Recalculating

I’m always looking for shortcuts when driving, especially during busy season. Most long-time Sanibel residents know that the easiest way off the island during March and April is not Periwinkle Drive, rather, it’s down West Gulf to Middle Gulf then East Gulf Drives (did I just give away a secret that I shouldn’t have?). But sometimes my “shortcuts” get me into trouble, especially when I’m traveling and don’t know the local terrain.

Coming up on a fork in the road, I ask my wife Patti “Should we take the left fork or the right fork?”

“How should I know?” Patti responds. I decide to go right.

“Recalculating,” Mrs. Garmin states in her soothing GPS voice. It turns out to be a wrong turn that takes us longer to get to where we are heading.  Despite the frustration of taking a wrong turn, I find it amazing when technology can help you correct a driving mistake.

Believe it or not, you can gear up your estate plan to “recalculate” if you make a mistake as well.  You can do this by granting someone a “power of appointment.”

Suppose, for example, that your estate plan leaves your assets in a continuing trust that benefits your spouse for the rest of his or her life. You can name your spouse as his or her own trustee so they don’t have to turn to a bank or trust company to receive income or assets.  At your spouse’s death your trust then distributes to your children in equal shares.

But what happens if one of your children becomes addicted to drugs or alcohol? What if they have made other poor choices that doesn’t warrant them to receive an inheritance, or at least control their own share as they normally would?

There might also be tax reasons to exercise a power of appointment. What if the distribution to grandchildren in the document would trigger a generation skipping tax that can be avoided? What if there are income tax issues that can be cleaned up?

Since you are dead, you can’t change the provisions of your will, right?

While you can’t change your will, you can embed a “power of appointment” to your spouse to allow him or her to change it. You can limit the powering in a way such that they can’t leave your estate to a new spouse that they remarry, but you can allow them to change how much or in what manner your children eventually receive their inheritance.

There is a danger with leaving a power of appointment, however. Your spouse could disinherit one of your intended beneficiaries for almost any reason, including a reason that you may consider frivolous. So when granting a power of appointment, you have to be sure that you explicitly trust that person, and should go so far as to have a conversation with him or her about your expectations.

This leads me to another interesting point. If you are a beneficiary of a continuing trust, you may have a power of appointment yourself. Suppose your father left a trust for you that continues on for your lifetime and then terminates on your death to your children. You may want your estate planning attorney to review your father’s trust to determine whether you have a power of appointment to change the ultimate disposition of the assets.

You may want your spouse to receive the income from those assets if you predecease him or her before the assets are distributed to your children. You may also find it advantageous for your children’s inheritance to continue on in trust as opposed to an outright distribution that could become subject to the claims of a divorcing spouse or creditors.

To exercise the power, you have to include very specific language in your will. A general disposition of “everything to my wife” is not an exercise of a power. Instead, your will should specifically reference the power and then be very specific and direct as to how the assets are to be distributed.  It’s easy to mess this up and create more problems than you solve, as there are a host of legal and tax issues associated with the identification and exercise of a power of appointment.

But it’s nice to know that you can build in your own “recalculation” of your estate plan if it should become necessary. For more detailed information on creating this power of appointment, please check out a recent podcast I recorded on my estate planning website, felp.estateprograms.com, under the Design Module.

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.

Health, Education, Maintenance and Support

For those of you who have wills and trusts that contain testamentary (post-death) trusts that continue on for your loved ones, you may notice that the trustee has a standard by which she can make income or principal distributions. It’s common to find that the standard relates to the beneficiary’s health, education, maintenance and support-based needs.

Attorneys from all over the country commonly use those terms — health, education, maintenance and support. Is this because we all use the same form book?

No, that’s not the answer.

The reason that distribution standards are tied to those four words is found in the Internal Revenue Code. When distributions to a beneficiary are limited to that beneficiary’s health, education, maintenance and support then the trust is said to have an “ascertainable standard” Interestingly, including the words “for that beneficiary’s comfort and general welfare” are not considered an ascertainable standard.

Why would it be important for a trust to limit the distributions to a beneficiary under an ascertainable standard? Oftentimes the beneficiary and the trustee are one and the same person. Consider if Harry created a testamentary trust that, upon his death, provides for his wife, Sally. Sally is to receive income from the trust and the trustee may invade the principal of the trust for Sally’s health, education, maintenance and support. Assume further that Harry has named Sally as the trustee of this trust.

Even though Sally is the trustee of the trust, she does not legally own the trust assets because her distributions are limited to an ascertainable standard. This could be important for a variety of reasons. If Harry and Sally do not want the assets of the testamentary trust included in Sally’s estate for estate tax purposes, it is important that she is not deemed to own the trust assets. This could also be true for liability protection. If Sally were to run over someone in her car causing injury to another, assets in a discretionary trust that are limited to an ascertainable standard may fall outside of the reach of a judgment creditor. Another important protection may include protecting the inheritance from a future divorce should Sally remarry.

