Estate Planning Essentials: The Durable Financial Power of Attorney

You are likely familiar with the concept of a power of attorney, a legal document that allows someone else to act on your behalf. Legal terminology denotes the individual designating the power of attorney the “principal” and the designated person the “attorney-in-fact”. There can be multiple attorneys-in-fact, but of course they must make decisions in concert. The scope of the power can be limited or broad, but the purpose is for the attorney-in-fact to make decisions that are in the best interests of the principal. A broad power of attorney is an attempt by the principal to give their attorney-in-fact the same rights the principal would have if they were able to act on their own behalf.

What does “durable” mean? A power of attorney goes into effect upon signing and terminates if the principal becomes incapacitated. Adding the durable specification means that the power of attorney will stay in effect if the principal becomes incapacitated. There is also the option to add a “springing” specification, which means that the durable power of attorney does not go into effect upon signing, but springs into effect if the principal becomes incapacitated. This addresses the situation whereby the principal wants to remain in control until they are unable to do so, and only at that point does the attorney-in-fact take over. While this is efficient, a drawback of the springing specification is that there could be disputes over whether or not the incapacity has occurred.

In addition to the durable financial power of attorney discussed here (also called a durable power of attorney for finances), there is a durable medical power of attorney (also called a durable power of attorney for health care). With a durable financial power of attorney, the attorney-in-fact has the right to pay bills, deposit checks, file tax returns, buy and sell real estate, invest in securities, make gifts, and even sue, among other things.  As one would expect, with the durable medical power of attorney, the attorney-in-fact has the right to make health care decisions for the principal in the event of incapacity. Due to their different concerns, and even if the attorney-in-fact is the same for both of them, these two documents should be drawn up separately for purposes of privacy and simplicity.

Families can benefit from having a durable financial power of attorney in place if there’s a significant chance that an older family member will become incapacitated due to disability, illness, or age. A durable financial power of attorney can prevent the family from having to go through the court system to appoint a guardian or conservator to manage the principal’s financial affairs. Additionally, a durable financial power of attorney can make it easier for a family member to take the helm and avoid conflict with other family members.

You don’t have to be older to benefit from having a durable financial power of attorney in place, because you never know if an accident might happen that could lead to your own incapacity and leave financial chaos behind. For example, it’s common for spouses to have durable financial powers of attorney for one another in case something happens to one of them. In community property states especially, many transactions require the signature of both spouses, and so it’s prudent for spouses to confer durable financial power of attorney upon one another. Some community property states such as California already provide that if one spouse becomes incapacitated, the other spouse automatically assumes the management of the community property. Which, to avoid conflict, makes it important that the other spouse and the attorney-in-fact are the same person.

In your suite of estate planning documents, a durable financial power of attorney could be an essential one.

To Lend or Not to Lend – That is the Question

There are times when lending one’s ear to a friend or family member going through a difficult time just isn’t enough. What they need the most is an infusion of cash. Should you or shouldn’t you reach into your pocket and help them out with a good-faith loan? While this intrepid financial planner cannot advise on relationship dynamics and how they might be detrimentally affected with a personal loan, I can tell you how to protect yourself if you do decide to go ahead with one.

Draw Up a Promissory Note
Despite everyone’s best intentions at the outset, a handshake is not enough to seal the deal. The best thing each party can do is protect themselves with a written contract called a promissory note. Basically, the promissory note is a document wherein the borrower promises to pay the lender back. It should state the loan amount, the interest charged, the repayment plan, the per diem for any late payments, and be signed by both parties. Once you have agreed on the interest rate, you can use an online calculator to calculate the amount of each payment over the term of the loan. Regarding repayment, you can arrange a lump sum payment (most common), an installment payment plan, or even a balloon payment plan (rare). Each party’s signature makes the promissory note an unbiased document that can be used as a gentle reminder, a means of exerting pressure, or evidence that will hold up in court (heaven forbid it comes to that).

Also, consider what would happen if you were to die before the loan is repaid. Depending on the amount loaned, you may want to add a line to the promissory note that stipulates that the borrower will either pay your estate back any amount still owed, or receive a decreased inheritance based on the amount still owed. This can protect other family members who will receive their inheritance out of your estate and prevent conflict between beneficiaries.

