Monday, July 01, 2024
By Jacob Phelps CFP®
As revolutionary as Bitcoin is, planning for its future beyond your lifetime is crucial - if your Bitcoin can’t outlast you, it ultimately fails to serve its purpose. Without a solid estate plan, that’s precisely what could happen. The essence of Bitcoin lies in its ability to serve as a store of value across generations, but this can only be achieved if you have a clear plan for its transfer. In this article, we’ll explore how to effectively incorporate Bitcoin into your estate plan, ensuring that your stack is preserved and passed on securely.
Compared to the other groundbreaking aspects of decentralized money, considering its place in an estate plan might seem, well, quite dry. However, it’s anything but that. You can discuss Bitcoin being the best form of money or the ultimate way to preserve your wealth across time—but none of that matters if, in the end, your Bitcoin dies with you.
Do you know exactly how, when, and to whom your Bitcoin will go after you’re gone? Are you confident that your intended beneficiaries will have the necessary access to stack? Have you considered the privacy implications of your estate plan? If you are not fully confident in your answer to any one of these, read on.
An Introduction on Estate Planning
Before we can begin to answer any of the aforementioned questions, we must first understand a few basic, but important estate planning terms & concepts. One note at the outset: the assumption of this article is that you have taken self custody of your bitcoin, whether outright or through a collaborative custody scheme. (If you want to learn the basics of self custody read my other article here that discussing just that.) If you hold Bitcoin on an exchange or through an ETF, this does not directly apply.
Who Really Owns a Thing?
There are two primary ways that ownership of an asset is conveyed: possession and title. Each determines a specific type of ownership you have over that asset. To have full ownership, you must have both. So, what are they?
Possession refers to physical control of an asset. For example, I physically possess this laptop that I'm typing this on, so I have possession of the laptop. Title, on the other hand, refers to legal ownership of an asset. For example, I hold the title to my house, this means that I have legal ownership of my house and can sell it, transfer it, etc.
Ways That Assets Pass
There are 3 primary ways that an asset will pass from you to your heirs & beneficiaries upon your death, it's important to know the difference between these ways as each has implications for your estate plan. They are:
1. By Law
2. By Contract
3. By Probate
Law
This is the simplest way for your assets to pass to your heirs. Assets that pass by law have certain ownership structures which determine to whom your assets should go. The most common form of this is via joint ownership. If you and your spouse own a parcel of land jointly, and you die, your spouse will automatically own that land. Assets that pass by law avoid probate and are not subject to your will, as they convey both title and possession, which is preferable. I’ll explain why shortly.
Contract
Assets that pass by contract are very similar to those that pass by law. The difference is that instead of a predetermined ownership structure, you have a legal arrangement (ie contract) that states to whom your assets should go. The most common form of this is naming a beneficiary on an asset, more commonly known as a TOD (transfer on death). Assets with a contract such as this also avoid probate and are not subject to your will, and so also convey both title & possession.
Probate
Probate is the process through which your estate & the assets contained within it (that do not already have an ownership structure or legal arrangement that determines to whom they should go) are distributed. In other words, it's the process that conveys both title & possession of assets. Probate is processed through the court system and is part of the public record.There are two ways in which your estate goes through probate; testate or intestate. The difference is whether you have a valid will or not. If you have a valid will, you are considered to have died "testate", if you do not have a valid will, "intestate". The difference in function is that the distribution of a testate estate is governed by your will & an intestate estate is governed by your states intestacy laws. Not only is probate a public process, it is both costly & time consuming.
Trusts vs Wills
Two of the most important documents in your estate plan are your will & your trust(s). But what are these documents & how do they differ?
A will is a legal document that outlines how your assets (again, those not already otherwise accounted for) should be distributed, allows you to name an executor of your estate & to appoint guardians for your minor children. As stated above, by only having a will, you will not avoid the public probate process.
A trust is a legal contract where a trustee holds & manages assets on behalf of beneficiaries that are named in the trust. This management can happen during & after the person who created the trusts lifetime. The area of trusts is a complex one, with many different trust structures that offer various benefits and drawbacks, for the article today, we will be focusing solely on the simplest trust structure, a revocable trust. A revocable trust (also known as a living trust or living revocable trust) is one in which you (as the creator/settlor) maintain full control of trust assets during your life, meaning you can put assets in and take assets out as you please, and are able to dictate how & when those assets are distributed after your death. Because this document is a legal contract, any assets that are put into the trust avoid probate, which is one of the greatest benefits of having a trust.
Bitcoins Role in an Estate Plan
Now that you have an idea of some basic estate planning concepts, let's talk about how bitcoin changes & interacts with your estate plan. I'll reiterate here that I'm assuming a self custody set up of some sort when discussing the following.
