APRIL 23, 2012 VOLUME 19 NUMBER 16
Let us try to demystify probate avoidance for a moment. Note that for the purposes of this description, we are not going to argue with you about whether avoidance of probate is good, bad, desirable or a foolish goal — we start here with the assumption that probate avoidance is important. Another day, perhaps, we will discuss with you whether you ought to be concerned about probate avoidance.
Definition of terms first: probate is the court process by which your estate is settled and distributed to your heirs (if you have not made a valid will) or your devisees (if you have). Confusingly, “probate” is also the term applied (in most states) to the court where probate proceedings, guardianship, conservatorship and sometimes even civil commitment and adult adoptions are conducted. We are not talking here about how to avoid probate court altogether, but just about how to keep your estate from having to go through the probate process upon your death.
Arranged (more or less) from least desirable to most, here are some of the ways to avoid probate of your estate upon your death:
Die poor. In Arizona, an estate consisting of up to $50,000 of personal property can be collected by the people who claim to be entitled to it without the need of a probate court proceeding. The affidavit for collection of personal property is widely available and usually free. Your survivors can use it to transfer title to your auto, or to collect small bank (or other financial) accounts. The statute providing for collection of small estates also provides a mechanism for the surviving spouse to get a decedent’s last paycheck, and for beneficiaries to transfer title to real property up to another $75,000 in value. Most other states have a similar law, but with dollar limits that vary widely.
Give it all away. One sure-fire way to avoid probate: give everything to your kids (or whomever you want to receive your stuff) now. The main problem with this approach should be obvious — what if they won’t let you live in your house any more, or withhold the interest you counted on them returning to you each month? Things change: you might change your mind about leaving everything to that child, or to all your children. The child you transfer assets to might marry someone you don’t trust. Worse yet, that child might die — leaving you at the mercy of his or her spouse and children. Maybe you and the child you give your stuff to will end up disagreeing about when you need to go to a nursing home, or whether you ought to get married late in life, or even take in a roommate.
As an aside, it amazes us how often clients come to us after having given everything to their children. Things so often do not work out as planned. This is a very poor way to handle your estate planning — but it would avoid probate. We hear that those new-fangled strap-on jet packs avoid traffic jams, too — but we don’t recommend them as a means of getting to the doctors office.
Joint tenancy. People often refer to this method of holding title by its formal name: “joint tenancy with right of survivorship.” That makes the value of the title pretty clear — the surviving joint tenant(s) own the deceased joint tenant’s portion of the property upon death of one joint tenant. You can have more than two joint tenants — upon the death of any one, the survivors’ interests all increase. We liken this arrangement to a tontine — a lovely idea that combines the best elements of estate planning and lotteries.
Lawyers generally discourage the use of joint tenancy in estate planning. The problems are less obvious than simply giving away your stuff, but they are still real. You might later decide that the child you established the joint tenancy with should get a larger or smaller share of your estate — but the joint tenancy is always, by definition, an equal ownership interest with all the other joint tenants. People who favor joint tenancy as an alternative to good estate planning invariably, in our experience, seem to think it would be OK to name just one child as joint tenant, and to trust her (or him) to divide the property among siblings. That often works just fine — but it often leads to family disputes when the children have different expectations or understandings.
Other problems with joint tenancy: you subject your property to the creditors, spouses and business partners of the child you put on your title. You lose the power to refinance your home, to cash out your certificate of deposit, or to liquidate your government bonds — more accurately, you lose the power to do those things unless your joint tenant will also go to the title company or the bank with you and sign willingly.
Lawyers tend to dislike joint tenancy, except in one circumstance. Many people own their property in joint tenancy with spouses (homes are especially likely to be titled in that fashion), and we lawyers generally think that is alright. In Arizona, there is another alternative between spouses that we like a little better: community property with right of survivorship. That conveys some income tax benefits to a surviving spouse while still avoiding the necessity of any probate on the first spouse’s death.
Beneficiary designations. You probably have a beneficiary (maybe multiple beneficiaries) named on your life insurance policy, on any annuities you have been talked into buying, and on your retirement account (if there is any death benefit included). Did you know that you can do the same thing with bank accounts, stocks and bonds, and even (in Arizona and a handful of other states) real estate?
POD (payable on death) bank accounts — you can designate a POD beneficiary (some banks use the acronym ITF — “in trust for” — and it means the exact same thing) who has no current interest in your account but receives it automatically upon your death. You can even name multiple POD beneficiaries. And you can do this at banks, credit unions, savings and loans. Caution: if you go to your bank and say “I heard that there’s a way I can put my son’s name on my bank account” the clerk will almost always hand you a joint tenancy signature card. Make clear that you’re talking about POD designations — they are used less commonly but are a better fit for most people.
