This is the second of two articles on reviewing a trust. In this one, discuss how we evaluate a living trust agreement, and how that differs from developing an estate plan.
My team and I examine dozens of things when we evaluate a trust document. To give you an idea, a few of them are:
- Does the trust agreement confirm to third-parties that a married trustor/trustee has authority to act when his/her spouse cannot (if desired by client)?
- Does the trust agreement include provisions to alter distributions to a surviving spouse in the event of remarriage after the death of the first spouse?
- Does the trust agreement include a common trust provision when one or more of the primary beneficiaries has not yet graduated from college?
- Does the trust agreement give the trustee of a continuing trust an appropriate amount of flexibility to make disproportionate distributions based upon the relative needs of the beneficiaries?
- Does the trust agreement set up continuing trusts for the beneficiaries, which are tailored to the needs of each trust beneficiary?
Is there evidence that the trust is properly funded? An unfunded or partially funded revocable living trust does not avoid probate. Great care must be taken to ensure that all necessary assets held by the trustor individually are either retitled to the trust, or that the trust is considered as an appropriate “designated beneficiary.”
The difference between evaluation of a trust and creating an estate plan
In trust reviews, my intention is to provide you with an objective analysis of the document, and nothing more. Still, my review may be very beneficial to you because your estate plan will eventually be interpreted by attorneys and financial professionals that you do not know. So it is far better to identify ambiguities or omissions in your estate plan while you are alive and healthy than when you are not.
When I am hired for estate planning, I conduct an in-depth "discovery" process that includes:
Gathering personal and financial information
First I need to review your personal data and your financial information, and discuss a potential plan to meet your goals and objectives. I need to learn about your family and how the various members handle money. I understand that this is sensitive information, something not always easy to talk about. I am not shocked by any characters lurking in your family tree – we all have our fair share of them!
Discussing goals and values
You have built up a large estate, and you probably have very specific wishes that you want someone to carry out. Before I can recommend any course of action, we need to meet in person so that I can learn about you, your values, what you are trying to accomplish and, maybe most importantly, what you want to avoid. When I am creating a plan for both spouses, it is an absolute requirement that both spouses meet with me.
Focus areas in an estate planning engagement
Here are a few of the many questions I ask the first time we get together to discuss your estate plan. The following is not a complete list - it is a sampling:
- Did you have any prior marriages?
- Have you signed any pre- or post-marriage contracts?
- Do you have an “umbrella” liability insurance policy?
- If any children are under 18, have you decided who would be their guardians?
- Do you have any business interests?
- Do you wish to leave money or assets to charitable or religious causes?
- Are you concerned about providing for your grandchildren’s education?
- Do you wish to prevent anyone from receiving a portion of your estate?
- Do you wish to make any provisions in your estate plan for your pets?
The more I understand about your circumstances, the better I can educate you about your choices and guide you so that your family members won’t need to make stressful decisions in trying times. You will have the peace of mind of knowing that you have “done right” by your family.
All the best,
There is a grain of truth in every cliché and that is particularly true of these two:
- Money. . .You can’t take it with you; and
- It’s better to give than to receive
In the context of estate planning, I encourage all of my clients to consider these old adages. Whether you are extremely wealthy or only moderately so, it’s important that you enjoy the fruits of your labor while you are alive because after you are dead, you have absolutely no use for your money. And you certainly won’t be able to enjoy it from the grave.
The larger your estate, the more estate taxes your heirs pay
Now, you may be thinking about your heirs and the fact that you want to leave something for them to enjoy once you’ve passed on. That’s a common consideration for just about all of my clients. But here’s the kicker. The larger your estate, the more estate taxes and gift taxes your heirs will have to pay after you die. So, spending some of your money now will actually benefit your heirs by reducing their exposure to estate and gift taxes.