When it comes to bitcoin, most of the time, title & possession are one in the same, because both possession and title are determined by who holds the private keys. But let's say that someone broke into your home and took your private key that gave access to all your bitcoin without your permission or knowledge. (If you have a significant amount of bitcoin and this is even possible, you likely need to change your self custody set up ASAP!) In that scenario, the attacker would then have possession of your bitcoin, but not title, as he stole it from you. That aside, the premise here is that we must understand how to effectively convey both title & possession in order to minimize the public probate process and make sure your desired beneficiaries can actually access their inheritance.
If You Do Nothing
Bitcoin is by default a probate asset. What that means is that if you take self custody of your bitcoin & do nothing else, it will be subject to the probate process. The reason for this is that while possession can be conveyed even if you do nothing else, title cannot. Remember, title is the legal possession of an asset. Without a method to convey that legal title, you are left with going through probate. This is especially an important consideration if you own a significant amount of bitcoin, as that is now on public record for all to see. Not only is this not preferable - it could be outright dangerous. It could make your beneficiaries a target of attack from bad actors. Outside of that, if you own No-KYC bitcoin, going through the probate process has in effect just re-KYC'd your stack. With this in mind, the question then becomes, what do I need to do to make sure my bitcoin doesn't go through probate?
Conveying Title
That's a great question, I'm glad you (me) asked! And before you get too many ants in your pants, don't worry, we'll talk about the best practices for conveying physical possession in a minute. As you read above, there are two primary methods to convey title of an asset outside of probate; those were by law & by contract. Each has specific documents & methods that need to be implemented to accomplish our goal. Each has their trade offs.
By Law
One of the more simple ways to convey title by law is to have an attorney draft a Joint Ownership with Rights of Survivorship (JTWROS) Agreement. This agreement would document who owns the bitcoin jointly (i.e. you and your spouse) and that when one of you dies the bitcoin automatically becomes property of the living spouse. Within the document itself it's prudent to list the XPUB(s) of the bitcoin you are designating to become joint property. If you would ever move bitcoin to a new XPUB, then you would need to update the document. The benefit of this structure is it's simplicity, if you die, your spouse gets your bitcoin. Very clean & concise. The largest drawback to this structure is that it really only helps you at the first death. Most estate planning (at least for married couples) is worried about what happens at the second death (your spouse). A JTWROS agreement does not help in the case of the second death.
By Contract
To help solve this issue (the issue of planning for the second death as well as the first), we must look to contracts. More specifically, trusts. By using a trust structure, we can plan for both the first and second death. As I said above, there are many different types of trusts, in another article, I'll explore some of the more complex trust structures that you may consider for holding your bitcoin, but for today we will focus on revocable trusts (I'll refer to as "trust(s)" from now on).
Two of the key benefits of a trust are the flexibility & control it affords. Unlike a JTWROS which only applies to one asset and can only convey ownership transfers between the owners at the time of death, a trust can hold many different assets and can specify not only the who of where those assets should go upon your death, but also the what & when. All while still avoiding probate. To be able to include bitcoin into an existing trust, it could be as simple as drafting an Assignment of Property document that details the XPUB(s) of your bitcoin, and assigns the ownership of that bitcoin to your trust. Within the trust document itself then, you will want to make sure you have language that discusses how the private keys are held and how those keys should be passed to the beneficiaries of the trust once you (& possibly your spouse) as trustee(s) are deceased. One other benefit of creating a trust is that you can then acquire bitcoin directly into the trust. Many exchanges now allow you to open an account under the name of your trust. If you still then take what you acquired to self custody, you must have it go to the same documented XPUB(s), or add the new XPUB(s) to your trust documentation.
What do I mean that I say you can control when your assets pass to another party within a trust? I mean that you can put time specific stipulations into the trust language so that the beneficiaries of the trust may not access it as soon as you have passed. To give an example of where this is helpful - if you have children, and you were to die today, you may not want your children to have full access to the entirety of their inheritance right away for whatever reason. Within the trust you can state that your children can only access their inheritance on a schedule, they can access 33% at age 25, another 33% at age 28, and the remaining amount at age 30. This can be a very helpful estate planning tool.
We are just scratching the surface of what a trust can do here. They are extremely valuable estate planning tools. I'll write another article in the future that dives into more of the nitty gritty of them and some alternative structures you might consider. For now, you now have two different ways you can think about accomplishing the passing of the title of your bitcoin. This is important because conveying title is how you can avoid probate.
Conveying Possession
You now have an idea of how you might convey title of your bitcoin. You may be thinking, that's great, I can name my bitcoin in some documents and avoid probate, but how do the people I want to inherit my bitcoin actually get it? This is where how you custody your bitcoin becomes paramount. It's one thing to avoid probate and transfer title of your bitcoin, but if your beneficiaries can't actually access it, it doesn't matter that they were able to avoid probate, because they don't have the bitcoin you gave to them! This is why your custody structure must consider the estate planning implications. A extremely complex DIY multisig setup may help avoid your funds being stolen, but they're more likely to be lost when your beneficiaries try to access them, because they may not be able to do so. Likewise, a very simple singlesig setup may make it easier for your beneficiaries to access, but it is more likely that you lose your funds prior to their being able to access it. Trade offs abound here is really what it gets to. Needless to say & reiterate, this is why transfer of possession is the crux of a well implemented estate plan, and a poorly implemented estate plan.
