The Broker: Meeting Your Fiduciary Obligations - The Essential Executor's Handbook: A Quick and Handy Resource for Dealing With Wills, Trusts, Benefits, and Probate (2016) 

The Essential Executor's Handbook: A Quick and Handy Resource for Dealing With Wills, Trusts, Benefits, and Probate (2016)

Chapter 11

The Broker: Meeting Your Fiduciary Obligations

Buying and selling securities is probably the one financial activity that most Americans know nothing about. Even though about half of Americans participate in a 401(k) or similar retirement plan through work, the vast majority leave the investment decisions to the plan administrator who, in turn, usually relies upon the advice of a broker. So, it seems prudent to begin this chapter with an explanation of the terminology used by an industry that both reflects and affects the world’s economy.

Broker and Brokerage

Collectively, investments such as stocks and bonds are known as securities. The people who invest in securities usually do so through a regulated professional known as a broker (aka a stockbroker). The broker, in turn, usually works for a brokerage (aka a brokerage house). This can get confusing when investors, the media, and sometimes brokers themselves also refer to the brokerage as a “broker.” The easiest way to remember the difference is that the shorter term, broker, refers to a person. But the longer term, brokerage, refers to the company that employs many brokers. So, for example, my friend, Lindsay Veleber, is a broker who works for the brokerage Edward Jones.

Securities

There are many kinds of securities, but if the decedent owned any it was probably stocks or bonds. Stocks are simply shares of ownership in a corporation. So, for example, if the corporation has issued a thousand shares of stock, and you own 500 of those shares, you own 50% of the company. And since stockholders are the owners of the company, the corporation’s directors may pay the stockholders a portion of the corporate profit, known as dividends. Though the corporation may provide proof of your ownership by giving you a stock certificate, that practice has been all but abandoned. Rather, these days, your investment appears only in the records of the corporation and your brokerage.

Bonds are debt investments. In other words, you are lending money to either a corporation or a government (federal, state, or local). In return, the entity borrowing the money pays you interest, usually every three months. United States Savings Bonds are the best known of these investments. You may also come across something known as a municipal bond. Municipal bonds are issued by a local government and are popular because the interest they pay is usually tax-free.

There are other investments that appear to be securities but are actually vehicles for buying, selling, or holding securities for the investor. The most common of these are mutual funds. A share of a mutual fund represents ownership in a collection of stock chosen and managed by the fund manager. Finally, there are retirement vehicles such as IRAs, 401(k)s, and annuities—all of which can hold stocks, bonds, and mutual funds. IRAs frequently own annuities as well. All of this can get very confusing. Just remember that at the heart of almost all investments are either stock (ownership investments) or bonds (debt investments).

If your decedent used a broker then you, as the executor or trustee, will receive monthly or quarterly statements from the brokerage detailing the account’s investments. At first, these statements appear to lack anything resembling a logical structure. However, with a little effort, you will soon be able to make sense of them. (If not, the broker is always there to help you out.) Regardless of the brokerage, the statements always contain a summary page that sets forth the total value of each type of investment, followed by several pages that set forth the particulars of each investment (e.g., number of shares of each stock owned). Some brokerages provide separate statements for IRAs, but not necessarily. If you are reading a combined statement, the IRA will have its own account number.

In reviewing the statement, you may notice a cash or money market component of the account. For the most part, the cash came from stock dividends or bond interest payments. This is ready cash that is available to you for paying the decedent’s bills. It is accessible immediately just as if it were a checking account. Furthermore, while the cash is going to essentially remain unchanged, a stock that has been steadily growing in value or paying dividends will usually continue to do so. Since it is part of your fiduciary duty to maximize the value of an estate’s assets, it is preferable to use available cash before liquidating (i.e., selling) a productive stock. In other words, if you callously kill the goose that’s laying the golden eggs, you may get yourself in trouble with your beneficiaries.

