Thursday, March 28, 2013

More Potential Pitfalls of the New Estate Tax Law

     As we discussed in our last post, the increase in the applicable exclusion to $5,250,000, which dramatically reduced the number of estates with estate tax liability, also has the potential to create large problems for surviving beneficiaries if older estate plans are not updated. This is especially true in plans where the existing non-marital share primarily benefits other than the surviving spouse. This situation arises most commonly where clients want their children to receive something immediately upon the death of the first spouse or where the client wanted to provide for the children of a first marriage after remarrying. This strategy may have made sense at the time, because in prior years the applicable exclusion was smaller resulting in a smaller non-marital share and thus leaving sufficient assets to provide for the surviving spouse in the marital share. 
     With the new larger applicable exclusion, existing trusts will allocate significantly more assets to the non-marital share, potentially resulting in an inadvertent disinheritance of the surviving spouse. Some alternatives for protecting the surviving spouse in a situation such as this, while still achieving the goals of older trusts include the following modifications to the trust provisions: 
  • Revise the non-marital share to provide the spouse is the sole beneficiary of distributions of income during the spouse's lifetime with the remainder going to children. 
  • Revise the non-marital share to include the spouse as a beneficiary or co-beneficiary of income and/or principal together with the children, within the discretion of the trustee. 
  • Revise the non-marital portion of the trust to limit the size of the non-marital trust for children and descendants (such as the figure that the client originally intended as the highest estate tax exemption) while providing the remainder of the non-marital portion be used for the exclusive or primary benefit of the surviving spouse. The amount of this cap will depend on the goals of the client and the needs of the surviving spouse. 
     Keep in mind that merely placing an arbitrary cap on the non-marital share, with the remainder going to the marital share will increase the surviving spouse's taxable estate by increasing the marital share. This increase could cause the surviving spouse's estate to be subject to estate taxes where the combination of the surviving spouse's separate assets and the enlarged marital share exceed the surviving spouse's applicable exclusion amount. The permanent adoption of portability has the potential to alleviate this problem in many situations. Portability is a complex topic that we will address in a separate post in the near future. 
     What is important to know is that with careful planning it is possible to provide a surviving spouse with extensive rights in and powers over the trust funds without causing the entire trust fund to be included in the surviving spouse's gross estate. Such rights and powers would include: 
  • The right to all income, distributed currently. 
  • The right to withdraw or require distributions of principal in such amounts and at such times as are necessary for the surviving spouse's health, education, support, or maintenance. 
  • The right to receive distributions of principal in such amounts and at such times as the trustee (other than the surviving spouse) deems appropriate for any or at least a broader purpose. 
  • The noncumulative annual right to withdraw the greater of 5% of the value of the trust fund or $5,000 dollars. 
  • A testamentary power to appoint the trust fund to a class of beneficiaries that does not include the surviving spouse, his or her creditors, his or her estate, or its creditors. 
  • The right to serve as the sole trustee or as a co-trustee or to remove and replace other persons serving as trustees. 
     As you can see, failing to review estate plan documents after tax law changes can lead to significant problems. Those problems can be remedied easily making changes to documents so that they again will reflect the intentions of the clients.

