Many people are not aware that your IRA and any other employee benefit plan that was tax deferred is taxable in a number of ways at your death. It may be taxed by the federal government as part of the federal estate tax. It may also be taxed by the State of Illinois for the Illinois estate tax. In addition, there are specific rules on when the money in these accounts needs to be pulled out by the recipients, which are complicated depending on the circumstances, the beneficiary and if a trust is involved, whether that trust qualifies as a “look through” trust. In any event, when the beneficiaries take the money out of the plan, it is subject to federal income taxes on it.

As you probably have read in the press, the federal estate tax was modified for a two year period to allow Congress to take a look at various options for the federal estate tax. Some in Congress wanted to eliminate the tax, some wanted to raise the exemption, but there was no consensus at the time. Congress enacted legislation that increased the lifetime exemption to $5.0 million. This means in general that if your estate is more than $5.0 million, your estate will be subject to tax on everything above $5.0 million, at a rate that starts in the 45% bracket.

The State of Illinois changed their estate taxes several years back, as they were receiving less tax revenue from estates of persons who died. The state had been connected to the federal system before. When the federal government raised the exemption, more estates did not have to pay federal taxes, which meant that more estates did not have to pay taxes to the State of Illinois. Consequently, the State of Illinois changed the tax to provide an exemption of $2.0 million. Everything above that amount is taxed at 17%.

How does this work in practice? Let’s do a couple of examples. For the first example, let’s assume that your estate (including life insurance, 401(k), house, mutual funds, stocks, bonds and all other assets) is $6.0 million and included in that is your 401(k) and IRA for about $1.0 million. Everything above the $5.0 million is taxed at 41%, so there is a federal estate tax of $450,000. For Illinois purposes, everything above the $2.0 million exemption is taxed at 17%, so the Illinois estate tax is about $680,000. So far, the tax on that 401(k) and IRA is 62%.

When the funds are taken out of the 401(k) or IRA, the beneficiary will pay the tax at his or her highest marginal rate. For purposes of the example, let’s assume that rate is 35% for federal purposes. Residents of Illinois do not pay Illinois income taxes on pensions and annuities, so there is no additional tax for Illinois residents.

As a result, in this simple example, the total tax rate for federal and state estate taxes and federal income taxes is a whopping 97%!

Of course, if your estate is under the $5.0 million and you are not subject to federal estate taxes, you still may have a 17% Illinois estate tax (assuming that your estate is above $2.0 million and under the $5.0 million), along with the federal income tax at the beneficiary’s highest marginal rate. The total tax rate in that circumstance would still be 52%!

At the start of this article, it stated that most people do not know this, but you do now.

Dementia and Testamentary Capacity: Can Your Loved One Still Sign a Will?

Dementia is the degradation of brain function caused by various ailments such as Alzheimer’s disease, Parkinson’s disease, strokes and sometimes simply just old age. Symptoms include a decline in memory and cognitive abilities, and generally result in the lack of ability to speak or write coherently, the ability to recognize objects, and the ability to execute motor activities. While dementia can strike a person of any age, it is predominately concentrated in the elderly population. As the life expectancy of an average American grows, and the Baby Boom Generation grays over the next thirty years, our country will see a dramatic rise in the instances of dementia. According to Alzheimers’ Disease International, the instances of dementia are expected to double over the next twenty years.

Dementia is generally a progressive disease, and the severity of its symptoms fall on a sliding scale. Some individuals may have a hard time remembering specific words, while others may not recognize their own children, or will be found lost wandering the streets. While it can be alarming for family members to watch their loved one suffer from dementia, such concern is compounded if your loved one has failed to devise an adequate estate plan.

Against the good and consistent advice of estate planning attorneys, most people tend to put off creating an adequate estate plan that will distribute their property upon death. If a person starts to suffer from dementia, the priority of creating an estate plan generally falls by the wayside. At this point, some family members may be resigned that their loved one suffering from dementia has “lost their mind” and could not possibly sign a will. Fortunately, the threshold for a person’s ability to sign a will is relatively low. Even in cases of dementia, a person can be held to have the mental capacity to sign a will, as long as they are of sound mind and memory at the time they sign their will.

