Quarterly Newsletters

March 2009: Watch Those Beneficiary Designations

Last month, the Supreme Court of the United States decided a case that can serve as a warning to a great many people. The case is entitled Kennedy v. Plan Administrator for DuPont Savings.

William Kennedy participated in his employer's savings and investment plan (SIP). His employer was DuPont. DuPont's SIP is a qualified plan governed by the Employer Retirement Income Security Act (ERISA). ERISA is a federal law that offers a great number of protections for individuals' qualified savings plans, such as the SIP.

William Kennedy was married to Liv Kennedy for a period of time. While they were married, William named Liv as the sole beneficiary of his SIP.

William and Liv divorced and in their divorce proceeding, Liv waived any interest that she had in William's SIP; however, William never changed his beneficiary designation. Subsequently, William died.

After William's death, his daughter, Kari Kennedy, was appointed as executrix of William's estate. Kari Kennedy requested the plan administrator of the DuPont SIP to distribute William's SIP plan to her as the executrix of William's estate. The plan administrator refused to distribute the SIP plan to William's estate and, instead, distributed the plan to Liv Kennedy, who was the designated beneficiary of the SIP.

Kari Kennedy initiated a suit against the plan administrator. Kari claimed that Liv had waived any interest she had in the SIP in the divorce from William. Kari claimed that the plan administrator violated ERISA by distributing the SIP to Liv.

The Supreme Court of the United States, in a unanimous decision, held that plan administrators are entitled to follow the clear and unambiguous beneficiary designation made by the plan owner. The Court held that a plan administrator should not be forced to look at extrinsic evidence, such as the divorce paperwork, to ascertain the intent of the decedent.

The Court noted that William had the opportunity to simply designate a new beneficiary of his SIP, a simple option of which he failed to avail himself.

The end result of the Kennedy case is that William's ex-spouse receives his retirement plan and his daughter receives none of the plan. Given the fact that many people's retirement plans are their most valuable assets, this decision could have a very big impact on who receives what from an individual's estate.

The Kennedy decision speaks directly about ERISA plans, but the decision also speaks to ensuring that your estate plan is in line with your intentions.

For instance, Mr. Kennedy might have had a Will that said everything to his daughter, Kari. As we see from the Kennedy decision, William's SIP plan passed to his ex-wife, Liv, because William failed to align the beneficiary designation on his SIP in accordance with his intentions.

But assume that Mr. Kennedy also owned a house with his girlfriend as joint tenants and several bank accounts with his girlfriend.

Even though Mr. Kennedy's Will might say "I give everything to my daughter, Kari," the fact of the matter is, nothing will pass to his daughter. The house will pass to his girlfriend as the surviving joint tenant. The bank accounts will also pass to the girlfriend as the surviving joint tenant.

Even if you think, how could William Kennedy have been so lazy as to fail to name his daughter as his beneficiary after he divorced his wife?, the fact of the matter is, there are more William Kennedy's out there than you might think. And I would say that almost every client I have is, to some extent, a William Kennedy, because just about every person fails to align each and every asset that he owns with his estate plan.

For instance, if a client has four children, the client might place one child's name on his bank account, but not the other three. This could result in the one child receiving the bank account, and not the other three, depending upon the attitude of the one child after the client's death.

In this respect, the Kennedy case is very instructive to all of us. It is important to understand how our assets pass after we die and to ensure that the disposition of our assets is in conformity with our desires.

YOUR MONEY, YOUR WAY

A large portion of my practice involves estate planning. Stated another way, I draft a great number of last wills for clients. Given the number of Wills that I draft, I have seen a large array of estate plans. Stated another way, I have seen how a lot of different people want to leave their money after they die. A significant percentage of people wish to disinherit relatives or leave some relative a smaller percentage of their estate than other relatives. More than you may think.

To me, how much a client leaves someone is up to the client. I am never receiving anything from my clients in their Wills-it is unethical for an attorney who drafts a Will to name himself as a beneficiary in the Will-so how they leave their money is wholly up to them.

Many clients believe that they must leave a token amount to a relative who they are disinheriting. For instance, if Mr. Smith has four children and wishes to disinherit one child, Mr. Smith might believe that he has to leave $1 to the child he is disinheriting in order to make his intention valid.

