March 18, 2013, 12:00 P.M. ET
Managing Wealth As You Age
By Carrie Coolidge.
A study by Harvard University entitled The Age of Reason found that about half of the population in their eighties suffers from significant cognitive impairment, effectively rendering them incapable of making important financial decisions. Approximately one-fifth of people between 70 and 80 are likely to suffer from either cognitive impairment or dementia severe enough that it is medically diagnosable. The study further found that the ability to make effective financial decisions peaks during middle age, then declines substantially over time. As a result, older investors can become vulnerable to fraud or just seriously mismanage their wealth. So it is wise that high net worth investors implement a wealth management strategy while they still have agile minds.
There are three phenomena related to cognitive function and how it is impacted by aging, according to Gautam Mukunda of Harvard Business School. The first is the difference between crystallized and fluid intelligence. “Crystallized intelligence is what we use for routine tasks, and it actually increases into people’s sixties,” he explains. Fluid intelligence, on the other hand, is the ability to handle novel tasks. “Unfortunately, on average this starts to decrease when people are in their twenties,” Mukunda adds. “Because most tasks are routine, declines in fluid intelligence can often go undetected for prolonged periods.”
The second issue, and in some ways the most important, is a decline in metacognitive abilities— essentially a person’s ability to assess their own capabilities. “So as people age, their own assessments of their ability to keep performing at a high level can become less reliable,” says Mukunda, an associate professor in the Organizational Behavior Unit.
The third phenomenon is the impact on personality. “Contrary to the normal idea that people mellow with age, in fact what aging seems to do most often is exaggerate people’s personality traits, almost turning them into caricatures of themselves,” says Mukunda. “It is important to note, however, that all of these are just general tendencies. There will always be particular individuals who can maintain extraordinarily high functioning into their eighties or even their nineties, and any judgments you make always have to take that possibility into account.”
Still, even though there are exceptions to the rule, it is prudent to plan for the possibility of being mentally out of it. Investors should arrange their affairs so that someone they trust has a fiduciary duty—the requirement to put a client’s financial interest first and foremost—and the power to handle their finances should they become incapacitated, recommends John M. Olivieri, a partner in the Private Clients Interest Group at White & Case.
The simplest tool is the power of attorney, allowing someone else to act as the investor’s agent and make financial decisions. It can be made to be effective immediately, or it can come into play in the event the investor loses their critical faculties. “The latter type, known as a springing power because it springs into effect in the event of incapacity, can be more cumbersome to use, because the agent will have to prove that the investor is incapacitated before using it,” Olivieri warns.
It’s also wise to have one or more replacements lined up in the event that the original surrogate is unable to perform their duties. The estate and trust lawyer further recommends all investors consider putting in a durable power of attorney in place at an early age. “I am 44 and I have one,” he says. “Old age is not the only thing that leads to incapacity— one can be incapacitated by a car accident, for example.”
Another way to manage mental decline is through a revocable trust, which is basically a vehicle for holding title to assets. “As long as the investor is alive and competent, he or she can put assets in the trust, remove assets from the trust, and as the name implies, amend or revoke the trust,” says Olivieri. Typically, the investor is the sole beneficiary of his or her trust during his or her lifetime, but he can also be the sole trustee, which means he also retains full control over investing the trust’s assets.
But, should he start losing his ability to make wise decisions, the investor can hand over the management of his or her affairs to a trustee. “If this is done, the investor still retains ultimate control, because by exercising the power to amend or revoke, he can change the trustee at any point,” adds Olivieri. That should provide someone who is declining gradually a degree of comfort that they aren’t being totally sidelined from their own financial affairs.
The trouble arises if you don’t recognize that you are deteriorating, but have an inflated sense of your abilities. As with the power of attorney, you can write in a trust provision that allows a trustee to “spring in” if you can no longer make sound calls.
Again, it’s a good idea to line up one or two alternative trustees, in the event that the original trustee is unable to perform his or her duties. Also note that the successor trustee will only have power over those assets that the investor has actually transferred to the trust prior to becoming incapacitated. A power of attorney can authorize an agent to add assets to a pre-existing revocable trust. So it’s always smart to have both a revocable trust and a power of attorney in place, says Olivieri.
Making someone else a co-owner of his or her investment account, in lieu of the above, “creates many traps for the unwary,” warns Olivieri. “There are both tax and non-tax problems with making someone a co-owner.” Consider this option only after a competent tax advisor has explained the tax implications.
While a financial adviser should be consulted, “he or she should not act as agent or as trustee of a revocable trust in the case of incapacity,” says Olivieri. “Someone who is more aware of the investor’s personal needs, such as nursing care, household expenses, etc., is in a better position to manage the investor’s finances. That person, in turn, can hire an advisor to assist with asset management.”
IRAs present special difficulties. All other assets can be transferred to a revocable trust, so the trustee can manage them; IRAs cannot be transferred to anyone or any entity. Olivieri says that “a power of attorney is the only way to arrange for someone else to manage an investor’s IRA.”
Incapacity is also, it turns out, not the only reason to have a revocable trust. “They also save on the time and expense associated with probate at death, and can provide privacy,” says Olivieri.