Mary Owens: Dealing with a lack of liquidity
The last several articles have been discussing a typical simple estate that contains a home with a mortgage payment, an individual retirement account, and a small checking account.
The elderly couple has been living on a pension and social security. Their modest income has allowed them to make their mortgage payment out of their retirement income but has neglected the maintenance of their home.
Their only withdrawal out of their IRA was to pay their income taxes each year as it came due. The couple passed away; all social security and pension payments stopped immediately.
Their eldest son, Thomas, was appointed the successor trustee and he is now facing a crisis. Where does he obtain the cash to pay the mortgage payment, fix the dry rot in the house so he can sell it, and pay the final income tax bill for his parents? He is befuddled.
How could such a simple estate create so many nightmares? The answer to that question is simple: the estate lacked sufficient liquidity.
The most common problem I faced as a professional trustee was the lack of adequate cash to manage an estate effectively. Effective pre-death planning must include a cash management plan for post death needs.
There are several things in this small estate that could have been done to avoid the problems that Thomas is now facing. Let’s go through each of them one by one.
First and foremost, is having enough liquid cash in a checking or savings account that the successor trustee can access in order to pay ongoing bills. The accounts should be designated as a “trust” or “estate” asset only.
The account should not be payable as a “Transfer on Death” account that is payable to a specific person. The cash needs to belong to the estate or trust so the successor taking charge does not need the cooperation of other family members to access and use the cash as needed in the estate administration.
Sometimes the only cash available may be in an IRA. Prior to the death of the owners of the IRA account, enough cash should be withdrawn and set aside so the funds are available to the successor trustee.
If the only liquid assets left in an estate are IRA accounts, the trustee does not have access to these funds unless the beneficiary of the IRA is the estate or trust, which may cause other undesirable tax issues.
If an older couple has a mortgage on their home and lacks the income to maintain the house in a state of home sale “readiness,” strongly consider a reverse mortgage as part of pre death planning. A reverse mortgage eliminates the monthly payments and can provide access to cash to maintain the home and provide a liquidity pool of funds post death.
A well-maintained home can be sold much more easily than one in need of major repair, and usually at a better price. A successor trustee has less cash needs if the house can sell quickly.
If the house has to be repaired in order to make it marketable, cash flow is hit hard. Monthly mortgage payments, insurance and property taxes must continue to be paid while the delay caused by repairs is rectified.
A reverse mortgage can aid in solving many of these issues. It is important to note that the reverse mortgage has to be in place prior to the death of the owner of the home.
I would encourage you to learn more about the options available with reverse mortgages. The product has a well-deserved bad reputation.
New regulations now govern these instruments adding much needed protections for seniors and to insure the loans are not abusive. They are not ideal for everyone, but can dramatically improve much needed liquidity and provide funds to stabilize cash flows in retirement and maintain the value and maintenance of a home.
Pre-death planning also should include a thorough evaluation of life insurance policies. Many senior adults have been paying on a small life insurance policy for decades.
Once the children are grown and out of the house they are inclined to withdraw the cash value and drop the insurance all together. While this is not an unwise thing to do in many situations, the estate liquidity needs should be considered as a “new and future” need of the couple.
If sufficient funds are in the estate to provide for effective estate administration, cancelling the policies might be their best option. But if enough cash is not present, consider keeping the policies in force, if affordable, to avoid all the problems associated with poor liquidity pre-death planning.
The policy beneficiary should be the estate or trust in most cases in order to insure the successor trustee or estate administrator has access to the funds when needed.
Next month I will start a series on the benefits and drawbacks of having a trust instrument with a pour over will versus a simple will.
This is fairly complex subject so my columns for the next several months will be covering this topic.
Mary Owens, Managing Principal/Branch Manager, RJFS, 426 Sutton Way, Suite 110, Grass Valley, CA 95945, 530-272-7500. Securities offered through Raymond James Financial Services, Inc., Member FINRA/SIPC. Owens Estate and Wealth Strategies Group is not a registered broker/dealer and is independent of Raymond James Financial Services. Investment advisory services offered through Raymond James Financial Services Advisors, Inc. The case study discussed is hypothetical and has been provided for illustrative purposes only. Individual cases will vary. Neither Raymond James Financial Services nor any Raymond James Financial Advisor renders advice on tax, legal or mortgage issues, these matters should be discussed with the appropriate professional.
Start a dialogue, stay on topic and be civil.
If you don't follow the rules, your comment may be deleted.