This is untrue. In fact, naming someone as even a nominal beneficiary of your estate entitles that person to a slew of rights that the person would not otherwise be entitled if he were not named as a beneficiary. For instance, a beneficiary is entitled to an accounting from the executor. Someone you disinherit would not be entitled to an accounting.

With one exception, you do not have to leave any amount to someone who you are disinheriting. With one exception, you can disinherit anyone you want. It's your money, and you can leave it to whomever you want, with one exception.

The exception is a spouse. If you are married, you may not be able to disinherit your spouse. A spouse may be entitled to assert the elective share against your estate.

The elective share is the right of a spouse to elect against the estate of the deceased spouse. If the disinherited spouse makes the election, she may be entitled to take up to one-third of the deceased spouse's estate.

The disinherited spouse must make the election within six months of the surrogate appointing an executor of the estate, that is, within six months of the Will being admitted to probate. Asserting the elective share is an affirmative action on the part of the disinherited spouse. If she does not make the election within six months of an executor being appointed, even if she would have been entitled to one-third of the deceased spouse's estate, then she will receive nothing from the deceased spouse's estate.

The disinherited spouse may be entitled to one-third of the deceased spouse's estate, emphasis on the word "may." The elective share amount is offset by property that the disinherited spouse owns.

For instance, if Mr. Smith dies with an estate worth $300,000, and Mr. Smith disinherits his wife, his wife's gross elective share claim would be $100,000, which is one-third of $300,000. But if Mrs. Smith has $100,000 or more in her own name at the time of Mr. Smith's death, then Mrs. Smith will be entitled to nothing from Mr. Smith's estate.

The elective share is a way to protect a spouse from being impoverished by the death of her spouse. Yet, the right to assert an elective share is not an absolute right in that the disinherited spouse must take affirmative steps to enforce the right and she may not be entitled to any portion of the disinherited spouse's estate if she has sufficient assets in her own name.

As for disinheriting other people, such as children or brothers and sisters, there is no obligation to leave these individuals any share of your estate. It is your money and you can leave it in any manner you want.

The bitter feelings that your actions may leave between your family members is another, non-legal issue. For instance, if you choose to leave your entire estate to one child and disinherit the other child, you shouldn't be surprised if the disinherited child never speaks to his fortunate sibling again.

GIVING IN THE NEW YEAR

As the New Year approaches, I am reminded of a topic that is nearest and dearest to many of my clients-gift tax. In 2009, the annual exclusion amount against gift tax will increase from $12,000 to $13,000.

The federal government imposes a gift tax. The state of New Jersey does not impose a gift tax. Many people believe that they can gift $10,000 (or $11,000 or $12,000) a year without paying the federal gift tax.

The truth is, everyone receives a $1,000,000 lifetime credit against gift tax. In addition to the $1,000,000 lifetime credit, taxpayers are entitled to an annual exclusion gift. As the name of the gift ("the annual exclusion") implies, it is an annual exclusion against the gift tax. The annual exclusion is in addition to the $1,000,000 lifetime credit.

The annual exclusion is currently $12,000, but the exclusion is indexed for inflation. In 2009, the exclusion will increase to $13,000. The annual exclusion allows a taxpayer to gift $13,000 per year to an unlimited number of people. In other words, Mr. Smith could gift $13,000 to one hundred people without reducing his $1,000,000 lifetime credit.

The recipients of the gift do not have to be related to Mr. Smith. Mr. Smith could make the gift to every person in the United States and as long as he does not gift more than $13,000 to any one person, he will not reduce his $1,000,000 lifetime credit.

If Mr. Smith gifted $13,000 to nine people and $23,000 to one person, his $1,000,000 lifetime credit would be reduced from $1,000,000 to $990,000. Since the $23,000 gift exceeded the $13,000 annual exclusion amount by $10,000, that $10,000 excess gift will reduce Mr. Smith's lifetime credit by $10,000.

In addition, since Mr. Smith gifted more than the annual exclusion amount, he is required to file a federal gift tax return, a form 709; however, if Mr. Smith failed to file the gift return, there would be no penalty because the penalty for failure to file a gift tax return is based upon the gift tax that was owed, and since there would be no gift tax owed, there would be no penalty.

