The Value of Assets to Beneficiaries

     In the estate planning process, one of the most difficult decisions for clients is how to distribute assets to their loved ones. Frequently clients run into problems because their desire to treat beneficiaries equally conflicts with their reasons for wanting to provide for those people in the first place. Often we find that when clients begin to consider their own goals in making gifts, and which of their assets can serve those goals best, clients have an easier time making decisions.

     In one instance, our client desired to treat her three children equally. Prior to beginning the estate planning process, the client achieved this goal by dividing her assets and a modest life insurance policy between her children by using beneficiary and transfer on death designations to assign different assets to each of her children. While this initial form of planning worked when the client was younger, the client expressed concern about unbalancing her gifts as she took larger retirement distributions or needed to sell stock in order to pay for medical expenses. The client also wanted to reward her daughter who lived with her and maintained the residence for that effort, and to ensure that another child had an additional source of income.

     As we discussed the client’s income and assets, we learned that she supplemented her modest pension with dividends from stock in companies with substantial long-term stability. We suggested that the client pass these stocks along to the child who would need additional income, holding the stock in trust so that the trustee would distribute income from the dividends to the child and be able to sell the stock in the event that the child needed additional funds. Following that child’s death, the client’s two other children (or their children) would receive the remainder of the stock free of trust. The idea that her son would have a continuous source of income appealed to our client. However she was still concerned about equality between the three children.

     Outside of her stock holdings, the client had approximately $200,000 worth of assets and was uncomfortable with the idea that she had given specific property, the stock and her residence, to two of her children without leaving anything identifiable to the third child. This perceived inequality threatened to derail the entire planning process until we began to discuss the value of various assets. A quick search showed that the client’s stock holdings had a value of approximately $250,000, which was likely to continue to appreciate. The client also knew that the value of her residence decreased substantially following the end of the housing bubble, but that her daughter intended to continue living in the home for the foreseeable future.

     Taking this information into account the client quickly realized that while the residence had value to her daughter as a place to live, the saleable value meant little when dividing her estate. Additionally, knowing that her other two children would inherit her stock holdings after their brother’s death allowed the client to feel more comfortable dividing the remainder of her assets between those two children, despite the knowledge that those assets would be significantly less valuable than the stock at the time of her death.

     To summarize, by helping our client realize that by giving particular assets to each of her children she was better able to achieve her goals than if she just divided assets equally at her death we pushed through a barrier that previously kept the client from establishing an estate plan. As planners, we all need to look at the big picture of the client’s goals because the client’s personal feelings can often create situations where they cannot see the forest for the trees and therefore fail to act. 

Alan Ferrara & Matt Ferrara

What is Really Important in Estate Planning

When clients ask, “What's really important in estate planning?” we as professionals put on our "expert hat" and generally respond with something like "you want to maximize estate tax savings" or "you must avoid probate.” We go on to wax eloquently, often a great length, about the many strategies for protecting assets and saving taxes. While these are laudable goals, they fail to take into account what should be the primary goal in estate planning, protecting the client’s loved ones.

As planners we are often more comfortable with the details of estate tax law than we are with discussing the personal situations of our clients. We tell them all the wonderful things they can do, rather than determining what they want to do, then try to fashion a tax and probate savings strategy around that. Discovering what clients really want for their families is sometimes difficult because they may not know themselves. They may be struggling with various issues with their spouses, children, grandchildren, or even parents and have not been able to voice those issues to anyone.

While we are all great technicians, perhaps we should spend much more time becoming great listeners. We serve our clients best not by telling them what they can do, but by asking them questions to better understand their concerns and desires for their family.

Some questions that may help clients articulate their wishes include:

1. Do you know the current value of all of your assets and how they are owned?
2. What kind of future lifestyle do you and your spouse want to enjoy?
3. Are you worried that the lifestyle you want to maintain may mean your children will receive a smaller amount than you would like to leave them?
4. Do you have any concerns about the financial acumen and spending habits of your spouse or significant other?
5. What is your relationship with each of you children, and will that affect what you would want to leave them at your death?
6. Do any of your children have any issues such as alcohol or drug dependencies, troubled marriages, gambling problems or other issues that affect their ability to handle money that you leave them at your death?
7. If you could place restrictions on the money these children eventually receive, what would you like to do?
8. Do you have any elderly relatives to think about if something happens to you unexpectedly?
9. Do you have any charitable inclinations you would like to have met from the funds available at your death?
10. Are you comfortable that the assets you currently have are sufficient to allow you to make small, or even large, gifts to your children or grandchildren?
11. Whom do you trust to make medical and financial decisions for you and your family if you are incapacitated or after you pass away?

After clients answer these questions, and more that stem from them, then we can explain the technical issues. In this way, our clients understand that within all the strategies and documents their true wishes and hopes for their family can be met.

In this ever-changing world, it is not enough to know the law. We must make a concerted effort to know our clients better and understand their needs before making any recommendations. Only then can we truly serve them well.

Alan Ferrara and Matt Ferrara

Happy Thanksgiving

With this week’s blog we take a break from educating to take a moment to thank all of our readers for taking the time from their busy schedules to read what we have to offer.

From Alan, Matt and everyone at Finkel Whitefield Selik, have a Happy Thanksgiving and, for our Jewish friends, a Happy Hanukkah.

Please be safe as you travel and prepare for your holiday celebrations, and when in doubt remember 1-800-BUTTERBALL is there to assist you

IRA Trusts as a Tool for Protecting Beneficiaries from Themselves

We all have clients who recognize their children's limitations and want to protect those children against their own shortcomings. These shortcomings may take the form of a drug or alcohol dependency, a gambling problem, or a spending problem. I once counseled a client who had two children who spent more than they made, often requiring my client to bail them out of financial trouble, as to how she could protect her children against themselves after she passed away. In addition, she wanted a portion of her estate held for the benefit of her grandson.

While this client had a number of assets, she had a particularly large IRA account. Because of her goals and the existence of this IRA account, I suggested the client set up an "IRA Trust".  An IRA Trust is a stand-alone trust, separate from a Living Trust, which acts as the beneficiary of IRAs or other retirement benefits. The provisions of an IRA Trust satisfy all of the regulations related to the distribution of IRAs and retirement benefits, allowing the beneficiaries to take advantage of stretching distributions of their inherited benefits over their lifetime, delaying taxation. Except for the required minimum distributions (RMDs), the IRA assets can continue to grow tax-deferred and protect beneficiaries against their own bad habits of misspending and mismanagement of money.