Gifts up to $13,000 per year are tax free
What if I told you there is a way to benefit your heirs and other loved ones now, before you die, and simultaneously reduce their exposure to estate and gift taxes? Well, there is and it’s by giving while you are still alive. Under current law, you can give any person up to $13,000 per year, without paying taxes. You can also give an additionl $1 million collectively to all of your heirs without taxes [assuming you’re a US citizen – if not, see my articles on international estate planning].
Let me illustrate. Suppose you have 3 chldren and 7 grandchildren. You can make annual gifts to them of $130,000 ($13,000 x 10). If they’re married, you can double that amount. Let’s assume you also decide to give them an additional one-time gift of $100,000 each ($100,000 x 10 = $1 million). You will have given them $1,130,000 without paying any taxes.
Assume that instead of giving them $1,130,000 that you die in 2011 with an estate worth that amount. Because of the way that the estate tax laws work, they will pay approximately $53,300 in estate taxes and receive only $1,076,700.
Think about it. . .if you leave your heirs $2 million dollars when you die, they will receive only $1,565,000 if the estate tax comes back as scheduled. So, it just makes sense to give as much as you can afford to give while you are alive. By giving now, you benefit your heirs while at the same time reducing your estate, thus reducing your heirs’ tax liability.
Gift tax rate expected to jump to maximum rate of 55%
In fact, I advise some of my clients to give more than $13,000 per year. Considering that the current gift tax is relatively low (35%), now is a perfect time to give more than you might ordinarily give and to simply pay the tax. Next year the gift tax is expected to jump to a maximum rate of 55%; therefore, it just makes sense from some clients to give more than $13,000.
GRAT facilitates asset transfers
In addition to making $13,000 gifts, you can use other estate planning techniques to reduce exposure to tax liability. One such technique is the grantor-retained annuity trust (GRAT). The GRAT allows you to transfer assets that you expect will appreciate in value into a trust and to receive periodic payments from the trust for a minimum of two years. Appreciation or gains in the assets placed in the trust go to the trust’s beneficiaries tax-free (caution: as they say in certain circles “some restrictions apply”)..
There is a strong possibility that the laws governing GRAT’s will soon change, making them far less beneficial for avoiding tax liability. If this speculation is correct, Congress may extend the minimum terms to ten years and make the distributions taxable.
Consider the intra-family loan option
Another option that I advise my clients to consider is the intra-family loan. The interest rate on intra-family loans is set by the government and currently stands at 0.53% for loans of three years or less. However, if the government believes that the “loan” is really a gift, it will be taxed as such if it exceeds the $13,000 limit. Therefore, it’s important to treat the loan as a loan by putting it in writing and requiring strict adherence to its terms including on-time payments and imposition of late fees when payments are not made on time.
If you are concerned about asset protection and reducing tax liability for yourself and your heirs, you need a qualified estate planning attorney in your corner who is also very well versed in the estate and gift tax laws – someone who is certified as a specialist in estate planning by the California State Bar Board of Legal Specialization and who has a Masters Degree (LLM) in Tax Law. I have both of those, and also 20 years of experience in estate planning for high net worth clients. I will review your assets and advise you of the best options to help you achieve your estate planning goals while minimizing your exposure to tax liability.
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The right move now can save you money in 2011 and beyond. Download our free Year-End Asset Protection Update for Bay Area Families to learn about options to consider before Dec. 31st.
All the best,
Innovative technique may eliminate a GRAT’s mortality risk
One of the most tax-efficient vehicles for transferring wealth to your family is a grantor retained annuity trust (GRAT). Plus it provides you, the grantor, with an income stream. But there’s a major drawback to this estate planning strategy: If you don’t survive the trust’s term, the assets are included in your estate and taxed as if you had never created the trust.
Over the last few years, a number of estate planners have begun using an innovative new technique — the guaranteed GRAT — in an effort to eliminate this mortality risk. This strategy is designed to let your family take advantage of a GRAT’s substantial tax benefits without worrying the benefits will be lost if you die unexpectedly.