TOD (transfer on death) for stocks and bonds — there is a designation similar to the bank POD account for stocks, bonds, brokerage accounts and mutual funds. It is usually referred to by its acronym, TOD. It is actually more flexible than the POD designation available to banks — it allows you to designate what happens if a TOD beneficiary should die before you, for instance. Talk to your stockbroker about this titling arrangement if you think it might be a good idea for you — but talk to your lawyer first.
Beneficiary deeds for real estate — this one is available in only about a dozen states, but Arizona is one of those. It is like a POD or TOD designation for real estate — including your home. It only works on real estate located in Arizona or one of the other beneficiary deed states. The beneficiary deed conveys no current interest in your property, but avoids probate and vests directly in your beneficiary upon recording of your death certificate. You and your spouse can, for example, own your home as community property with rights of survivorship but upon the second death automatically transfer to your children in equal shares (with provisions about what happens if one of them should not survive both of you) upon the second death. We have written about beneficiary deeds in Arizona before, and our earlier explanations are still valid (even though our newsletter style has been updated).
What’s wrong with these beneficiary-based devices? Two things, at least: (1) they don’t provide for what happens if you make life changes that effectively adjust your estate plan (if, for instance, you live off of one account that was to go to one or two children, and thereby reduce their share of the estate) and (2) they make it hard to change your estate plan (if you decide to disinherit a child, for instance, you have to make sure to change all of the operative documents and titles). But in the right circumstance, beneficiary designations can effectively transfer your estate without probate — they act as a sort of a “poor man’s” trust.
Trusts. Which gets us to the most efficient way to avoid probate for most people — the living trust. To be clear, the trust doesn’t really avoid probate at all — but your trust assets do not have to go through the probate process and so anything you have transferred during life to the trust will avoid probate. It is the “funding” of the trust that avoids probate, not the trust itself.
So there you have it. Probate avoidance in a nutshell. But wait — what’s not on that list? Did you notice? There is so much confusion about the missing item, which does not avoid probate:
Making a will. Preparing and signing your will is a good thing to do. It avoids intestate succession, which might not be right for you. It designates who will be appointed by the court to act as your personal representative. It can name the person who will be your children’s (or your incapacitated spouse’s) guardian. It can even create a trust. But it does not avoid probate.
Your will is instead instructions to the probate court. It has no effect unless and until it is admitted to probate, which another way of saying that a court has determined that it really is your last will. Clients frequently say: “thank goodness I’ve signed my will today. Now I can sleep better knowing my children won’t have to go through probate.” We say: “sit down. We have some more talking to do. Obviously we have failed to get you to understand the distinction between wills and probate avoidance.” Then we talk about living trusts.
Did that help? Do you have a better idea for probate avoidance (we’ve left a couple of less common methods off)? We’d love to hear from you.
JANUARY 9, 2012 VOLUME 19 NUMBER 2
With the increased emphasis on (and use of) living trusts for estate planning, we lawyers are seeing more and more cases in which an old trust needs modification. Perhaps the tax laws have changed since a parent or grandparent died. Maybe what once made sense is less defensible in light of modern investment thinking, or the cost of living has caught up with what once seemed like a generous bequest. Family dynamics, always fluid, can change the reasonableness of a decades-old estate plan. Everyone knows someone whose family was once considered wealthy, and now is considerably less so. Any of those scenarios — and dozens of others — can be the basis of a desire to change something that seemed set in stone when the plan was adopted.
That’s when lawyers begin talking about trust reformation or modification. In recent years we have begun talking about decanting — pouring the contents of an older trust into the vessel of a new trust document. Not every state permits decanting, though, and state laws vary in how they approach modification of trusts. That can lead to uncertainty, family friction and even litigation.
Take, for instance, the recent Indiana case involving the trust — and the family — of John and Ruth Rhinehart. In 1997 Mr. and Mrs. Rhinehart established an irrevocable trust for the benefit of their daughter, Julie R. Waterfield. They placed $4 million in the trust, and provided that at least $100,000 per year would be paid to their daughter. When she dies her trust will divide into three new trusts — one for each of her children. Each of those trusts will pay $25,000 per year to the grandchild for whom it is set up.
That was certainly a generous gift, and should help provide for the welfare of the Rhinehart’s daughter and grandchildren for decades. In fact, the trust has grown — as of 2009 it was worth about $22 million. What could possibly be wrong with the Rhineharts’ largesse?
