As baby boomers age, it’s increasingly imperative that advisors become well-versed in understanding and helping clients plan for incapacity.
Today there are roughly 5.8 million people in the United States
Individuals are generally best served when they take matters into their own hands — appointing someone to act on their behalf and, more often than not, executing certain documents while they still have the mental and physical capacity to do so.
What follows is an overview of some options — as well as warnings — for advising clients on giving a trusted family member access to accounts so that, in the event of cognitive decline, they can seamlessly step in.
CONVENIENCE ACCOUNTS
In many instances the easiest way to grant another person authority over an account is either to make them a co-owner of the assets by establishing a joint account, or to add them as an additional owner to an existing joint account. A joint account owned by Mom, for example, can be retitled to a joint account owned by Mom and Daughter. Similarly, a joint account owned by Mom and Dad can be converted into a joint account owned by Mom, Dad and Daughter.
Such accounts are commonly known as convenience accounts. They may be specifically identified as such by the financial institution. Many times a convenience account is simply a joint account that gives an identified individual access for administrative purposes.
This approach allows the original account owner to avoid professional legal work, facilitate the change at no cost minus administrative fees and complete the change in short order. But as is often the case with quick and easy fixes, this solution is far from ideal. In fact it can introduce a number of problems.
RETITLING ACCOUNTS
Establishing a joint account creates joint ownership of assets, virtually eliminating any checks and balances there might otherwise be over a family member’s funds. Even if a custodian, banker or advisor may suspect something is not quite right about a requested transaction, their hands are generally tied, and they must process the transaction accordingly if those instructions are received from an owner of the account.
The good news is that if or when this sort of malfeasance is discovered, there may be a way to recover misappropriated funds. Doing so will generally require expensive and time-intensive legal action, and even then, nothing is certain. To recover any funds the other joint account owner — or a party acting on their behalf — must generally prove that the joint account relationship
One of the most troubling aspects of using a joint account is that it potentially exposes the account itself to the overseer’s creditors. Imagine that Mom decides to add her son as a joint owner of her $1 million brokerage account so he can help manage its investments for her. Several years later, her son is driving when he hears over the radio that one of the companies in which he invested Mom’s money was acquired, and its stock price has jumped. Excited, he pulls out his phone to look up the current price — while still driving.
The ensuing crash is his fault, and in the resulting legal action the son is sued for everything he’s got — which would generally include funds in his recently established joint account. Through no fault of her own, Mom could be out $1 million. Note that if she can prove the joint account was established purely for her convenience, Mom may be able to protect her funds from her son’s creditors. But the burden of proof will be on her, and at best she’s looking at substantial legal fees to defend her savings.
What’s more, creditors from a tort lawsuit or a defaulted loan are far from the only people who may lay claim to the assets. Suppose the son’s infant child had been in the back seat at the time of the crash. Appalled by her husband’s lack of common sense, his wife immediately files for divorce. The assets in the newly established joint account could be up for grabs as part of the proceedings.
Note once again that if Mom can prove the joint account was established purely for her convenience, she may be able to keep its funds out of the divorce proceedings. However, the general presumption will be that the account was established to create joint tenancy. Further, while such property may be considered separate, in certain cases a judge may order the division of separate property as part of an
ASSET ELIGIBILITY
Even if an account owner were willing to disregard all these risks and issues, the very act of retitling certain types of assets as joint property can be difficult, if not impossible.
For instance, IRAs, Roth IRAs and other retirement accounts cannot be converted to joint accounts. There is no such thing as a joint IRA, and only an individual person can own such an account during their lifetime. The only way to transition an IRA into a joint account would be to distribute the funds in a taxable distribution and then move them into a joint account. Of course doing so would represent a fully taxable liquidation event for the entire IRA.
Retirement investment vehicles are far from the only accounts that run up against this limitation. Jointly owned annuities exist, but adding a child as a joint owner of a contract after it has been established can similarly trigger immediate income tax consequences for any gains under
Thus, even in the best of situations making a person the joint owner of an account is a limiting approach.