The IRA beneficiary designation specified that at the client’s death three separate sub-trusts would each be the beneficiary of one-third (1/3) of the IRA. This specific allocation allowed the Trustee to use each beneficiary's separate life expectancy to calculate the required minimum distributions, rather than the life expectancy of the oldest beneficiary of the trust. There was eight years difference in the daughters' ages, which allowed the younger daughter to take a smaller required distribution every year. This strategy was particularly beneficial to the grandson, who was only 13 at the time his grandmother passed away. This allowed the trustee to calculate his required distributions using 70 additional years of life expectancy, resulting in very small taxable distributions, thereby deferring tax.

We also designed the IRA Trust with different sub-trust provisions for each beneficiary. One daughter only would receive the greater of income earned by her sub-trust or the required minimum distribution. This restriction was always in force and that daughter could not accelerate any distributions. The second daughter, who was somewhat more responsible with her finances, also received the greater of income earned by her sub-trust or the required minimum distribution, but after three years was entitled to take up to 10% of the value of her sub-trust each year if she chose to request it. Finally, the share for the grandson was set up to provide for income and principal as needed, but if not used, remained in the trust for later use, such as education, purchasing a home, or starting a business.

Our client did express one final concern that her daughters would be unhappy with the limitations placed on them, but was comforted by the fact that by the time the children were aware of the restrictions she would not be in a position of having to listen to their complaints.

 Our client was somewhat less restrictive with distributions to her daughters from her Living Trust because she knew that even if the daughters spent those assets quickly, the terms of the IRA Trust still protected her daughters and grandson from completely running out of assets. The client was also able to make charitable distributions from her Living Trust without worrying that charitable beneficiaries would negate the "stretch out" of IRA distributions over the other beneficiaries' lifetime.

Clients are often reluctant to place restrictions on their children even if it is for their own good. It is often the difficult obligation of advisors to begin the discussion about ways to protect the beneficiaries from their own shortcomings and let the client eventually find comfort with specific strategies for protecting them. As with all estate planning strategies, careful consideration should be given not only to the relevant tax provisions, but also to understanding a client's true desires. 

Alan Ferrara and Matt Ferrara

Year End Charitable Gifting Strategies

As we discussed last week, many of our clients use this time of year to make annual gifts to family members. A number of those clients also plan their charitable gifting for the end of the year to take advantage of the deduction that such gifts provide against income tax liability. Some of our clients make direct cash gifts to their chosen charities, while others satisfy their charitable inclinations with gifts of property, such as artwork, real estate, or stock. These gifts allow them to deduct the charitable contributions, up to 50%, 30%, or 20% of their adjusted gross income, depending on the type of property contributed and the type of donee. Depending on the client’s financial situation, more advanced gifting techniques can provide greater benefit to both the client and the charity.

One of our clients, who will likely have some estate tax liability, uses Charitable Remainder Trusts (CRT) to maximize the value of her charitable gifts. The CRT stipulates that the client receives an annual payout of a percentage of the value of the trust during her lifetime, with charities receiving the remainder of the trust assets at her death. In addition to satisfying her charitable intentions over the long-term, she reduces her potential estate tax liability, obtains an income stream for her lifetime, and is eligible for an income tax deduction equal to the present value of the remainder interest, determined by using IRS tables. In her case, at age 70, a $1,000,000 transfer to a CRT with a 6% annual payout provided her with $60,000 of annual income for life, and give her a $466,370 charitable deduction.

Another client, who does not need additional current income, chose to take the opposite path and fund a Charitable LeadTrust (CLT). A CLT provides charities with an annual income stream for a period of time, with the remainder interest going to other beneficiaries. In this case, the client just sold a business, had a significant gain, and wanted a tax deduction in the year of sale. We set up the CLT to provide a 6% payout to charities for twenty years. At the end of twenty years, the remaining balance of the trust will be held for the benefit of his three children. This allowed our client to take an immediate charitable deduction of $2,124,000. In order to take the deduction in the year the CLT is funded, the taxpayer must report the income earned by the trust over the next 20 years, which our client was comfortable with because his income in future years would be much less than the current year. As with the CRT and additional benefit of a properly structured CLT is a reduction in the value of the client’s future estate tax liability.

Not all techniques require a long-term trust to facilitate gifting. One of our clients, knowing he was selling his business, sought advice regarding the best way to donate a portion of the proceeds to his favorite charities. To maximize funds received by the charities, we recommended that he donate a portion of the stock to a charitable trust set up for those charities. The trust then joined in the sale, received a portion of the proceeds tax-free, and distributed those proceeds to the charities. By contributing the stock first to the charitable trust and then having the charitable trust join in the sale, the charitable trust received the full amount of the proceeds without liability for income taxes. If the client had sold the stock first, he would have been liable for capital gains tax and there would have been fewer dollars available for the charitable contribution.

Finally, for those clients receiving distributions from an IRA, 2013 provides a unique opportunity. The tax rules provide that if a donor is at least 70 1/2 years of age, he or she can have the IRA distribute up to $100,000 per year directly to a charity and treat it as excludable from income. One of our clients, with a large IRA but little other available assets, has been using direct distributions from an IRA to charities for the last few years. This technique allows her to satisfy her chartable inclinations and reduce her own potential income tax liability. Unfortunately, due to a change in the law, 2013 is the last year this option is available.

There are a number of other creative ways to fund a client's charitable desires, provide them with income tax deductions, and limit liability for future estate taxes, but these techniques require proper planning. If any of your clients are interested in charitable gifting options for this year, they should consult with their advisors soon in order to provide sufficient time to implement strategies that maximize their charitable contributions.

Alan Ferrara and Matt Ferrara

Making the Most out of Year End Gifts to Family

This time of year, many of our clients begin considering making gifts to family members. Some of our clients will use the annual gift-tax exclusion ($14,000 in 2013), to make family gifts tax-free. Others, who desire to make larger gifts to family members, are willing to use of a portion of their lifetime exclusion amount (totaling $5,250,000 in 2013).