Sometime shortly after the trust was created, Julie Waterfield made a pledge to Indiana University – Purdue University Fort Wayne (IPFW). She promised the University $1.5 million so that a new recital hall could be built in the campus’s new music building — a building, incidentally, named after her parents.
There was only one problem with her pledge. By late in 2002, stock holdings she had expected to use for the donation had become worthless. It appeared that the only way for her to meet her pledge would be to increase the annual payments from the trust established by her parents. She would need not $100,000 per year, but more like $275,000.
She and her lawyer approached the trustees about how to reform the trust to permit the larger distributions. Everyone agreed that if she could get the approval of all of the future beneficiaries, the trust could be modified. The trustees engaged Ms. Waterfield’s lawyer to complete the process, and he filed a court proceeding seeking an increase in the distribution. The Indiana court approved the increase, conditional on getting all eighteen potential beneficiaries — current, future and contingent — to sign consents.
At a family meeting in December, 2002, all three of Ms. Waterfield’s children signed the agreement to reform the trust. One of them requested a copy of the full agreement, and the trust’s lawyer sent him a copy a few days later. Ms. Waterfield’s distributions were increased and, presumably, her pledge fulfilled.
Three years later, two of Ms. Waterfield’s children expressed concern about the increase in their mother’s distributions. They argued that their signatures on the agreement to reform the trust had been obtained by fraud, and they brought suit against their mother and the corporate co-trustee of the trust. Ms. Waterfield and the trustee argued that it was too late — that the statute of limitations on such an action ran out two years after the change was approved. In any case, they insisted, there was no injury to Ms. Waterfield’s children: there would be plenty of money available to fund their annual $25,000 distributions. The trial judge agreed and dismissed the lawsuit.
The Indiana Court of Appeals agreed. The appellate judges noted that both sons’ signatures were on the agreement, that they acknowledged they had gotten a letter from the lawyer which claimed it enclosed a copy of the agreement, and that it strained credulity to think that they would have failed to ask for the referenced enclosure if it had not in fact been in the envelope with the letter. In other words, their cause of action — if they had one — was known to them at least by the date of that letter. In Indiana, the statute of limitations on such an allegation of breach of fiduciary duty is two years — the Waterfield children waited more than a year too long before filing their lawsuit.
Furthermore, according to the appellate judges, the growth of the trust to $22 million — despite several years of increased distributions to Ms. Waterfield — adequately protected her sons’ interest so that they were not injured by the trust reformation. The Court of Appeals rejected their argument that the trust itself was injured by what they insisted was fraudulent behavior. The beneficiaries do not have the authority to bring their action on the basis of injury to the trust, but must show injury to themselves, according to the Court. Matter of Waterfield v. Trust Co., December 30, 2011.
Would the answer have been different in Arizona? Possibly. But it is more likely that the process itself would have been different in Arizona. With adoption of the Arizona Trust Code (a version of the Uniform Trust Code) it has become easier to modify or reform a trust. Some modifications can be done without the court’s involvement at all. Perhaps more importantly, it has become somewhat easier to clearly begin the running of the statute of limitations on claims against trustees under Arizona’s new law.
MARCH 7, 2011 VOLUME 18 NUMBER 8
Two weeks ago we answered some of our readers’ frequent questions, and we solicited more. We heard from several of you with good questions of general interest. Among those (with identifying information and some details stripped out):
My wife and I do not have any obvious family member to handle our estates. Whom should we name as executor? Most (but not all) married couples will leave administration of their estate in the hands of the surviving spouse after the death of one spouse. Most (but not all) will name one or more of their children to act in the case of simultaneous death, or upon the second death. But what are your choices if you do not want to name your children, or if you have no children?
Of course you can name other family members to handle your estate. Some clients even name parents, although of course it is uncommon for parents to live longer than their children. Siblings, grandchildren, cousins can all be good candidates. Cousin Emily, the lawyer in Illinois, might be a perfectly good candidate. Same for nephew Dale, the CPA in California.
Some clients — occasionally even those with children — may choose to have a professional named to handle their estate. In that case there are at least four types of choices to consider:
1. Bank trust offices. Not all trust companies are related to banks, so we do not mean to limit the choice to bank trust companies — but the image of a bank officer acting as trustee is at least a little bit familiar to most. The good news: it is likely that your bank trust department will still be around, even long after your death. Even if it changes names, or merges with another bank, it will still exist and be identifiable. We can safely predict what the bank trust office will look like, and how it will make its decisions, even well into the future; we have several centuries of experience to draw on in describing how a trust company works.