POWER OF ATTORNEY
A much better way to allow another individual to help manage the account and/or facilitate transactions to/from the account is to name them attorney-in-fact via a power of attorney document.
A power of attorney legally grants an individual or group of persons, or even an organization, the power to act on another person’s behalf. It creates a fiduciary relationship between the document’s creator, referred to as the principal, and the attorney-in-fact, who becomes an agent of the principal.
Critically though, while an attorney-in-fact becomes an agent for the owner, they do not become an owner of an account over which they have been granted power. Furthermore, by virtue of the fiduciary nature of the relationship, the attorney-in-fact is legally required to act in the principal’s interest, exercising — among other responsibilities — a duty not to use the money for themselves.
One practical challenge: While a valid power of attorney document may allow the attorney-in-fact to act on the principal’s behalf, there is no centralized power of attorney database or other method to instantly alert all an individual’s financial institutions that such a document has been executed. Rather, the attorney-in-fact generally must provide a copy of the document to each of the institutions at which the principal holds an account prior to being able to exercise their legally granted authority.
An additional complication to using a power of attorney is that institutions don’t always know when such a document is still in force, as the granting of authority over an individual’s assets does not last forever. Instead, a power of attorney will expire when the principal does — i.e., the attorney-in-fact’s authority to act on behalf of the principal ends when the principal dies.
Moreover, principals can alter and revoke their own power of attorney documents as well, which makes institutions all the more cautious and keen to verify that a current power of attorney document is truly current.
GENERAL VS. LIMITED
In many instances when a power of attorney is created, the goal of the principal is to grant their attorney-in-fact the authority to act on their behalf to the extent legally possible, and with regard to all the principal’s assets and accounts. Such a document is known as a general power of attorney.
Alternatively, a power of attorney can be drafted such that it provides the attorney-in-fact a narrower set of powers and/or authority over a more limited group of investments. Such a document is known as a limited power of attorney, and can be extremely useful in a variety of situations.
Example No. 1: Bill’s wife recently passed away. During her lifetime, Bill’s wife effectively managed all the couple’s finances.
Bill is in good physical and mental health and wants to maintain control over distributions from his account. He has no interest, however, in learning about investments or figuring out what should actually be in his account. Bill’s son, on the other hand, is an avid investor. Bill can, if he wishes, execute a limited power of attorney, giving his son only the power to change investments within his account but no power to effect distributions from the account or to make any other changes.
Example No. 2: Tyrone currently is working with an estate planning attorney to craft his just-in-case documents. He has a number of traditional accounts, including an IRA, a Roth IRA, a taxable brokerage account, a checking account and a savings account, all of which he believes can be managed effectively by his wife.
Tyrone is also very active in the cryptocurrency space and has accounts established at a number of online exchanges. And while he trusts his wife implicitly, he believes that if for some reason he were incapacitated or otherwise disposed, his friend Sean, who is also a cryptocurrency investor, would be better equipped to manage those accounts.
In such an instance, Tyrone could create a
Note that discretionary investment advisors should be intimately familiar with limited powers of attorney. In fact, it is such a document that grants the advisor the ability to make discretionary trades within a client’s account and, in certain circumstances, deduct advisory fees from the account.
NONDURABLE VS. SPRINGING VS. DURABLE
Occasionally an individual may look to allow a family member to access an account to provide management or facilitate transactions, even while they are healthy and otherwise capable of handling those things themselves. Oftentimes, however, the prevailing concern is: “If something happens to me, I want to make sure that someone can access my accounts so that investments can continue to be managed, bills can continue to be paid, etc.” In such situations it is necessary to have either a springing power of attorney or a durable power of attorney.
As noted above, an attorney-in-fact’s powers end no later than the principal’s death. But again, depending on the nature of the power of attorney agreement, those powers may terminate long before that point.