Of course, you don’t have to wait for a statement to review your decedent’s investments. All major brokerages now give their investors access to their accounts online. As the executor or trustee, you just need to register on the brokerage’s website. Most even provide a smartphone-friendly version of the site so you can check up on your estate’s investments from anywhere, any time of day. If it becomes necessary to sell any of the securities, or even buy more, that can usually be done from your phone as well. And if your brokerage is owned by your bank (e.g., Merrill Lynch and Bank of America), you can even move the cash component to a bank checking account faster than you can say, “Online Banking.”

Non-Brokered Securities

It is possible, though not likely, that some of your decedent’s investments are in certificate form. That is to say, there may be physical stock certificates. You may not even know they exist until a statement or dividend check arrives from the corporation. If such is the case, you are going to have to locate them. Check the obvious places such as safes and safe deposit boxes. However, I have had some clients who simply left them in a desk drawer, along with their deed, will, and other valuable papers. If all else fails, carefully sift through the pile of mail on the dining room and kitchen tables.

Once the certificate has been located, turn it over to your broker. If your decedent did not have a broker, this is the time to hire one. In fact, all non-brokerage securities should be turned over to a broker who will then do the work of incorporating them into a brokerage account. As you are about to see, you don’t need to have a lot of experience with securities so long as you have a broker.

Your Broker’s Role

For the most part, a broker’s job is to provide investment advice and take trade orders (i.e., customer requests to buy and sell securities). But for our purposes, your broker will provide three additional critical services: accepting non-brokered securities, consolidating investment accounts, and creating beneficiary accounts.

As we discussed above, not all securities are held by a brokerage. So, once you have selected a brokerage, your first order of business is to provide the broker with any and all non-brokered securities. Your broker will advise you as to whether you should add these investments to your new account or sell them. You will probably be advised to keep investments in the more solid companies (often called Blue Chip Stocks), such as Disney, and sell those companies that are on their way down. In fact, don’t be surprised if the decedent owned stock in companies that no longer exist. Many senior citizens go for decades without reviewing their portfolios.

You may also find that your decedent worked with many different brokers, mutual fund managers, and retirement account administrators. It is important that all of these accounts be consolidated with your new brokerage. Your job is going to be hard enough without having to track a dozen different investment accounts and interpret their wildly diverse monthly or quarterly statements. Unless you just enjoy working needlessly, it is best to consolidate and simplify.

Finally, when you are ready to begin making distributions, you may distribute the securities by simply having your broker establish a new account for each beneficiary. For example, let’s say that at the time of distribution, your Probate Estate or Trust Estate brokerage account is worth $1 million in stocks and bonds. Let us also say that the beneficiaries are five adult children. Your broker would simply create five new accounts (one for each child) and transfer $200,000 worth of stocks and bonds from the estate’s brokerage account into each of the new beneficiary accounts.

Now be careful here. It is not enough to simply transfer securities that are worth $200,000 at the time of distribution because, by the close of business the next day, those values will have changed. If one child got stock that went down while another child got stock that went up, you are going to have at least one very unhappy beneficiary. No, what you must ask your broker to do is to transfer into each beneficiary’s account securities that are not only equal in value but are absolutely identical. So, if John gets 40 shares of IBM, every one of his four siblings gets 40 shares of IBM. If John gets 50 shares of Microsoft, every child gets 50 shares of Microsoft. And so forth. To be perfectly honest, you will rarely achieve identical accounts. You may have to sell a little of the stock to get it right. Even then, someone usually winds up giving up a few pennies. If you are one of the beneficiaries, that someone should be you.

Your Role

You have a fiduciary duty to shepherd and maximize an estate’s assets. Your broker can give you advice, but ultimately the burden rests on you. You may not be Warren Buffett, but there are a few rules of thumb that will keep you out of trouble.

