level for 13 additional months.

With all of this, I’m sure there will be additional minutia on this once the details come out. Over the course of the next few weeks I will be posting on my blog the planning implications of and how this will affect our economy over the short and long term as finality and details come in.

Be Ready for Changes in Our Income Taxes

On January 1st, 2011 the largest tax hike in history will take place if Congress does nothing. This came into play because the tax legislation in 2001 and 2003 had the support to be enacted, but not permanently. Now Congress in a quandary; I’m sure they would love the tax revenue to reduce the federal deficit (hopefully). However raising taxes at the height of a growing anti-incumbent sentiment with mid-term elections coming up isn’t the best for job security. I suspect some sort of legislation will get passed that will at least temporarily extend the tax breaks for taxpayers in the lower tax brackets so our representatives have something to bring with them on the campaign trail. I also suspect some sort of permanent resolution to the federal estate tax code will occur by year end (although I’m surprised Congress let the estate tax die this year).

My primary concern is beyond the above. Raising taxes in a weak economic environment historically has been an effective recipe for economic slowdown. The powers that be have not declared that we ever exited the recession and raising taxes may create a rare double dip. Solely taxing the higher tax brackets isn’t a solution either. The problem is that many of the people who are in the higher tax brackets fall into the category of the small business owner. These are the people that are the engine for job growth in our country. With the entrepreneur already dealing with the anti-business political dialogue coupled with higher taxes from the healthcare legislation, increased tax hikes may further curtail job growth and Washington could be shooting themselves in the economic foot. Extending the current income tax rules for an intermediate time period (3-5 years) is much better economic stimulus than Congress can conjure up. A one year extension is not a solution; it will just prolong the uncertainty which means business will hold onto its wallet. It would be a gimmick like the rebate checks we got a few years back which did nothing to stimulate the economy.

Despite the uncertainty, these are the things that you can do now that will still be effective no matter what ends up happening in our tax world:

-Accelerate Income: Normally you don’t want to do this, but if you have the ability to accelerate your income into 2010 rather than waiting until 2011, you should be poised to take action if the current tax rules are not extended.

-Accelerate Deductions: If the tax rules are not extended and if your personal exemptions and deductions were phased out in the past, then it may be likely to see this come back into play in 2011. Some deductions are non-discretionary and the only thing you can do is accelerate moderate amounts (such as paying real estate taxes due in 2011 or paying your January mortgage or home equity payment in December). But if you are subject to the phase outs above and are charitably inclined, you may be better off accelerating donations this year

-Tax Gain Harvesting: Financial folks like to talk about accelerating losses, but I would be thinking about harvesting some gains, especially long term holdings that have very low cost basis that you were reluctant to sell because of the tax implications. If legislation isn’t extended, the capital gains rate goes from 0% to 10% for lower tax brackets and from 15% to 20% to higher tax brackets. It seems Washington would like to see the higher tax brackets even pay more if they could. Even if you have a holding you want to keep, you may want to sell at a gain and repurchase to step up the cost basis. If you are potentially subject to the healthcare tax surcharge, it may be wise to start working on this now before the tax becomes effective. You may want to consider gifting appreciated assets to your children and having your children sell and recognize the gain if they fall into the 0% tax bracket (just be aware of gift taxes).

-Roth Conversions: There are many reasons why a Roth conversion may make sense and when to avoid it that goes beyond the scope of this entry. But with potentially higher taxes in the future, it is something that should be considered. For those who have a lot of investment income from taxable investment holdings and appear to be subject to the healthcare surcharge in a few years, it may make sense to convert and pay the tax out of the taxable holdings. On the front end, converting and incurring the taxes when they are lower makes sense. On the back end, shrinking the taxable assets and the investment income created by it may help avoid or reduce your taxes subject to the future healthcare surcharge.

-Be Ready for Estate Planning: If you have a heightened concern about estate taxes, you should be ready to review your strategy once the federal estate tax legislation is passed and adjust if necessary. Also don’t forget about the estate taxes your state imposes. States usually react to what the federal government does so this should be addressed as well.

With the above, everyone has a unique set of tax circumstances. You will need to do your due diligence to see if this makes sense for you and get help if you aren’t an expert. Some tactics above may create unintended consequences as many deductions and credits can be subject to phase-outs; higher amounts of your Social Security benefits could be taxed. Also you have to be careful to avoid the alternative minimum tax (AMT), which is in legislative limbo as well. Also keep in mind that it’s not about avoiding taxes; often more problems occur by trying to avoid taxes. It’s about managing taxes efficiently. But by being proactive of your tax situation, you will be better off in the long run.