Posts Tagged ‘spendthrift’

Husband’s Interest in Trust Not Divided in Divorce Proceedings

AUGUST 22, 2016 VOLUME 23 NUMBER 31
Carl and Debbie (not their real names) were married, and have two children together. After more than a decade together, Carl filed for a divorce in their home state of Massachusetts.

In the course of the divorce action, the court was required to divide Carl and Debbie’s assets equitably. But what would that mean for the trust established for Carl by his father back in the early years of the couple’s marriage?

Carl’s father had set up the trust to make distributions to Carl, his two siblings, his children, nieces and nephews. Debbie was not named as a beneficiary of the trust, and distributions could not be made to her. Over a two-year period just before the marriage ended, Carl had received over $800,000 in distributions from the trust. At the time of the divorce trial, the trust was valued at almost $25 million; Carl was one of eleven potential beneficiaries of the trust.

The divorce court had to figure out what to do about the trust. Noting that it provided for payments for Carl’s “comfortable support, health, maintenance, welfare and education,” the divorce judge decided that Debbie should be entitled to a share of the trust.

Calculating that Carl’s one-eleventh interest in the trust would be about $2.2 million, the divorce judge assigned 60% of that figure to Debbie. Carl appealed; the Massachusetts Court of Appeals affirmed the divorce judge’s determination. Carl appealed again, this time to the Massachusetts Supreme Court.

The state’s high court disagreed, and reversed the award of an interest in the trust to Debbie. Part of the reason for the reversal: the trust included a spendthrift provision, which should prohibit any claim by third persons against Carl’s interest. The justices also noted that Carl was not one of the trustees of the trust (his brother and one of his father’s lawyers were trustees), that Carl’s interest was not a separate share of the trust (it provided that distributions could be unequal and, in fact, no distributions had yet been made to or for second-generation beneficiaries), and that no distributions had been made to Carl since the divorce petition was filed (though distributions had continued to his two siblings).

Because of the exact nature of the trust, the Massachusetts Supreme Judicial Court ruled that Carl’s interest in the trust was not available to be assigned to his wife in the divorce proceedings. The court did note, however, that when the divorce judge reconsiders the division of property, she might want to assign more of the couple’s assets to Debbie because of Carl’s potential benefits flowing from the trust. Pfannenstiehl v. Pfannenstiehl, August 4, 2016.

Many of our clients are concerned about the scenario in Carl and Debbie’s situation — but from the other side of the equation. If you want to leave some of your property to your child, but worry about the possibility of divorce or other marital problems, what can (or should) you do?

Arizona, of course, is a community property state. That means that everything a married couple acquires during the marriage is presumed to belong equally to both spouses. One huge exception to that general rule: gifts and inheritances.

If you give or leave money to your married daughter in Arizona, it is not community property. It remains her separate property — unless, of course, she converts it to community property by putting her spouse’s name on the title (that’s not the only way to convert it into community property, but it’s the most common one).

What about leaving property to your daughter in a trust? That should help protect it even better against her spouse — and her other creditors. It’s hard to explain the original divorce judge in Carl and Debbie’s case, or the Court of Appeals decision that upheld it, but the final outcome should clearly be the one adopted by the high court in Massachusetts. A trust for your daughter should not figure in her later divorce — though it is possible to imagine that her divorce court judge might award slightly more of the couple’s property to her spouse if she has ready access to a substantial trust account.

Does it make any difference who is named as trustee of your daughter’s trust? The court in Carl and Debbie’s case thought it was worth noting that Carl was not the trustee of his own trust, but the outcome should not have been different if he had been. A trustee has a duty to all of the potential beneficiaries, and therefore can’t just act in their own interest. That means that even if Carl had been trustee (or co-trustee) of the trust established by his father, his access to the trust’s principal would have been limited.

Would it make a difference if there were other compelling financial concerns involved? It should not, and in that regard it might be worth noting that Debbie’s earning potential was found to be substantially less than Carl’s, and that the couple’s daughter is a Down Syndrome child.

Should it matter whether a trust beneficiary has a history of relying on the trust? It probably does not — note that Carl and Debbie more than doubled their earnings in the years in which the trust made distributions.

Are you concerned by the possibility that an inheritance you leave to your child might become an element in a future divorce proceeding? Talk to your estate planning attorney about your options, and don’t be surprised if you find yourself discussing a trust arrangement.

The “Spendthrift” Trust Explained

JULY 27, 2015 VOLUME 22 NUMBER 27

Lawyers love to name and categorize everything they deal with. It’s a useful way to group similar concepts, but it can lead to confusion and misunderstanding. That’s particularly true when a legal concept is non-exclusive — in other words, when one instrument can go by a number of different names. Let’s see if we can address one good example: the “spendthrift” trust.

You might reasonably ask: “is my trust a spendthrift trust?” It likely does not have the term in its name (no one wants to be a beneficiary of the “John Jones Spendthrift Trust” — not even John Jones). How will you know? Because it will have a paragraph somewhere in the trust that says something like this:

“Trustee shall not recognize any transfer, mortgage, pledge, hypothecation, assignment or order of a beneficiary which anticipates the payment of any part of the income or principal. The income and principal of the trust estate shall not be subject to attachment, garnishment, creditor’s bill or execution to satisfy any debt, obligation or tort of any beneficiary, nor shall any part of the trust estate pass to a trustee or receiver in any bankruptcy or insolvency proceeding initiated by or against any beneficiary.”