1.   Don’t sell anything unless you absolutely need the cash to pay bills or if the stock is dropping faster than the Times Square ball on New Year’s Eve—and even then, only with your broker’s approval;

2.   Don’t buy anything (even if your broker thinks it’s a good idea);

3.   Allow the cash from interest and dividends to accumulate;

4.   Review each brokerage statement as soon as you get it; and

5.   Never hesitate to seek your broker’s help or advice.

Of course these rules are not to be taken as absolute and inviolate. Every rule has its exceptions. You will know it when you see it. Just keep these rules in the back of your mind and review them before taking action.

Other Methods of Distribution

In addition to creating beneficiary accounts and filling them with identical securities, there are two other methods of distribution. They are distribution through liquidation and non-uniform distributions.

Distribution through liquidation is a simple concept. Let’s return to my example of the five adult children and the million-dollar estate account. You simply call your broker and say, “sell everything.” The proceeds of sale, less the broker’s commission, is deposited into the cash portion of the brokerage account. Then you divide the cash account by five and write a check to each child for that amount. So, if the broker’s commission was 5%, or $50,000, you would write a check to each child for $190,000.

That being said, I suggest that distribution through liquidation be used as a last resort. It is usually necessary when there is endless squabbling among the beneficiaries as to who gets what. In such instances you can use it as a threat. “Stop this fighting or I will simply turn everything into cash.” It’s the executor’s way of saying, “Don’t make me turn this car around.”

The reason distribution through liquidation is not the best solution (as tempting as it may become) is that it carries costs. As I said, if the broker sells securities for you, the broker and the brokerage are entitled to compensation (i.e., the commission). In addition, and as we shall explore later in this chapter, there are usually tax consequences. Finally, it may result in one or more beneficiaries attempting to remove you or, worse, sue you for malfeasance. Nevertheless, you have a right to use liquidation if there appears to be no other way to close the estate.

Non-uniform distributions are distributions that are not identical in value or component securities. This seems to contradict what I said earlier and it does. What has happened in such cases is horse trading, plain and simple. Let’s say, for example, that your decedent’s estates consisted not only of securities but also real estate. Let’s also say that one child insists on getting the real estate and is willing to forego a part if his securities for it. Finally, we will assume that the real estate is worth $175,000 (appraised value) and the securities are worth $825,000. Then in that case, four of the siblings take identical securities packages, each worth $200,000, and our problem child takes the real estate ($175,000) and the remaining securities ($25,000). The components of his securities package are identical to those of his siblings but proportionately smaller (e.g., each of his siblings got 40 shares of IBM but he gets only 5).

Despite all of the extra work you and your broker had to do just to make the problem child happy, it is still possible that he may later become dissatisfied with his choices and seek to alter the distribution yet again. To do that, he will point to the will or the trust and argue that the five children did not get equal shares as the will or trust required. To pre-empt this sort of nonsense, you employ a device known as a Beneficiaries Agreement, which can be drafted by your lawyer. In the Beneficiaries Agreement, all the beneficiaries agree that the distributions will not be identical and acknowledge that, because they are not identical shares, they may appreciate or depreciate differently. Your trouble maker is now stuck with his choice because you made the Beneficiaries Agreement a condition of the non-uniform distribution.

Taxes

Owning securities usually results in three different kinds of taxable income: interest, dividends, and capital gains (or losses). Interest and dividends will be reported to you in January on a form called a 1099. Most brokerages show interest dividends and capital gains (or losses) on the same 1099. You will provide this form to your accountant to prepare your federal and state fiduciary tax returns. With a few exceptions, interest and dividends are taxed as ordinary income. That means that, if the 1099 says that your securities paid $100 worth of dividends, that is precisely what will show up on the fiduciary income tax return and precisely what will be passed through to the beneficiaries to report on their personal income tax returns. Capital gains and losses, however, are a different animal altogether. The 1099 does not usually reflect your sales activities so calculating capital gains and losses will be up to you. In addition, unlike interest and dividends, capital gains and losses are figures that you can manipulate.