There are two problems with trust companies for many of our clients. First, the banks have begun to set their fees and selection criteria to favor larger estates. For many banks, that means that they are not interested in acting if your estate does not exceed a million dollars in value — though many banks’ minimums are half that, and banks will often accept estates that are less than their stated minimums.
The other objection we often hear to naming a bank: they tend to be an expensive option. To administer a continuing trust, most banks will charge between 1% and 1.5% of the value of the trust each year (although the precise figures vary widely and are often negotiable). To handle the administration of an estate that will be closed in a year or so, the bank may charge 3%-5% of the value of the estate — or more, if there are complicated assets, difficult administration issues or a modest estate.
Banks also tend to be very conservative organizations, with plenty of rules and a complicated decision-making hierarchy. They may decline to handle real estate, for example, or have a very methodical and inflexible approach to investments or to making distribution decisions. For many clients that is exactly why the banks are a comfortable choice. For others, that can make them look less attractive.
2. Professional fiduciaries. In recent decades an industry of non-bank private fiduciaries has grown up in Arizona (and in many other states). There is even an organization of professional fiduciaries — the Arizona Fiduciaries Association. If your estate is too modest to interest the banks, or if you anticipate that there will be a need for a lot of personal oversight (if, for example, you want to set up a special needs trust for your child who has a disability), the non-bank fiduciaries may be an option.
The good news: the ranks of professional fiduciaries include social workers, accountants, lawyers, money managers, and individuals with a variety of backgrounds and interests. There is a high likelihood that you can locate someone who will be a good fit for your personal situation.
There are a number of problems with naming professional fiduciaries to handle your estate, however. First, the individual fiduciary is probably (we might even say “likely”) mortal. They might not outlive you, in fact — and they probably won’t still be around to handle the trust you set up for your great-grandchildren. Unlike the centuries-long experience with bank trust companies, we do not yet know what the professional fiduciary industry will look like decades into the future.
Private fiduciaries can also be expensive. Many private fiduciaries will charge hourly rates (which tends to save some of the expense, though it can actually increase the cost). Some will charge amounts similar to those charged by bank trust companies — though they may provide additional services, like care management, in those similar costs.
3. Other trusted professionals. Many of our clients choose to name their accountant, or their investment adviser, or their lawyer, to handle their estate. Yes, that can sometimes mean they name our office, and we are willing to name ourselves in documents we prepare — though we encourage clients to think of us as a last choice.
The good news: if you name someone who has already been involved in your life you increase the likelihood that the “fit” will be good. As you continue to work with the person named in your estate plan, you can periodically re-assess that fit and modify your estate planning if it becomes an issue. You will also have a fairly good idea of how rates are set, and whether the costs are reasonable.
As with other non-institutional fiduciaries, one big problem with the professional adviser is (how do we say this delicately) a general lack of immortality. Your accountant’s firm may continue for years after your own accountant dies (or retires), but are you comfortable in predicting that it will have the same values, principles and personality?
4. Friends. Sometimes clients name long-time friends to handle their estates. They may reason that friends’ values and reliability are known quantities. Friends, in turn, are likely to know your values and to make decisions in a way that you would have approved, had you still been around to monitor the administration of your estate.
The good news: friends tend to be less expensive than most of the professional choices, and there is indeed a high likelihood that they will know your family situation and personal values. If you name a close friend, however, you should periodically pull out your estate plan and reconsider whether it remains the right selection — our personal relationships do tend to fluctuate over time.
The bottom line: there often is not a perfectly obvious answer. It can be challenging to balance costs, availability (over the long term) and suitability to come up with the best choice to handle your estate. And we haven’t even discussed the differences between naming a personal representative for your will (the more modern term for the commonly-used “executor”), a trustee for your trust (what many people actually mean when they say “executor”) and an agent for your power of attorney (the role that is often most important while you are still alive). Maybe another day. In the meantime, keep those questions coming.
JANUARY 31, 2011 VOLUME 18 NUMBER 4
One question we are frequently asked: isn’t it a good idea to set aside money for a child or grandchild, and isn’t a UTMA (Uniform Transfers to Minors Act) account a simple way to do that? OK — that’s really two questions. Our answers: Yes, it is a good idea to set aside money. Yes, the UTMA account is a simple way to do it. Don’t set up a UTMA account, however, until you understand the consequences.
