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How to Prepare Financially Before a Loved One Dies

Nikada | Vetta | Getty Images

One Colorado woman had been helping her elderly mother manage her accounts, so it made sense when her mom suggested they add her name to the mother's bank accounts. When the older woman died, her daughter became the sole owner of a checking account with a balance of about $500,000.

That sounds like a tidy way to inherit a half-million dollars. But the turn of events hasn't sat too well with the woman's two siblings.

Though her mother had intended for her estate to be split with her two other children, the helpful daughter is more or less stuck with the money. She can't disclaim it, as she could with an inconvenient inheritance that she doesn't already own, and she can't gift her siblings their portion more than $14,000 without paying taxes on the money.

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Like many financial problems that crop up after the death of a family member, the Colorado woman's unintended inheritance could have been prevented if she had asked herself, and her mother's banker, the simple question, What if Mom dies?

The right answer is often no more difficult than the makeshift ones parents and children, brothers and sisters come up with on their own. "The daughter could have accomplished the same thing with a power of attorney," said Kimberly Maez, a private wealth adviser with Ameriprise Financial in Colorado Springs who offered the story above.

Maez has seen families torn apart or money forfeited when the transfer of homes, IRAs, even a client's treasured arrowhead relic, are improperly deeded or designated, usually as a result of refusing to take the certainty of death into account.

Even when a family does anticipate an older relative's demise, they often attempt to glide over the fact of death. "Where I see it happening a lot is where a parent will transfer the deed on a house to the kids while they are still alive," said Maez, under the theory that the children will be in immediate possession of the house when the parent dies, and can sell it more easily.

The problem is that because the house never formally changes hands, its value is never reset to current market prices. When the children sell, they'll pay tax on the difference between the sale price and what Mom and Dad paid several market cycles before. In tax jargon, said Maez, "You lose the step-up in basis."

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The better course is to write a transfer-on-death clause into deeds and other investments. By recognizing the death formally, heirs avoid probate, but only pay taxes on the appreciation since they inherited it.

Similarly, IRAs and 401(k)s can transition simply to the next generation, but only if the owner specifically configures them to anticipate their eventual demise. A multigenerational IRA is one that can be converted on the death of its owner to a beneficial IRA belonging to one or more heirs.

Financial advisers say many families don't avail themselves of these instruments, developed to accommodate the inevitable because people are afraid to talk about death. "It doesn't mean you're going to die," said Annalee Leonard, president of Mainstay Financial Group in Pensacola, Fla. and Mobile, Ala. "It's all paperwork."

The paperwork should begin, of course, with a will, with directions on who gets anything of value: Even something as simple as a family heirloom can get complicated in the emotional aftermath of a relative's death.

If your close kin already has a will, or any legacy-related documents, it's important to review them occasionally. "I always ask my clients, 'How old is your will? How long since you set up that trust?'" Leonard said.

These questions are important because arrangements made a decade or more before can often be out of date: People's wishes change, but so do spouses, sons- and daughters-in-law, and the number of grandchildren. It's not uncommon, said Maez, for clients to own a 401(k) from a previous employer that names a long-divorced spouse as the sole beneficiary.

And the will is not always the final word on a bequest. "Most people think that if your will says an amount should go to a new spouse, you'll be fine. They think a will trumps the beneficiary designation," said Maez. In fact, designations on the financial instrument can overturn a directive in a will. "You need to review your designations periodically and make sure they mesh with your will," Maez said.

Tax-deferred accounts require particular care, as they also come with strict rules about how they can be inherited without exposing their contents to taxes. Beneficial IRAs may not be left to an estate or a trust, for instance, without being taxed at an accelerated rate.

And even after the heirs are in possession, they need to pay attention. If the deceased was already 70-and-a-half, the IRS requires a minimum annual distribution to be taken, or else the new owners will face a stiff penalty. (The distributions are smaller, though, because the amount is based on draining the account over the much longer life expectancy of the usually younger heirs.)

If the details of naming beneficiaries (or being one) sound complicated, financial advisers warn, they don't get less so when your loved one is close to death, when their focus is usually elsewhere, and emotions are running high. "This is something you want your family members to prepare for now, not on their deathbeds," said Leonard.

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