Before diving in much more, I must be clear here. To convey possession of your bitcoin your beneficiaries must be able to access and use the private key(s) associated with the bitcoin you want them to have. This means that they must know where the keys are and how to utilize them to move your bitcoin. Just giving them your list of 12 or 24 seed words may not be enough so that they can do what's required.
There are three primary self custody structures, each of which could potentially be used within your estate plan. These are: single signature, multi signature & collaborative custody. While we will discuss each of these through the lens of it's impact on an estate plan today, please do realize that that is only one aspect of custody. There are other aspects that can and should be balanced with the estate lens.
Single Signature
One private key is all that's needed to move your bitcoin. For your heirs, this does make things quite simple. As long as they can access that key, they can move the bitcoin. Conversely, if they can't access that single key, or the mechanism in which they should theoretically be able to access that key is some how faulty, like in the case of you not recording one of your seed words correctly, then their ability to access those funds is likely gone.
Put another way, a single signature setup is the least fault tolerant way to custody your bitcoin. It does not leave much margin for error on your part or your beneficiaries part. This minimal fault tolerance is contrasted with the simplicity of custody. In general, the prudent way to use single signature within an estate plan follow those of general custody practices, which is that funds held via single signature should be minimal and you should hold a majority of your stack via another mechanism.
Multi Signature
In order to introduce more fault tolerance into your custody structure, you may look towards multi signature. The most common form is 2-of-3. Meaning, you have 3 possible private keys you can use to sign a transaction, but you only need 2 of them to sign it and move funds. You can see immediately how this can be beneficial, you can lose access to one whole key, and still be able to have control of your bitcoin. The same goes for your beneficiaries, maybe they can't find one of the keys that you used, but they do have the other 2, so they can still move the bitcoin.
The drawback to this structure is that while it certainly does make custody more fault tolerant, it also makes it more complex. Now instead of your beneficiaries needing only one key to access their inheritance, they need at least 2.
Furthermore, if they don't have direct access to the software coordinator you used to set up the multisig, they will need the configuration file to import the specific details of your multi sig so that they can move funds.
Collaborative Custody
Enter collaborative custody. The difference between this and multi signature custody is that there is more than one party that holds a key. Whether in multi or single sig, you are the only party that holds the key(s) to your bitcoin. With collaborative custody, you now have one other (hopefully trusted) party that holds at least 1 key. The most common form keeps the 2-of-3 multisig structure, where you continue to hold the 2 keys you need to be able to move funds, the difference is that the 3rd key is now held by the external party. This can be beneficial to you as now you are introducing even more fault tolerance. The reason being that you are no longer responsible for 3 separate keys, only 2 and there are now 2 parties that are privy to the details of the configuration of the multi-sig wallet, so that the third party can help guide your beneficiaries through the process to inherit their bitcoin. Since the third party only holds 1 key, they can also never move your bitcoin without your permission, all they can do is help you move it.
The drawback to collaborative custody is in the same vein as the main benefit, you now have another party that knows the details of your stack. They know the balance and can see all of your transactions. This is much less private. Additionally, if you have no-KYC bitcoin, this could effectively re-KYC it.
Communication is Key
No matter which of these custody structures you choose to implement, the most important aspect for estate purposes is communication. If your beneficiaries or trustees cannot or do not know how to access the bitcoin you've left for them, then again the custody structure does not matter. In practical terms this means that if you use a trust, all trustees must know how your bitcoin is held (custody structure) and how to access it (where the private keys are, what hardware or software signing devices you are using). The structure of custody should be detailed in the trust documents themselves. The same goes for the executor of your will if you are not going to utilize a trust. These people must be educated enough to know how to move funds.
This again is why collaborative custody is so powerful, if there is any possibility that the people you've named as trustee or executor cannot access your bitcoin, then having a separate third party that does know how and can help them gain that access is paramount. This is why we at Strong Wealth offer a collaborative custody solution to our clients, so that they can be rest assured their beneficiaries can receive what is rightfully theirs.
Wrapping Up
If you can believe it or not, this is just scratching the surface of the estate planning implications of bitcoin. You now know that ownership is conveyed through two primary mechanisms, title & possession, that there are ways your bitcoin can pass to your heirs that go through probate and avoid probate, and that the structure of your bitcoin custody scheme has many down stream impacts on your estate plan. If you would like clear, specific guidance on your Bitcoin estate plan to ensure your wealth doesn't vanish or pass as you would intend, schedule a call with us.