Tuesday, March 26, 2013

Unexpected Effects of the $5,000,000 Exclusion

     Now that the applicable exclusion amount for determining when the federal government assess estate taxes is $5,250,000, many clients believe that they no longer need to worry about updating their estate plan because their estate will never be large enough to pay estate taxes. However, the majority of estate plans prepared when the applicable exclusion amount was much lower than the current $5,250,000 never contemplated the exclusion reaching such a high value. Plans drafted as late as 2010 expected the exclusion to remain at $3,500,000 and plans drafted prior to 2001 were written when the exclusion was less than $1,000,000. Practitioners must now revisit these plans in light of the higher applicable exclusion amount, to determine whether the non-marital and marital shares created will leave the surviving spouse with sufficient assets on which to live comfortably. 
     There may be no need to amend a Living Trust that creates separate marital deduction and non-marital deduction shares if the provisions of the two shares provide the surviving spouse sufficient flexibility. This is particularly true where the clients have only common descendants and believe that the surviving spouse may need their entire combined wealth to maintain his or her accustomed standard of living. The increased applicable exclusion amount will have little effect on the surviving spouse in such an estate plan, because allocating the first $5,250,000 to the non-marital portion with little or none going to the marital portion will have little actual economic effect on the surviving spouse. Still, with the applicable exclusion now at $5,250,000, most if not all of the assets of most Living Trusts will be allocated to the non-marital share, leaving little flexibility for the spouse. Faced with this reality on the death of the first spouse, the surviving spouse will likely be very unhappy to be told that she is only entitled to income automatically and principal within the discretion of the trustee. 
     However, the increased applicable exclusion amount can create a serious problem if the marital and non-marital deduction shares do not both benefit the spouse or if they both benefit the spouse, but substantially different ways. An estate plan that creates a non-marital deduction share that benefits family members other than the surviving spouse can produce a particularly unfortunate result under the current law. If the trust provides that the non-marital share is equal to the available applicable exclusion amount and the total estate is less than that applicable exclusion amount, it will create a non-marital share that will disinherit a surviving spouse to a degree that the client never intended. 
     Even if the non-marital share benefits the surviving spouse, if the distribution provisions only allow for distributions of income to the spouse, with principal distributions only made within the discretion of the trustee then the surviving spouse has very little flexibility. Provisions such as these were common with a lower exclusion because the thought was that assets allocated to the Marital Portion would provide for more flexible distribution provisions, such as all income and all principal within the discretion of the spouse. Because the prior applicable exclusions were only $1,000,000, or at most $3,500,000, there would be sufficient assets allocated to the marital portion to provide the spouse with sufficient flexibility. 
     In our next post we will suggest some strategies that can protect the surviving spouse even considering the new law, yet protect family members after the death of both spouses.

Thursday, March 21, 2013

The Trouble with Naming Guardians

    Selecting guardians for their children is frequently one of a client’s most difficult decisions in the estate planning process. The decision is complicated by a desire to name those people the client feels will be the best surrogate for their children, without offending other family members or loved ones. Members of two families usually feel they are better suited to be named guardians than other family members. It is possible, for many reasons, that a nonfamily member is the best person to be named guardian.
   Each set of grandparents may feel they are best able to be guardians of their grandchildren. Hard feelings can result if the client chooses one set of grandparents over the other. However, due to age or other factors, grandparents may not be the best guardians, even though they unrealistically feel that they are. The clients must consider the needs of their children and if grandparents could realistically meet those needs. 
       If another family member is considered, it may still create issues. The client may desire to name one of the client’s family members (such as a sister) and spouse as guardian, but does not want the sister’s spouse to serve alone if something should happen to the sister. In this situation, we will frequently name both the sister and her spouse as initial Guardians as a team, but name contingent guardians if those named cannot serve as a team. If there is a divorce or the spouse has died, the sister need not feel she has the additional obligation of guardianship. 
     Often a client will delay making a guardianship decision when they are not comfortable with any of their relatives or when relatives do not live in the same area. The clients believe that it would be unfair or unwise to relocate their children, who are already dealing with the loss of their parents. Close friends, living in the area, may actually be the ideal guardians in this case. In these circumstances, the client can name those geographically distant relatives as secondary Guardians. The client can then explain to their relatives that while the continued connection with their family is important, the client believes that being able to remain in a familiar comfortable environment will be more conducive to their children's well-being. 
       Ultimately, just as with any other position of responsibility in the estate plan, we remind our clients that whatever decision they make should be made with the best interest of their loved ones in mind. If there is a person who the client would not want as Guardian it is better not to name the person and risk offending them than name someone the client is uncomfortable with caring for their children. We always hope the decisions a client makes in naming a Guardian for minor children will never be needed. When the day comes when a Guardian is no longer needed, we remove that language from the estate plan so that no one will ever know that the client did not want them to care for their children.

