These are
interesting years in estate planning for families in the Upper Middle and Lower Upper Classes.
As a high estate
tax exemption has reduced the tax-driven imperatives for using trusts to hold
inheritances, non-tax applications of trusts come to the fore.
To answer these
questions, a family should do the best it can to look ahead to its future, and
make reasonable (but unavoidably imperfect) estimates of what its future might
look like.
That takes us
back to the Quadrant at the heart of a Life
Cycle approach to estate and financial planning, with its four domains of
Facts, Forecasts, Life Stages, and Unexpected Events.
The decision whether or not to use a trust to hold an inheritance begins
with a family’s Facts.
The array of
options includes the obvious, but thinking about the beneficiaries is the right
place to start.
Common potential
inheritors include a widow(er), a surviving spouse and children, adult
children, nieces or nephews, parents, siblings, and/or charities.
·
What will the trust’s funding level be?
Funding is a
tremendously important Fact underlying good trust design.
Funding often
occurs during estate administration, when probate and non-probate assets
(such as retirement accounts and life insurance proceeds) are gathered, and
transferred to the trust.
A quick review
of a family’s balance sheet will suggest the
anticipated potential funding level for a trust.
Funding is only
the first stage of a trust’s life cycle; the stage that follows is administration –
investing the trust’s assets and making distributions to its beneficiaries.
Designing a
trust well requires taking into account the Life Stages of the
beneficiaries during the trust’s term.
For instance, if
clients are a married couple with young children, the trust might need to
“financially parent” the children through primary and secondary school, and
then possibly college and graduate school.
In contrast, if
a married couple had adult children, the trust might be protecting assets for
those adult children to help boost the children’s retirement savings.
It might also be
protecting against claims of a child’s creditors, or against loss of assets to
divorce by preventing commingling a child’s inheritance with marital property.
The Life Stages
of a trust’s beneficiaries will suggest how long the trust should last, as well
as the “exit strategy” for trust assets – the distribution stage
of the trust’s life cycle.
Examples of
distribution options for trust assets include:
·
All at once. The trust might distribute
its remaining assets among beneficiaries when its youngest beneficiary attained
a specific age.
·
Stages – at ages. The trust might make
partial distributions when a beneficiary attained particular ages (such as 30,
35 ,and 40). This approach fits when clients believe maturity in financial
decision-making comes with increasing age.
·
Stages – at times. The trust might make partial
distributions at particular times (such as 5, 10, and 15 years after funding).
This approach fits when clients think good financial decisions come with
opportunities to learn through experience, or even by making poor choices about
the use of early distributions.
Another key
variable in deciding on the best distribution design for a trust requires a Forecast of
the remaining value of assets in the trust at the time of distribution, the
number of beneficiaries at the time of distribution, and – by extension – the
likely amount of distributions to each beneficiary.
One can consider plausible investment returns and the
likely costs of Life Stage events that will be funded with trust assets (for
instance, college, or a surviving spouse’s costs in retirement).
It’s important
to align Forecasts of a trust’s remaining assets with its distribution design.
If a trust would
be funded with $5 million and its pricipal purpose would be to pay for college
and graduate school for a couple’s sole child, an outright distribution of
remaining trust assets when the child attains age 25 may not be wise.
Similarly, if a
family has four children, none over age 10, and the trust would be funded with
$1.5 million, keeping remaining assets (after all the children are raised and
educated) in separate lifetime trusts for each child may be more complicated
than necessary.
Trust design
should also incorporate Unexpected Events – occurrences that
aren’t uncommon in the overall population, but tend to take any individual or
family by surprise (such as divorce, an illness, the birth of a special needs
child, or a spouse living much less than their life expectancy).
Examples of
planning for flexibility in the face of Unexpected Events include decanting, powers of appointment, and defining precisely who
may be a qualified trustee in various circumstances.
With these
variables in mind, it’s possible to evaluate on an individualized, case-by-case
basis whether and how a trust might be helpful – even in situtations not
dominated by estate tax issues.
Future posts
will explore some of these situations, which include:
·
Anticipating a spouse’s remarriage
·
Planning to conserve family assets when a surviving
spouse is very elderly
·
Protecting family assets against a child’s divorce
·
Using a trust as a substitute for a prenuptial
agreement
·
Defending against sons- or daughters-in-law who make
unwise business or spending decisions
·
An “asset protection wrapper” for a child’s
inheritance
·
Protecting a family’s core capital for grandchildren,
when children seem unlikely to make good financial decisions
·
Incentive trusts to encourage particular behaviors and
choices by descendants
For each of
these situations, when clients and their advisors thoughtfully consider Facts,
Forecasts, Life Stages, and Unexpected Events, they’ll likely reach better
estate and financial planning outcomes.
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