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

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

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

Distributing Potentially Problematic Assets

     Our previous two blogs focused on how estate-planning documents achieve the client's planning goals. Today's blog focuses on how successor Trustees distribute assets to beneficiaries. While sometimes the distribution of trust assets is as simple as writing checks to the beneficiaries, certain assets, such as items of personal property and investment accounts, present special issues.

     With personal property, we provide our clients with the ability to leave a memorandum indicating which individuals receive particular pieces of personal property. After giving effect to this memorandum, the Trustee must distribute the remaining personal property pursuant to the terms of the trust, usually in approximately equal shares amongst a number of people. In many circumstances, this division is amicable, with the beneficiaries each keeping the items of personal and monetary value without issue. The trustee can then dispose of the unwanted remaining personal property through either an estate sale or donation to charity. This of course is the best-case scenario, but there are times beneficiaries are unable to agree as to the division of the property. At this point, the Trustee becomes a mix of accountant and mediator, keeping track of the value of property and sorting out disagreements between beneficiaries over whom receives what from their loved one’s estate. Trusts often provide the Trustee with the final decision as to the distribution of personal property when beneficiaries disagree, allowing the Trustee to settle disagreements as he or she see fit and in compliance with the terms of the trust.

     Investment accounts may also be difficult to divide and distribute. While the actual division of an investment account is a simple matter easily accomplished, the Trustee must first determine when the assets should be distributed and how they should be invested prior to distribution. The Trustee is a fiduciary under a high standard of care, and therefore must make distribution decisions with care. If the Trustee intends to make distributions in the near future, it may be better to liquidate investments to protect the principal against market losses. If assets will be held in trust prior to distribution, the Trustee must decide between the benefit of capturing market gains against the possibility of incurring market losses. If possible, it may be simpler to equally split each of the investments in the portfolio distribute them in kind, and allow each beneficiary to make their own investment decisions.

     It is important that the Trustee consult with knowledgeable advisors to ensure that the interests of both the present and residual beneficiaries receive fair treatment. The employment of such a qualified advisor may relieve the trustee of their duty to ensure that assets are properly invested, so it is important to that the Trustee work closely with the advisor.

     These are just two examples of assets that may cause successor trustees issues when distributing trust assets to the beneficiaries. Because of these potential issues, it is important for the initial trustees to keep good records regarding the assets held in their trust so that their successor trustees can administer the trust to achieve the grantor's goals with a minimum of trouble and inconvenience. If you have questions regarding funding assets to the trust please feel free to contact us directly and we will provide you with additional information.

Matt Ferrara

Addressing Client's Concerns Regarding their Children's Marital Issues

We typically post about general issues involving estate planning, but as we all know, clients have specific problems with which require individualized solutions. One good example of this are concerns regarding adult children potential issues related to their marriage.

A common client concern, because of trends in divorce, is the worry that an adult child who receives an immediate distribution from a trust will lose some or all of those assets to an ex-spouse following a divorce. Obviously the clients would much rather have all of the assets owned by their child and eventually used for the benefit of their grandchildren. To alleviate this concern we are now modifying Trusts to change distribution provisions so that there is no longer an immediate distribution of assets to some or all of the children. Instead, the Trust distributes income and principal over time, protecting the bulk of the distribution from loss in the event of a divorce.

Clients have a wide variety of options for the limitations they place on these distributions, ranging from automatic distribution of income annually to distributions of income only within the total discretion of the Trustee. In addition to limiting distributions of income, the Trust normally provides that distributions of principal also be within the discretion of the Trustee. By using this type of language, the Trust assets being held for the child are not considered "marital assets" subject to a division upon divorce. The Trust can even provide for distributions of assets held for the benefit of children to grandchildren to help defray the costs of education or other expenses of maintaining their accustomed standard of living.

