I mentioned earlier that the personal representative of a probate estate and the trustee of a trust have a duty to protect and preserve the assets during the estate administration, as well as following the “prudent investor rule.”
So what does this really mean? Should the personal representative/trustee invest all of the money in the stock market? Should they instead convert everything to cash? How does one satisfy the “prudent investor” standard?
The first thing to do is to meet with the estate’s financial advisor. This usually means to meet with whomever the decedent employed as his or her financial advisor, but it can be anyone that you have trust in. My thought is if the decedent’s financial advisor did a good job, there’s good reason to stay with that professional at least through the administrative process.
It becomes more difficult when the decedent managed his own investments without the help of a professional financial advisor. Many individuals open accounts through discount and online brokerage houses such as Fidelity, Vanguard, E*Trade, and others.
When this is the case, I suggest that the successor trustee or personal representative find a reputable advisor who is willing to review the portfolio to determine if there are any glaring problems. The advisor can be paid from estate assets for his expertise, and it is well worth the liability protection, because simply “staying the course” with what the decedent owned may not be the prudent thing to do.
Why might that be? Several reasons, actually.
First, the decedent may have retained certain stocks or mutual funds because selling them would have resulted in the recognition of capital gains, and hence the payment of income tax on those gains. Generally speaking, however, these unrealized capital gains vanish on the death of the account owner.
The reason the capital gains vanish is due to something in the tax code known as the “step-up in tax cost basis.” This is best explained by example. Assume that Jim bought Coca Cola stock at $1/share and that over the course of several years, the stock increased to $11/share. If Jim sold the stock during his lifetime, he would have recognized a capital gain of $10/share ($11 selling price minus $1 cost basis), and paid tax on the capital gain.
That capital gains tax served as a disincentive for Jim to sell the stock, even if the stock grew to an abnormally large holding in his portfolio. Generally speaking, a portfolio should not have too many eggs in any one stock-holding basket. Ask anyone who owned a great deal of Enron stock in the 1990s. Many held on to the stock during its rise, only to see the value of their portfolio diminish to nothing. The fall of Enron made many one-time millionaires penniless.
Returning to the concept of “step-up in tax cost basis,” when Jim died, his estate/trust received a step-up under the tax code to the date of death fair market value of the stock, in my example $11. So if the personal representative/trustee sells the stock the next day, there is no capital gain recognized ($11 selling price minus $11 new tax cost basis).
What this means is that the personal representative/trustee is not constrained by taxes to act as a prudent investor would and therefore has the opportunity to diversify holdings that might otherwise constitute too large of a percentage of a portfolio.
Another reason to review the holdings is that the personal representative/trustee’s duty is to preserve and protect the assets in the estate/trust. They do not have a duty to maximize return during the administration, although they may have to generate income for a surviving spouse or other beneficiary.
Here, the advice of a good investment professional can help the personal representative/trustee determine the proper holdings during the period of administration to achieve the goals of the beneficiaries while at the same time guarding against a drop in the market during the relatively short time period required to complete the administration.
Finally, the personal representative/trustee may have to liquidate portions of the portfolio to pay for estate taxes, professional fees, real estate carrying costs or to meet such other expenses that may be necessary during the administrative period. Here, good professional advice may be worth its weight in gold to determine which assets might best serve to pay these expenses.
Don’t underestimate how good advice can actually save a great deal of money in the long run.
Next, we’ll review the bank accounts that the personal representative/trustee may open, close, or retain during the probate and trust administration.