Many of our clients attempt to keep things simple by giving cash. "Cash makes no enemies" as they say, but it still can remove a significant amount of assets from a client's estate in the event of future estate tax liability. For example, a couple I represent, who will have a taxable estate, give $14,000 each to a total of 33 children, grandchildren, and great-grandchildren, as well as to spouses of some of those beneficiaries. Each year they give away more than $900,000, which will save over $360,000 in federal estate tax liability at their death. I suggested the clients give interests in LLCs holding real estate rather cash because it would have allowed them to give away more than $1,100,000 under their current gifting scheme. Unfortunately, many of their beneficiaries have gotten used to living outside of their means and need these cash gifts to help balance out their annual expenses.

As I mentioned above, clients can get even greater advantage against future tax liability by using the annual exclusion gifts to give highly appreciating property rather than cash. The current value of the gift and any future appreciation escapes taxation. Giving children a portion of real estate or minority interests in closely held companies are two common methods of taking advantage of this technique. In addition, it is possible to discount gifts or a minority interest for gift tax purposes because of lack of marketability and lack of control. For example, using a 20% discount allows clients to treat a gift of minority interest valued $18,000 as a gift valued at $14,000. Depending upon the asset the clients choose to transfer, sometime greater discounts are possible.

Others of my clients have taken advantage of the possibility of discounts by giving awayclosely held stock or minority interests in LLCs, which may hold real estate or other invested assets. Can clients not only leverage the annual exclusion gifts, but also can actually leverage the lifetime estate tax and gift exclusion. If there is a desire, a client can make gifts above the annual exclusion amount by using some or all of their lifetime exclusion. If only a 20% valuation discount is available, the current $5,250,000 lifetime exclusion could support gifts of over $6,500,000, not including future appreciation. One client in particular gave away a 99% nonvoting interest in an LLC holding real estate that is leased by his other businesses. Not only were we able to use discounts because the interest was nonvoting, but his retained 1% voting interest allows him to control the entity. This particular client did not need the income from the leases so we structured the LLC to distribute that income to the children. Another client used a similar strategy and distributed income to his grandchildren for their education expenses.

Even if the clients do not have a taxable estate, making gifts to children may be a good idea because it allows them to see if their children will use or invest the money wisely. If the children make mistakes with small amounts, they can modify their estate planning documents to provide guidance to children after their deaths so assets are not wasted. In addition, it can allow them to enjoy seeing their children do things and have things while they are still alive.

Any time during the year is a good time to make gifts to help facilitate planning, but as the days grow short and the year nears an end, there is a finite amount of time for clients to take advantage of gifting opportunities using the annual exclusion gifts or lifetime exclusion gifts. It is important for us as planners to help clients understand the opportunities and facilitate good planning. We need to remind them that if an annual exclusion gift is not made in any particular year, it lapses and cannot be carried over to a following year.

This time of year is also an excellent time for clients to consider charitable gifts, and next week we will discuss some of the planning opportunities for charitable donations.

Alan Ferrara and Matt Ferrara

Helping Clients with Their Homework

     Over the past year, we repeatedly referred to estate planning as an ongoing process requiring the participation of the attorney, client, and other affiliated professionals in order to achieve the best outcomes. Nowhere is this more evident than during the recent meeting with couple who have been long-term clients.

     Since the clients executed their documents in 2001, they have relied on us to inform them when the documents needed updating. Over the course of the last dozen years, much has changed in the clients’ lives, and we have kept their plan consistent with their goals. As we reached the end of the meeting and asked if the clients had any new assets that were not funded to their Trust, the husband, somewhat sheepishly, pulled out the funding instructions that they were given in prior meetings and said, "I know I was supposed to do something with this but I never really did. Is that important?" Because this has occurred with other clients, we now take an active role in the funding of our clients' Trusts. We work closely with our clients and there other advisors to insure that when the client leaves our office their assets are funded to their Living Trust.

     Upon discovering that the clients’ Trust owned little, we began discussing their assets, beginning with their real estate. In this case, the clients owned their home jointly. Historically when dealing with real estate most estate planning attorneys have advocated executing a quitclaim deed to a Living Trust but not recording that deed while both spouses are living. This strategy has resulted in many attorneys having filing cabinets full of unrecorded deeds. With the relatively recent adoption of the “quitclaim deed with reserved life estate to grantor”, more commonly known as the "ladybird deed”, unrecorded deeds are unnecessary. We prepared a ladybird deed for the clients’ residence so that they can continue to have the creditor protection of jointly owned property during their lifetime, and the property will automatically transfer to their Trust following the death of the second of them.

     Next, we looked at the clients’ mutual funds and other investments, with the goal to make sure that the clients' Living Trust was the titled owner of all of these accounts. By working directly with the clients’ financial planner we were able to obtain the forms needed to open a new account in the name of the clients' Living Trust, and completed them at our signing meeting. The clients actually had some mutual funds they purchased directly and we suggested they transfer these to their current planner, which the clients (and the planner) thought was a good idea. This allowed us to return the forms and a Certificate of Trust Existence to the planner, who then was able to the transfer of ownership to the Trust.

     We also reviewed the clients' beneficiary designations for retirement accounts and life insurance policies. For this particular client, both the 401(k) and life insurance policies named the wife as primary beneficiary but failed to name a contingent beneficiary in the event that the wife should predecease him. Again, we coordinated with the clients’ financial planner to have change of beneficiary forms ready at our signing meeting. These forms continued to name the wife as the primary beneficiary of the 401(k) plan account and then named the Living Trust as a contingent beneficiary. The new beneficiary of the life insurance policies was the Trust, because upon the death of the husband the wife had total control of the Trust.

     Initially the clients’ financial planner resisted naming the Living Trust as a beneficiary because he was aware of the general rule that required immediate distribution of retirement accounts if a nonperson was named as beneficiary of the 401(k). We made him aware of the important exception to that rule that allowed Trust beneficiaries to stretch distributions over the life expectancy of the oldest trust beneficiary if the Trust contained "see-through provisions", that allow the Trustee to stretch distributions from the 401(k) account over the lifetimes of beneficiaries of the Trust. By requiring that any IRA distributions pass through the Trust we were also able to protect one of the clients’ children, whose spending habits are of great concern to the clients, from electing to take their share of the IRA immediately or over a short period of time and spending it .

