23 March 2018
The Following Article Appeared in the May/June 2009 Issue of Private Wealth Magazine
Every family has complicated dynamics, but when significant wealth is added to the mix, things can get particularly difficult. Planning for the modern-day family involves a myriad of sometimes sensitive issues. From the child who struggles with substance abuse issues to the “black sheep” daugh ter-in-law, each family member has a different set of circumstances that need to be addressed in the planning process. Planning for todays wealthy families requires the advisors to be well versed in a number of different planning options that will provide flexibility, protection and the opportunity to preserve and increase wealth over multiple generations. What follows is an examination of the issues and tools advisors should consider when addressing the needs of their client family.
Qualified Terminable Interest Property (QTIP) trusts are a key planning component for many married couples. QTIP planning is particularly effective in dealing with the spouses and children of first and second marriages. If, for example, a wife wants to set up a trust to support her husband and ensure that, upon his death, the __ remaining assets go to the children of a prior marriage, a QTIP trust may be appropriate.
QTIP trusts are also effective in the case of a first marriage not involving any stepchildren. A QTIP trust can provide financial support to the surviving spouse while insulating those assets from the reach of a future spouse, should the surviving spouse remariy. A QTIP trust can provide generous, minimal or no discretionary distributions to the surviving spouse. The trust, however, must provide mandatory distributions of net income to the spouse at least annually to defer estate taxes until the surviving spouse’s death.
Lifetime QTIP Trust
A lifetime QTIP trust is useful for providing enough assets to fully utilize the estate tax exemption in cases where a less wealthy spouse dies first. In 2009, U.S. law allows $3.5 million of assets to pass to non-spousal beneficiaries free of federal estate taxes. A married couple can avoid the confiscatory 45% federal estate tax on up to $7 million of assets if they each are deemed to “own” $3.5 million of assets. A transfer of assets into a lifetime QTIP trust will allow the funding of the spouse’s estate tax exemption amount and ensure the ultimate disposition of the trust assets upon the spouse’s death. The lifetime QTIP trust has yet another benefit: If the beneficiary spouse dies first, the individual establishing the trust can retain an income interest in the lifetime QTIP trust for the balance of his or her life without causing those assets to be taxed in the estate.
To address the possibility that a spouse (including a beneficiary’s spouse) may be different at the time of the creation of a trust than in the future, the use of a “floating spouse” definition in a trust can be a valuable tool. This type of definition can provide that a spouse will only be a beneficiary of the trust if he or she is married to and living with a specified beneficiary. If they divorce, the definition automatically will exclude that spouse from any further interests in the trust. This is especially important for irrevocable trust planning, where amending the trust after it is created is not an option.
Limited Powers Of Appointment
Under a typical trust arrangement, a trust will contain a “default” disposition that will generally provide for distribution equally to the individual’s descendants in the absence of the exercise of a limited power of appointment by the beneficiary. The limited power of appointment can be provided in a “testamentary” format to be effective at the death of the beneficiary exercisable through his or her will, or in a “lifetime” or “inter vivos” format which can be exercised by the beneficiary during his or her lifetime. While the power of appointment in most cases will be created to be a “limited power” so as to ensure that the trust assets are not included in the power holder’s taxable estate, limited powers of appointment can be drafted to be very broad or very narrow.
Multi Generational Trusts
Many estate planners are advocates of structuring “two-generation” trusts that typically provide for assets to pass from the first generation (“Gl”) to the second generation (“G2”), perhaps in some sort of limited trust format that may make partial outright distributions at certain ages. This type of planning may be sufficient for smaller estates in which the value of the assets that are ultimately passed to G2, after the payment of estate taxes, may be, for example, $5 million or less, where it may be simpler to just distribute the assets to the children in G2. However, it may not be the most efficient planning from a transfer tax and wealth preservation standpoint when advising families with larger wealth.