It might not read exactly like that (the sample is taken from one of our documents at Fleming & Curti, PLC, and lawyers tend to love tinkering with language like this). It might be identified as “Spendthrift Provision” — or it might not. In Arizona, just calling the trust a “spendthrift trust” is probably sufficient (though we’d never recommend relying solely on the designation).

The point is that the trust’s beneficiary can not sell or transfer their right to receive future distributions from the trust. If there is a provision with similar language, the trust might reasonably be called a “spendthrift” trust. That, in turn, raises other questions:

Does the beneficiary have to be a spendthrift for such a provision to be useful? No. Plenty of very reasonable people, conservative in their financial arrangements and thoughtful about expenditures, get in financial trouble. Or they might be involved in a lawsuit. Or a messy divorce. The spendthrift provision is helpful to keep the beneficiary’s interest in the trust away from those creditors, current or future.

Can I put a spendthrift provision in my own trust? Yes, and we routinely do. But it likely won’t be effective to protect your own assets from your own creditors. The general legal principle is that you can’t shelter your assets from current or future creditors, though there are some exceptions to that rule. This is also one topic on which state laws vary considerably. Ask your lawyer if you are eager to seek protection for your own assets.

Does the spendthrift provision require that someone else be trustee? Wouldn’t it be great if you could set up a trust for your daughter, make her the trustee, and include a spendthrift provision to protect against her creditors? That way she could have complete control of the funds, make decisions about when to distribute money to herself, and still keep her inheritance secure. Turns out you can do just that — at least in most circumstances and in most states.

To keep the protection from slipping away, most of the time lawyers suggest that someone else be trustee of your daughter’s inheritance. It’s not uncommon, though, for your son to be trust of her trust, and for her to be trustee of his trust. That way they can continue to communicate and work with one another, they can help protect one another, and the decisions can stay within the family. Of course, everyone’s situation — assets, family dynamics, family structure — is different, so talk with your estate planning attorney.

Is there anyone who can pierce the spendthrift provision? There might be, depending on state law. Arizona law, for instance, creates a possibility that spendthrift trusts might be reachable for child support payments.

One other possible exception: if the trust requires distributions on a regular schedule, a creditor might be able to collect those future mandatory distributions. But the exceptions are usually very narrow — spendthrift trusts are very effective most of the time.

How likely is it that my trust is not a spendthrift trust? Not very likely. The vast majority of trusts in the U.S. include spendthrift language — or at least the vast majority of lawyer-drafted trusts do.

Should there be a spendthrift provision in my will? It’s a different question for wills, since they usually direct the distribution of all assets outright to beneficiaries in a relatively short period of time. But if your will includes a trust for one or more beneficiaries, you might want spendthrift language in those “testamentary” trusts. Talk with your lawyer about this issue.

We hope this helps. The language can be a little daunting, but lawyers’ categorizations (and labels) are actually understandable and helpful — even by real people.

Why You Might Want to Create a Trust for Your Kids

NOVEMBER 25, 2013 VOLUME 20 NUMBER 45

This conversation comes up a lot with our estate planning clients. “So, you’re leaving your entire estate equally to your three kids,” we say to our client. “Do you want to leave it outright or would you consider putting it in a trust for them?” The two most common responses:

  1. “No, my kids are all OK. They can manage money and would be insulted if their inheritance was left in trust.”
  2. “No. If they can’t manage their inheritance then I can’t help them. I don’t want to try to control things after I’m gone.”

Then we explain that creating a trust is actually a good thing for the kids — but it’s usually hard to convince clients. So let’s try it here, and then we can just hand them this newsletter.

Why consider a trust for your child’s inheritance? It may be a real benefit to them, protecting their inheritance from their creditors, spouses — even estate taxes. Let’s look at each of those concepts briefly.

One common concern we hear: “we love and trust our daughter, but though we like her husband he doesn’t really have any money sense.” There’s good news for that client: even though Arizona is a community property state, inheritances start out as separate property. In other words, the money you leave to your daughter is not immediately available to her husband, even in a community property state.

But wait. It’s really easy for your daughter to turn that separate property into community or joint property. All she has to do is add it to her joint banking account, or add her husband to the account title. Once it has become joint property, it is difficult to return it to separate property status. If your son-in-law or daughter-in-law is a “spendthrift,” that can expose your estate to loss after your death.

By creating a trust for your child’s inheritance, you make it easier to keep the property separate from spouses, and more likely to pass to your grandchildren on your child’s death. Sadly, divorce is very common: you can help keep the inheritance from being considered as part of the property to be divided if your daughter does divorce.

Let’s consider creditors. “Our son is a doctor,” you say, “and he has plenty of money.” Ah, but professionals are vulnerable to future malpractice lawsuits, and anyone can have even a substantial estate drained by an auto accident or medical crisis. Creating a trust for your son can help protect the inheritance from lawsuits, creditors, and bankruptcy.

How about taxes? If your daughter is a successful professional, she might well have a taxable estate on her death. That could be true even though she is not particularly close to that figure today. If estate taxes do kick in, they start at a very high 40%. And though we tend to ignore state estate tax considerations in Arizona (we don’t have a state estate tax at all), other states do impose taxes, even on much smaller estates. You may have settled in Arizona for good, but your children may move several times before picking their final residence — and that may subject them to a state estate tax.