If there is serious concern about repayment, an added layer of protection would be to have the promissory note notarized, which would officially recognize the document and give you increased legal standing in court, although it is not necessary. However, if there is serious concern about repayment, perhaps the loan is not the best option anyway.

Charge a Favorable Rate
If you make a personal loan, the IRS requires you to charge a minimum interest rate, called the Applicable Federal Rate (AFR), to avoid potential income tax and gift tax consequences. The interest you collect is then reported as interest income on your tax return. The AFR is less than what borrowers would have to pay for a bank loan, but more than what lenders could earn from CDs or money market accounts. The AFR you must charge depends on the term of the loan:

Short-term (< 3 years)
Mid-term (3 – 9 years)
Long-term (9+ years)

What if it makes you feel Scrooge-like and ungenerous to charge the borrower interest? You might consider that the function of interest is to fairly compensate the lender for using money that could have been earning interest elsewhere. By lending that money to your borrower, you give up the opportunity cost. That said, you can still go ahead with an interest-free loan if that is most comfortable.

What happens then? If you make an interest-free loan and the IRS discovers it, they can impute the interest and require you to report it on your tax return. The uncharged interest can be treated as a tax-free gift to the borrower as long as it’s under the gift tax annual exclusion amount for the year (it’s $14,000 in 2016). Otherwise, any uncharged interest over the gift tax annual exclusion amount will need to be reported on your tax return. However, only a handful of people ever pay gift taxes in the end. This is because any amount over the gift tax annual exclusion amount reported on your tax return is added to your lifetime exclusion amount free of Federal estate tax (which is a whopping $5.34 million in 2016).

Let Go
With the promissory note in place, let go of any attachment you might have to the borrower’s use of the money. You have made a careful effort to set up an agreement where you are the bank and this should free you (and the borrower) of any emotional tangles or obligations that belong outside of the loan agreement. Ideally, both parties can compartmentalize the loan and resume their normal relationship with one other.

Estate Planning Essentials: The Advance Health Care Directive

If you are a Gen Xer or older, most likely you remember the highly publicized case of Terry Schiavo, a Florida woman in a persistent vegetative state who tragically became the center of a legal battle between her parents, who wanted to keep her alive, and her husband, who wanted her feeding tube removed because he said that would have been her wish. Since Schiavo did not have a living will, her case worked its way up through state and federal courts, eventually landing on the desk of President George W. Bush, and in the end it took seven years for her feeding tube to be removed.

I can’t think of a better example that illustrates the need for everyone to have explicit end-of-life care instructions, just in case. After all, it is your constitutional right to choose or refuse medical care, so why not exercise it? In California, the Advance Health Care Directive does just this, simply and unambiguously. This Advance Health Care Directive combines a living will and a power of attorney for health care, and following are descriptions of both parts of the document. (To be expected, each state uses slightly different terminology for these documents.)

Living Will: This document describes your health care wishes. The Living Will bears no relation to the traditional will or living trust used to leave property to your beneficiaries at death. It’s a document that lets you state what type of medical treatment you do or do not wish to receive if you are too ill or injured to direct your own care. (Among other things, you can use it to be sure that doctors do – or do not – “pull the plug.”)

Power of Attorney for Health Care: This document names someone to make healthcare decisions for you. The Power of Attorney for Healthcare, also known as a medical power of attorney, allows you to name a trusted person to make medical decisions for you if you are unable to communicate on your own. The person you name to make these decisions is usually called your agent or attorney-in-fact. You can give your agent the authority to oversee the wishes you’ve set out in your health care declaration, as well as the power to make other necessary decisions about health care matters.

Procrastinators take note and go-getters take a breather – it is a misconception that this is a costly and cumbersome process. You do not need an attorney to draft the Advance Health Care Directive for you as you can easily do it yourself. Conveniently, the Advance Health Care Directive provided by the State of California Department of Justice Office of the Attorney General is available on this website: Click on the link to “California Probate Code Sample Form.pdf”, download the pdf, and print. All you need to do is fill out the form, have it signed by two witnesses, and then keep it in your files. Needless to say, for most people this can be a significant accomplishment in estate planning, an oft-neglected subject.