Keep in mind, however, that guaranteed GRATs have not yet been accepted by the IRS or the courts. Before using this strategy, be sure to discuss the pros and cons with your estate planning advisor.
A GRAT is an irrevocable trust you fund with a one-time contribution of assets. The trust pays you an annuity for a specified number of years, and at the end of the term any remaining assets are transferred tax-free to your children or other beneficiaries.
The annuity can be a fixed percentage of the initial contribution’s value or a fixed dollar amount. You also may design it with predetermined increases. You must report the annuity payments on your individual income tax return.
Gift tax savings
A GRAT’s tax-saving power lies in its ability to minimize or eliminate gift tax. The present value of the heirs’ remainder interest in the trust assets is subject to gift tax. That value is determined using the Section 7520 interest rate, published monthly by the IRS.
The annuity amount can be designed to minimize the value of the remainder interest — or even eliminate it altogether (a so-called “zeroed-out GRAT”) — for gift tax purposes. Then any actual appreciation beyond the IRS’s “assumed rate of return” passes to the heirs tax-free. (See the sidebar “GRATs are great in a low interest rate environment” for an illustration.)
The key to reducing gift tax with a GRAT is to fund the trust with assets you expect to outperform the Sec. 7520 interest rate, such as real estate or securities with great appreciation potential. A GRAT also can be a viable strategy for transferring assets that are subject to valuation discounts, such as limited partnership interests or closely held business interests (especially if the company may be sold or go public in the future).
As discussed earlier, if you don’t outlive its term, assets remaining in the trust will be included in your taxable estate. To avoid this downside, consider creating a guaranteed GRAT. How?
First, you establish a GRAT and retain a contingent reversion interest, which means that if you don’t survive the term, the remaining trust assets will be paid to your estate. Shortly after you form the GRAT, you and your children enter into an agreement for them to purchase the equivalent of your contingent reversion interest at fair market value. Because the purchase price is set at the time you draft the GRAT, it should be only a fraction of the value of the assets your children ultimately receive.
If you die before the end of the trust’s term, the remaining assets are distributed to your estate, but under the purchase agreement, the estate is contractually obligated to pay an equal amount to your children. Even though the assets are included in your estate, the estate is entitled to an offsetting estate tax deduction for the amount it’s required to pay to the children. In effect, the children receive the remaining trust assets tax-free as if you had outlived the trust.
Properly structured, this strategy lets your family take advantage of a GRAT’s substantial tax benefits without worrying the benefits will be lost if you die unexpectedly.
A guaranteed GRAT can give you peace of mind that your family will be able to take advantage of your GRAT’s tax benefits if you die suddenly. But like any new estate planning technique, the guaranteed GRAT is relatively untested, so it’s important to consider potential risks of an IRS challenge. And keep in mind that traditional GRATs also are subject to complex rules and regulations, so careful planning is necessary.
GRATs are great in a low interest rate environment
Grantor retained annuity trusts (GRATs) can be especially attractive when interest rates are low. Let’s take a closer look at an example that illustrates why.
Susan, age 60, transfers $2 million in assets to a five-year GRAT that provides for five annual annuity payments of $449,000 (22.45% of the value of the initial contribution). At the end of the term, the remaining assets pass to Susan’s daughter, Caroline. Assume that the Section 7520 rate for the month the GRAT is established is 4%, and the actual rate of return on the assets is 10%.
Based on the assumptions, the gift tax value of the transfer is $65,484 even though nearly $500,000 is transferred to Caroline. The gift is potentially significantly less in light of a recent decision involving the Sam Walton family. It’s still too early, though, to rely on that decision. Please contact your professional advisor to help you determine how this decision may affect your estate plan.
Year-End 2010 Tax Law Update for Bay Area Families
Get a free 6-page PDF packed with year-end 2010 asset protection tips from Palo Alto estate tax attorney Janet Brewer.
All the best,