Retirement and Estate Planning

Revocable Living Trusts

A revocable living trust is a method to manage and distribute property. Like a will, the trust is "revocable," meaning that it can be modified or eliminated at any time.

These trusts are established by a written agreement or declaration that names a "trustee" to administer the property. It also gives detailed instructions on how the property is to be managed and eventually distributed. If clients want the trust to substitute for probate (court administration of property after death) or for guardianship (court administration after incapacity), they must give the trustee detailed instructions about how to handle these situations. Furthermore, they will have to legally transfer all of their property to the trustee.

A revocable living trust agreement or declaration is usually longer and more complicated than a will, and transfers of assets to the trustee can be time-consuming and expensive. Assets not formally transferred to the trustee will possibly not be considered part of the trust and might be subject to probate.

The trustee must keep separate records for trust assets and might have to file separate income tax returns for the trust. If the trustee does not obey these rules, the trust may not avoid probate.

Sometimes it is not a good idea to avoid probate. For instance, a probate personal representative has special powers to deal with creditors and can force them to file claims within a set time or lose their claims. The trustee of a revocable living trust has no such powers.

A revocable living trust can help:

• Avoid probate; specifically, avoid expensive multiple probate proceedings when you own real estate in several different states
• Avoid guardianship
• Reduce delays in distribution of property after they die, although delays caused by filing an estate tax return cannot be avoided
• Obtain privacy, because trust instruments ordinarily are not filed in court
• Maintain continuity of management of property after death or incapacity, especially if they do not serve as the trustee
• Segregate separate property from community property assets if you are married

A revocable living trust, however, may have some disadvantages:

• It is more complicated than a will to draft, and asset transfers can take time and result in various additional costs
• If clients appoint a bank or trust company as trustee, they will have fees to pay
• Once the trust is established, trust books must be maintained and all assets must continue to be registered to the trustee
• If there are litigation or creditor concerns, a probate personal representative may be better able to protect assets; the same applies to guardianship.

A revocable living trust will help couples with estates of $3 million or less ($4 million in 2006) avoid estate taxes.

Irrevocable Trusts

Like revocable living trusts, the assets in an irrevocable living trust do not have to go through Probate Court thus saving time and expense in passing them to beneficiaries. However, unlike a revocable living trust, an irrevocable living trustmay not be altered or terminated by the trustor once the agreement is signed. Nevertheless, there are two distinct advantages of irrevocable trusts:

• The income may not be taxable to the trustor
• The trust assets may not be subject to death taxes in the trustor's estate

But these benefits will be lost if the trustor is entitled to receive any income, use the trust assets, or control the administration of the trust in a manner that is inconsistent with the requirements of the Internal Revenue Code.

Irrevocable trusts are usually set up to remove property and its growth from the estate thereby saving estate taxes.

Life insurance is a popular asset to hold in an irrevocable trust. The trustor funds the trust, which in turn, purchases the policy in its own name, and pays the policy's premium. The death proceeds will not be included in your estate because the trust owns the policy.

Your survivors can then have cash to loan money to or purchase assets from the estate. This would create liquidity in the estate for payment of death taxes, without the funds causing additional death taxes at the insured’s death.

It is also possible to transfer an existing life insurance policy to a trust. For example, this may apply where the trustor is older or has health problems that make a new life insurance policy too expensive. Keep in mind, though, that you must irrevocably relinquish all control over the policy to the trust. The idea is that the trust takes over ownership of the policy. The trustor then contributes to the trust, which uses the contributions to pay the policy's premium.

Crummey Provisions

In cases where you must make premium payments, you might want the gifts to fall within the annual exclusion ($11,000 in 2005, $12,000 in 2006) and be exempt from gift tax. To qualify, the trust often will have a “Crummey” withdrawal power for the beneficiaries.

With a Crummey withdrawal power, beneficiaries have the temporary right to demand withdrawal from the trust each time a contribution is made. If they don’t exercise the right, the transfer for that year remains in the trust. However, if they do request the money, the trustee must oblige them. Fortunately, beneficiaries usually understand that the gifts were made to help their own future interests and requests to remove money will most likely discourage grantors’ from making future contributions.

After the withdrawal right lapses, the trustee is free to use the recent gifts to pay the life insurance premiums.

Spendthrift Clauses

Spendthrift clauses can prevent trust assets from going to anyone other than a trust’s beneficiaries. And in many cases, it can keep trust funds away from beneficiaries’ creditors.

Generally, the provision will restrict the beneficiaries’ ability to transfer trust assets, either voluntarily or involuntarily. Furthermore, the beneficiaries’ interest in the trust may be limited since distributions could be at the trustee’s sole discretion. This will prevent a prospective beneficiary from making a pledge to a third party in the hopes that he or she will receive an inheritance.

For example, suppose that your sick client, Martha, includes a spendthrift clause within her trust for her financially irresponsible grandson, Johnnie. Johnnie decides to buy a new Ferrari to be delivered in 12 months and signs an assignment with the dealer that he’ll have the cash as soon as his ill grandmother dies. Ten months later, Martha dies. Now the dealer wants his $450,000 and directs his demands to the trustee. The trustee must ignore the dealer’s demand for the payment based on the assignment.

QTIP Trusts

Are you in asecond marriage. You might have children from the prior marriage, or one spouse is significantly wealthier than the other. Such a situation can make estate planning complex and sensitive.