     Finally, we looked at the clients’ business interests. Recently the clients assisted one of their children by providing capital to open a small business. In exchange for the startup funds, the client was became a 50% owner of the business. The clients intended that their son would inherit any portion of the business the clients owned at their death, and not involve the other children in the business. To achieve this goal we prepared an Assignment of the L.L.C. interest to the Living Trust and added specific language in the Trust for distribution of that interest to the child in question.

     Trust documents and Trust funding go hand-in-hand. Because as planners we understand that many clients are unlikely to complete "homework assignments" that may be integral to the operation of their planning, it is incumbent on us to find ways to work together to make the process as simple as possible for our clients. For this reason, we strive to be as open and available to both our clients and their other advisors as possible so that we can ensure that the clients are receiving the greatest value from our services.

Alan Ferrara and Matt Ferrara

Planning for Same-Sex Couples in Michigan

While the Federal and state rules regarding same-sex marriage are changing rapidly because of the recent Supreme Court opinion and legislation in some states, Michigan currently does not recognize same-sex marriage. This failure to recognize same-sex marriage makes estate planning even more important for same-sex couples in Michigan because many protections that exist automatically for opposite-sex couples do not protect same-sex couples.

A few years ago, we met with a same-sex couple who asked how they could insure that their partner not only had the right to make legal and medical decisions in the event incapacity, but how they could guarantee their partner would be entitled to assets. While both partners worked, one contributed more monetarily and had a greater amount of assets, including their home. Knowing their desire to protect each other, we designed their estate planning documents to meet their needs.

One of the clients was particularly concerned that in the event of her incapacity some of her family, who disapproved of her relationship, would attempt to exclude her partner from being present and making decisions on her behalf. Knowing that in the absence of other instructions, the Probate Court prefers to name a family member as Guardian or Conservator, we prepared Durable Powers of Attorney, Patient Advocate Designations, and Living Wills, clearly specifying that each of the women wanted the other present and in control of making decisions in the event of their incapacity.

After addressing the clients’ concerns regarding care in the event of emergencies, we turned to what happens after one of them passes away. Under Michigan law, if a person dies without a Will or a Trust, the state intestacy statute determines how assets are distributed. That statute ignores same-sex partners in making distributions and can leave one partner homeless and perhaps even penniless. The first step we took to avoid this situation was to transfer their residence to the two of them as "joint tenants with right of survivorship." While this form of ownership does not provide the same creditor protection to same-sex couples as it does to married opposite-sex couples, it does still guarantee that the survivor of them would own the residence. Additionally, we set up a Living Trust for each of them and provided that upon the death of one, the other partner received all of the tangible personal property, household items, and jewelry to insure that neither would end up owning a home but have to give up other tangible reminders of their loved one.

The Living Trusts also provided that each of their assets would be held in trust for the survivor of them. While in some situations, for tax or personal reasons, it would make more sense to leave assets to a same-sex partner outright, it was important to our clients that in the event any assets remained after the death of the second of them those assets would go to each of their family members who supported them and their choices. However, each named their partner as the successor Trustee so that during her lifetime she would retain almost total control over the assets and never need to request assets from someone else.

Over the years, we have amended these client’s documents to comply with changes in the laws that affect their relationship. But while times and laws are changing, and more states, as well as the Federal government, are treating same and opposite-sex couples equally, until Michigan law does the same it is important for us as professionals to provide guidance to our clients so that they are aware of the ability to control their situation. It is also important to remember that each situation is unique and calls for an analysis of what the partners want, and not presuming that every same-sex couple’s needs will be met with the same plan. 

Planning to Meet the Client's Goals and Limit Estate Tax Liability

Last week we profiled a client and the strategies used in his estate plan to protect his loved ones after doctors diagnosed him with a likely fatal disease. While we did a great deal of planning in his final months, as with many endeavors, planning prior to discovering problems leads to greater success. When we began working with this client, we immediately recognized that he faced significant potential issues related to estate planning, tax planning, and family dynamics.

After analyzing his situation, we found three areas of potential concern. First, due to the scope of business and invested assets, as well as his real estate holdings there was likely to be a substantial estate tax liability at both the client’s death and the death of his wife. Second, because he wanted to provide that some of his assets went to his daughters from his first marriage if he predeceased his current wife, we were unable to set up the traditional marital/residuary strategy to eliminate taxes on the first death. Finally, we knew that the value of his real estate holdings continued to increase and increased the potential estate tax liability.

We first discussed the potential estate tax liability and the effect it would have on his business if he died suddenly and a significant tax liability arose. He recognized that while his assets generated significant annual income, most of his assets were illiquid and would not provide cash for taxes without adversely affecting the business itself. Without planning, we would have to "kill the golden goose" to provide sufficient assets to satisfy tax liability. To address this issue we recommended a number of Irrevocable Trusts to own life insurance on the client’s life and on both the client and his wife’s lives jointly.

One Irrevocable Trust held a policy on his life alone, which matured at his death and provided the funds to pay the estate tax liability at that time. Since we could not know at that time if the client or his wife would die first, the second Irrevocable Trust held a second to die policy, which would mature in any event on the second death and provide funds to pay any additional tax liability at that time. After years of continued success and an increasing estate, we also later set up an Irrevocable Trust to own a policy on his wife's life, to provide additional protection against tax liability whenever she passed away. In addition to providing liquidity to the estate to offset potential tax liability, these Trusts freed up estate assets for other family planning. As an added benefit to the client, premiums paid were a fraction of the policy face value, so the client was able to pay estate taxes at his death with cheaper dollars.

When it came time to address the matter of the client’s evermore-valuable real estate holdings, the client indicated that he did not need the asset value or the income from these properties and was willing to gift the property to his five daughters, as long as he could maintain control of them. Using limited liability companies to own the property, we gave our client a 1% voting interest in the entities and gifted the 99% nonvoting interest to the daughters. While he was alive, the client maintained control of the properties with the voting interest and the LLCs held the rental income received for the benefit of the daughters. Eventually we entered into an agreement where the LLCs loaned money to the Irrevocable Trusts to pay life insurance premiums, which freed up a significant amount of cash flow for the client. In order to protect the children, we annually distributed a sufficient amount of money to pay taxes on the "phantom income" they received from the LLCs.

As you can see, while it is possible to complete some planning when emergencies arise, the best planning is done beforehand by anticipating issues and using strategies that protect the client and loved ones. It is important that we as planners anticipate our clients’ needs because they are often too busy to do so themselves.