Tuesday, March 19, 2013

Planning without Offending

     Occasionally a client will choose to name all of their children as administrators of their estate plan by placing different children in charge of different aspects of the plan. That can become a problem if children do not have the skill or ability to properly act as an administrator or have certain moral values that will prevent them from making a decision, for example a “pull the plug” decision under a Patient Advocated Designation. Another problem may arise when the client names all of their children to share in the administration duties equally, for example as co-trustees. While occasionally multiple co-trustees can better facilitate achieving the client's goals, a more common occurrence is the inability of those co-trustees to agree on actions, thus delaying the administration of the trust. An even number acting in any capacity has the possibility of creating a deadlock on decisions.
      We never tell the client they cannot do something with their estate plan. Instead, we inform the client of the potential consequences of their actions and attempt to find a solution that alleviates the client's concerns and achieves the estate plan's goals. Frequently that solution involves naming different children to different positions, where their real life experience is most advantageous. For example, a child with experience in the medical profession will serve as Patient Advocate, while a child with business management experience serves as the representative under a Durable Power of Attorney. Alternately, naming multiple, but not all of the children, to act together in a role allows the client to involve their family members without creating an administration scheme that is so complex it derails the whole process. Occasionally clients will name an independent party to cast a deciding vote only if the children are unable to agree on a course of action.
      Avoiding offending any of their children becomes more complex when a child with personal issues such as substance abuse problems or financial problems can benefit from having a strong trustee to oversee distributions, but the client wishes to avoid overtly treating their children differently. In these cases, we can use a combination of distribution provisions and/or an objective third-party co-trustee to achieve this goal and avoid hurt feelings. For example, the provisions of a Trust can name a trusted family friend as co-trustee with each child over that child's share of the Trust. The Trust then provides the co-trustee with the authority to make outright distributions at the co-trustee's sole discretion, allowing the co-trustee to distribute assets to children who do not have personal issues while allowing that co-trustee to retain assets in trust for the other child while working with them to overcome their life challenges before making distributions.
     Ultimately, the decision of who to name in an estate plan falls to the client and occasionally we find that it helps to remind people that by the time anyone may be offended with their actions they will no longer be around to listen to the complaints.
        On Thursday, we will discuss the often difficult decision of naming guardians for minor children, and how to avoid offending family members who are not named in this role.

Thursday, March 14, 2013

Planning for the Terminally Ill Client, Part II

     As we discussed last time, when a client becomes seriously ill or is diagnosed with a terminal illness it is obviously a trying time, but a complete review of their estate planning documents is important. We previously discussed the Durable Power of Attorney and the Patient Advocate Designation, but a client's Trust and funding documents also require review.
     The client may have neglected to update their Living Trust despite changes in the client's financial situation and family situation. Their estate planning documents require revisions because of these changes in order to avoid adverse consequences. Items to consider include:
  1. The value of assets in the Trust may have increased dramatically since the last time the Trust was reviewed. Distribution terms for spouse and children may need to change because of the increase in assets. 
  2. If the spouse or the other family members have been identified as being spendthrifts, the terms of distribution may need significant revisions. Rather than allowing for automatic distributions within the spouse's total discretion, an "ascertainable standard" as defined by the IRS, may be more appropriate so that the Trustee has the ability to pay or withhold principal and/or income for the spouse's benefit. 
  3. The children who are beneficiaries may have creditor issues, unhappy marriages or destructive dependencies, which may require restrictions on distributions to protect them from themselves. 
  4. If the client has remarried since the last time the Living Trust was reviewed and modified, provisions may be needed to protect the children of the prior marriage. While it is normal for the client to want to protect the current spouse as long as the spouse is alive, the trust should provide for the eventual distribution of principal to the client's children. Otherwise, the second spouse may be able to distribute assets to her family, disinheriting the client's children. 
  5. Because of the increased size of the estate, or because of changing charitable inclinations, a client may want to make charitable contributions at death. 
  6. The client may no longer be comfortable with those persons designated as Trustees and Successor Trustees to administer the trust assets for the benefit of spouse and children. 
  7. A client may want to revise the trust to protect the current spouse demanding children or a second spouse. 
     In addition to carefully reviewing the trust distribution provisions, a client should review the ownership of assets to confirm that all of the assets have been transferred to the Living Trust or beneficiary designations revised where appropriate, in order to avoid probate upon the client the death. If not, these transfers should be made soon as possible.
     Once these changes are handled, the client can be comfortable that if the worst happens, loved ones will be protected.

