Planning for the Generations

In the previous blog we mentioned that our client, Edna, contemplated leaving gifts to her grandchildren that they would not receive outright until they reached retirement age. While Edna opted against this gifting option, other clients have seen value in restricting the distribution of gifts until beneficiaries attain physical, if not mental, maturity.

Harold is in his seventies and while he is now retired, he enjoys his time because he has significant investment income in addition to his Social Security. Harold’s investment income is sufficient to allow him the luxury of only taking the minimum distributions required by law from his IRA, allowing that account to continue to grow tax-deferred. Presuming that nothing changes, Harold will have the opportunity to provide for his loved ones after his death in a variety of ways.

Harold outlived two wives but was close with his own children, Isaac and Janice, as well as his stepchildren, Karen and Luke. While he wants to treat all four children equally, he recognizes that Luke has issues managing money, as evidenced by a recent bankruptcy. Additionally, Harold wants to provide for his grandchildren, but sees that each of them is at a different point in their lives and therefore it might not be appropriate to make gifts to them in the same manner. This sort of complex family situation is ideal for a Living Trust, because the Grantor (Harold) can divide assets as he sees fit and the successor Trustee has the responsibility of dispersing assets in the manner Harold chose.

In this case, Harold chose to divide the majority of his assets into four equal shares for the benefit of Isaac, Janice, Karen, and Luke. While the value of each of these shares is to be equal, the terms of distribution are not. Isaac, Janice, and Karen are to receive their shares over the course of five years, with the Trustee having the discretion to make distributions for their health, maintenance, or support if circumstances warrant. Luke’s share, in light of his ongoing bankruptcy, is to be held in trust with the Trustee having the authority to make distributions for Luke’s benefit, but not to distribute funds directly to Luke.

This difference in distribution terms will help to protect any inheritance Luke receives from garnishment by his bankruptcy proceeding, while still allowing Luke to benefit from the funds. Harold has provided that upon reaching age 65, Luke may receive whatever remains of his Trust outright. This additional restriction, lasting long beyond the current bankruptcy, helps ensure that as Luke gets older there will be  funds available for him in retirement. Due to the value of Harold’s trust, it is likely that there will be funds remaining at this time and Harold hopes that by 65 Luke will have the maturity to handle his own affairs.

To address Harold’s desire to provide for his grandchildren we established a separate “IRA Trust” that does not contain any assets during Harold’s lifetime, but the IRA Trust is named, in very specific fashion, as the beneficiary of Harold’s sizable IRA. The IRA specifically names sub-trusts created under the terms of the IRA Trust, each for the benefit of a particular grandchild, as a beneficiary. This designation, along with other terms that allow the IRA trust to comply with the law and regulations, allows the IRA Trust to serve as the beneficiary of the shares of Harold’s IRA while still using the separate ages of Harold’s grandchildren as the measuring ages for making the minimum distributions required under the law. As a result, each of Harold’s grandchildren, ranging in age from 30 to 12, will be treated slightly differently but all of them will benefit more from Harold’s IRA than if the IRA Trust did not exist.

First, the IRA Trust allows the Trustee to manage the assets and comply with laws, leaving the beneficiaries free to enjoy the boon from their grandfather. The IRA Trust also prevents a beneficiary from electing to take a large distribution from their inherited IRA without fully appreciating the consequences of that action. Finally, because the IRA Trust allows each beneficiary’s age to act as the measuring age for their required minimum distributions, the younger beneficiaries do not need to withdraw more funds in a year than necessary. This benefits the younger grandchildren by allowing more funds to grow tax deferred until age 65 when Harold has decided that his grandchildren will gain complete access to the funds.

Clearly, this level of complexity is not necessary for all clients but many clients like the idea of using particular assets to benefit certain beneficiaries and often there is a benefit to doing so in order to gain either tax savings or increased growth potential. The complexity of Harold’s plan is something that people should not attempt without consulting financial planners and attorneys experienced in complex estate planning as even simple errors in implementation may be very costly when it comes time to execute the plan.

Matt and Al