Alan Ferrara

Planning to Protect a Second Wife and Five Adult Daughters

Over the past year our goal in writing Plainly Legal was to discuss many of the technical legal issues in the area of estate planning that impact the practices of financial planners. Using this information as a basis, going forward we will be addressing specific situations raised by our clients and how we dealt with those situations. As we address these examples, we will do our best to link back to previous posts that address the technical issues. If any of you run across an issue or have a question on how to solve a client problem, feel free to e-mail us and we can address it in future posts.

A client of ours, diagnosed with cancer and given only a short time to live, was concerned about protecting his second wife during her lifetime, yet treating his five adult daughters fairly. The client owned a valuable business and also had significant personal assets, but was concerned that some of his daughters might create problems for his wife after his death. He was also concerned that he had not taught his daughters the value of money and worried they would not handle an inheritance well.

Initially, he wanted to leave everything in trust for his wife for use during her lifetime, with distributions to the daughters after her death. Knowing that the wife was somewhat younger than our client was and in good health, I raised the issue that it might be some time before the daughters received anything. To address this concern I suggested we carve out sufficient assets in a Marital Trust, including the residence and sufficient invested assets to maintain the wife's accustomed standard of living, for her use during her lifetime. Since the residence had significant value, we wanted to provide flexibility for the wife if she ever decided to sell the residence, and therefore we provided the Trustee with the power to sell the residence and use the funds to purchase a new residence for the wife, with any remaining funds added to the Marital Trust for the spouse. This power to purchase a new residence gave the wife the flexibility to downsize her residence or move to a different state for health or personal reasons if necessary. We also named the wife as a Co-Trustee of the Marital Trust set aside for her benefit, so that she had a say in the management of the assets held for her benefit.

To protect the daughters from their spending habits and maintain the value of the business, we placed the business and the remaining assets in a Children's Trust for the daughters benefit. The daughters received income automatically from their Trust each year, but principal distributions were totally discretionary until the oldest child reached the age of forty. At that point, the trust began distributing principal at the rate of 20% per year for the next five years. Our client felt comfortable that this would provide an income stream for each of the daughters, allowing them time to learn the value of money and how to manage the business, yet protect the value of the business so that disagreements among his daughters would not result in the sale of the business. To address the client’s concern that his daughters might cause his wife problems, we suggested that the wife be the Trustee of the Children's Trust, with a corporate fiduciary as a Successor Trustee in the event that the wife ever decided to resign as Trustee. Our client liked the idea because it gave the wife control over the children's future assets and distributions, which he felt would lessen the chance that the children would give her problems.

Fourteen years have passed and I am happy to report that the Marital Trust, with good investment advice, has provided sufficient income to maintain the wife's accustomed standard of living. She still lives in and enjoys the residence. Over time, the daughters received all their distributions and now jointly own the still successful family business. They learned the values of hard work and cooperation and the business provides each of them a good income. As an added bonus, some of them even enjoy a good relationship with their stepmother.

This is a good example of how planning can protect families and their assets following a client’s passing. While this particular client was in good health, we completed other planning that facilitated a smooth transition of other business assets and provided funds for payment of Federal Estate taxes when the client passed away. Next week we will address this planning in detail.

Alan Ferrara

Coming Soon: Changes to Plainly Legal

For the past year we have provided you with a bi-weekly education in aspects of estate and tax planning. In the coming weeks we intend to build on that education to help clients and planners understand the value and importance of proper estate planning.

Stay tuned to see what comes next.

2014 Inflation Adjusted Tax Limits

     As you are aware, a number of tax figures are adjusted each year for inflation. The Government has released Inflation adjusted 2014 figures for Estate and Trust Tax brackets and other Transfer Tax items. The adjustments are based on the average Consumer Price Index (CPI) for the 12-month period ending the previous August 31. The August 2013 CPI has been released by the Labor Department, and using the CPI for August 2013, (and the preceding 11 months) some of the tax figure adjustments for 2014 are: 

• Unified estate and gift tax exclusion amount. For gifts made and estates of decedents dying in 2014, the exclusion amount will be $5,340,000 (up from $5,250,000 for gifts made and estates of decedents dying in 2013).
• Generation-skipping transfer (GST) tax exemption. The exemption from GST tax will be $5,340,000 for transfers in 2014 (up from $5,250,000 for transfers in 2013).
• Gift tax annual exclusion. For gifts made in 2014, the gift tax annual exclusion will be $14,000 (same as for gifts made in 2013).
• Determining 2% portion for interest on deferred estate tax. In determining the part of the estate tax that is deferred on a farm or closely-held business that is subject to interest at a rate of 2% a year, for decedents dying in 2014, the tentative tax will be computed on $1,450,000 (up from $1,430,000 for 2013) plus the applicable exclusion amount.
• Increased annual exclusion for gifts to noncitizen spouses. For gifts made in 2014, the annual exclusion for gifts to noncitizen spouses will be $145,000 (up from $143,000 for 2013).
• Kiddie tax. The exemption from the kiddie tax for 2014 will be $2,000 (same as for 2013). A parent will be able to elect to include a child's income on the parent's return for 2014 if the child's income is more than $1,000 and less than $10,000 (same as for 2013).
• 2014 Estates and Trust tax rate brackets:

If taxable income is                                                                       The tax is:

Not over $2,500..................................................................................... 15% of taxable income

Over $2,500 but not over $5,800........................$375.00 plus 25% of the excess over $2,500

Over $5,800 but not over $8,900.................... $1,200.00 plus 28% of the excess over $5,800
Over $8,900 but not over $12,150...................$2,068.00 plus 33% of the excess over $8,900
Over $12,150..............................................$3,140.50 plus 39.6% of the excess over $12,150

Alan Ferrara

Grantor Retained Annuity Trusts as a Tool for Wealth Transfer

We often discuss the benefits of including Living Trusts as part of an estate plan, but there are other types of trusts that may provide our clients with significant benefits as part of a larger estate plan, depending upon the client’s particular situation.

A Grantor Retained Annuity Trust (GRAT) is one method for wealthy clients to maintain an income stream for a period of time yet transfer property (often which is highly appreciating) to a child with minimal gift or estate tax. A GRAT consists of assets transferred into an irrevocable trust with the transferor retaining the right to annuity payments for a fixed term of years or their lifetime. If income earned by the trust assets is insufficient to cover the annual payment, the Trustee will make the required payments from principal. When the set time period ends, the remainder of the trust, including any appreciation, can go to a named beneficiary. Alternatively, it is possible to structure the GRAT to return the principal and a certain amount of income to the grantor, and distribute the excess income to the remainder beneficiary.