If you leave your daughter’s inheritance in trust, you can fairly easily arrange to keep it out of her “estate” for tax purposes. Even though she is worth, say, $3 million, and you are only going to leave her another $500,000, the math is compelling: by the time she dies, that $500,000 could mean $200,000 or more in additional tax liability to her estate.

So there are good reasons to leave an inheritance in trust, even though all your children are responsible and your estate is modest. But aren’t there some serious downsides? Doesn’t it mean a lot of additional costs and imposition of a bunch of difficult rules? Not really.

Depending on your family circumstances, you might even name your son trustee of his own trust. Or make your son trustee of the trust for your daughter, and make her trustee of his trust. Or make your daughter (you know, the one with her CPA who works for the bank) trustee for all the kids’ trusts. In other words, creating a trust does not mean you have to incur professional trustee fees — though it might actually make sense to name a non-family trustee. We can talk about those options.

The trusts for your children will have to file tax returns each year. That will in fact mean a small additional cost. But the total amount of income tax paid need not increase — it should be fairly easy to assure that each trust’s income is taxed to its beneficiary, rather than paying taxes at the (often much higher) trust rates. We can talk about those issues, as well.

What about your son’s access to the money? Do you think he might want to use his inheritance to pay off his mortgage, or to allow him to put more away for retirement, or to send your grandkids to college? You can give him the power to demand money from the trust, or give the trustee direction to follow those kinds of requests. Let’s talk about how much control you want to give each of your children over the trust while they are alive. And on their death, you can even give your children the power to name which of their children (or spouses, or charities, or whomever you want to permit) will receive the remaining trust’s assets. This concept, incidentally, is sometimes described as a “dynasty” trust — which makes it sound like a very fancy, expensive idea only for rich people.

Cost? Setting up a trust for each of your children will likely increase the cost of your estate planning — but by a pretty small number, in most cases. We do this a lot, and so we already have a library of provisions and ideas to draw on. We almost always charge flat fees for our estate planning work, so we can tell you upfront how much additional cost such provisions will add to our fees — and we predict that you will be at least mildly surprised at how little cost it adds.

Oh, and these principles apply even (perhaps especially) if you are leaving your estate to grandchildren, nieces and nephews, or anyone other than your children. The illustrations we use are not intended to limit the point by gender, either — whenever we say “son” you can substitute “daughter” and the point is still valid.

When Is a Living Trust More Appropriate Than a Will?

JUNE 6, 2011 VOLUME 18 NUMBER 20
Last week we answered a pair of questions from our readers and solicited others. Almost immediately we received an excellent question:

What are the factors you look at to determine if a client is best served w/ a will and durable power of attorney or a living trust? In other words, what are the key factors that would lead you to recommend a living trust?

Let us start with a quick disclaimer: the answer to this question is significantly different from state to state. What is true in Arizona may not be the same in other states — and some states will be wildly different. Even for lawyers in the same state there is significant difference of opinion; we are fond of saying that if you ask ten lawyers for their opinions you are bound to get at least fifteen strongly-held, well-reasoned views. Disclaimers aside, what follows is our take on the question.

We think most people do estate planning for one or more of these four reasons:

  1. To minimize taxes. Usually, but not always, that means estate taxes.
  2. To avoid probate, or (more broadly) to simplify matters for their heirs or successors.
  3. To control the way their assets are used after their death.
  4. To make it easier for someone to handle their affairs in the event of their own incapacity or disability.

Which does better at each of those tasks, a will and powers of attorney or a revocable living trust? In almost every case the trust will handle each of those tasks better than a will and powers of attorney. But that is not really the right way to address the question. Since trusts are somewhat more expensive to prepare (assume your lawyer will charge from three to ten times as much for preparation and “funding” of a trust as for a will and powers of attorney) and involve some extra effort, the analysis really becomes one of cost vs. benefit. Will the extra expense and effort of creating a living trust generate enough savings of time or money for heirs that it will turn out to be the right choice?

For most people, the answer is unclear. There are a handful of our clients for whom the trust is unquestionably the right technique, and another handful for whom the trust is not harmful but simply too much legal help for a problem that doesn’t exist. But most of our clients fit into the large middle ground — it would not be foolish of them to opt for a living trust, and it would not be foolish of them to avoid the expense and trouble now and let their heirs deal with it later.

So how do those four estate planning goals relate to the will vs. living trust question? Here’s what we think:

Taxes. Few people need to worry very much about estate taxes these days. With a federal exemption set at $5 million, and no Arizona state estate tax at all, only a tiny fraction of clients have estates large enough to make their decisions on the basis of tax effect.

It is true that the federal estate tax is scheduled to return to the $1 million level in 2013. It is also true that the Arizona legislature could decide to reimpose an estate tax (though most people think that highly unlikely). But for most people, even a taxation level set at $1 million would not make any difference in their planning.

But that’s not the end of the inquiry about taxes. Even if your estate is large enough for you to worry about estate taxation, there is no inherent tax benefit in living trusts. There used to be a way for married couples to lower their combined estate tax bill if their total estate was over the taxation level, but even that has changed (though of course it might change back in 2013). Bottom line: estate tax concerns simply do not drive the trust vs. will question in 2011 the way they did in, say, 1999. And if you are unmarried, or if you are married and your combined estate is less than about $1 million, you simply do not care about estate tax considerations.

Probate avoidance. Arizona’s probate process is not nearly as complicated as its reputation would suggest. It is also not nearly as expensive. Have you read stories about estates that have gone entirely to the lawyers because of a messed-up probate system? Yes, it does happen — but not really because of the system so much as because of family disputes over the validity of documents (including, increasingly, living trusts).

