Stand-Alone Retirement Plan Trusts

Dear Clients and Friends,

IRA’s, and in particular inherited IRA’s, represent one of the greatest sources of family wealth, yet many clients and estate planners are not aware of the significant benefits of utilizing Stand-Alone Retirement Plan Trusts, sometimes referred to as Stand-Alone IRA Beneficiary Trusts.

Who should read this letter? Owners of substantial IRA’s or benefits under retirement plans that permit a stretch-out of benefits.

What is a Stand-Alone Retirement Plan Trust? A trust document established by an IRA owner or participant in a qualified retirement plan. It is separate from the IRA agreement and the beneficiary designation form. The trust is a revocable standby trust which is not funded during the IRA owner’s lifetime but becomes the beneficiary of the IRA or qualified plan benefits upon the death of the IRA or plan owner or the death of the owner’s spouse, whichever is later.

What’s at Stake?

  1. Protection of children and grandchildren from divorced spouses and creditors.
  2. Providing for maximum stretch-out of benefits for maximum income tax deferral and wealth accumulation.

Why is Protection Necessary? In 2014, the U.S. Supreme Court ruled in Clark v. Rameker that inherited IRA’s are not protected by federal bankruptcy law. The effect of this ruling is to allow bankruptcy creditors to attach inherited IRA’s. Some states, including Massachusetts and Florida, have adopted laws that protect inherited IRA’s from creditors, but these state laws cannot be relied upon as beneficiaries often move from state to state and may live in a state where there is no exemption. If the IRA owner or qualified plan participant desires to protect the account for their children and grandchildren after their death, a trust should be part of the plan.

Separate trust shares can be established for each beneficiary and the beneficiaries can be a Trustee or Cotrustee of their shares and have significant control so that trust property will be available for their benefit when needed. These trusts can be structured as beneficiary controlled multigenerational trusts and be excluded from the taxable estates of the children and grandchildren and protected from their divorced spouses and creditors.

Why is an Accumulation Trust Beneficial?  In drafting a trust for a beneficiary, the IRA owner or plan beneficiary has two options (if authorized by the trust instrument): permit the beneficiary to select a “conduit trust” or an “accumulation trust”.

In a conduit trust, the required minimum distribution (“RMD”) is distributed from the plan to the trust and the trust is required to distribute the RMD to the beneficiary. The Trustee has no power to accumulate or hold the RMDs. The trust is protecting the underlying plan but not the RMDs for which it is merely a pass through or conduit to the beneficiary. Thus, a conduit trust is not the best tool for asset protection as the distributions when received by the beneficiary may be reached by former spouses and creditors.

An accumulation trust, however, offers much better creditor protection. In an accumulation trust, the plan distributes the RMD to the trust but the trust is not required to distribute the RMD to the beneficiary. Rather, the distributions may be retained and accumulated in the trust and be available for distribution to the beneficiary when needed. The RMDs can be retained in the accumulation trust and be protected.

In order for the trust to qualify as an accumulation trust, specific issues need to be dealt with in the trust drafting: identifiable separate trust shares must be established and linked specifically to beneficiary designations under the plan; a mechanism (such as an authorized Trust Protector) has to be included in the trust to prohibit trust distributions to persons significantly older than the trust beneficiary whose life expectancy is to be used for calculating RMDs; and other technical provisions should be included.

Living Trust vs. Stand-Alone Retirement Plan Trust. Since maximum stretch-out of benefits is desired, naming the living trust as the beneficiary of an IRA or retirement plan may create substantial uncertainty as to whose life expectancies will control the RMDs. Unless the living trust is coordinated with a division detailed in the IRA beneficiary designation form, the beneficiaries will all be required to use the life expectancy of the oldest beneficiary of the living trust, or possibly a five-year period, depending on the living trust terms.

Also, an accumulation trust is difficult to draft in a living trust since a mechanism is necessary to remove contingent beneficiaries whose life expectancy would shorten the term of the payout and such removal is usually inconsistent with the IRA or plan owner’s objectives for the disposition of assets not in the IRA or plan.

Recommendation: For owners of substantial IRA’s or retirement plan benefits, strong consideration should be given to establishing a Stand-Alone Retirement Plan Trust granting beneficiaries the option to establish accumulation trusts and retain all or part of the RMDs in such trusts thereby building wealth in a vehicle that is creditor protected for beneficiaries and their descendants.

The Importance of Updating Your Estate Plan

What steps should I take to update my estate plan?