There are confusing issues about UTMA accounts. Sometimes the confusion is heightened by the fact that each of the 48 states which have adopted versions of the UTMA Act has changed it a little bit — so what is true in Arizona may not be true in another state (and vice versa). Rather than indulge in all that confusion, however, we are going to tell you in straightforward language what to watch for in Arizona. Be careful about applying these principles to other states’ UTMA acts.
They are inexpensive to set up and to administer. They do not require a lawyer, and avoid courts and formal accounting requirements altogether. All you have to do to create an Arizona UTMA account is to include the name of a custodian, the name of the beneficiary, and the letters UTMA in the title. This will work: “John Jones as custodian pursuant to the Arizona UTMA for the benefit of Marie Smith.”
A UTMA account can simplify the gifting of substantial amounts of money by multiple family members. Set up an account for your 2-year-old, and all four grandparents can put $13,000 each into the account each year (using 2011 numbers — the maximum non-taxable gift may go up next year or in future years).
They automatically end at 21, so the money will not be tied up indefinitely. One of the points of confusion: sometimes UTMA accounts end at 18 in other states, and in some circumstances in Arizona. But if you are putting your money into an account for a minor in Arizona, the end date is age 21.
They encourage regular savings by simplifying the process. Open an account with, say, $1,000, and put $50/month into the account. You won’t save a fortune in 15 years, but you will have $10,000 that you wouldn’t otherwise have saved without this discipline. Plus the earnings and growth on the investment, as a bonus.
If the minor receives public benefits like SSI or Medicaid, the money will usually not be treated as “available” (and therefore reduce or eliminate benefits) until age 21.
Of course it’s not all good news. Here are some problems or limitations:
The money in the UTMA account will need to be reported on the minor’s FAFSA (Free Application for Federal Student Aid) form when applying for student aid — and it will be treated as completely available to the student. In other words, the very existence of a UTMA account may prevent receipt of needs-based student aid.
The income in the UTMA will be taxed at the minor’s parents’ income tax rates. Unless, of course, there is so much money in the minor’s name that his or her rate is higher — then the UTMA account will be taxed at that higher rate.
The minor may have to file an income tax return if the UTMA money produces significant income. The UTMA account may be used to pay any income tax due, and the tax preparation costs, but it will require that a return be prepared.
At age 21 the (former) minor is entitled to receive all the money. Period. It doesn’t matter if he or she has become a drug addict, a spendthrift or a cult member.
If the (former) minor receives public benefits like SSI or Medicaid, at age 21 the UTMA account becomes an “available” resource and may compromise those benefits.
If the UTMA custodian is the parent of the minor (which is by far the most common arrangement), then there may be additional complications in how the money can be used and/or what tax effect the money might have. Since a parent has an obligation to support his or her minor children, the UTMA account generally can not be used by a parent/custodian in ways that reduce or satisfy that support obligation. If, on the other hand, the donor of the money acts as custodian, he or she may not have gotten the money out of his or her estate (which is usually one intention on the donor’s part).
Although UTMA accounts are usually seen as simple mechanisms avoiding lawyers and conflict, the custodian still has an obligation to give the minor (or his or her guardian) account information. Thinking of giving a divorced and non-custodial parent money for the benefit of his or her minor child? Know that you are inviting a dispute between the custodial parent and the UTMA custodian over how the money is invested and spent (or not spent).
What happens if the custodian dies or becomes incapacitated? There is no easy mechanism to select a successor custodian; it may require a court proceeding to name a successor. A fourteen-year-old minor may be able to select his or her own custodian, which could raise concerns for a thoughtful donor. (Note: Arizona law does allow the current custodian to name his or her own successor custodian, but few do. If you are planning on setting up a UTMA account, insist that the custodian select a successor.)
What happens if the beneficiary dies before reaching age 21? The money goes to his or her estate — which may require a probate proceeding (if the total is over $50,000 in Arizona) and usually means that the money will be split between the child’s parents. That may be fine, but it may not be what the donor intends or wants.
The effect of interstate proceedings is unclear. If you live in New Mexico and set up a UTMA account in an Arizona bank with an Arizona custodian for a minor who lives in Iowa, what happens when your custodian moves to Wisconsin? What courts might the custodian have to answer to, and whose law applies in the case of a disagreement? Fortunately, this problem seldom arises — there are few legal proceedings involving UTMA disputes. But they do happen, and increasingly so in an increasingly mobile society.