That said, most people will say that even a modest probate cost and time spent in lawyers’ offices would be something worth avoiding. What you need is a solid estimate of what it would cost to probate your estate if you relied on a will instead of a living trust, so that you can compare that cost to the cost of opting for a living trust. It is too hard to generalize about either expense, but we are prepared to go this far: in Arizona, the cost of preparing a living trust (and “funding” it — transferring all your assets into the trust’s name) will almost always be less than the cost of probating your estate later. But not necessarily by much.

There are some other points to be made here. If you own real estate in more than one state, your will must be probated in each of those states (unless you create a living trust or other probate-avoidance mechanism for some or all of those properties). That can drive the expense up considerably, and certainly complicates things for your family. On the other hand, if you have less than $50,000 worth of personal property and no real estate at the time of your death, no probate proceeding is likely to be needed anyway, since there is a “small estates” affidavit mechanism to avoid the probate process.

In general terms, larger estates tend to be more complicated to administer. More complex estates are better candidates for a living trust. So if you are wealthy, probate avoidance is more likely to be a concern for you — and especially if you have unusual assets, or real estate in multiple states, or other uncommon kinds of property issues.

One special consideration here: if you are married, you are probably comfortable putting most or all of your assets in “joint tenancy with right of survivorship” or designating your spouse as beneficiary. You might not feel the same way if you are single; it is not quite as easy (or advisable) to put your children or other beneficiaries on your bank and stock accounts as joint owners. So single people are usually better candidates for living trusts as a means of avoiding probate.

Control. We use the word advisedly. That’s what you might want to do with your funds, even after your death. Are you in a second marriage, with children from the first marriage, and a desire to provide for your spouse but ultimately pass most of your estate to those children? Maybe you have a spendthrift son (or a son who has married a spendthrift). Perhaps your daughter is disabled, and receiving government benefits she would lose if you left her an inheritance outright. Or maybe you want your money to be a retirement fund for your children, or to encourage your grandchildren to get an education, or some other laudable goal you are trying to achieve.

How can you address all of those issues? By putting your money in trust, with a trustee who has been instructed on how you want the money to be used.

You don’t have to create a living trust to put your money in trust. Instead you can create a trust in your will — what we lawyers call a “testamentary” trust. But it will cost you more, and the difference between the cost of a will (with your testamentary trust) and a living trust will shrink. So if you need (or just want) to control the uses of your funds after your death, you will be a better candidate for a living trust.

Your own incapacity. This is why you should sign a power of attorney. It is simultaneously one of the most important documents in your estate plan, and the single most dangerous one. But the cost of going through the courts (in a probate-like proceeding called a conservatorship) is almost always high and the invasion of privacy significant.

There are some times when a power of attorney just won’t solve the problem, though. Plus it is hard to predict when those times arise. Banks, title companies, the federal and state governments — none of them are required to accept the power of attorney. If you sign a living trust and transfer all of your assets to it, though, the problem becomes simpler and narrower: if your successor trustee can show the item the trust calls for (like a letter from your doctor, for instance), then the successor trustee just takes over. There will probably be somewhat fewer problems administering your affairs with a living trust than with a power of attorney.

We don’t want to overstate this benefit, however. It is almost never valuable enough to justify creating a living trust all by itself. As far as we are usually willing to go on this score is to suggest that, if one or more of the other categories make you a good candidate for a living trust, this one might put you over the top.

There’s one more category of living trusty candidates we can suggest: those who are more likely than others to (how can we say this gently?) “use” their estate plans in the next few years. In other words, the older you get the better of a candidate you become for a living trust.

So who should be considering a living trust as part of their estate plan? Look over the explanations above, and you will see that you are a better candidate for a living trust if you:

  • are older
  • are not married
  • are wealthy
  • have children who are not children of your spouse
  • have complicated assets, and especially if you
  • have real estate in more than one state
  • have beneficiaries with special needs, inability to handle money or other similar considerations

Again, we caution you against putting too much stock in these descriptions or applying them to your situation without good legal counsel. But look over this list of considerations and think about what they say about your estate planning needs. Share them with your own lawyer and ask for a thoughtful, critical evaluation. Your family and heirs will be glad you did.

More on Types of Trusts — Some of the Less Common Varieties

JANUARY 24, 2011 VOLUME 18 NUMBER 3
Last week we wrote about different types of trusts you might have encountered, and tried to explain some of the generic terms, differences among and between types, and likely settings where a given type of trust might be appropriate. We wrote about spendthrift trusts, bypass trusts, special needs trusts and the difference between revocable and irrevocable trusts. Let’s see if we can clear up some of the confusion over less-common trust names.

Crummey trusts. In 1962 Californian Dr. Clifford Crummey created a trust for the benefit of his four children, who then ranged in age from 11 to 22. He was trying to address a problem with estate tax law: he could give the money to his children outright (and then worry about how they spent it) or put it in trust for them to protect it (but then not get it out of his own estate for estate tax purposes). His clever idea: put the money in a trust for each kid’s benefit, but give that child the right to withdraw his “gift” from the trust until the end of the year. When they didn’t exercise that right (hey — the youngest was only 11, and even the oldest would understand that withdrawing his money might affect future gifts) it would lapse, and the gift would be completed but stay in trust.