The gift tax value of the transferred assets is determined at the time of trust creation and funding by subtracting the value of the annuity interest from the fair market value of the assets transferred to the trust. The value of the annuity interest will depend on the interest rate used, the value received by the grantor, and the value of the remainder beneficiaries’ interest. The IRS Regulations set rules for determining what interest rates may be used in the calculation of valuations, especially when family members are involved.

As an example, if a 60-year-old client sets up a GRAT to last two years and uses the following provisions:

• Contributed Asset Value: $1,000,000,
• the §7520 interest rate required by IRS Regulations: 2%, 
• the asset earns 5% per year
• the asset appreciates at 5% per year 

Over the term of the Trust, the client will receive two annual payments of approximately $515,000, and the remainder beneficiary will receive approximately $130,000 remaining in the GRAT with no gift tax cost. If the asset is anticipated to appreciate faster than 5% per year, the benefit to remainder beneficiaries is even greater

Since the GRAT permits payment of both income and trust principal to satisfy the annuity payments, it is important to treat the GRAT as a grantor trust for income tax purposes. This means the client retains liability for taxes on income and realized gains on trust assets even if these amounts are greater than the trust's annuity payments. This further enhances this tool's effectiveness as a family wealth-shifting and estate tax saving device because the client pays the income tax, thus reducing the their estate.

         In the right circumstances, the GRAT can be a powerful tool to transfer assets with minimal gift or estate tax consequences, but clients should carefully review their financial situation with both an experienced attorney and financial advisor before entering into such a transaction.

Alan Ferrara

Fairness and Gifting Across Multiple Generations

     Last Thursday we discussed a variety of ways to address clients' concerns regarding lifetime gifts made to their children. Issues such as these stem from the clients’ common concern for treating their beneficiaries equally. Another frequent sticking point when addressing fairness in distributions is a client’s desire to leave bequests to both their children and grandchildren. As clients begin to contemplate leaving gifts to multiple generations, the complexity of achieving fairness multiplies.

     One option when choosing to include grandchildren in trust distributions is to provide that each living grandchild receive a fixed sum prior to dividing the remaining trust assets among the client’s children. This ensures that the client treats each grandchild equally and that each child receives an equal share of the remaining estate. Alternatively, some clients elect to divide their entire trust estate equally between their children, but stipulate that from each child's share a specific dollar amount or percentage is set aside in trust for that child's offspring. While both of these methods ensure that each grandchild receives an equal gift, the second method reduces the gift to each of the client's children proportionate to that child's number of offspring.

     The second method for dividing the trust estate between the client's children and grandchildren requires the trustee to establish an equal share for each of the client's children as well as an additional equal share for the benefit of the client’s grandchildren. The share for the grandchildren is then subdivided, giving each individual grandchild in equal sub share. As with the first option discussed, this method ensures that every member of the same generation receives the same size gift but avoids making a fixed denomination gift to grandchildren that can potentially overwhelm the client's intention to provide for their children.

     A third method for making distributions that include grandchildren involves again dividing the trust assets equally between the clients’ children and then holding each child's share in trust. The terms of these trusts may vary, but a common choice is to provide that a portion of the income from each child's trust is distributed to that child automatically each year, while the remaining income and principal may be used for the grandchild's needs subject to an ascertainable standard. Following the death of the child, each of their offspring receives an equal share of any assets that remain in the trust. This technique, while requiring more substantial involvement from the trustee, allows the client to provide an annual gift to their child while also providing for their grandchildren's long-term needs.

     As you can see from these examples and as we have said before, distribution provisions are limited only by the client's imagination and our ability to draft to those desires. What is important to remember is that clients should not lose sight of their planning goals in order to ensure fairness among their beneficiaries. Engaging in the estate planning process and establishing a living trust serve to provide structure, guidance, and peace of mind to the client and their loved ones. When engaging in planning, clients should work with an experienced professional who takes the time to understand their family situation and assist them in creating documents that address the clients' wants and needs.

Adjusting Estate Plan Documents for Lifetime Gifts or Loans

Clients are often concerned with ensuring that they treat each of their children equally. Clients worry that imbalanced gifting between children, for example providing more funds to one child to attend a private university while their sibling attended a state school, providing one child with the funds to assist with the down payment on a house, or assisting one child with launching a business, will cause tension if not balanced out in the long run. This concern leads to a discussion about which children previously received gifts or loans from the parents and how to adjust the distribution of trust assets to children to be fair to siblings who did not receive such gifts and loans.

One of my favorite phrases with clients is "the only limitation on what you can do is your imagination." I have one client who has chosen to add a provision to his trust that states that all distributions to children whether as a loan or a gift are to be treated as a gift and shares of the children are specifically not to be adjusted for anything received during lifetime. Other clients want options that provide greater equality, but are more complex. While I am happy to provide those options, I will often suggest to a client he or she may want to consider what is "fair" for each child rather than what is "equal.”

There are a number of ways to adjust distributions to account for gifts or loans to children during the client’s lifetime. One example is to have the trustee add all loans and/or gifts made during the client’s lifetime back into the estate at death for calculation purposes. The trustee then provides an equal division for all children, adjusting each child's share for loans and/or gifts they received during lifetime. If clients elect to use this method to adjust bequests, careful records should be kept, to ensure that children are not penalized for loans that were previously repaid.

Another option is to provide a specific dollar amount for each of the children who did not receive loans or gifts during lifetime, which the trustee distributes from the estate before the equal division occurs. Again, good record keeping is important with this method to avoid creating an imbalance in favor of a different child.

There are number of other options, but it is clear that such clauses should be added to a client's documents only after a discussion with the client and careful drafting by a qualified professional.

Alan Ferrara

What's the Difference between Living Wills & Living Trusts?

     A common problem clients have when starting the estate planning process is confusion regarding the purpose of the various documents involved in an estate plan. Legislatures and attorneys augment this confusion by using similar common names for some of the documents. When you have a Will, a Living Trust, and a Living Will, a measure of uncertainty is understandable from clients who do not deal with these documents on a daily basis.