What are your alternatives to a UTMA account? Consider 529 plans for educational purposes, and separate trusts if the money is intended to be for more general use. For a child who earns income an IRA might even be an appropriate choice — if the child earns $3,000 in a given year, he or she can contribute up that amount to an IRA (and the source of the money does not have to be the earnings). Talk to your financial adviser and your lawyer about the cost of the various options, the problems they raise, and the best alternative in your circumstances.
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:
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.
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.
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.
DECEMBER 27, 2010 VOLUME 17 NUMBER 40
Kenneth Boyd established a revocable living trust in 2002. He named his daughter Carol Boyd as trustee, and directed that the trust be divided, upon his death, into three shares. One share each was to go to Carol, to Kenneth’s mother Elizabeth Boyd, and to Carol’s son Ben Scott. So far nothing is remarkable or unusual about Mr. Boyd’s trust arrangements.
Elizabeth Boyd entered a nursing home in November, 2007. Kenneth Boyd died a month later. When it came time to divide the trust estate among the three beneficiaries, Carol Boyd simply wrote checks to each one, and sent Elizabeth Boyd’s share to her in care of the agent under her durable power of attorney.
The agent refused to cash the checks. Putting the money into an account in Elizabeth Boyd’s name, she argued, would simply make her ineligible for Medicaid assistance with her nursing home costs, and assure that a third of Kenneth Boyd’s estate would go to nursing home care for Elizabeth. If Elizabeth Boyd’s share could stay in trust, it could benefit her during her life, allow her to remain eligible for Medicaid, and assure that there would be something to pass on to her heirs on her later death.
It seemed obvious to Elizabeth Boyd’s attorney-in-fact that the continued trust would be in her best interest. Language in the trust could be construed to permit Carol Boyd to do just that — to turn the distribution from the trust into a “third-party” special needs trust. Elizabeth, through her attorney-in-fact, ultimately filed suit in California, asking the court to compel Carol to continue to hold the funds in trust for Elizabeth but not distribute any proceeds outright to her.
Carol Boyd pointed to the language of the trust, which gave her the power to do what was asked but did not direct her to do so. She insisted that her father would have wanted his money to support his mother until her death (or until the money ran out), and she declined to establish a special needs trust. So the legal question became whether Carol had an obligation to do so.
In an unpublished opinion, the California Court of Appeals ruled that Carol did not breach her duty to Elizabeth by failing to segregate her trust distributions into a separate, third-party special needs trust. It was not completely clear to the appellate judges whether such an action would even be effective; in any event, the opinion makes clear that Kenneth Boyd’s trust gave Carol the power, but not the duty, to modify the distribution terms. Boyd v. Boyd, December 16, 2010.
As is so often the case, there were a number of complicating issues in the Boyd case. They help point up the importance of communicating clearly with the lawyer who prepares your estate planning documents, and keeping those documents updated. Among the complications:
Kenneth Boyd’s trust actually left a larger share to his brother, James, who was scheduled to receive 40% of the remaining funds on Kenneth’s death. James, however, died just a year before Kenneth did, and the trust did not provide that his share would pass either to his surviving wife or his step-daughter. Despite the fact that James’ marriage was of long standing, he had never adopted his step-daughter — if he had, she would have taken his share of the trust as his child. Since he died without any legal “issue,” his share lapsed and was divided equally among the other three beneficiaries (Carol, Elizabeth and Ben).
Carol Boyd was actually the adopted daughter of Kenneth Boyd. That makes no legal difference, and probably was explained to the lawyer who drafted the trust at the time. But the adoption had been completed when Carol was 32 years old, and she had never met Kenneth’s mother Elizabeth, his brother James or his wife.
Kenneth and Carol lived in California. Elizabeth, James and his wife lived in New York. Consequently, the California courts had jurisdiction over the trust interpretation — but they had to consider the effect on New York Medicaid eligibility and trust law. Interstate proceedings often create additional confusion and difficulty.
It is extremely hard to know what Kenneth actually would have wanted in the facts as they developed. That is why estate planning lawyers go through the almost ghoulish routine of asking clients to imagine unusual sequences of family deaths and disability. The reality is that Kenneth Boyd died just a year after his brother’s death, and a month after his mother entered the nursing home (and qualified for Medicaid). If he had discussed the family situation with his lawyer during the year after his brother died, he might have made changes in his trust language. At least he might have clarified his wishes, so that the issue would not have to be decided by court proceedings.
AUGUST 16, 2010 VOLUME 17 NUMBER 26
Let’s say you have created a revocable living trust, and you have named yourself as trustee. You also name your two children as successor trustees, to act together upon your death or incapacity. Two years later you become incapacitated; because of a dispute between your two children about who should handle assets outside the trust, the probate court names a local bank as your conservator. Now who handles your trust — the bank, or your children?