By limiting distributions to an ascertainable standard, you can give your beneficiary a great deal of control over the assets of a trust as the trustee, but not subject those assets to a variety of dangers mentioned above. The trustee of a trust generally has the ability to decide what investments, assets or property the trust will own, and when to sell or distribute trust income or principal. So it might be very important in your estate plan to give your beneficiary these trustee powers, yet at the same time protect the inheritance for that beneficiary.

Sometimes clients will voice concern whether the language is too limiting. The trust document can broadly define health, education, maintenance and support. Those words encompass almost any need that your beneficiary might have short of luxury goods or leisure travel. When you have your attorney draft your trust, you can restrict the distributions by requiring the trustee/beneficiary to first consider other income or resources available to him, or you could open up the distributions for any reasonable request notwithstanding other income or resources available. It’s all in how you want your document drafted.

Another consideration is to ask who might challenge a distribution as improper. Generally speaking, the remaindermen beneficiaries would have the opportunity to review annual accountings and to question any distributions as falling outside of the written standard. A remaindermen beneficiary is someone who inherits once the initial beneficiary’s interest is terminated, usually after a term of years or upon death. A marital trust, for example, may continue on for the lifetime of the spouse, and then terminate to the children upon the spouse’s death.

If you grant your beneficiary a power of appointment that allows him or her to alter the remaindermen beneficiary’s inheritance then for a remainderman beneficiary to challenge a distribution could end up jeopardizing that beneficiary’s economic interest in the trust. Suppose, for example, that Harry gave Sally the power to appoint the trust at Sally’s death among their descendants, spouses and charities. Assume Sally’s daughter, Denise, believes that Sally is making distributions to herself outside of the health, education, maintenance and support standard.

When Denise confronts Sally, Sally’s answer is, “Well, Denise, I suppose you could question my distributions. But if you do, remember that I have the power to write you out of the trust!”

There are many nuances and considerations to consider when creating and drafting trusts, even when the ascertainable standard of health, education, maintenance and support are used. But at least now you know why those words are so common in estate planning documents, and what choices you might have even when using such “standard” phrases.

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.

When Your Plan Doesn’t Work Out

“Sarah” had a Will that left $50,000 specific bequest of cash to each of her five grandchildren, while the rest, including her residence, was to be distributed among her two daughters. At her passing she owned her Florida homestead, a $90,000 investment account, a $10,000 checking account and an IRA account of $1.2 million. Her two daughters were also the IRA account beneficiaries.

So what happens at Sarah’s death? Does each of her grandchildren receive $50,000? The short answer to that question is “No.”

The reason rests in the types of assets Sarah had at the time of her death. Her homestead is not an inventory asset of her probate estate under Florida law. Moreover, in my example it is specifically devised to her two daughters. That only leaves $100,000 of cash and other assets subject to her estate administration. This is what her will governs.

What of the $1.2 million IRA account? That account has a beneficiary designation, so it is not subject to distribution under the terms of Sarah’s will. This leaves her $90,000 investment account and a $10,000 checking account. Assuming, for a moment, that there are no creditors, taxes or administration expenses associated with Sarah’s estate, then this $100,000 would be apportioned among the five grandchildren, with each receiving $20,000 as opposed to the $50,000 promised under the will.

The grandchildren receive nothing from the IRA account because they are not a beneficiary of that account. Nor do they receive any equity from the homestead that was specifically devised to Sarah’s daughters.

As you can see, it is therefore important to understand what assets you own and how you own them when making out your will or considering the distributions in your revocable living trust.

The same problem as Sarah’s may arise when you have “Pay on Death” or “Transfer on Death” accounts. Assume that Sarah titled her investment and checking accounts as “Pay on Death” to her daughter, Jane. Even if Jane is named in Sarah’s will as her personal representative (executor), the pay on death designation would usually result in Jane inheriting the accounts. Jane would not distribute those accounts in her role as personal representative under the will. It doesn’t matter what Sarah has in the will, as her account would pass outside of the will. In this example, the grandchildren would inherit nothing. Jane’s sister would also not receive any interest in the accounts, even though she was to share equally with Jane under the terms of the will.

Sometimes clients aren’t certain how life insurance and annuities work either. Most life insurance and annuity contracts have designated beneficiaries and therefore pass outside of a will or revocable trust. Sometimes the trust is named as the beneficiary. Since life insurance is generally income tax free, naming a revocable trust usually doesn’t carry any adverse income tax consequences. Annuities are a different story, however.

Distributions from annuities usually carry with them some amount of ordinary income, resulting in the payment of income tax. The annuity contract should be carefully examined as well. If a person is not named as the contingent annuitant, then there is the possibility that the annuity company will make a full distribution upon the original annuitant’s death. This could result in a significant distribution that triggers a large income tax. If the trust traps the income inside, then the highest marginal tax rate may also apply, exacerbating the problem.

This all highlights why you should have your estate planning attorney involved not only in the creation of your will and trust, but also in the proper titling of your various bank, investment and brokerage accounts, as well as having him at least confirm the proper beneficiaries of your IRA, 401(k), life insurance and annuities. Too often clients will take the advice of their financial planner – or worse – the bank teller – when deciding how to title their accounts. As you can see from this simple discussion, a coordinated, thoughtful review by a qualified professional could head-off unintended consequences.

 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.