The Internal Revenue Service thought it was a trick, and they argued that Dr. Crummey and his wife had not made gifts at all. The IRS lost that argument, and the “Crummey” trust was born, in a 1968 decision by the U.S. Ninth Circuit Court of Appeals. If you’d like to read the actual decision in Crummey v. Commissioner you may — but we warn you that it will be interesting to only a few diehards, most of them lawyers or accountants.

For nearly a half-century, then, the Crummey trust has been a primary tool in the estate planner’s toolbox. The trusts have morphed over time — now they are often used to purchase life insurance (and may be called Irrevocable Life Insurance Trusts, or ILITs). The length of time for a beneficiary to withdraw the funds has been shortened in most cases — often to a month and sometimes even less. Some practitioners even give the withdrawal right to people other than the primary trust beneficiary. The Crummey trust in each case is an irrevocable trust intended to get a gift out of the donor’s estate for tax purposes but into a trust to control the use of the money after the gift is completed. With the present high gift tax exemption in federal law ($5 million for 2011 and 2012) the use of Crummey trusts will probably diminish appreciably.

Generation-Skipping trusts. In the simplest sense, a GST (practitioners love acronyms) is any trust that continues for more than one generation of beneficiaries. The “current” generation, if you will, might or might not have the right to receive income, or access to principal, of the trust — but it will continue until at least the death of that current generation representative.

GSTs are often constructed to skip multiple generations. The model for the maintenance of accumulated family wealth is usually the Rockefeller family — some of the trusts established by John D. Rockefeller before his 1937 death and valued collectively at over $1.4 billion at the time — are still chugging along for the benefit of his descendants.

Because of concerns about the accumulation of family wealth, and the avoidance of estate taxes in multiple generations by the use of such trusts, the federal government in 1976 introduced a new GST taxation scheme. More recent changes in the GST tax have driven the types, terms and use of GSTs. The GST tax is very high, but only applies (as of 2011 — the rules may change in two years or thereafter) to “skips” of over $5 million. Very elaborate GSTs are sometimes marketed as Dynasty trusts. One common problem in addition to tax issues: the common-law “Rule Against Perpetuities” may make it difficult to extend trusts for multiple generations. In Arizona it is now at least theoretically possible to extend a trust over more than 500 years without facing problems with the Rule. That is a sobering thought when you consider that 500 years ago the land that was to become Arizona was all but unknown to ancestors of the Europeans, Asians, Africans and even many Native Americans who live here now.

QTIP trusts. QTIP stands for “Qualified Terminable Interest Property.” Does that explain the trust type? Well, not quite.

In very general terms, a QTIP trust is probably designed for one narrow purpose. It permits a wealthy spouse to leave property for the benefit of a less-well-off surviving spouse without consuming the deceased spouse’s full estate tax exemption amount. In other words: if you were worth, say, $10 million dollars in 2009, when the estate tax exemption was at $3.5 million, you might have left $3.5 million to your adult children from your first marriage and most of the rest of your property in a QTIP trust for your second husband (or wife). That way your estate would pay no estate tax, and the tax would be due on the death of the surviving spouse. Since he (or she) had no property in our example, that means that his (or her) $3.5 million exemption would get used on your property first, and only the excess would be subject to taxation as it passed to your children from the first marriage.

As you can see, it is getting harder and harder to make a QTIP trust a good planning opportunity, except for extremely large estates with very high disparity in net worth between the spouses. But the QTIP trust isn’t dead yet — uncertainty about the federal estate tax, continued state estate taxes in some states (but not Arizona) and inertia preventing modification of older estate plans will all contribute to keeping the QTIP alive for a few more years, at least.

We don’t know about you, but we’re exhausted. Maybe we’ll tackle some more trust types on another day. Suggestions? Do you want to know about QDoTs (sometimes called QDTs or QDOTs)? QDisTs (Qualified Disability Trusts)? Cristofani Trusts? Just ask, and we’ll take a run at them.

Different Types of Trusts for Different Purposes

JANUARY 17, 2011 VOLUME 18 NUMBER 2
We frequently are asked to explain the differences between different types of trusts, or to analyze a trust with no more information than its type. Confusion about the differences is widespread, and we hope to provide a little clarity to consideration of trust types.

Before we embark, we have three caveats:

  1. We are not trying to list every possible type of trust here, but just those our clients most often encounter. We may expand this list over time.
  2. Just because you believe your trust is, for example, a “spendthrift” trust does not necessarily make it so. Even if the name of the trust includes one of these categories, it might be inaccurate. The type of trust is determined by the language of the trust itself, and it may take some close reading to identify a trust’s correct categorization.
  3. Most of these categories are neither magical nor exclusive. Just because we can categorize a given trust as a “spendthrift” trust, for example, it does not necessarily mean that it will be protected against all of the beneficiary’s creditors. And just because a trust is a “spendthrift” trust does not mean it could not also be a “special needs” trust, a “bypass” trust or some other category.

With that out of the way, let’s get started on a partial list of common types of trusts you might encounter (or create):

Spendthrift trust. This trust is protected against the creditors of a beneficiary. The trustee can not be compelled to make distributions to a beneficiary, or to the beneficiary’s creditors. This does not necessarily mean that the trustee is not permitted to make such distributions (after all, it might be in the beneficiary’s best interests to pay his or her debts). Even very strong spendthrift language might not be effective against some types of creditors in some states. Common exceptions adopted by state law include child support and alimony obligations or governmental debts. State laws vary widely on these lists.