Before we answer that question, let us complicate it. You are also the beneficiary of a trust set up by your late husband — and you are trustee of that trust, as well. About half of the assets the two of you owned are included in each of the two trusts. Your husband’s trust names you as trustee (now that he is deceased) and names the two children as successor trustees if anything should happen to you. Does your conservator have any authority over that trust?
Those were precisely the questions faced by a probate judge in South Dakota when Evelyn Didier became incapacitated. The bank appointed as her conservator asked the court to clarify that it had control over both trusts as well as Ms. Didier’s non-trust assets. The judge agreed, and Ms. Didier’s daughter Barbara Didier-Stager appealed.
Court appointment of a conservator does not amount to appointment of a successor trustee, argued Ms. Didier’s daughter. In fact, appointment of a conservator proves the incapacity that triggers a change in trustees — resulting in the son and daughter taking over as successor trustee of their mother’s trust. As to their father’s trust, the successor trustee provisions are triggered by the conservatorship in the same way — though our simplified version of the facts described above fails to clarify that the successor trustees of that trust were actually Ms. Didier-Stager and another local bank — different from the bank acting as Ms. Didier’s conservator.
South Dakota, like Arizona, has adopted the Uniform Probate Code — though South Dakota’s version has been updated more recently and is more current. The Code includes provisions about guardianship and conservatorship (though now those sections have been set aside as a separate uniform law, the Uniform Guardianship and Protective Proceedings Act). Those uniform laws permit the judge in a conservatorship proceeding to enter orders related to the protected person’s estate plan.
So, reasoned the South Dakota court, the probate court could permit Ms. Didier’s conservator to do anything that Ms. Didier herself could have done before becoming incapacitated. Her own trust was revocable and amendable — if she had wanted to do so, she could have changed the successor trustee at any time. She could have named the bank that was ultimately appointed as her conservator. Consequently, the court could allow her conservator to assume the powers of successor trustee over that trust.
The late Mr. Didiers trust was a different matter, however. Ms. Didier herself did not have the power to change the trustee, and so her conservator could not exercise that power on her behalf. That trust would have to be dealt with separately, and the Supreme Court ordered the case remanded to the probate judge to determine what to do about Mr. Didier’s trust. Conservatorship of Didier, June 30, 2010.
Does this mean that Mr. Didier’s successor trustees automatically take over, instead of Mrs. Didier’s conservator? Probably not. Other provisions of the Probate Code give the probate judge authority over trust administration, and if it appears that there is some reason not to allow the named successors to become trustee there will presumably be an order to that effect. But it does change the discussion from a choice between blindly following the document or giving Mrs. Didier’s conservator power to do anything she could do. Instead, the probate court will have to determine which approach is most consistent with the trust, with proper administration, and with the best interests of the trust’s beneficiaries.
The Uniform law actually goes quite a bit further today than the 1974 version originally adopted in Arizona (though Arizona has updated portions of the law several times). Reviewing the statute in the context of the Didier case highlights some of the changes. Among the powers given to conservators by the “new” Code (as adopted in South Dakota, for instance) is the power to “make, amend, or revoke the protected person’s will.” (See Section 411(a)(7) of the Uniform Guardianship and Protective Proceedings Act.) Court approval is required, but the very notion of a conservator changing the protected person’s estate plan might strike some as dangerous.
JUNE 28, 2010 VOLUME 17, NUMBER 21 Mesa, Arizona, lawyer Donald C. Galbasini first began representing members of the Tremble family in 1998. That was when he filed a notice that he would be the attorney for Vernice Tremble, who was serving as conservator for Edward Tremble, Jr., her grandson.
Nine years later Vernice Tremble was removed by the probate judge as conservator — and also as trustee of a special needs trust that had been set up for Edward Tremble. A professional trustee was appointed to take over management of the special needs trust. A year and a half after that, Edward Tremble died and another family member was appointed to finalize the trust administration and distribution. Mr. Galbasini filed a notice that he would be representing the new trustee in connection with wrapping up the trust.
A month after stepping in as the new trustee’s lawyer, Mr. Galbasini filed a request for approval of a $46,736.65 fee — for his representation dating back to 1998. The state Medicaid agency (which would receive most of the balance of Edward Tremble’s trust under the rules governing self-settled special needs trusts) objected, arguing that it was too late for Mr. Galbasini to be filing his bill for approval and payment.