In fact, absent language to the contrary, the powers granted to an attorney-in-fact by a principal via a power of attorney will generally terminate at the earlier of the:
- Principal’s death
- Principal’s revocation of the power of attorney
- Expiration date built into the power of attorney
- Principal’s incapacity/mental incompetence
Note the final termination event listed above: incapacity. If the client’s goal is to ensure someone can seamlessly step in to manage their finances, what good is having a power of attorney document that removes that trusted person’s authority precisely at that moment?
Thus, while a nondurable power of attorney can make sense if the client has granted powers for someone to help manage certain affairs in their stead but under their direction, and the client doesn’t want them to continue to do so when the client is no longer able to direct them, such a document won’t work. That’s when either a springing or durable power of attorney comes into play.
THE WATCH-OUTS
You can think of a springing power of attorney as the yin to a nondurable power of attorney’s yang.
More specifically, whereas a normal nondurable power of attorney grants the attorney-in-fact powers immediately upon execution that will end at a specific event — i.e., the principal’s incapacity — the springing power of attorney grants no power to the attorney-in-fact until a specific event occurs. At that point the attorney-in-fact’s powers “spring” to life, and he/she can begin acting on behalf of the principal.
This type of power of attorney is appealing for obvious reasons. Many individuals prefer to maintain sole control over their assets until they are no longer able to do so. And if the goal is to allow a family member to continue managing an account only after the owner is no longer able to do so, then why give the attorney-in-fact any power before that time?
It all sounds great in theory. But in practice the springing power of attorney can be rather problematic.
Example No. 3: Blake has been named attorney-in-fact for his elderly mother, who has executed a springing power of attorney that takes effect upon her incapacity. During Blake’s most recent visit he notices that Mom is having an increasingly difficult time remembering things that happened only moments ago.
As he heads into the living room, he finds a large stack of unpaid bills stretching back several months. It is now clear to Blake that his mother’s cognitive impairment has reached the point where he must take action as her attorney-in-fact.
He begins to sort through the mail until he reaches an electric bill with the words “Final Notice. Return Immediately.” stamped across the envelope. Opening the envelope he finds that if payment is not received within three days of notice, service will be suspended.
Aghast, Blake turns to his mother and ask why she hasn’t paid the bills, to which she replies, “I have, and mind your own business.” Rightfully concerned, Blake immediately leaves the house and heads to the bank, power of attorney in hand, where Mom maintains her checking account. Blake informs the teller that he needs a check from his mother’s account immediately to pay the electric bill and avoid an interruption in service. Accordingly, he presents her with the power of attorney.
Here’s the problem: Blake doesn’t necessarily get to make that call. Suppose that Mom’s springing power of attorney includes the common requirement that her incapacity be certified by two licensed physicians. At best that will likely delay his ability to act on her behalf by several days. At worst the physician may not agree with Blake’s lay assessment — or Mom may not be willing to go to the doctor and risk being told she’s no longer competent.
Example 3a: Suppose that after being told by the bank they will not act without a physician’s certification, Blake immediately calls his mother’s doctor, who agrees to see them both first thing the following morning.
But lo and behold, the next morning Mom is having one of her good days. Thus, while privately the physician sympathizes with Blake’s predicament, the physician refuses to certify her as incompetent.
To make matters worse Blake’s mother is so insulted by her son’s insinuation that she refuses to execute any sort of new agreement that would grant Blake authority over her accounts.
Hypothetical though this example may be, this type of scenario plays itself out every day all over the country.
DURABLE BENEFITS
A tool can be used to effectively combat the risks associated with a springing power of attorney, which is known as a durable power of attorney.
Unlike the nondurable variety, which ceases to be effective once the principal becomes incapacitated, or the springing variety, which may only become effective after such an event, a durable power of attorney is effective upon execution and remains in effect even after the principal becomes mentally or physically incapacitated.
By default, however, powers of attorney — notwithstanding health care powers of attorney, a.k.a., health care proxies — are nondurable in nature. Thus, to make a power of attorney durable the document must include specific language, generally determined by state law, to stipulate that it will indeed be durable.
While both durable and springing powers of attorney can allow a family member to step in and manage an account after the principal is incapacitated, durable powers of attorney offer several advantages.