Tuesday, March 12, 2013

Planning for Terminally Ill Clients

     While we hope the estate planning we engage in will be as good thirty years from now as it is today, and that we will not need to use it until then, it is a sad fact of life that an unexpected serious illness requires us to reconsider our planning.
    Most of my clients have a Durable Power of Attorney that is only effective upon their incapacity. This means that the person designated to make decisions has no power until two doctors certify that the client is incapacitated and cannot care for their own physical or financial well-being. It may be a good idea for seriously ill clients and those with a terminal illness to provide for an Immediate Durable Power of Attorney. This allows the person designated to make legal decisions even if the client is not incapacitated, but simply unable to physically deal with financial issues. It gives the person designated flexibility in working with banks, brokers and others on behalf of the seriously ill client.
     An additional concern we have started to encounter is that some banks and brokers are unwilling to accept Durable Powers of Attorney executed longer than six months ago. These entities consider these documents "stale,” and are concerned they may not reflect the current viewpoint of the client. While the Michigan statute has no time limit on a Power of Attorney properly executed, it is usually cheaper to revise the Durable Power of Attorney rather than argue with the entity. For that reason, it may be advisable for a seriously ill or terminal client to "refresh" the Durable Power of Attorney so it is acceptable to banks and brokers.
     Just as Powers of Attorney frequently only function following a client’s incapacity, most clients are the sole Trustee of their Living Trust, and a successor Trustee does not have any authority until the client becomes incapacitated or dies. Again, it may be a good idea for a seriously ill or terminal client to modify their Living Trust to provide for a Co-Trustee immediately rather than only on the death of the client. Again, this Co-Trustee will help the client deal with matters relating to assets owned by the Trust.
     Finally, when reviewing documents in these circumstances, it is also a good idea to review the Patient Advocate Designation and evaluate those people named to make medical decisions in the event the client is unable to make their own decisions. Since those people may be called upon to make decisions sooner than later, it is important that the client remain confident in their ability to follow the client’s wishes. 
   On Thursday we will discuss reviewing dispositive provisions of the estate plan in consideration of the fact that a person's life may be cut short.

Thursday, March 7, 2013

Why a Will is only Part of an Estate Plan

     Prospective clients will sometimes arrive for our initial consultation convinced all they need is a simple Will to have a complete estate plan. Sometimes a Will may be all the client needs, but more often after a review and discussion of their situation, we recommend the inclusion of a Living Trust. After explaining how Wills and Trusts work and their benefits, clients will occasionally comment that Wills and Trusts seem to serve the same purpose. Today’s blog addresses the ways that Wills and Trusts vary. 
     While both a Will and Trust can set up provisions for the distribution of a decedent’s assets, there are significant differences. The biggest difference between a Will and a Trust is that property passing to beneficiaries through a Will must pass though the potentially long and expensive Probate process, while property passing via a Trust does not. This is because Probate only attaches to property owned individually by the decedent. A Trust is a legal entity separate from the individual (even though the Grantor totally controls the Trust during lifetime), and cannot die, and therefore assets owned by the Trust almost never require the intervention of a court to facilitate transfer. 
     Before any actions are taken with assets passing through a Will, the Probate must be opened and the Court must approve the Personal Representative. This can take time and create problems if any decisions need to be made quickly. While a Will provides directions as to what happens to assets, the Probate Court stays involved and confirms the Personal Representative’s actions are appropriate and the assets are accounted for properly. A Trust, on the other hand creates a contractual relationship between the Grantor, who creates the Trust, and the Successor Trustee. The Grantor specifies in the Trust the beneficiaries who are to receive assets, when they are to receive assets, and the powers given to the Trustee to administer the Trust provisions. That relationship functions without the intervention of the Probate Court.
     Another difference between a Will and a Trust is that a Will only functions following the death of the person who executed the Will. The Trust on the other hand functions from the moment of its execution. This means that should something happen to incapacitate the Grantor, a successor Trustee can immediately step it to care of the Grantor’s assets and use those assets for the Grantor’s benefit. A Will does not provide this benefit, and absent a Durable Power of Attorney or the Probate court appointing a Conservator, assets may be inaccessible. 
     Estate planning is a personal activity and each person’s circumstances are unique. The insight of an knowledgeable attorney can be the difference between an easy transition following a death and a long drawn out probate process.