     We have discussed in detail how a Will dictates the decedent's desires regarding property held in their name alone the death, that must pass through the Probate Court before passing to their heirs. Similarly, we have addressed how a Living Trust administers property held in the name of the Living Trust, and deals with many of the same issues, but does so outside of the Probate Process. Today's post addresses the Living Will, what it does, and how it fits into an estate plan., A Living Will deals with what we refer to as the "here and now" . Together with the Patient Advocate Designation, the Living Will helps to address health care issues that arise during a client’s lifetime where, due to incapacity, the client is unable to make medical decisions for themselves.

     When executing a Patient Advocate Designation, clients nominate an individual to make medical decisions on their behalf if they are incapacitated and unable to make those decisions for themselves. A Living Will acts as an instruction manual from the client to their designated patient advocate, stating their wishes to that advocate regarding their healthcare. The choice to have a Living Will is purely voluntary and the Living Will may be as specific or as general about health care wishes as the client prefers. Under Michigan law a Living Will has no legal force. However, if there is a conflict regarding an incapacitated person's care that necessitates Probate Court involvement, written or oral statements, such as a Living Will, are admissible as evidence of the incapacitated persons desires as to their own care.

     The basic Living Will addresses the client’s desires concerning the use of medical devices to artificially prolong their lives. It is our belief that regardless of the client’s other desires regarding health care, it is important the client articulates an opinion regarding their desires for continued care if their lives are being maintained solely by machines. If clients wish to include more expansive directions to their patient advocate, we ask them to provide us with a list of those instructions for inclusion in their Living Will and encourage them to speak with their designated patient advocate so that everyone involved is on the same page regarding care.

     While contemplating our mortality is an uncomfortable topic for almost everyone, some solace can be gained by knowing that those people who we trust to make decisions on our behalf are guided in those decisions by our own instructions.

Matt Ferrara

Protecting Beneficiaries from Experiencing Problems with Their Inheritances

Inherited wealth comes with many advantages, but it also has disadvantages. Depending upon which source you consider, between $10 trillion and $30 trillion will pass by gift or inheritance by the year 2030. More of our clients, be they older with adult children or younger with small children, are becoming increasingly concerned that passing large sums of money may not be in the best interests of their families.

Over the last 30 years, the focus in estate planning has been upon reducing gift, estate or generation-skipping transfer taxes. The intent was to minimize the amount of a client's estate that was "shared" with the IRS. However, with the increased exemption creating a decreased focus on the tax implications of inheritances, more of our clients now focus on how distributions to their children may affect their lives. They worry about children losing the motivation to accomplish something of worth. They also worry about the significant complexity added to their children's lives when they acquire wealth and suddenly have a variety of relatives and strangers trying to tell them what to do with those newfound assets. Some clients even worry about their children engaging in addictive or self-destructive behavior or even a spendthrift lifestyle that causes them to spend their money too quickly.

I believe it was Warren Buffett who said, "You should leave your children with enough money so that they can do anything, but not so much they can do nothing."  With similar thoughts in mind, clients are starting to look at incentive clauses to discourage unproductive behavior and encourage worthwhile pursuits. Access to the trust funds may now be subject to incentive clauses, such as

•      Tying distributions to a demonstration of some type of personal accomplishment, such as receiving educational degrees (but making sure you avoid creating "professional student", contribution to charitable pursuits or distributions to equal income earned.

•      Requiring financial training to be able to manage wealth responsibly.

•      Matching earned income, at least up to a certain point

•      Providing funds for "extended family vacations" to encourage continuation of family relationships after the death of parents

•      Requiring periodic testing to provide knowledge of any substance abuse issues and limitations of distributions therefore

•      Matching contributions to retirement savings to encourage a beneficiary to save for retirement

•      Requiring a prenuptial agreement in order to protect the "family assets" from being lost to an ex-spouse.

Each of these incentive clauses, and many others, can have many benefits, but clients should also consider the drawbacks. Matching earned income with the trust distribution may work against those beneficiaries who have chosen public service, a religious vocation or chosen to be stay-at-home parents. Incentive clauses can be excellent ways to protect and pass on family assets, but should be considered carefully with assistance from qualified professionals.

When discussing such provisions with clients we take the position that it is not our place to tell the clients what action to take. Instead, we serve as an advisor, informing them of the potential consequences of their actions and allowing them to make the decision that they feel is best for their loved ones. This method allows the clients to achieve their goals while minimizing the chance that their intentions will be subverted after they are gone.

Alan Ferrara

Making Changes to Powers of Attorney

     We previously discussed how a Power of Attorney allows another person to make legal decisions on your behalf, whether immediately or only upon your incapacity. However, what happens if, after executing a Power of Attorney, you change your mind about whom you want to act on your behalf? If this happens, you need to take certain steps to make certain you revoke that person's power.

     The first step is to execute a new Power of Attorney, changing the individual designated to act, known as the Attorney-in-Fact. The new Power of Attorney should specifically state that it supersedes all previous Powers of Attorney.

     Next you should notify the person previously named in writing and request the return of any copies of the original Power of Attorney. This notice informs the person that they no longer have the duty or the power to act on your behalf. When you receive copies of the superseded Power of Attorney make sure to securely destroy those copies along with any other copies in your possession.

     It is also important to inform third parties that this person no longer has the authority to act on your behalf. This notice should be done as soon as possible orally, and then follow-up in writing. The third party, such as a bank, is then fully aware of the change and acts at its peril if it allows the original Attorney-in-Fact to act. By providing a copy of the new Power of Attorney, you specifically show that you revoked the prior document and executed a new document in its place. This allows the third party to know not only that it should no longer honor the previous document but also whom you have chosen to replace the previous Attorney-in-Fact.

     Used properly, a Power of Attorney can make difficult situations much easier by allowing someone to make important decisions while you are incapacitated or merely unavailable. However, because a Power of Attorney provides another person with the authority to act on your behalf it is important to review that document periodically to ensure that the people named are still the best people to make those decisions. Finally, it is important to consult with an attorney before signing any form of Power of Attorney. Do-it-yourself books and websites offer broad, general documents that are often insufficient to meet a person’s needs. By speaking with an experienced attorney, you are assured of receiving documents and the support needed to address your specific situation.

Matt Ferrara

The Ripple Effect of US v. Windsor on Planning

     Today marks a milestone for Plainly Legal. This is our 100th post, and we would like to thank everyone who has supported this venture and visited our Blog. That said, let's move on to today's topic, as recent weeks have produced significant news that affects our practice and those of our associated professionals.