First, since they are in continuous effect after execution, there is no triggering event that must first be proved before the attorney-in-fact can act. Thus, problematic delays caused by disagreements over whether the triggering event has occurred can be avoided.
Additionally, since it allows the attorney-in-fact to begin acting as soon as the document is executed — at which point the principal must be of sound mind and body — it can give the principal an opportunity to give their attorney-in-fact a trial run of sorts.
Example No. 4: Martha names her daughter her attorney-in-fact via a durable power of attorney. Though Martha is still capable of making sound decisions, her daughter can begin managing her affairs. If questions arise during this time, Martha should be able to help guide her daughter, effectively enhancing the degree to which she will be able to stand in for Martha if and when the need arises.
Similarly, if things go well during this trial run, Martha can rest easier knowing she’s made the right choice with respect to her attorney-in-fact. And on the off chance it doesn’t go so well, Martha can make a change while she is still capable of doing so.
INSTITUTIONAL REQUIREMENTS
Having a valid power of attorney is an integral part of just about every estate plan. Unfortunately not every bank or brokerage firm will honor the generic document drafted by an attorney. Instead, absent a court order, the institution may require the principal to complete the institution’s own standard power of attorney form.
Other times the institution will accept the document, but only following an often lengthy review by its legal department. Clearly, either of these situations could become problematic.
As such, one of the most important aspects of ensuring that a loved one can manage an account on the client’s behalf is to find out what the institutions’ policies are. If an institution requires its own power of attorney form, the client must be sure to complete it while they are still capable of doing so.
Alternatively, if the institution will honor the client’s own power of attorney document, the client should consider submitting it to the institution as soon as possible — i.e., while the client is still healthy and the document isn’t actually needed. This way, if a legal review must be conducted, it can be completed before the attorney-in-fact’s services are needed.
A third potential option for allowing a trusted family member to aid in the management of an account is to create a revocable living trust, and to fund that trust with the account(s) in question.
Such a trust — sometimes referred to as an inter vivos trust after the Latin meaning “between the living” — is a legal entity created upon the execution of the document that provides for a trust relationship between the creator and a trustee. In general such trusts provide for the benefit of the creator during their lifetime and are drafted in a manner that allows their terms to be changed during said creator’s lifetime, or even to be terminated altogether, thus being revocable.
Notably, revocable living trusts must be administered by a trustee. And similar to the fiduciary duty owed to a principal by an attorney-in-fact upon the execution of a power of attorney, the trustee is also a fiduciary, and must legally act in the interest of the beneficiaries.
Revocable living trusts offer several advantages when compared to powers of attorney. For starters they are less likely to be flat-out rejected by an institution because once one is created, it is its own, ongoing entity. Furthermore, if it has taken legal title of property, by definition the trust is active and controlling with respect to that property. This precludes the institution from scrutinizing it as if it were a power of attorney.
And since the revocable living trust must become the actual owner of the assets in order to work, if an existing institution has any issues with the trust paperwork the principal should be able to find that out before it has the potential to become an issue.
Another advantage of using revocable living trusts to allow a family member to gain access to an account for management purposes is that the powers given to the trustee don’t end at the trust creator’s death. Rather, the trust lives on — though generally as an irrevocable trust, since the creator is no longer alive to revoke it — allowing the trustee to continue administering trust property going forward.
Thus, such property can bypass the probate process and almost immediately be transitioned for use by the next-in-line beneficiaries. Alternatively, the trust can terminate after the death of the creator, and its assets distributed outright to the remainder.
CO- VS. SUCCESSOR TRUSTEES
Oftentimes revocable living trusts are drafted such that the creator serves as the sole trustee and retains complete authority of the trust’s assets. This makes sense, givens the revocable living trust is funded with the creator’s own assets, for the creator’s benefit, akin to the creator owning those assets outright.
Thus, it’s common for the creator to retain control as trustee until such time that they resign from that position or are no longer able to fulfill their duties due to death or incapacity. Only at that time would the next-in-line trustee, known as a successor trustee, assume responsibility for administering the trust and its property.