Frequently when clients choose to include such limitations on distributions the Trust will also include a provision that the Trustee, in its complete discretion, can distribute the entire share of the child at any time. This is beneficial because if there is a troubled marriage, the assets can be held, but after a divorce, or if there is comfort that there are no longer marital issues, the Trustee can distribute all Trust assets the child and the child can then control their own destiny.

Regardless of the provisions used, the child in question should not be the sole Trustee of his or her own sub-trust, or a spouse in a divorce may be able to argue successfully that the child has sufficient authority for an automatic distribution and thus the assets should be considered marital property. In these types of situations, there should be an independent Trustee, or at least a sibling who is both understanding of the situation and sympathetic to the child.

In reviewing existing documents for clients with concerns regarding their children's marriages, close attention should be paid to the following concerns:

1. Does the Trust provide for an immediate distribution of assets?
2. If the Trust holds assets for the benefit of a child, using distributions that specified ages or anniversaries of the parents' deaths, will this provision require distribution over a shorter time than would be needed to protect against marital issues?
3. Are protections in place for grandchildren as well as children?
4. Is the child in question a Trustee of his or her sub-trust, which might create an ability of a divorcing spouse to reach assets of the Trust?
5. Is the Trustee of the Trust for the child on good terms with the child so that the child can be comfortable that he or she will be treated favorably, or is the Trustee one who is not on good terms with the child or is not sympathetic to the child's situation? Siblings who are fighting or on bad terms with the child may not be the most appropriate Trustee for the child's sub-trust.

     As our clients relate concerns and problems with other family members, it is important that we review their estate planning documents to make sure that appropriate changes are made to protect their interests and the interests of their children.

Alan Ferrara

Using Motivational Distribution Provisions

     One of the reasons for having a trust is the significant control the trust provides the grantor over distribution of their assets. Some clients use this control to include distribution provisions designed to motivate the beneficiaries to either take or abstain from certain actions. We believe in explaining the consequence of any given action to our clients and then allowing them to decide whether those consequences are worth the benefit of their actions. This philosophy frequently comes into play when clients want to use distribution provisions as a carrot or stick for their beneficiaries.

     One common form of motivational distribution is a payment to the beneficiary upon their graduation from college. Without careful drafting, such provisions can create situations where it is more advantageous for the beneficiary to remain a student supported by the trust or opt for a lengthy education resulting in many degrees and an equal number of distributions. With provisions requiring very particular educational achievements, for example graduation from a Big Ten university, a beneficiary may never receiving gifts intended for their benefit if such a degree is beyond their capabilities.

     Another form of motivational distribution reflects the grantor’s desire to influence their beneficiary’s marital decisions. A danger in this type of distribution, in addition to the chance of creating substantial resentment between the parties, is a poorly worded distribution provision can result in the beneficiary engaging in a spree of weddings and divorces in order to take advantage of overly broad provisions. As with education-based distributions, it is possible for relationship-based distributions to fail entirely because a beneficiary is completely unwilling or unable to engage in the required behavior.

     It is part of our responsibility as counselors to our clients it to create documents that achieve their goals and avoid these types of situations. Frequently we do this by suggesting alternatives that achieve the grantor’s overall goals, while limiting potential future problems in the administration of the trust. This means that clients who want education-based distributions are encouraged to include trade schools and other forms of post-secondary education as benchmarks for the distribution. For clients concerned about their beneficiary's spouses, distributions made over time may offset some concerns that a spouse will end up with assets in divorce or provisions for distributions to grandchildren in the event that a parent fails to receive a distribution will keep assets available to assist loved ones even if beneficiaries fail to conform to the grantors preference.

     Ultimately, the choice of distribution provisions is up to the client. If the desire to achieve certain outcomes despite the potential challenges results in complex distribution provisions it is important to remember that in a living trust such provisions are always amendable during the life of the grantor. Hopefully in time, clients will realize that their beneficiaries have grown into the productive members of society they hoped for and adjust their documents accordingly.