“Third-Party” Special Needs trust. These trusts are usually specialized spendthrift trusts created for a beneficiary who suffers from a disability. The language of the trust will usually include a clear expression of the intent that the trust’s monies should not interfere (or not interfere too much) with the beneficiary’s public benefits, like Supplemental Security Income or Medicaid. The variation here from state to state, and from beneficiary to beneficiary, can be tremendous, so be very careful about generalizing when discussing third-party special needs trusts.

“Self-Settled” Special Needs trusts. Just to keep the confusion level high, there are also special needs trusts created by the beneficiary himself or herself. Of course, a beneficiary with a disability may have to act through a court proceeding, a guardianship or conservatorship, or a parent or grandparent. But whoever signs the actual documents, if the money in a special needs trust comes from the beneficiary’s own resources (like a personal injury settlement, or an unrestricted inheritance) then the special needs trust will be treated as a self-settled trust. That means the rules will be more difficult, both as to creation and administration of the trust. Can a self-settled special needs trust also be a spendthrift trust? What an interesting question you ask.

Bypass trust. Sometimes these trusts are called “credit shelter,” “exemption,” “decedent’s,” or just “B” trusts, but all of those names are pretty much interchangeable. The basic premise of a bypass trust is that a married couple arranges to take full advantage of the federal estate tax exemption amount, so that they can pass up to twice that amount to their heirs on the second death. That means that on the first spouse’s death a portion of the couple’s assets transfers to the bypass trust irrevocably, with some limitations on the use of the money during the surviving spouse’s life.

Bypass trusts are a special breed just now. Because the new federal estate tax law allows a married couple to retain both estate tax exemption amounts without having to create a bypass trust, there are a lot of trusts out there that may not still be needed. If both spouses are still alive it may be time to change the documents. If one spouse has already died the problems are more complicated. About the time we all figure this out (in two years) the estate tax provisions are scheduled to end automatically. We will have to wait most of those two years to find out if bypass trusts will fade out of existence.

Revocable trusts. Any trust that can be revoked — by anyone, but usually by the person who established the trust — is “revocable.” You may sometimes see the phrase “revocable living trust,” which means the same thing. If the only person who can revoke the trust has died (or become permanently incapacitated) then the trust has become irrevocable. Even if the name of the trust includes the word “revocable” (as, for instance, “The Smith Family Revocable Trust”) it may now be irrevocable.

Irrevocable trusts. The flip side of a revocable trust is, obviously, an irrevocable trust. The category just means that no one has the power to revoke the trust. That does not mean it will go on forever — if the assets held by the trust are spent or distributed, it ceases to exist even though it was irrevocable.

Grantor trusts. This term is most important in considering federal income tax liabilities, but it is often used more broadly. In a nutshell, a grantor trust is one in which the person who established the trust has retained one or more of the elements of control listed in the federal income tax code. Most important (but not the only ones) are: the power to revoke the trust, the right to receive the trust’s income and/or principal, and the role of trustee. Grantor trust rules are actually quite complicated, and are sometimes subject to some interpretation — fortunately, the shades of meaning don’t show up very often. Most trusts are either quite obviously grantor trusts or quite clearly not.

Those are some of the most common terms you might see to describe trusts. In a future Elder Law Issues we will tackle some of the less common ones, like “Crummey” trusts and ILITs, QTIP and QDoT trusts, and — well, feel free to ask us to try to describe/define your favorite trust category.

How to Leave Your IRA to a Trust — And Why You Might

OCTOBER 4, 2010 VOLUME 17 NUMBER 31
Last week we wrote about how you can go about leaving your IRA (or 401(k), 403(b), etc.) to a child with a disability. In passing we mentioned that the discussion about how to leave your IRA to any trust could wait for another day. Today is that day. Let’s tackle this as a Q&A session (or, if you prefer, we can call it a FAQ list).

Can I name a trust as beneficiary of my IRA?
Yes. That was easy.

Are the rules the same for 401(k), 403(b) and other retirement accounts?
Generally, yes. If you have more esoteric retirement accounts, talk to someone to make sure you are doing the right thing. What the heck — talk to an expert in any case. Our purpose here is just to give you some background and introduce the language and issues, not to give you direct legal advice.

Before you tell me how to do it, why would I want to name a trust as beneficiary of my IRA?
There are several reasons you might:

  • If you have a child who is a spendthrift, or married to a spendthrift, or who is involved in tax issues or legal proceedings, you might want the retirement account to be protected against creditors.
  • If you worry that your child might get divorced and want to keep your retirement account out of the divorce calculations and proceedings, a trust might help protect the account (and, for that matter, other assets you are considering leaving to that child).
  • You might just want to delay the withdrawal of your retirement account as long as possible. Of course, you could name your child as beneficiary and trust him or her to withdraw the money as slowly as is permissible. With a trust you can help assure that “stretch-out” of the IRA.

Why is my banker/broker/accountant telling me I can’t name a trust as beneficiary?
That used to be the rule, and lots of professionals are not yet caught up. There are also a couple of special rules that apply when you name a trust as beneficiary — though they are not at all hard to comply with, so it’s not clear why advisers get hung up on those rules. Finally, even though the rules permit naming a trust as beneficiary they do not require all account custodians to go along — so your broker might be telling you that, while the rules permit naming a trust, your account can not take advantage of those rules.