While such a structure may sound appealing to the trust creator because it allows them to hold the reins right up until they’re no longer fit to do so, it can produce similar problems to those associated with a springing power of attorney.
In order for the successor trustee to assume that role, the original trustee must generally be proven incapacitated — often by the same two-licensed-physicians test. This can lead to critical delays.
To that end, rather than having the responsible party serve as a successor trustee, it may be more advantageous to name them a co-trustee effective immediately — even while the creator is still healthy and able to manage their own affairs — and to further structure the revocable living trust such that each trustee can act independently of the other.
In doing so the trusted person will have access to administer the trust assets from Day 1, but other than signing a few account opening forms, they won’t need to exercise their powers until the need arises.
When it does, however, there should be no delays or gaps in access to trust assets because a co-trustee already has access to those assets — i.e., there’s nothing new for the institution to review.
Of course, granting a co-trustee power immediately creates the risk that such power may be used irresponsibly. However, as with the durable power of attorney, using a co-trustee setup with a revocable living trust can allow the creator to test drive the trustee first. If unforeseen problems arise or the job seems overly burdensome, the creator can always make use of the living part of the revocable living trust and use their powers to vote the current co-trustee off of Trust Island, and name a new one.
But if the creator trusts their co-trustee enough to be responsible for the trust property while the creator is incapacitated, it ostensibly shouldn’t be a problem for the co-trustee to have powers while the creator monitors the situation.
The trust creator is still more protected in the meantime, because while a co-trustee may have immediate access to trust property, they must still use it for the creator’s benefit. Nor are the trust assets subject to the co-trustee’s own creditors, as would be the case if the co-trustee were added directly to the property title.
THE FUNDING FACTOR
One of the most important aspects of a revocable living trust is that the trust document — and thus, the trustee — only controls assets for which the trust itself actually owns.
To that end, after a revocable living trust has been created it must be funded for it to be effective. Generally, “funding” means opening new accounts in the name of the trust and transferring assets from existing accounts into the newly established trust accounts. For other assets such as real estate, it means changing the title of the asset to be held in the name of the trust, and not directly in the creator’s own name.
The caveat to funding revocable living trusts is that funding must occur while the trust creator is of sound mind and body. They after all must effect the transfer of their existing property into the trust. Even a co-trustee is of little to no use if the revocable living trust isn’t funded before incapacitation — because again, even the co-trustee’s powers only extend to trust assets.
Thus, if assets are not already inside of the trust at time of the creator’s incapacity, it will likely require either a court order or the act of an attorney-in-fact with gifting powers to make the transfer into the trust. And at that point the attorney-in-fact could just deal with the assets themselves, making the revocable living trust somewhat useless.
NO SINGLE SOLUTION
Like most planning scenarios, determining the best way to manage an individual’s potential incapacity while maintaining seamless access to accounts must be determined on a case-by-case basis. Though as the prior scenarios illustrate, the answer often requires more than just one solution.
After all, certain assets cannot be moved into a revocable living trust during the owner’s lifetime, and thus cannot be controlled by the trustee via their trust-given powers. Similar to the joint account tactics discussed earlier, IRAs and other retirement accounts are a prime example of this problem, as transferring such assets into a trust would be treated as a taxable distribution of the retirement accounts. Similarly, retitling an annuity into a trust can also trigger a taxable account, although
Still though, when planning for incapacity, some of the largest assets in an individual’s estate often cannot be adequately addressed with a revocable living trust. Rather, a power of attorney is often the only solution. Incapacity planning for multiple types of accounts and assets is often a blend, where a revocable living trust may be used for bank and taxable brokerage assets while a durable power of attorney may be used for retirement assets.
The key takeaway is to plan – and plan often — so that when the time comes there is minimal disruption to one’s finances. By doing so, clients can ensure that what happens to their assets is decided on their own terms, and not in a courtroom.
Jeff Levine, CPA/PFS, CFP, MSA, a Financial Planning contributing writer, is the Lead Financial Planning Nerd at
