Jeopardizing Creditor Proof Life Insurance

Under Florida law, life insurance is exempt from the claims of creditors. The exemption is rooted in public policy in the sense that when a person dies and leaves behind life insurance, that insurance is supposed to take care of a spouse and perhaps children. If creditors are first in line for the proceeds, then we might have many widows and children without any funds on which to live.

But sometimes the beneficial creditor protection of life insurance can be jeopardized. This is when the insured’s estate is named as the beneficiary. When your estate is named as the beneficiary to your life insurance policy, now it could be subject to the claims of your creditors since it is a probate inventory asset.

Allow me to provide an illustration of how this problem may arise:

Lisa owns a $500,000 life insurance policy on her life. She has two minor children. Knowing that minor children would need a court-appointed guardian to collect her life insurance, Lisa names her estate so that her personal representative could collect the life insurance proceeds at her death, and then hold those proceeds in a testamentary trust created under her will for the benefit of her two minor children until they become adults. When Lisa died, she had many medical bills that weren’t covered by insurance. The hospitals and physicians filed claims against Lisa’s estate, thereby consuming a good portion of the life insurance that Lisa otherwise intended to benefit her children.

The problem may also arise in another sense. Assume, for example, that Lisa never named a beneficiary to her life insurance. The default beneficiary under the life insurance contract itself is often the insured’s (Lisa’s) estate. This happens more often than one would imagine.

So what should you do when you wish to name minor children as beneficiaries to a life insurance policy in order to keep the creditor-protected character in place? The best way to deal with this issue is to create a trust that would become the beneficiary of the life insurance policy. The trust would then include the minor children as beneficiaries. Here, the trustee of the trust would be able to collect the life insurance proceeds, and distribute those proceeds creditor-free to the beneficiaries.

If the trust you create is irrevocable, then you have what is known as an Irrevocable Life Insurance Trust (ILIT).  In order to qualify the contribution of amounts to the ILIT in order to pay the premiums as gift tax free under the $14,000 annual gift tax exclusion amount, the beneficiaries must be given a “Crummey withdrawal right”. Generally speaking, after you contribute the amounts to the trust to pay the premium, the trustee must provide the beneficiaries (or their legal guardian) a 30 day window to withdraw their share of the contribution. The beneficiaries don’t exercise that right usually, since to do so would thwart the payment of the premium and consequently the policy would lapse.

You don’t necessarily have to create an ILIT in order to protect the insurance benefits. This may be accomplished through a revocable living trust, although you should work closely with your estate planning attorney to ensure all of the proper elements are drafted into the trust to provide the proper protection, and that the life insurance policy’s beneficiary provisions are properly completed.

Many of these same issues come into play when you leave life insurance to disabled beneficiaries or to beneficiaries that would squander the money. For those you will likely need a testamentary trust of some kind with a gatekeeper trustee.

The bottom line is to let your estate attorney know about any life insurance that you might own, especially if you have minor or other beneficiaries with special considerations.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Estate Planning Attorneys Say ‘No’ Too Much

Remember when your kids were little and one of the first words they learned to say after “Mama” or “Dada” was an emphatic “NO!” As a toddler my daughter Gabrielle would march around our home pointing at her baby doll yelling “No! You can’t do that!” It’s obvious that children feel the need to voice their frustrations at being told “No” all the time, so they do this to the family pet or to inanimate objects they feel a sense of control over.

It turns out that none of us like to hear the word “no”, even after we reach adulthood.

Unfortunately, attorneys have a habit of rejecting our clients’ ideas out of hand. This makes for bad counseling.

“No – you can’t just sell that million dollar asset to your son for a dollar and report it to the IRS as a capital loss or as a tax-free gift.”

“No – you can’t have us draft provisions terminating the marital trust if your spouse remarries and expect to achieve a marital deduction on the estate tax return.”

“No – your trust can’t simply direct the payment of a $5,000 monthly stipend without first carving out some asset or amount of principal from which to generate the income.”

And on and on.

Rejecting Bad Client Ideas

Of course, your attorney is correct to direct the client away from a course of action that is likely to fail or that may even fall outside of the law. After years of practice we develop an instinctive ability to reject bad client ideas. I admit to becoming frustrated when a client tries to dictate how I should draft his trust when it is clearly headed down a wrong path.

But I’ve learned over the years that in so doing, my client is merely giving me something that is very valuable – his intent. He may not be doing it in a way that will actually serve to achieve his goals, but by throwing ideas at me, he is merely attempting to voice what it is that he would like to accomplish.