If Mr. Smith were married, he and his wife could gift $13,000 each (or $26,000) a year to an unlimited number of people. So, if Mr. and Mrs. Smith had four children, they could gift $104,000 per year to their children without reducing either of their $1,000,000 credits against gift tax. Yes, both Mr. and Mrs. Smith have a $1,000,000 lifetime credit against gift tax.

In addition to the $1,000,000 lifetime credit and the annual exclusion, a taxpayer can pay a relative's education and medical bills directly to the provider of those services without reducing his $1,000,000 lifetime credit. A taxpayer can also gift an unlimited amount of money to charities without reducing his $1,000,000 lifetime credit.

By the way, the recipient of a gift never has to pay tax on the gift. The receipt of a gift is a non-taxable event. If Mr. Smith gifted $2,000,000 to his son, Mr. Smith might have to pay gift tax on the amount of the gift that exceeds his $1,000,000 lifetime credit and the $13,000 annual exclusion, but his son would not have to pay any gift tax.

The subject on which I receive the most questions is gift tax. People are fascinated by the subject. But as you can see, a person would have to gift a heck of a lot of money before he would ever pay gift tax.

Now, there is a significant downside to gifting assets. The recipient of the gift receives the gift-giver's basis in the asset. So, for example, If Mr. Smith bought some stock for $10,000 thirty years ago and the stock is now worth $400,000 and Mr. Smith gifted the stock to his son, his son would receive his $10,000 basis in the stock. When the son sells the stock, he would have to pay capital gains tax on $390,000 in gain.

On the other hand, if Mr. Smith died owning the stock and left the stock to his son as an inheritance, the son would receive a stepped up basis equal to the date of death value, or $400,000. When the son sold the stock for $400,000, he would not realize any gain and would not have to pay capital gains tax.

LIVING WILLS

Several weeks ago, a friend of mine who, like me, is a certified elder law attorney, asked me to participate in a presentation for the New Jersey Institute of Continuing Legal Education (ICLE). ICLE is an organization that provides educational presentations to lawyers in New Jersey. My friend asked me to speak on the topic of living wills.

I was somewhat excited about giving the presentation because even though I draft living wills several times a week, if not every day, it has been some time since I have actually sat down and read the New Jersey Advanced Directives for Health Care Act (the "Act"). A living will is an "advanced directive."

In fact, there are two types of advanced directives-living wills and health care proxies or health care powers of attorney. A living will is an instructive directive, meaning that it says what the person wants in writing. For instance, "if I am ever permanently unconscious, then I do not want to be kept alive on a respirator."

A health care proxy is a proxy directive, meaning that it appoints someone else to make health care decisions for you if you are incapable of making those decisions for yourself. For instance, "if I am ever permanently unconscious, I want my wife to make decisions for me."

Both living wills and health care proxies are "advanced directives" and both are addressed by the Act. In most instances, a person will have a combined living will and health care proxy. For instance, the person's advanced directive will say something such as "if I am ever permanently unconscious, I do not want to be kept alive on a respirator and I want my wife to make decisions for me."

I am happy to report that after re-reading the Act thoroughly, my thoughts about advanced health care directives for all of these years have been correct.

When I speak about the need for a living will, one of the biggest misconceptions that people bring up is the belief that doctors and hospitals do not pay attention to living wills. "Oh, my aunt had a living will but the doctors just put her on the machines anyway."

I guess I shouldn't call this a misconception, because the aunt probably was put on machines despite having a living will, but from my perspective, it is a misconception because the family could have forced the health care providers to abide by the aunt's wishes. Under the Act, a physician or a hospital has an obligation to abide by the patient's wishes as expressed in her living will or to find another doctor or hospital that will abide by the patient's wishes.

In other words, a doctor might object to terminating treatment for reasons that are personal to that physician; however, if the physician does have a personal objection to those wishes, then the doctor must find another doctor who will abide by the patient's wishes.

In the living wills that I draft, I like to put language that permits the health care agent, the person chosen to make health care decisions, to sue a doctor or hospital that fails to abide by the patient's wishes. One thing that doctors and hospitals hate is the threat of lawsuit, particularly when the health care provider is clearly wrong.

The Act also makes clear that a living will is only effective if the person cannot make decisions for themselves; however, even if the person is incompetent, if the person expresses a desire to revoke the living will and to participate in treatment, the health care provider must listen to the person. There is a very strong lien in the Act to abide by the person's wishes, even if the person is having tremendous difficultly in expressing those wishes.