Remove And Replace Powers
A multi generational trust structure holds trust assets for the beneficiary’s lifetime rather than distributing the assets to the beneficiary. While there are clearly several benefits to holding assets in a flexible trust for the beneficiary’s lifetime, there are some potential burdens that should be considered and addressed. For instance, perhaps a beneficiary and the appointed trustee may not agree on certain issues. Mechanisms should be included in a trust arrangement to resolve such conflicts. One approach is to provide each beneficiary with a “remove and replace power,” which would allow the beneficiary to fire the existing trustee and to hire a new individual or corporate trustee.
Beneficiary As Co-Trustee
In order to provide that the beneficiary has some input in the administration of the trust, a beneficiary can be named as a co-trustee to make certain investment decisions with the independent trustee. The beneficiary co-trustee should not have any ability to make decisions with respect to the distribution of trust assets in order to ensure that the trust assets will not be taxable in the beneficiary’s estate, or subject to creditor’s claims. If the creator of the trust wants the beneficiary to participate in distribution decisions, the beneficiary could be given the right to make distributions to himself subject to an “ascertainable standard” for the beneficiary’s health, education, maintenance or support. Such an ascertainable standard may not be desirable, however, as it may forfeit some of the asset protection features provided by the multi-generational trust structure.
“Decanting” provisions can enable the trustee to effectively amend certain provisions of a trust (even if the trust is irrevocable) by decanting or transferring trust assets from an existing trust into a new trust created by the trustees. There are critical tax provisions that need to be analyzed prior to decanting any trust to ensure that the generation-skipping tax status of the trust is not disrupted. Nonetheless, these decanting provisions can provide significant flexibility to the trustee to adapt to the current needs of the beneficiaries.
Power To Add or Remove Beneficiaries
An irrevocable trust can be drafted to provide the trustee with the ability to add or remove beneficiaries. Given the complex and changing dynamics of wealthy families today, this can be a very effective way to rewrite a trust agreement without jeopardizing the status of the trust from a transfer tax perspective. It is important to note, however, that the existence of this power will cause the trust to be a grantor trust for income tax purposes.
Incentive Trusts And Letters Of Wishes
If an individual feels strongly that he or she would like to promote certain behavior by trust beneficiaries, the individual may consider an “incentive trust” or a “letter of wishes” as part of the planning process. A letter of wishes is a document in which an individual expresses to the trustee his or her philosophy about making distributions from a trust. The letter, while not legally binding on the trustee, provides a general set of guidelines to aid the trustee in the management of the trust and determining the course of action that would be consistent with an individual grantor’s intentions.
In contrast to a letter of wishes, an incentive trust contains standards that are generally legally binding on a trustee. An incentive trust is designed to mandate distributions to beneficiaries, but only if the beneficiaries meet certain criteria established in the trust. Specificity is the key to an incentive trust. For example, an individual could create an incentive trust to encourage his or her children to work hard, by directing a matching distribution from the trust for every dollar the child earns.
Planning for Same-Sex Couples
Federal tax law does not recognize the marital deduction for estate or gift tax purposes for same-sex couples, so that a transfer by gift or at death from one partner to the other will be fully subject to the estate or gift tax just as if the transfer was made to any other non-spouse individual. In contrast, an unlimited amount may be transferred between U.S. citizen spouses of an opposite sex marriage without triggering gift or estate taxes. This certainly continues to put same-sex couples on an uneven playing field when compared to a husband and wife with respect to estate and gift tax treatment.
There are, however, some ways in which same-sex couples can make other arrangements to address estate issues. For instance, life insurance trusts can be created for the benefit of the surviving partner funded with life insurance policies that are outside of the estate of the deceased partner. The death benefit payable to the life insurance trust on an estate tax free basis could be used to effectively replace the assets that are payable to the IRS, as well as state taxing authorities, as a result of the death of a partner. While this may be more costly than simply having bequests to a spouse qualify for the marital deduction, it is a relatively straightforward way to address the estate tax liability.
Because all families are different, and ever changing over the years, family advi sors must honestly consider the unique aspects of the families they work with, and show the forethought to provide flexibility in their planning to deal with family circumstances as they may change.