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,
When planning your estate, your primary objective is probably to pass on as much wealth to your heirs as possible. And if you’re like most people, you want to reduce or eliminate estate taxes as well.
But litigation, divorce, malpractice and other potential claims may damage your net worth more than taxes. So protecting assets from potential claims has become an additional planning objective. Fortunately, many of the same techniques you can use to reduce estate taxes also can provide creditor protection.
You can use many techniques to reduce your estate for tax purposes while also protecting your assets from creditors. Yet these measures won’t protect against existing creditors if a transfer constitutes a “fraudulent conveyance” under the Uniform Fraudulent Transfer Act. A fraudulent conveyance occurs if you had actual intent to hinder, delay or defraud a creditor when you made the transfer.
Here are seven ways to safely protect transferred assets from creditors:
1. Outright gifts. An outright gift protects a transferred asset from creditors. But you’ll lose all economic interest in and control over the asset
2. Family limited partnerships (FLPs). An FLP is an excellent asset-protection device because it limits a limited partner’s creditor’s ability to attach partnership assets to satisfy a debt. Creditors generally can obtain a charging order only against a limited partner’s interest in a partnership. A charging order would permit a creditor to receive distributions only when they’re made from the partnership, and the general partner could choose not to make distributions. The creditor could even end up with taxable income without any cash distributions.
3. Irrevocable life insurance trusts (ILITs). From the standpoint of protecting your assets, an ILIT removes insurance proceeds from your estate for federal estate tax purposes. And the trust protects from creditors the cash value of the policies during your lifetime and the policy proceeds when you die.
4. Qualified personal residence trusts (QPRTs). A QPRT lets you transfer a primary or vacation residence to a trust while you reserve the right to live in the home for a term of years. The value of the interest you retain (that is, the right to live in the house for a term of years) is calculated using IRS tables. The value of the property transferred into trust, minus your term interest’s value, is a gift known as the “remainder interest.” This gift can be sheltered from gift tax by your $1 million gift tax exemption. If you survive the term of years, the trust is not included in your estate for federal estate tax purposes. (QPRTs provide creditor protection by insulating the residence from your creditors’ claims. In a creditor protection situation, the nondebtor spouse should create the QPRT and retain the term interest.)
5. Inter vivos qualified terminable interest property (QTIP) trusts. You create this trust during your lifetime for your spouse. It qualifies for the gift tax marital deduction. The federal estate tax benefit to this technique is that when your spouse dies, the QTIP trust is included in his or her estate for federal estate tax purposes. If your spouse lacks sufficient assets in his or her own name to use his or her federal estate tax exemption, the QTIP assets will achieve this.
If you survive your spouse, an amount of assets equal to the estate tax exemption (currently $1.5 million) will first go to fund a family trust created under the QTIP trust for your benefit. The balance of the QTIP trust assets will be allocated to the marital trust for your benefit and will qualify for the marital deduction, resulting in no federal estate tax at your spouse’s death.
By structuring the QTIP trust this way, the assets allocated to the family trust when your spouse dies will escape estate tax. That is, the assets allocated to the family trust don’t qualify for the estate tax marital deduction, but your spouse’s estate tax exemption “shelters” them from estate tax. They also won’t be subject to federal estate tax when you die, because assets allocated to a family trust — including their appreciation — for a surviving spouse’s benefit aren’t part of the surviving spouse’s estate for federal estate tax purposes.
The inter vivos QTIP trust is extremely popular as a creditor protection device because the QTIP assets are completely insulated from claims of your creditors and your spouse’s creditors during your spouse’s lifetime.
6. Charitable remainder trusts (CRTs). A CRT usually provides for distribution of a percentage of the trust principal, at least annually, to a person, usually the grantor, for his or her lifetime. The CRT can provide that when the grantor dies, the grantor’s spouse shall become the CRT annuitant for his or her lifetime. When this period ends, the charity receives the remaining CRT assets (the “remainder interest”).
Creating a CRT provides several income tax benefits. For example, the grantor can deduct the remainder interest’s value (the interest passing to the charity) as determined at the CRT’s inception by consulting IRS tables.
An additional benefit is that the CRT is exempt from all income tax. So a grantor owning assets subject to a large capital gain can transfer these assets to the trust, and it can sell them without the grantor or the trust having to pay any tax on the gain. Or a grantor holding highly appreciated assets that aren’t producing much income can contribute them to the CRT and create an income stream and owe tax only as annuity payments are received. It sells them and reinvests the proceeds to service the annuity.
A nondebtor-spouse-created CRT protects assets from a debtor spouse’s creditors. A creditor can’t attach the principal because of the charitable interest. And a debtor spouse’s creditors can’t attach the nondebtor spouse’s annuity payments. If the nondebtor spouse dies first — and the CRT provides that the debtor spouse becomes the annuitant — the debtor spouse’s creditors could attach the annuity when distributed to him or her.
7. Grantor retained annuity trusts (GRATs). A GRAT is a gift of a remainder interest in an irrevocable trust, under which the grantor has retained an annuity interest for a term of years. For example, if $500,000 is transferred to a GRAT and the grantor has retained a 6% annuity, $30,000 per year will be distributed to the grantor. The remainder interest in the GRAT can be a trust for the grantor’s spouse, with trusts being created for children when both spouses die.
The value of the gift to a GRAT for gift tax purposes is the value of the property transferred to it, less the value of the grantor’s retained annuity interest. The value of the annuity is calculated according to IRS tables.
If the grantor survives the GRAT’s term, its assets will be excluded from the grantor’s estate for federal estate tax purposes. If the grantor dies during the term, some of the assets will be included in the grantor’s estate for federal estate-tax purposes.
If a nondebtor spouse is the grantor of a GRAT, the debtor spouse’s creditors can’t attach the annuity distributions to the nondebtor spouse. These creditors also can’t attach the GRAT principal. If a debtor spouse becomes a GRAT beneficiary when the nondebtor spouse dies, his or her creditors could attach any distributions to the debtor spouse.
These are just a few of the ways proper estate planning can also safeguard your assets from creditors. And in a society rife with litigation, you simply can’t underestimate the importance of protecting yourself. Learn all you can about these measures and others that may benefit you.
All the best,