If I want to name a trust as beneficiary, what must I do?
There are a handful of requirements. The important ones: give the IRA custodian a copy of the trust (that, by the way, can be taken care of later — but you can do it now if you want), name only one income beneficiary for the trust, and make sure your beneficiary designation comports with the trust set-up and your larger plans. That probably means you should get competent professional assistance, but that’s usually a good idea for your estate planning anyway.

Are there bad things that happen if I name a trust as beneficiary?
Yes, but not very bad. Depending on the ages of all the beneficiaries and potential beneficiaries, you might have shortened the stretch-out time to a period less than the life expectancy of the primary beneficiary.

Uh, could you please repeat that — in English?
Of course. Let’s use an illustration.

Suppose you have three children: Abigail, Ben and Candy. You are OK with Abbie and Ben getting their shares of your IRA in their names — you trust them to make sound judgments about how quickly to withdraw the money, and you don’t want to bother with a trust for them. Candy is a different story. The details of that story don’t matter: you just want to put Abigail in charge of deciding whether to withdraw more than the minimum amount each year from Candy’s share of the IRA.

You can name a trust for the benefit of Candy as beneficiary of 1/3 of your IRA (naming Abbey and Ben as the other two beneficiaries outright). But what will happen if Candy dies before the IRA is closed out?

As it happens, Candy does not have children. You decide to have the trust say that upon Candy’s death the remaining trust interest in “her” share of your IRA will go to Abigail and Ben. Abigail is ten years older than Candy. That all means that Candy will have to make her IRA withdrawals using Abigail’s age and life expectancy.

But wait. Candy does have children?
Well, why didn’t you say so? That makes it even easier. You can have the trust provide that if Candy dies before the last IRA withdrawal her children become the beneficiaries of the trust (and, indirectly, the IRA). As before, we use the oldest potential beneficiary as the determining age — and we are going to assume for the sake of this piece that Candy is older than all of her children. No effect on Candy’s withdrawal rate. But note that if Candy does die, her children will still have to withdraw from the IRA at Candy’s rate, not their own.

What about estate taxes?
Now you’re talking about a whole different kettle of fish (or something). As you know, the estate tax situation is in flux right now, and some states have their own estate tax rules. That makes it very hard to generalize, and unnecessarily complicates this discussion. Suffice it to say that your IRA will be part of your estate for estate tax purposes, and just because there is income tax due on it does not mean that there won’t also be an estate tax liability attached to it. But if your entire estate is worth less than $1 million, you probably are not going to care very much. Stay tuned for a new number to be inserted in that sentence sometime before the end of 2010.

That sounds pretty simple. Could you please make it more complicated?
We’d be happy to, but it’s not required. We could give you information about what lawyers call “conduit” trusts and “accumulation” trusts. We could explain why you can’t have the money go to a charity upon Candy’s death. We could even try to give you some better names for your imaginary children (while still adhering to the A, B and C convention). But for most of our clients, those complications are unnecessary.

The bottom line: it is not that hard to name a trust as beneficiary of your IRA, 401(k) or other qualified retirement plan. You just need to review the rules, and understand why you might want to do such a thing.

It is also permissible to consider all that, try to get the rules straight, and then decide not to bother. One thing that we don’t want to allow you to do, though: ignore the issue, prepare a will that seems to handle all of your assets, and then have an IRA beneficiary designation that doesn’t agree with the rest of your estate plan, imposes an undue burden on your children and beneficiaries, or fails to address your child’s disability, money problems or legal or financial situation.

We hope this has helped demystify a subject that lawyers and accountants often seem to enjoy complicating. Your life, however, tends to be complicated. Please get good legal, financial and investment advice before you decide what you should do.

“Spendthrift” Trust Protects Against Beneficiary’s Creditors

MAY 17, 2010  VOLUME 17, NUMBER 16

What makes a trust a “spendthrift” trust, and what does it mean? A recent Florida Court of Appeal case gives a good snapshot of the significance and the effect of the categorization.

Elizabeth Miller wanted to leave her property to her two sons, but wanted to protect against her money being subjected to the claims of their creditors. This was particularly important to her because one son, James F. Miller, had already been sued over a business deal gone bad. In fact, there was a million dollar judgment on record and the plaintiffs were trying to collect from James.

Ms. Miller left James’s share of her estate in a trust with her other son, Jerry Miller, as trustee. The language of the trust authorized Jerry to give James any or all of the trust’s assets, but ordered that he not turn over anything to James’s creditors. Within weeks of making that change, Ms. Miller died and her estate passed partly to Jerry as trustee of James’s trust.

James’s creditors sued Jerry and the trust, claiming that James really exercised control over investments, distributions and trust decisions. The trial court agreed, and ruled that James had so much control over the trust and his brother that his interest in the trust had effectively “merged” into an ownership interest. The court’s order allowed James’s creditors to get to his inheritance.

Not so fast, said the Florida Court of Appeal. The appellate court agreed that James had effectively made trust decisions in place of Jerry, but noted that Jerry had the power to take back control at any time. It is the language of the trust itself and not the behavior of the trustee or the beneficiary that must control whether a spendthrift provision is effective, said the judges.

Had Ms. Miller’s trust given James the right to demand principal (or income) from the trust, that would have been a different matter. Because the decision to make those distributions ultimately rested with Jerry as trustee, James’s creditors could not reach behind the trust to gain access to the assets directly.

The appellate court agreed that “the facts in this case are perhaps the most egregious example of a trustee abdicating his responsibilities to manage and distribute trust property.” Nonetheless, the failure of the trustee to exercise control over the trust did not invalidate the spendthrift provision itself, and James’s creditors could not gain access to his inheritance. Miller v. Kresser, May 5, 2010.