Creating an estate plan is only the first part of the estate planning process.  It clarifies your wishes and provides for those you love. However, because your life and the lives of those around you are constantly evolving, we recommend that you review your estate plan at least every five years. Circumstances that may require you to alter your original estate plan include: marriages, divorces, births, illnesses, deaths, and buying or selling of real estate or businesses. There may also be more subtle changes in relationship or status that influence your decisions about how you want to distribute your assets.

What should you consider when reviewing your estate plan?

There are several things to take into consideration when you look over your existing estate plan. These include

  • Has the value of your assets changed considerably?
  • Have you moved to a different state or purchased real estate in another state?
  • Are there any new health issues for you or your family? Have any special needs arisen?
  • Are your named fiduciaries, such as trustees or health care agents, still appropriate choices?

Which documents should you review?

While you’re reviewing your overall estate plan, it is a good idea to review your existing estate planning documents as well.  The documents that you should review include: your will, power of attorney, living will, healthcare proxy, and trust. Because life events may alter your views, it is important to have your latest wishes reflected in your estate planning documents.

Don’t Overlook Your Insurance Coverage

Life insurance is one way to pass income tax-free assets to your heirs. It may also be a critical aspect of sustaining family members who depend on your income. As you review your life insurance, it is critical to take note of any changes in the circumstances of your beneficiaries. Have they married, divorced, had a child, become independent, lost a job, become ill, retired? These factors may affect how much life insurance you should be maintaining.  Because life insurance proceeds are taxable for estate tax purposes, you should also discuss with your lawyer whether or not an irrevocable life insurance trust is advisable.  An ILIT is a strategy to avoid taxes on insurance proceeds.

Minimizing Your Taxes

It is usually wise to incorporate a trust into your estate plan to reduce exposure to federal or state estate tax.  A trust will also make managing your assets much easier if you become incapacitated and save your heirs the complications and expenses of probate after your death.

Keeping Life Insurance Out of Your Taxable Estate

How can you use life insurance trusts to minimize estate taxes on the proceeds of life insurance policies?

Life insurance can be an effective way to leave a large sum of money to a loved one free of  income tax. But mistakes may prevent beneficiaries from reaping the full advantages as well as create adverse estate tax consequences.

For example, if the life insurance is payable to your estate, rather than to a specific person, it may be subject to probate which can be a lengthy process. The beneficiaries of your estate may  have to wait up to one year to receive their share of the death benefits from your life insurance policy. Even if you name a beneficiary, the proceeds from your life insurance policy are included in your taxable estate. When combined with your financial assets, the value of your home, and other assets, the proceeds from your life insurance policy could increase the value of your estate substantially, thus resulting in an estate tax.

Create a Life Insurance Trust

If a life insurance policy is owned and payable to an irrevocable trust, the proceeds of the life insurance policy will not be considered part of your taxable estate and the proceeds are not considered taxable income. A transfer to a trust has other advantages. You can name the persons you want to serve as trustees who will manage the investment of the proceeds. You can also set forth the distribution terms for the beneficiaries which is particularly important for minor and disabled beneficiaries. You can also provide for the trust to pay the insurance premiums.

The transfer of a life insurance policy to an irrevocable trust is subject to the “three-year” rule, which requires that the transfer to the trust occurs at least three years prior to your death.

If you wish to keep life insurance proceeds out of your taxable estate, a qualified estate planning attorney can help you design and implement an irrevocable trust.

Sometimes Seemingly Simple Estate Planning Ideas Add Complexity and Confusion

Why is giving title of your assets to your children not a good idea?

Contemplating one’s own death is never easy, so we often look to simplify the estate administration process. Unfortunately, unless we do this with the assistance of a competent estate planning attorney, we are likely to create additional issues.

Adding your children to the title of your assets, so that they already have possession of your assets if you become incapacitated or die, may seem appealing. The idea here is that, once you put your child’s name on your home, bank accounts, vehicles or any other titled assets, that property avoids probate when you die and passes directly to your child.  In addition, your child is able to manage these assets if you become physically or mentally incapable of doing so.

Your intention is to make for a smoother transition if you are incapable of managing your own affairs or when you die. You fully expect that the child to whom you give this responsibility will share the remaining property with his or her siblings when the time comes.

There are two major problems with this line of reasoning. One is that, by putting your child in co-control of your assets, you make those assets vulnerable to his or her actions. The other is that the arrangement may not be carried out as you wish and may provoke family disputes after you die.

