Thursday, September 26, 2013

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.

Tuesday, September 24, 2013

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.

Thursday, September 19, 2013

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.

Tuesday, September 17, 2013

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.

Thursday, September 12, 2013

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.

Tuesday, September 10, 2013

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.

Thursday, September 5, 2013

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.

Tuesday, September 3, 2013

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.