The trustee who had been handling the trust in the interim joined in the state’s objection, adding other arguments. Because of Mr. Galbasini’s long involvement and representation of a conservator who had been removed, argued the trustee, it would be impossible at this late date to figure out whether his representation had benefited Edward Tremble or other family members. The trustee pointed out that Mr. Galbasini had billed at his regular attorney rate for ministerial actions like writing checks out of his client trust account. Furthermore, the trustee was concerned that none of Mr. Galbasini’s reported time was for contact with Vernice Tremble, his client — all of his contacts had been with Edward Tremble’s parents, Mr. Galbasini’s client’s son and daughter-in-law.
The probate judge agreed, and denied Mr. Galbasini’s fee request as untimely. The Arizona Court of Appeals, however, disagreed — it reversed the fee denial and sent the matter back to the trial judge for further hearings. The question wasn’t whether the fee request was late, ruled the appellate court — instead, the important question was whether the fees were reasonable and for the benefit of Edward Tremble’s trust and conservatorship estates.
The appellate court did not rule that Mr. Galbasini’s fees were reasonable, but only that he needed to be given a chance to explain and defend them. If the court finds that the fees were incurred during times when he did not actually represent the conservator or trustee, for instance, the Court of Appeals agreed that those fees should be denied. The mere lateness of the application, however, was not enough to justify a complete denial of Mr. Galbasini’s fees. Conservatorship of Tremble, June 10, 2010.
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.
United Financial Systems Corporation looks like they can do it all. According to their website (which you will have to look up for yourself — we don’t want to point to it since it still includes information about how to sign up for the activities that have now been prohibited), they can tell you how to plan your estate, retirement, insurance needs, health care — even your funeral arrangements. There is a disclaimer that lets you know they do not practice law (and do not give investment advice). The Indiana Supreme Court begs to differ.
In a disciplinary action three weeks ago, that state’s high court found that UFSC was “an insurance marketing agency,” and it was practicing law. The company was ordered to stop selling living trusts, to give every client a copy of the Court’s opinion, to offer refunds to all clients they had worked with in the past four years, and to pay the costs and some of the attorney’s fees associated with the proceeding. A handful of lawyers were included in the disciplinary process; most agreed to end their involvement with UFSC (and the practice of participating in non-lawyer legal work) and were dismissed from the case.
What was UFSC doing? It had “Estate Planning Assistants” (non-lawyers) contact prospective customers to tell them about the importance of estate planning. If the customer signed up for the $2,695 living trust package, the salesperson collected $750 to $900 and helped the customer fill out a questionnaire.
That questionnaire was then sent to one of several attorneys UFSC hired to prepare living trusts, wills and powers of attorney. The attorney would be paid $225, and would make one telephone call to the client to discuss the estate plan. Once a trust and supporting documents were prepared the signing was handled by another UFSC salesperson — for another $75 slice of the total fee.
The person handling the signing, whose title was usually “Financial Planning Assistant,” also had access to the customer’s financial information (remember that questionnaire?) and could make recommendations about investment changes. One common proposal was to liquidate other investments in order to purchase an annuity — which, incidentally, would yield a significant commission for the Financial Planning Assistant and UFSC.
The Indiana Supreme Court’s opinion details one extreme example of the effect of this marketing juggernaut. The 72-year-old woman was persuaded to liquidate $500,000 worth of Exxon Mobil stock — the bulk of her entire net worth — in order to purchase an annuity. The result: she incurred a $132,000 income tax liability and her salesperson received a $40,000 commission. State of Indiana ex rel. Indiana State Bar Association v. United Financial Systems Corporation, April 14, 2010.
Would UFSC face the same result in Arizona? Probably not. While the unauthorized practice of law is prohibited by court rule, Arizona repealed its criminal statute decades ago. The Arizona Supreme Court has not been active in reviewing such cases, and indeed has even created a “certified document preparer” classification for non-lawyers who “assist” clients in creating wills and trusts.
How can you avoid being taken advantage of by non-lawyer “estate planners” or “document prepapers”? Lawyers tend to think the best answer is the simplest one: hire a lawyer for your legal needs. If you are approached by a “finanical planning assistant” or something similar, you might want to ask “assistant to whom?”
If the salesperson assures you that they have a crack team of estate planners, tax advisers and financial consultants, ask for a few names, titles and credentials. Above all, be very cautious of any person or group who also happens to sell annuities or other insurance products. Not all insurance salespersons are questionable, but practically all questionable non-lawyer “estate planners” sell insurance products.