Your Assets Become Vulnerable

If the child that you added to the title of your assets gets into legal difficulty of any kind (causing vehicular damage or personal injury, being on the wrong end of a lawsuit, getting arrested, getting divorced), your property is in jeopardy. Because all of your assets belong to your child as well, they can be used to settle any judgment against him or her.

Your Wishes May Not Be Carried Out and You May Inadvertently Cause Family Conflicts

Typically, when you add a child to the title of your assets, you choose the child who has the easiest access to your affairs, usually the child who lives closest to you. Even though, in this scenario, you make it clear to all of your children that this decision is being made for convenience, and that you intend for all your children to inherit equally after you die, this may not happen.  Legally as a co-owner of your assets, upon your passing, the child is entitled to 100% of the assets.   That child has no legal responsibility to split the assets with his or her siblings.

All too often, the child who is given title to the assets is also the child who assists you during your declining years. This child is frequently the one who shepherds you to doctor appointments, on shopping expeditions and social visits, and also arranges for, or performs, household cleaning, banking, bill paying, and so on. For this reason, when it comes to dividing up the assets after you pass away, this child may feel entitled to the lion’s share of the assets and be unwilling to share equally with his or her siblings resulting in family conflicts.

The way to avoid both of these pitfalls is to create a living trust with the accessible child named as co-trustee or successor trustee. This allows that child to step in and take control when you become incapacitated, but avoids the problem of co-ownership. With the living trust in place, the designated child would not own the assets in question, so they could not be attached in case of any lawsuit or financial difficulty of the child. In addition, at the time of the parent’s death, the designated child would have to distribute the remaining assets according to the instructions the parent has written into his or her living trust. It would not be possible for the child who is named as trustee of the living trust to change the terms of the living trust or the beneficiaries.

This being said, it is wise for the parent to take into account the extra burden put on one child during the parent’s declining years, since, if this is not done, family disputes and hard feelings may still surface. It is often wise to provide the caretaking child with an allowance while you are still alive to pay for groceries, gas, car maintenance and other additional expenses they incur.

2018 U.S. Tax Reform is Here: What You Need to Know About Estate Planning Implications

In December 2017, Congress passed the Tax Cuts and Jobs Act that changes significantly tax planning for corporations, small businesses and individual creating unprecedented planning opportunities for both individual and business clients.

This memo focuses on some of the estate planning implications:

Gift Planning

The doubling of the estate, gift and generation-skipping tax (“GST”) exemptions means that, beginning in 2018, taxpayers can transfer up to $11.2 million of assets without transfer tax consequences. Between January 1, 2018 and the sunset of the increased exemptions on December 31, 2025, clients have the opportunity to remove assets from their estates and exempt future appreciation from taxation.

Whether a client should make taxable gifts depends on many factors, including the effect of state-level estate taxes and the tax basis of the property to be gifted. If the client is considering gifts for non-tax reasons (such as asset protection), the increased exemption amount may be enough to tip the scales in favor of a lifetime gift. This is especially true if the client has a gross estate significantly above the exemption amount.

Spousal Lifetime Access Trusts

Some clients who would otherwise make gifts to irrevocable trusts for tax planning purposes may be reluctant to do so because of the loss of control. These clients may be concerned that lifetime gifts will deplete their funds to such an extent that they can no longer support their current and future lifestyle. For married clients, these concerns can be alleviated with a spousal lifetime access trust (SLAT).

A SLAT allows one spouse (donor spouse) to make a gift to a non-reciprocal, irrevocable trust that names the donor spouse’s spouse (beneficiary spouse) as a lifetime beneficiary of the trust. The beneficiary spouse or the couple’s children may serve as the trustee if his or her discretion to make distribution of trust assets is limited by an ascertainable standard. The gift constitutes a completed gift to remove the asset from the donor spouse’s estate, but ensures that the donor spouse will still have access to trust assets through the beneficiary spouse as long as the couple remains married to each other. The SLAT may also give the beneficiary spouse a limited (but not a general) power of appointment to distribute assets among the couple’s children after the beneficiary spouse’s death.

Clients should evaluate whether to establish SLATs (or make transfers to existing SLATs) before the increased exemption amounts expire. As long as the gifts to the trust are below the increased exemption amount, a transfer to a SLAT may offer increased protection against future changes to the tax laws with little downside risk.