     As we discussed in July, the Supreme Court's decision in the case of US v. Windsor, holding Section 3 of the Defense of Marriage Act (DOMA) unconstitutional, impacts planning for married same-sex clients. Since that decision, other departments of the Federal government have announced responses to this holding.

     On August 29th the US Department of Treasury and the Internal Revenue Service ruled that same-sex couples, legally married in states that recognize their marriages, would be treated as married for federal tax purposes. This ruling applies to all married same-sex couples regardless of whether their state of residence recognizes same-sex marriage. This ruling applies to all forms of federal taxation including income, gift, and estate tax. Because of this ruling, legally married same-sex couples may file their 2013 federal income tax return using either the married filing jointly or married filing separately filing status. These couples may, but are not required to, file amended returns for the tax years 2010, 2011, and 2012, choosing to be treated as married for those years. However, Michigan has yet to weigh in on whether legally married same-sex couples may file joint returns. 

     While the IRS has readily complied with the Supreme Court's decision, other departments of the Federal government are not as quick to change their policies. The Department of Veterans Affairs Secretary Eric Shinseki announced that the Supreme Court ruling did not specifically strike down a federal regulation defining a spouse as someone of the opposite sex, and therefore the Department of Veterans Affairs would continue to limit VA benefits to opposite sex spouses. This decision was almost immediately challenged, and on August 30th US District Judge Consuelo Marshall of Los Angeles ruled that based on the Supreme Court's decision in US v. Windsor, the regulation in question was unconstitutional and approved an injunction permanently barring the VA from applying that regulation.

     In contrast to the Department of Veterans Affairs, the Pentagon has announced that as of September 3rd same-sex spouses of military members will now be eligible for the same health care, housing, and other benefits enjoyed by opposite sex spouses. This decision has been met with some resistance, especially from the State of Texas, where the Texas National Guard currently refuses to process requests from same-sex couples.

As events unfold and the scope of the Supreme Court's decision becomes clearer, we at Plainly Legal will continue to provide you with commentary that may assist you in new planning for clients covered by the decision. 

     Again, thanks to all of our readers for their regular visits to the site, and we look forward to continuing to provide you with useful and insightful information regarding estate, tax, and business planning.

Matt Ferrara

Planning for College-bound Children

     With the beginning of a new school year, today is a perfect opportunity to address the subject of Powers of Attorney and Patient Advocate Designations for a client’s adult children. As we previously discussed, despite their parent’s perception, once a child reaches the age of eighteen they are an adult in the eyes of the law, and therefore their parents no longer have the right to make decisions on their behalf should they become incapacitated.

     This can be corrected by having children execute Durable Powers of Attorney and Patient Advocate Designations, naming their parents to make decisions, and parents can continue to care for their children should they become incapacitated. These documents provide both parent and child with peace of mind that, in the event of an emergency that causes the child to be incapacitated, the parent will have the ability to assist their child without needing to petition the probate court for that authority.

     It is important the clients’ children understand how the documents they sign will protect them should their parent need to use them. The Patient Advocate Designation allows their parent to make medical decisions in the event that the child is unable to make those decisions because of illness or injury. A Durable Power Of Attorney is more complex, because it allows the parent to make legal and financial decisions, including paying bills, dealing with landlords, and filing lawsuits on the child's behalf if the child is incapacitated and unable to take these actions for themself. Both the parent and child should know that without these documents, if the child becomes incapacitated, the Probate Court must be petitioned to name a party to make decisions, which can be expensive and time-consuming.

     The process of drafting and executing these documents also has the added benefit of providing the opportunity to introduce clients’ children to the client’s legal and financial advisors. While discussing the importance of these documents with their children the client also has the opportunity to begin to explain their own planning.  This early introduction to both the estate and financial planning can set the children on a path to a more secure future as well as act as a stepping-stone to understanding their parents’ planning. While some clients balk at the idea of introducing their children to the planning process at such a young age, taking the time to execute a patient advocate designation and durable power of attorney can save the client and their child from significant inconvenience, time delays and cost in the event of an emergency.

Matt Ferrara

Unwinding Irrevocable Life Insurance Trusts

     On Tuesday, we addressed the technique of funding insurance policies to an Irrevocable Trust and using the annual gift exclusion to make premium payments. For those clients with potential estate tax liability this technique allows them to help fund the estate tax liability at a fraction of the actual cost because policy proceeds at death that will not be includable in the client's estate will more than offset the premiums paid during lifetime. When collected by the Irrevocable Trust, the proceeds can be used to purchase assets from the Living Trust or loan funds to the Living Trust to pay estate taxes until illiquid assets are sold.

     However, what happens if circumstances change and the purpose for which the Irrevocable Trust was created no longer exist, or if the client has a change of heart about owning the policies? Since the trust is irrevocable, the client cannot unwind the trust through revocation. The client can however discontinue annual gifts to the trust (and its lifetime trust beneficiaries), leaving the Trustee of the Irrevocable Trust without any assets to pay the life insurance premiums. Eventually the insurance coverage will lapse leaving the trust without any assets, at which point the trust ceases to exist as a matter of law.

     Alternatively, as part of the initial planning for the Irrevocable Trust, specially added provisions may allow the Grantor to unwind the trust despite its irrevocable nature. One strategy is to structure the Irrevocable Trust as a "Grantor Trust”. If properly drafted, the Trust can be treated as property of the Grantor for the purposes of income tax liability, excludable from the Grantor's estate for estate tax purposes. If the trust holds only life insurance there should be no income, presuming the Trustee uses all of the gifts made to the trust by the client to pay the premiums on the life insurance owned by the trust, and  there should be no impact on the client’s income tax liability.

     The Internal Revenue Code Sections 671-678 detail the circumstances under which the grantor trust rules apply. One of those provisions gives  the Grantor the right to substitute assets of equivalent value for the assets held by the trust. This allows the Grantor to substitute or exchange other assets equaling the value of the insurance policies contained in the trust for the life insurance policies themselves. Those assets are still subject to the distribution terms of the trust.

     As with any advanced estate planning technique, including the creation or termination of irrevocable trusts, advice and counsel of experienced attorneys is important in order to avoid unintended consequences. 

Matt Ferrara