The qualifying terminable interest property (QTIP) trust can be a valuable tool even though it is not designed to avoid estate taxes. Rather, it can give the surviving spouse a lifetime income as well allowing the first spouse to control where the property goes at the surviving spouse’s death.

This is how a QTIP could work:

1. The wealthier spouse or the one wishing to pass assets to children from a prior marriage sets up the trust and funds it with $1.5 million (Exclusion Amount for 2005, increases to $2 million in 2006)).
2. The trust will pay a lifetime income to the surviving spouse after the first spouse dies without allowing the survivor to have power of appointment over trust assets.
3. When the survivor dies, the amount still in the trust is included in that spouse’s estate. But it will be offset up to his or her Exclusion Amount, thus could eliminate all estate taxes.
4. The trust’s assets pass to the beneficiaries (children) as per the wishes of the spouse who established the trust.

Perpetuity

Although dynasty trusts are available in all states, the laws in many states subject these trusts to the "Rule Against Perpetuities," which forces trusts to end approximately 80 years to 110 years after they are created. This means that estate taxes might recur generation after generation, thus eroding funds that could have benefited grandchildren and great-grandchildren.

For states without a rule against perpetuity, clients can make use of the generation skipping tax (GST) exemption ($1.5 million for at death transfers, $1 million for lifetime transfers) to fund the dynasty trust. This creates a separate estate to allow assets to accumulate for distribution from generation to generation while greatly reducing taxes. Each generation can then benefit from the assets, although they will have limited access to the principal. Incentives could be set up so that future generations do not become dependent on trust income. For example, your clients could require that distributions will match annual earned income.

Consequently, dynasty trusts can last for as long as the creator wants them to last, even in perpetuity. This allows clients to establish trusts of infinite duration. The trust can be funded while your clients are alive or after they die. But if they fund while living, future appreciation of assets will be kept out of their taxable estates.

The rules are state-regulated. Some, such as Delaware , do not impose a capital gains tax or a tax on accumulated income in trusts for the benefit of non-Delaware beneficiaries. Therefore, it is possible that the assets in the trust could grow significantly over many decades.

Clients do not need to be a resident of the state where the trust is created. There just has to be some connection with the state, for instance the trustee is located there.

If you have clients who might benefit from a dynasty trust, team up with a local estate-planning attorney or a corporate trustee who is familiar with these instruments.

Advance Directives

While retirees are usually able to exercise their rights to make health care and financial decisions, problems can arise when they may become unconscious, incompetent, or otherwise unable to make such decisions. Advance directives are the legal documents in which clients give written instructions about what should happen if, in the future, they cannot speak for themselves.

Each state has its own rules that must be followed when drafting advance directives. In addition, one state’s documents might not be valid in another state. Therefore, the following is only intended to give you an overview of three important documents that all clients should draft with their attorney’s guidance.

A durable power of attorney is a legal document that allows clients to appoint someone as their agent to manage financial and personal affairs in case they become incompetent or incapacitated. An attorney-in-fact will have the ability to write checks on your clients’ account. Banks may have a special form for this purpose.

The agent does not have any ownership or survivorship rights in the account. When your client dies, the money remaining in the account is controlled by the will.

Many lawyers recommend having two doctors' opinions to establish that an individual is incapacitated. If there is not a procedure for making this determination, the power of attorney could possibly become effective when the attorney-in-fact swears in an affidavit that your client is incapacitated.

Some clients may think that it is enough to simply tell their family how they want their medical care handled if they are unable to make such decisions. But it is not. They need to give someone the legal right to make these decisions for them. A health care power of attorney allows clients to appoint someone to act as a health care agent to make health care decisions for them should it be determined by a physician that they are no longer able to make these decisions themselves.

Clients can give their health care agent total power and authority to make medical decisions for them. This includes the power to consent to the doctor giving, withholding or stopping any medical treatment, service or diagnostic procedure, including life-sustaining procedures. Or they may want to limit their health care agent’s power and provide directions or guidelines as part of the health care power of attorney.

A living will provides that under certain conditions life not be prolonged by extraordinary or artificial means. It is a declaration that clients want to die a natural death and do not want extraordinary medical treatment or artificial nutrition or hydration used to keep them alive if there is no reasonable hope of recovery. A living will gives doctors permission to withhold or withdraw life support systems under certain specified conditions.

Choosing an Executor

An executor (called a personal representative in some states) is the person named in a will to be in charge of finalizing a person's financial affairs after death. Responsibilities could include taking care of property, paying bills and taxes, and making sure that assets are transferred to their new rightful owners. And if probate proceedings are required, the executor must handle them or hire a lawyer.

Most executors don't need special financial or legal knowledge. And people usually name their spouse or an adult child. Common sense, conscientiousness, and honesty are the main requirements. An executor who needs help can hire lawyers, accountants, or other experts, and pay them from the assets of the estate.

Look for someone who is honest, organized, and good at communicating with people. Suggest that if possible, they should name a person who lives nearby and is familiar with their financial matters. That way their executor will have an easier time doing jobs such as collecting mail and finding important records and papers.

People frequently select someone who will inherit a significant portion of their assets since that person is likely to be a thorough manager of their affairs. In addition, he or she may also know where records are kept and the reasoning for the way the estate was divided.

But make sure that whomever you chose, that that person is willing to do the job. Furthermore, they should name an alternate executor just in case the first choice is unwilling or unable to handle the chore.