Remember that the date of death value becomes the new cost basis. Proceeds minus basis equals capital gain or capital loss. If you have to liquidate securities to pay bills or to facilitate a distribution, you must consider what will generate the least capital gain. Ideally, you should sell something that will actually generate a capital loss. So, for example, if IBM was worth $50 per share on the date of death but now it is selling for $40 per share, selling 100 shares will yield a loss of $1,000 ([$40–$50] x 100).

In deciding what to sell, you have to look at the stock market as a whole. If IBM stock dropped $10 per share, as in my example, you have to ask if it was because the corporation was having difficulty or was it because the market as a whole was having difficulty. When stocks drop together, the event is called a “market correction.” Market corrections really do not reflect the value of any individual company. Actually, what market corrections do reflect is the insecurity of investors on any given day. It was a market correction, after all, that gave us the Great Depression in 1929.

So, before selling IBM, make sure that other stocks have not dropped a proportionate amount. If you look at each stock, over the past three to five years, its upward or downward trend becomes evident (your brokerage will provide online charts). In this way, you can pick a true dog of an investment to unload. The effect is threefold. First, you have the cash you need. Second, the beneficiaries get a deduction. And, third, you have disposed of an investment that was pulling down the value of the estate, and in so doing, you have demonstrated that you understand your fiduciary duty.

Special Rules for IRAs

Although IRAs (i.e., Individual Retirement Accounts) most often hold securities, their tax treatment is governed by a different set of rules entirely. First and foremost, when your decedent makes someone the beneficiary of an IRA, the beneficiary gets what is called, not surprisingly, an Inherited IRA. While most retirement accounts require the owner to start withdrawing money from it by the time the owner reaches 70 ½ years of age, the recipient of an Inherited IRA must start drawing money out almost immediately (i.e., the Required Minimum Distribution or RMD). What difference does it make? Well, while the IRA is left alone, it grows, tax-free. But when you draw money out, the money you take is taxable as ordinary income. It doesn’t matter that your broker had to sell stock that the IRA held in order to give you your RMD, the proceeds are not a capital gain. Nor are they a capital loss. The proceeds are treated just like interest and dividends.

One other interesting thing to note about Inherited IRAs: The Required Minimum Distribution is based on the beneficiary’s age. All else being equal, the younger the beneficiary, the smaller the Required Minimum Distribution. For example, a beneficiary who is 70 has a much larger RMD than the beneficiary who is 50. But the relationship between the disparate RMDs is not readily apparent. In fact, there are tables and formulas used to make the calculation. The good news is that every RMD will be calculated by the broker. (Incidentally, the tables and formulas used to make this calculation were so complicated that beneficiaries almost never got it right on their own. So the government simply enacted new regulations requiring the brokers to do it for them.)

Summing Up

Securities are, for the most part, stocks and bonds. Stocks represent ownership in a corporation and bonds represent a loan you have made to a corporation or government. Your broker works for a brokerage and has the primary function of providing investment advice as well as buying and selling securities for the customers. For you, the executor or trustee, the broker provides three additional and critical functions: transferring non-brokered assets into the estate’s account, merging other brokered accounts into the estate’s account, and setting up accounts for the beneficiaries to receive distributions. Although distributions are made to the beneficiaries in a uniform manner, they may take non-uniform distributions provided they all sign a Beneficiary Agreement. Securities produce three kinds of taxable income: interest, dividends, and capital gains and losses. You should always endeavor to maximize the estate and reduce taxes by selling securities that have been steadily declining in value and will produce the most deductible losses. Finally, remember that the tax rules governing Inherited IRAs differ from both the rules governing other types of IRAs as well as from the rules governing capital gains and losses.

Things to Do

1.   Interview and select a broker.

2.   Provide the broker with all of the decedent’s most recent investment statements.

3.   Provide the broker with the EINs for both the Probate Estate and the Trust Estate.

4.   Provide the broker with all of the beneficiaries’ personal information if beneficiary accounts are to be established.