When I wave my hand in rejection of his idea, he becomes frustrated. Like the parent who is only trying to keep the toddler away from danger, I may sternly and emphatically deny the very thing that he hopes to realize when my work with him is complete.

But that’s the wrong way to deal with the gold mine of information that my client has just laid down at my feet.

Ask a Simple Question or Two

When I instead treat these seemingly bad ideas as significant information seeping into my client’s wishes and desires, I’m inclined to approach his bad direction differently.

Instead of voicing an outright rejection of the ideas I’ve learned to ask a few simple questions: “What are you trying to accomplish?” and “Why is it important to you to do it this way?’

The conversation might look something like this:

“Why do you want to make this million dollar gift to your son now, during your lifetime? What do you hope to accomplish?”

“Why would it worry you if your spouse remarries after you left the income trust to her?”

“How do you envision this $5,000 stipend being paid? Which assets or money do you see generating the necessary income?”

I’m sure you can see how these answers don’t directly rebuff my client’s idea; rather they demonstrate an attempt through dialogue to reach into his thought process. By examining his mindset I begin a constructive conversation centered on why he is sitting in my office seeking advice in the first place.

He also feels heard.

Wisdom Achieves Client Goals

The end result of our client conversations is to use my wisdom and experience to help my client achieve as many of his goals as possible. That’s where true value creation arises. By delving into my client’s mindset I am able to do so in a uniquely positive way. Once I understand where the client is coming from, it’s usually quite easy to direct them to a course of action that will work.

Even where the best tax outcome isn’t possible, given his intent, so long as I communicate that and he is fine with the result, he’ll be happy.

“I understand your desire to cut off the income if your wife remarries. So long as you understand that the federal estate tax marital deduction isn’t available when you provide an income interest that terminates in any way before her death, I’m okay drafting it that way for you.”

Never the let the “tax tail wag the dog” is an adage that a wise law partner told me almost three decades ago. Sometimes clients want to do things because they want to do things, come hell or high water. So long as they make informed decisions, I’ve done my job.

Another trick that I’ve learned over the years is to provide alternatives:

“What if instead of a marital trust we left some portion of your IRA to her outright? How do you feel about that? This way you disengage your children from their step-mother. A marital trust ties your children and your wife together economically for the rest of her life. Maybe it’s best to avoid that.”

When I learn my client’s motive, I have a better opportunity to provide true client value in the form of leadership, relationship and creativity by coming up with alternative solutions he may never have considered. That’s a win-win for everyone.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Don’t Name Minor Children as Beneficiaries

A common mistake, particularly with young parents who come into my office, is the naming of minor children as beneficiaries to financial assets such as life insurance, retirement accounts, or beneficiary designations on brokerage accounts. I can best illustrate this by example:

Assume that Joe and Sally Youngparent have two children, Bobby (age 12) and Brenda (age 8). Joe owns a $500,000 life insurance policy on his life, and he has named his wife Sally as the primary beneficiary. He then names Bobby and Brenda as equal contingent beneficiaries. If Joe and Sally were to die together in some sort of an accident, the idea is to provide funds to raise both Bobby and Sally.

Here’s the problem: the life insurance company won’t pay directly to Bobby and Brenda, because they are minors. Until Bobby and Brenda are at least 18 years of age, the life insurance company will insist that a guardianship be established through the court system before paying the death benefits. Then the court appointed guardian would have to manage the funds and provide accountings annually to the court. As you might imagine, this is an expensive process.

Why won’t the life insurance company pay to the guardian established in the estate? This is due to a number of different laws, but the bottom line is that the life insurance company doesn’t want to get sued when the children become adults if the funds weren’t handled properly. The life insurance company therefore uses the legal process to protect itself.

And it isn’t just life insurance companies that have to worry. Retirement account custodians, brokerage and mutual fund companies, banks and other financial institutions all have to do the same thing if a minor is named as a direct beneficiary to an account.

On top of all that, even with the court appointed guardian, in the scenarios I describe the children will have access to their funds upon turning 18 years of age. Would you expect an 18 year old to make wise decisions with a lump sum of cash when their parents weren’t around to guide them?

So how does one avoid this mess? Easy. Establish a Revocable Living Trust. In the trust name a trustee and designate how the children’s funds are to be used for their benefit. Then instead of naming the children directly as beneficiaries, name the trust as the contingent beneficiary. Problems solved.

Of course, consult with your own counsel when establishing any such trust and designating the trust as a beneficiary to any account. There are a variety of legal and tax consequences that should always be addressed in these types of circumstances.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.