Opportunities for GST Planning

The increased exemption amounts also create opportunities for GST tax planning. For example, grandparents can combine lifetime gifting with GST tax planning and make lifetime gifts directly to their grandchildren (skip persons) instead of their children. This would be particularly beneficial in light of the December 31, 2025, sunset of the increased exemption amounts because it will allow an additional $5 million of assets (twice the current exemption amount) to escape estate taxation at the children’s death, by which time the exemption amounts may have reverted back to the 2017 levels.

Instead of making outright gifts to skip persons, clients can also establish a GST trust and allocate the increased exemption amount to such trust, which may render it fully exempt from GST tax even when the increased exemption sunsets. For clients with existing trusts to which no GST tax exemption was allocated, 2018 (until the sunset) may be the time to make a late allocation. For clients with existing GST tax exempt and non-exempt trusts, the period of increased exemption could be the ideal time to make distributions out of the non-exempt trusts either directly to skip person beneficiaries or to a GST tax exempt trust.

Assuming there is no clawback of any or all of the doubled exemption amount, a proper allocation to a trust of the increased GST exemption amount should render the trust fully exempt from GST tax for the duration of its term, even after the reversion of the exemption amount back to the 2017 level. It is important to remember that there is no portability of the GST exemption, so each person must use his or her exemption either during lifetime or on death. Otherwise it is lost.

Domestic Asset Protection Trusts and Hybrid Domestic Asset Protection Trusts

Now may be the best time in a client’s life to contribute to self-settled domestic asset protection trusts (DAPTs). This is especially true for unmarried clients that cannot use the SLAT strategy described above. There are various ways that DAPTs can be designed with built-in flexibility, such as by naming a trust protector or non-fiduciary with authority to add the grantor back as a trustee at a later time (hybrid DAPT). Establishing and funding a DAPT not only removes assets (including future appreciation) from the estate, but also provides ongoing asset protection for the term of the trust.

Review and Revision of Prior Estate Plans

All clients that have previously engaged in tax planning should revisit their estate plans, including the dispositive provisions of all testamentary and non-testamentary trusts. These plans should be evaluated for tax purposes, but—perhaps just as importantly—for non-tax purposes. For example, many estate plans make bequests equal to the federal estate tax exemption amount. Clients that may have been comfortable with a $5 million bequest may not be comfortable with a $10 million bequest, and with the built-in expiration of the increased exemption already in place, clients should consider the effect of another change in 2026.

Power of Appointment Planning

Depending on the circumstances, clients should also consider giving older, trusted relatives a general power of appointment for basis step-up purposes. Giving an elderly relative a general power of appointment over a trust can result in a basis step-up for the trust assets on the death of the elderly relative. If clients have considered this strategy but have been reluctant to move forward because of the size of the elderly relative’s own estate, those concerns may be alleviated—at least in the short term—by the increased exemption amounts.

Building Flexibility into Plans

Given the scheduled sunset of the increased estate, gift, and GST tax exemptions and the possibility that changes in Congress and the White House will change the tax laws, flexibility is more important than ever for clients with potentially taxable estates. For example, in appropriate cases trusts should include powers of appointment that allow trust assets to be re-vested in the grantor to obtain a basis step-up. Trust protectors, formula powers of appointment, and other strategies designed to future-proof planning strategies should be considered.

Recent Death of Prince Shows the Need for Thoughtful Estate Planning

The death of the renowned musician Prince at age 57 shocked the world. It also brought into focus for many of us the need for us to be mindful about our own estate planning. Not only was Prince’s death untimely and unexpected, it was the death of a celebrity with a substantial estate who died without a will.

The Ubiquitous Need for Estate Planning

Though most of us would assume that Prince, with all of his wealth and status, would have sought sound financial advice and proper estate planning, his situation is not as uncommon as it may seem. A recent survey by Rocket Lawyer showed that a whopping 64 percent of Americans don’t have wills.

His passing reminded us that it is not only the retired or elderly who should plan for the disposition of their assets after they’re gone. Some of us may still believe that wills are only essential if one has a sizable estate. This is not the case, however. Dying intestate (without a will) creates difficulties for those you leave behind, regardless of the size of your estate.

Where will Prince’s money go?

Because Prince’s parents were already deceased at the time of his death, and because Prince himself was unmarried and without children, his estimated $300 million estate will be divided among his closest relatives, one full sister and many half-siblings. His full sister has filed court documents to probate his estate and administer the distribution of his assets. Apparently, Prince did not have a good relationship with all of his half-siblings, but since he left no will, and according to law, they all stand to inherit considerable money.