One big thing that I confirmed in reading the Act is my belief that the Act only permits you to have one health care agent at a time. In other words, you can say "if I cannot make decisions for myself, I want my wife to make decisions for me. If my wife cannot make decisions, I want my son to make decisions for me," but you cannot say "I want my wife and son to make decisions for me." You can have multiple, alternate agents, but you cannot have co-agents.

Living wills are very important documents. Like a power of attorney for financial decisions, I strongly recommend that every person over the age of eighteen have a living will.

NEW JERSEY'S FIRST FAVORABLE ANNUITY CASE

Last week, I received a favorable decision in a case of mine. The case involves Medicaid planning with an annuity. The decision that I received is the first favorable New Jersey decision in an annuity case since the laws governing the Medicaid program were modified in February 2006.

In the past several weeks, I have written two columns on the concept of Medicaid planning with annuities. These columns were prompted by two federal court decisions on this issue. Both of those cases were decisions of federal courts in the Third Circuit.

The federal court system is broken up into thirteen circuits, or areas. The Third Circuit encompasses New Jersey, Delaware, and Pennsylvania. Of the two recent federal court decisions, one was an appeals court decision and the other was a trial court decision. Both of these decisions were favorable to the concept of planning for Medicaid eligibility with an annuity.

Annuities have been used for years as a Medicaid planning technique. Typically, an annuity is used when you are planning for the Medicaid eligibility of one married spouse.

Under the Medicaid laws, assets of a married couple are pooled. In other words, whatever assets one spouse owns, the other spouse owns. If, for instance, Mr. Smith owns assets worth $200,000 in his name alone, as far as Medicaid is concerned, Mrs. Smith owns assets worth $200,000.

Income, on the other hand, is not pooled. If Mr. Smith receives Social Security income and a pension of $3,000 a month, none of his income counts against Mrs. Smith's eligibility for Medicaid. Moreover, if Mrs. Smith eventually qualifies for Medicaid, her income will be owed to the nursing home, but Mr. Smith's income will not be. Mr. Smith can retain all of his income for his own benefit.

In essence, the concept of qualifying for Medicaid with an annuity uses this asset-income distinction. What the client is attempting to accomplish with the annuity is to convert excess assets into income. For instance, assume that Mr. and Mrs. Smith have excess assets of $150,000. In other words, Mr. and Mrs. Smith have $150,000 too much to qualify for Medicaid.

The Medicaid Office tells Mr. Smith that he must spend down the excess $150,000 before Mrs. Smith, who is currently residing in a nursing facility, will qualify for Medicaid. By "spend down," the Medicaid Office means that Mr. Smith must pay the nursing home until he has spent the excess $150,000 on Mrs. Smith's nursing home stay.

In my case, the husband was residing in a nursing home and the wife was the well-spouse. The wife had an individual retirement account (or IRA) worth approximately $200,000. The wife's IRA made the husband ineligible for Medicaid benefits, that is, the couple had approximately $200,000 too much to qualify for Medicaid. I advised the client to purchase an irrevocable, non-assignable annuity inside her IRA that met the requirements of the Medicaid law.

When the Medicaid laws were modified in February 2006, the federal government placed a number of requirements into the Medicaid Act for annuities. The annuity that I advised my client to purchase met all of those requirements.

After I applied for Medicaid benefits, the Medicaid Office denied benefits, claiming that the annuity was an asset and that the client owned assets worth too much to qualify for Medicaid benefits, since his wife owned a $200,000 IRA annuity. I appealed the determination of the Medicaid Office.

Last week I received the decision of an administrative law judge. That judge agreed with my arguments. This decision is the first favorable decision in New Jersey with regard to annuity Medicaid planning since the federal Medicaid Act was modified in February 2006.

The director of the Medicaid department will now review the decision of the administrative law judge. While I hope the director will also rule in my favor, I am prepared for an unfavorable ruling and will certainly appeal that unfavorable decision to the Appellate Division of the Superior Court.

I firmly believe in the end that I will win, and I hope that if I am forced to appeal the Director's decision, the court awards me counsel fees and costs. The policy of New Jersey's Medicaid Office on this issue violates federal law. While many may debate this technique and some may believe it is abusive, the fact remains that the law, as written and as modified only three years ago, permits this type of planning.