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Avoiding Probate: Myths and Realities

530439Many clients I work with have done a little bit of research about estate administration before we meet.  Often, they are surprisingly focused on “avoiding probate.”

This is such a common part of the client mind map that I think it’s worth examining myths and realities of avoiding probate in Kentucky.

Myth: Probate is expensive, so avoiding probate saves money.

Reality: In Jefferson County, the filing fee to probate a Will and appoint an executor or administrator is $193. If $193 is not expensive for you, then probate’s not necessarily expensive.

Myth: Avoiding probate saves taxes.

Reality: Federal estate tax laws are agnostic about whether assets are included in the probate or non-probate estate.

Myth: My heirs will fight over my estate in probate, so if my estate isn’t probated, there won’t be a fight.

Reality: Non-probate assets such as transfer-on-death accounts cause some of the most bitter inheritance disputes.

Probate provides an organized process for wealth transfer, and the transparency and structure it offers sometimes prevents sibling discord from boiling over into litigation.

Myth: My privacy will be compromised when my estate is probated, so I should avoid probate.

Reality: The extent to which probate discloses your wealth and the way you transfer it to your beneficiaries is up to you. If you use a “pour-over” Will and a Revocable Trust, your distributions to beneficiaries can remain private.

If you fund your revocable trust (at least in part) while you’re living, the inventory filed for your probate estate won’t disclose the complete extent of your wealth.

In addition, non-probate assets also include life insurance and retirement accounts that are designated to beneficiaries other than your estate.

For most of the upper middle and lower upper class, these non-probate assets (even without any lifetime funding of a revocable trust) constitute the majority of wealth.

Even without any extraordinary efforts to avoid probate, this wealth will be “off the grid” for privacy purposes.

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37Flood-1stBreckLately I’ve been thinking a lot about what a “Corporate Event” at Humana might mean for Louisville. A rosy analysis I’ve heard suggests that Aetna might buy Humana, and then move its headquarters here.

We’d all love that outcome (sorry, Hartford).

Other Humana transactions may have collateral effects on our city that are, to put it mildly, non-accretive.

But, if Tip O’Neill was correct when he famously observed that “all politics is local,” then it’s probably equally true that “all merger impacts are personal.”

  • What would regional economic risk like a Humana event mean for you?
  • What are your particular exposures?
  • Most importantly, what can you do to get ahead of those risks?

Because I believe the right pictures help clarify things, I created an Economic Risk Quadrant to evaluate your personal impacts from regional economic risk (whether sudden, or gradual).

Locating yourself, your business, or your employer on the Economic Risk Quadrant suggests how you might be affected, what you can do to prepare, and how you can most effectively adapt and respond.

Economic Exposure Grid

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burbsSeveral months ago I read Cut Adrift: Families in Insecure Times by Marianne Cooper, a Stanford sociologist. Cooper’s chapters on the extremely professionally successful upper middle class and their project of “doing security” were particularly interesting.

These families were operating an increasingly unstable career and social environment, and devoted tremendous energy to enhancing their own financial security.

At the same time, parents also worried about launching their children on career and life pathways from which they could realistically hope to replicate their parents’  outcomes.

In the wake of the Great Recession and in a context of increasing global competition and winner-take-all income stratification, these concerns of Cooper’s upper middle class families seemed justified.

If the inheritance project of the Upper Class is managing abundance to enhance overall thriving of children and grandchildren, and the project of the Lower Upper Class is managing volatility in descendants’ upward or downward mobility outcomes, the project of the Upper Middle Class is managing risk.

Risk management is paramount for the Upper Middle Class because this class is still building wealth, but doesn’t yet have a capital base larger than what they might realistically need themselves.

Nonetheless, as life expectancy increases, children and grandchildren need to be launched in life when parents are still living.

More so than for their wealthier colleagues and relatives, Upper Middle Class wealth needs to be adroitly managed to hedge against several genuine risks. Some of the most significant are unplanned early retirement, a long term care event, or unexpected longevity.

If any of these risk events occurs (let alone more than one), it can dramatically transform a family’s balance sheet for the worse. To explore these effects, I updated our inheritance model. Results of the model runs are summarized in the two charts below.

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FarmingtonLast week, Business First of Louisville published a report and slideshow on the top 25 largest residential real estate transactions of the first quarter of 2015 in Jefferson County.

It might surprise you to know that a home bought for $646,000 was pricey enough to make the first quarter slideshow.

The most expensive home on the list cost $1.7 million.

I hope clients and their advisors realize that it is very easy to avoid this sort of publicity, if it’s unwanted.

Simply create a limited liability company, and have the property deeded to the LLC at closing.

Be sure to give the LLC an obscure name, like “Marvin Gardens LLC”. Don’t taunt reporters by using “Pulitzer Bait LLC”.

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This week I’ve been reading Claire Tomalin’s Jane Austen: A Life. That’s risky for me to admit, as surveys show the female/male ratio of “Janeites” runs about 25:1. Mockery from readers may be unavoidable, and even deserved.

I think one of the most interesting aspects of Tomalin’s biography is how it shows the Austens and their neighbors as a case study of the Lower Upper Class.

Tomalin describes the Austens’ neighbors as:

“pseudo-gentry, families who aspired to live by the values of the gentry without owning land or inherited wealth of any significance… families who merely happened to be where they were at that particular time, some floating in on new money, others floating out on their failure to keep hold of old.”

Even though Tomalin wrote about families in 1790s Hampshire, I am hard pressed to think of a better description of the lives of the Lower Upper Class in America today.

For discussion purposes, today’s Lower Upper Class enters retirement with an asset base between $3 million and $10 million, and adult children of this class usually inherit more than $1 million each, but less than $5 million.

A qualitative view on those numbers is that in this class, there is usually a safety net of financial and/or human capital that’s sufficient for one generation, but not for more.

In plain terms, if children of Lower Upper Class parents are tripped up by bad luck, circumstances, events, and/or bad choices, the grandchildren will face a substantial risk of downward mobility.

On the upside, upward mobility is a distinct opportunity. As in Austen’s time, marriage to a high-earning spouse can create a pleasant shift into the Upper Class (Pemberley then, Palo Alto today?). Or, a successful run in an emerging “New Economy” business can create abundant wealth (the East India trade then, tech companies today?).

It’s hard for a family to stay in the Lower Upper Class over several generations – descendants tend to move up, or move down, but not simply tread water.

Successful inheritance strategies for this class need to manage volatility in descendants’ outcomes, and variability in their situations.

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Miami-Nassau sailboat race, 1947Broadly speaking, I have observed Upper Class families use three types of inheritance strategies: deferral, ad hoc gifts, and income streams.

Deferral is a traditional strategy: pay to raise and educate your child, and then give them not very much (if anything) until they inherit as your survivor.

Ad hoc gifts are transfers for a particular purpose, such as paying off credit cards, covering club assessments, grandchildren’s tuition, buying a vacation home, or capitalizing a business.

Income streams are arrangements (often using trusts, or partial ownership of businesses or rental real estate) that provide ongoing income to the child.

As an aside, please bear in mind that by “Upper Class”, I’m referring to families in which children could inherit more (sometimes, much more) than $5 million each. Especially if parents can transfer that much wealth to each of two or more children, the parents themselves are likely in a substantially secure financial position, even after making lifetime transfers to their children.

For discussion purposes, this creates freedom to focus on how wealth transfers affect children, rather than parents.

Each type of inheritance strategy presents pros and cons.

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