Why Your Estate Plan Needs a Stress Test
An effective estate plan can provide financial security for your loved ones, help ensure your assets are distributed as you intend, and address potential tax consequences. However, a plan that appears sound on paper may produce unintended results when unexpected circumstances arise. Stress testing your estate plan can help you see whether it would still achieve your goals under a variety of scenarios.
How Does It Work?
A stress test is an assessment tool used to evaluate the performance of a system, plan, process, or person under extreme, challenging, or changing conditions (whether real or simulated). For example, a doctor may order a stress test to evaluate a patient's heart function during exercise. Similarly, a bank may run simulations to determine how adverse events, interest-rate changes, or other market conditions would affect its financial health. In either case, stress testing can reveal potential risks that need addressing.
In estate planning, stress testing involves reviewing your plan and asking a series of "what if" questions to evaluate how it would perform in those scenarios. If the results do not align with your goals, you may want to modify your plan.
What Problems Can It Uncover?
Every estate plan, and every family, is different. So, stress-testing results will depend not only on the scenarios tested but also on your plan and circumstances. Examples of potential findings include:
Risky assumptions. You may, for instance, have developed your estate plan assuming you will live much longer, giving your heirs time to mature or allowing your assets to grow significantly. Stress testing might reveal that if you die sooner, your plan could produce unexpected or undesirable consequences.
Perhaps assets would be distributed outright to your children before they would be prepared to manage the funds on their own. One solution may be to set those assets aside in trust for your kids' benefit. Similarly, a smaller-than-anticipated estate could cause certain estate plan provisions to produce different results than intended. Revisions may give your plan the flexibility to better achieve your goals.
Improper titling of assets. Many estate plans use revocable, or "living," trusts to help avoid probate and manage assets if you become incapacitated. But such a trust is effective only to the extent that you fully "fund" it, that is, transfer title to assets to the trust. A stress test may identify assets that are not properly titled in the trust and, therefore, will be subject to probate or will not be under the trust's control if you become incapacitated.
Missing beneficiaries or fiduciaries. A stress test may reveal that you have failed to name a contingent beneficiary for a retirement plan or an insurance policy. You may also have failed to identify a backup for a fiduciary (such as an executor, trustee, or agent) in one or more important estate planning documents (such as your will, trusts, or powers of attorney).
These gaps can disrupt your estate plan's operation if a beneficiary or fiduciary predeceases you. Without a contingent beneficiary, assets may pass in a way that differs from your wishes.
A stress test may also reveal, for example, that your former spouse is still the beneficiary of a life insurance policy you had forgotten. It might also show that someone you named as a fiduciary years ago is no longer the best person for the role.
Inflexible trust language. Based on the standards currently set for your trusts, would they achieve your goals? For example, a "maintenance" standard restricts distributions to the beneficiaries' most basic living expenses. If you want to provide more, consider raising the standard or giving the trustee complete discretion to make distributions in accordance with your wishes.
Insufficient liquidity. Stress testing may reveal that a significant portion of your wealth is tied up in illiquid assets, such as real estate or closely held businesses. This may make it difficult to cover taxes and expenses, as well as to distribute these assets fairly among your heirs. For instance, if one child will inherit valuable real estate or a family business, your plan may need another source of funds to treat your other children fairly. Life insurance or other vehicles can provide such liquidity.
Who Can Help?
A stress test cannot predict the future, but it can show how your estate plan may perform under potentially unanticipated circumstances. Reach out to our advisory team to learn how we can help with your trust, gift, and estate planning.
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Our firm provides the information in this article for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this blog are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.