 Mental Capacity

Mental capacity, as it relates to the law, is the ability of a person to have the understanding and awareness to enter into legal transactions. The standard by which a person’s mental capacity to engage in legal transactions varies greatly depending upon the transaction. For instance, there are separate mental capacity standards for making a gift, entering into a contract, conveying real property, making a will, and executing powers of attorney.
The mental capacity of a person to make a will is called testamentary capacity. Fortunately, testamentary capacity is a relatively low standard. Under Illinois law, a person has testamentary capacity if she has “attained the age of 18 years and is of sound mind and memory.” 755 ILCS 5/4-1. This law has generally been interpreted to mean that a person is of “sound mind and memory,” measured at the time the person signs their will, if they:

      1) Have the ability to know the nature and extent of their property;
      2) Have the ability to know to whom they wish the property be given to;
      3) Have the ability to dispose of their property according to some sort of plan.

Testamentary Capacity of a Person With Dementia

If you are concerned that a loved one without an adequate estate plan is showing signs of dementia, it is important to contact a qualified estate planner immediately. A qualified estate planner has typically dealt with dementia situations before and can adequately assess your loved one to determine if he/she has the requisite capacity to make a will and create an estate plan.
As stated earlier, the symptoms of dementia occur on a sliding scale. Sometimes symptoms are intense and at other times they can be relatively mild. The severity of the symptoms typically fluctuates in their length of time and intensity. It is important to note that even if you believe your loved one is “too far gone” to have the capacity to sign a will, please keep the following tips in mind:

• Dementia can come and go at various times. Doctors have reported that dementia patients will have “lucid intervals,” where for a short period of time a person will have full awareness of his/her actions and reasoning. A will can be signed by a person during a lucid interval if he/she has the requisite mental capacity. Therefore, just because your loved one has appeared to have “lost his mind” the last time you saw them, this does not mean they cannot sign a will when they are in a lucid interval.

• In addition to symptoms of dementia, many elderly may also experience stress, grief and depression during this time of their lives. For instance, they may have recently lost their spouse, a number of friends have died, or maybe they are just plain sick of being old and having limited mobility. Confusion, lack of attention, and the inability to make decisions may be symptoms of their stress, grief or depression, as opposed to mental dementia. Dealing with these issues first may reduce the symptoms that most people attribute to dementia.

• Many elderly also experience the loss of their senses as they age. Losing their eyesight and hearing may make them appear as if they do not understand you, or will not pay attention to you. Your loved one may have full mental capacity; you just may have to speak slower, louder, and attempt to limit distracting noises.

If dementia begins to set in on one of your loved ones, consider contacting an estate planning attorney immediately to draft a valid will and develop an estate plan. Doing so now will give you and your family a piece of mind, and will allow you to focus on the care of you loved one.

As our parents age, it sometimes becomes apparent that the parents are unable to live alone in their own home. The first option may be to provide adequate support for their needs while they live in their own home. This is generally a good option, as the parents are able to stay in their own home. It is a particularly good option if your parents have obtained long term care insurance.

To find out how much various types of long term care should cost, there are several websites, which can help you to compare costs for various types of care for your particular area. For instance, Genworth Financial, one of the country’s largest long term care insurance providers, shows local costs at Genworth.com/costofcare. Another big insurance carrier, MetLife, provides area specific information at MatureMarketInstitute.com. Other resources include a Medicare manual called “Medicare and Home Health Care”, which describes what home-health care benefits Medicare covers (see Medicare.gov). There is also information at United Hospital Fund’s “Next Step in Care” website for family caregivers (nextstepincare.org).

Besides the fact that your parents would generally be happier staying in their own home, the cost of in home services is roughly the same this year as last, according to the Genworth annual survey. However the charges at assisted living facilities or nursing homes have increased significantly over the same period. For instance, the national median rate for a shared nursing home room climbed by 5.7% to $193 per day from 2010 to 2011. The cost of a private room was $213 a day or a 5.1% increase from 2010.

While you may not wish to haggle about the price at a time when your parents need the extra care, if the long term care expense is way above the market rate, it may give you some negotiating strength. Having the knowledge that these websites may provide may allow you to save some real money over time, which is important when you are trying to stretch your parents’ money for as long as you can.