Proper Estate Planning While You’re Thinking of It

No matter what your age, as long as you have accumulated assets, you should meet with an experienced estate planning attorney to ensure that your affairs are in order. The  following are some examples of estate planning documents that you may wish to incorporate into your plan to ensure that your wishes are carried out:

  • Durable power of attorney naming someone to make financial decisions if you become incapacitated
  • Health Care Proxy, Living Will, or Advance Healthcare Directive naming someone to make health care decisions if you become incapacitated and setting forth your wishes
  • Last Will and Testament stating how you would like your assets distributed and also designating a guardian for any children under the age of 18
  • Living Trust to avoid court involvement (probate) and setting forth the distribution terms for the beneficiaries at your death
  • Beneficiary forms to indicate who will receive your 401(k)s, IRAs, life insurance, etc.
  • POD (payable on death) forms to indicate who will receive your bank accounts

Because not only death, but other changes, are inevitable and unpredictable, it is essential that your estate plan includes changes in your circumstances — such as marriage or divorce, births or deaths in the family, etc. Don’t forget that events that occur in your children’s, siblings’, or parents’ lives may also affect your estate plan.

In order to ensure that all your estate is in order, that you have considered all your options, and that the arrangements you make are legally binding and financially sound, you should consult with an experienced estate planning attorney.

Why is estate planning for your business so important?

If you are a business owner, you are probably overwhelmed as it is. You might feel you are too busy to think about what will happen to your business when you die. So, you push these thoughts out of your mind and resolve to consider it when you have more time. However, putting off estate planning for your business can seriously reduce your business’ worth, prevent your wishes from being carried out and even cause the business you worked so hard to develop to close it’s doors.

There are a lot of ways proper estate planning can help your business.  Here are a few:

If you die without an estate plan for your business, it will pass to your heirs as determined under the laws of intestacy.  Proper estate planning can help prevent your business from falling into the hands of unintended or inexperienced beneficiaries and allow it to remain in the hands of the person you have chosen.

Estate planning also allows you to keep the particulars of your business intact and ensure that your business runs the way you envisioned it for years to come. You don’t want anything to change the brand you have worked so hard to create and business principals you believe so much in.

Estate planning for your business can also minimize the taxes that may be due upon your death. Without proper planning, if you have assets in excess of $5.45 million dollars federally and $1 million dollars in Massachusetts, your estate would owe substantial estate taxes.  Proper planning, such as the use of a trust, can help you reduce and possibly avoid these taxes.

Estate planning for your business also gives you peace of mind. You know that anything can happen at any time. If you have planned, your business will continue without interruption should something happen to you.

If you are a business owner, you should speak with an estate planning attorney about your business as soon as possible.

CLIENT ADVISORY October, 2015 – Trust for Child included in Child’s Marital Estate in a Divorce

Dear Clients and Friends:

On August 27, 2015, the Massachusetts Appeals Court ruled that a husband’s interest in a lifetime trust can be included in the marital estate and be subject to division in a divorce proceeding.  The case, Pfannenstiehl v. Pfannenstiehl, has significant ramifications for those clients seeking to protect their children’s inheritances from divorces.

In the case, the husband was the beneficiary of a lifetime trust established by his father that gave the trustees the discretion to make distributions to the husband based on an ascertainable standard of comfortable support, health, maintenance, welfare and education.  For four years the trustee made significant distributions to the husband based upon such standard of payment until just before the divorce was filed.  The Appeals Court held that the ascertainable distribution standard obligated the trustees to distribute trust assets to the husband to satisfy his needs and that the distributions he received were part of the “husband income stream.”  On such basis, the Appeals Court ruled that the husband’s trust interest is part of the marital estate and subject to division with his wife in his divorce despite the existence of a spendthrift provision in the trust and despite the fact that there were other beneficiaries of the same trust.    Importantly, the court distinguished the case from those cases involving a wholly discretionary trust with no ascertainable distribution standard.  The court has ruled that wholly discretionary trusts with no standard are not included in the marital estate in a divorce.

While this issue will be appealed, it underscores the importance of establishing lifetime wholly discretionary trusts for children and grandchildren when clients wish to protect gifts and inheritances they make to children and grandchildren from divorces.  Since 2009, in those estate plans where our clients have chosen to implement multigenerational lifetime trusts for children and descendants, we have included wholly discretionary distribution provisions for each trust share.  If you have questions about whether your existing plan contains wholly discretionary lifetime trusts for your children or if you would like to learn more about this planning, please contact us.