Would Arizona courts have the same high regard for spendthrift provisions? Probably, if the trust’s property did not originally belong to the beneficiary. An individual can not create a spendthrift trust to protect his or her own property from creditors — though there are some exceptions. The most important exception under Arizona law is for trusts established for a beneficiary with a disability — so-called “special needs” trusts.

Arizona Adopts New Uniform Trust Code Effective Next Year

OCTOBER 6, 2003 VOLUME 11, NUMBER 14

[NOTE: After this article was published and circulated, the Arizona legislature delayed the effective date of the Uniform Trust Code in Arizona for two years and then repealed the UTC altogether, and then re-adopted it in a significantly modified form. Readers need to check the current status of the UTC in Arizona rather than relying on this synopsis, prepared before the legislative revisions of the Code.]

After several years of work by some of the leading trust law experts across the country, last year the National Conference of Commissioners on Uniform State Laws published a proposed new law for consideration by all the states. The Uniform Trust Code (the UTC) was promptly introduced in ten states and the District of Columbia. Arizona became the fifth state to adopt the UTC earlier this year.

Many of the UTC’s provisions simply restate existing trust rules, but a few new ideas have now become law in Arizona. Among the changes facing Arizonans who either create or administer trusts:

Notice Requirements

 

Trust law has long required that beneficiaries be given notice of the existence of the trust and periodic accountings. What’s new about the UTC is the specificity of that requirement. Before March 1, 2004, every Arizona trustee is required to give notice of the existence of the trust to any “qualified beneficiary.” Accountings must be given to the same “qualified beneficiaries” every year. This requirement can not be written out of the trust document, so notice and accountings will be mandatory in every case.

Notices and accountings will usually have to go to anyone presently permitted to receive trust benefits, plus anyone who might receive benefits on the death of someone in the first category of beneficiaries. Among those clearly affected by the change will be surviving spouses who receive income from so-called “bypass” trusts and their successors.

Powers of Attorney

 

The UTC also clarifies the authority of an agent under a durable power of attorney to revoke or amend a trust. The agent will have such power only if the written power of attorney contains specific provisions and the trust itself does not prohibit an agent from acting.

Spendthrift Provisions

 

A trust which prevents either a trustee or a beneficiary from conveying the beneficiary’s right to future trust distributions may be described as a “spendthrift” trust. The UTC clarifies that creditors of the beneficiary of a spendthrift trust can not reach trust assets. At the same time, the UTC codifies a number of exceptions to that rule, including claims against the trust’s settlor, claims for child support and alimony, and claims by some governmental entities.

Capacity

 

Arizona lawmakers took out the UTC provision on the level of capacity required to establish a trust. In future years it will probably be set at “testamentary” rather than the higher “contractual” capacity level.

Effective Date

The new Uniform Trust Code becomes effective in Arizona on January 1, 2004. It will profoundly affect the administration of trusts in the state, and it will also provide several challenges for those who are considering creating a trust in the future.

Grandson’s Creditors Can Not Reach Spendthrift Trust Assets

OCTOBER 29, 2001 VOLUME 9, NUMBER 18

When Kyle Krueger’s grandmother established a trust for him in 1985, she may or may not have known how the 19-year-old would turn out. For whatever reason, she locked up his trust benefits until his fiftieth birthday. As it turned out, her decision was good for Mr. Krueger—but not so good for the victims of his later acts.

In 1998 Mr. Krueger (by then 32 years old) was sued by the mother of a young girl. She alleged that he not only had sex with her minor daughter, but that he also videotaped the act and made it available over the internet. She got a court judgment against Mr. Krueger for $551,286.25.

Criminal charges were also filed against Mr. Krueger for his actions. He faced a lengthy prison sentence and little likelihood of release back into the community any time soon.

The child’s mother sought to collect her judgment from the proceeds of the trust Mr. Krueger’s grandmother had set up. She faced one major obstacle, however: the trust included what is usually called “spendthrift” language. That meant that the trustee was prohibited from paying anything directly to Mr. Krueger’s creditors, regardless of the circumstances.

Spendthrift provisions are common in trusts for the benefit of someone other than the person who establishes the trust. Though it may be difficult or impossible to restrict the availability of one’s own assets when placed in a trust, the general rule is that money set aside for the benefit of another person can be subjected to such a restriction. In fact, that is one of the primary reasons for many trusts—to protect beneficiaries from their own inability to handle funds in the future.

The victim’s mother argued that this case should be treated differently, however. She insisted that the rules should not permit the retention of funds to benefit an individual after such a heinous criminal act. In fact, she argued, the original purpose of the trust (to help care for Mr. Krueger) could no longer be met—precisely because he would likely be in prison past his fiftieth birthday.

State law in New Hampshire (like the law in most states, including Arizona) permits establishment of a spendthrift trust for another person. Even though Mr. Krueger’s later behavior was inexcusable, his grandmother’s money was set aside for his benefit and should not be reachable by his creditors, said the state Supreme Court.

A long prison sentence would not prevent the trust money from benefiting him, the court noted. Neither did it make any difference that the trust allowed Mr. Krueger to decide who would receive the balance if he died before fifty. The analysis makes it clear: the money in his grandmother’s trust did not belong to Mr. Krueger, and he did not have the power to lose it by even the most reprehensible actions. Scheffel v. Krueger, July 26, 2001.


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