Tuesday, March 5, 2013

Should I Panic about being Named a Successor Trustee? - Part II

     Last week we began discussing the obligations of a Successor Trustee after the death of the Grantor. In addition to determining whom the beneficiaries of the Trust are and reviewing the Trust provisions, an important duty is assembling a list of the trust assets Sometimes that task is easy because the Grantor has kept good records. Other times the Successor Trustee must become a "detective" and find some of the assets. In addition to locating the assets, the Successor Trustee is responsible for determining the best way to invest the assets until making distributions pursuant to the terms of the Trust. The Trustee must follow the "Prudent Investor Rule", which requires that the Trustee must exercise reasonable care, skill, and caution in the investment and management of assets, taking into account the purposes, terms, and distribution requirement expressed in the Trust. Fortunately, the Trustee may retain qualified investment professionals to manage the assets if the Trustee does have the requisite investment skills necessary.
     The Successor Trustee may also be required to work in coordination with the Personal Representative of the Grantor’s Estate. In many instances, the Trust agreement instructs the Trustee to work with the Personal Representative of the Estate to pay for expenses, settle debts, and make tax elections. It is also common for an estate plan to name the same person as Personal Representative and successor Trustee. Whatever the case, it is important that the successor Trustee comply with the administrative provisions of the Trust and keep complete records of any expenses paid or distributions made from trust assets. 
     After securing the Trust assets and determining the instructions for administration and distribution of the assets, the Trustee should inform the Trust Beneficiaries of their interest in the Trust, how the assets are to be distributed, and how the assets are being spent. Once the initial duties of the successor Trustee are complete, the Trustee can begin making distributions from the Trust assets pursuant to the Trust provisions. While the Trustee may have some discretion, the Trustee must make distributions pursuant to the terms of the Trust. This means if the Trust places any limitations on the use of distributions or requirements that must be met prior to making a distribution, it is the Trustee's responsibility to ensure that the Beneficiary complies with these limitations or has met those requirements. 
     While in some cases, the administration of the Trust is very simple because the Trust requires immediate distributions to all beneficiaries, often the Trustee’s responsibility continues for many years while making distributions to Beneficiaries as they meet the Trust's requirements, assisting Beneficiaries who have spending and/or dependency issues, or simply maintaining assets until Beneficiaries reach mandated milestones, at which point the Trust assets may be distributed. 
     The role of the Successor Trustee is not one to accept lightly, as the position exposes the individual to a great amount of responsibility and work. Thankfully, Successor Trustees do not need to be personally responsible for all of the tasks of administering a Trust. The Successor Trustee can rely on other professionals, such as attorneys, accountants, and financial managers, to assist in the review, explanation and the administration of the Trusts. These professionals can be of great assistance to a Successor Trustee by providing guidance and assistance throughout the administration process. With this assistance, the Successor Trustee can serve in this important and rewarding position, and assist the Grantor's loved ones after the death of the Grantor.