These are interesting years in estate planning for families in the Upper Middle and Lower Upper Classes. As a high estate tax exemption has reduced the tax-driven imperatives for using trusts to hold inheritances, non-tax applications of trusts come to the fore.
As non-tax issues in trust design assume greater relative importance, what factors should a family consider when deciding whether to use a trust?
If they will use a trust, how should that trust be designed?
To answer these questions, a family should do the best it can to look ahead to its future, and make reasonable (but unavoidably imperfect) estimates of what its future might look like.
That takes us back to the Quadrant at the heart of a Life Cycle approach to estate and financial planning, with its four domains of Facts, Forecasts, Life Stages, and Unexpected Events.
The decision whether or not to use a trust to hold an inheritance begins with a family’s Facts.
- Who would be receiving the wealth?
The array of options includes the obvious, but thinking about the beneficiaries is the right place to start.
Common potential inheritors include a widow(er), a surviving spouse and children, adult children, nieces or nephews, parents, siblings, and/or charities.
- What will the trust’s funding level be?
Funding is a tremendously important Fact underlying good trust design.
Funding often occurs during estate administration, when probate and non-probate assets (such as retirement accounts and life insurance proceeds) are gathered, and transferred to the trust.
A quick review of a family’s balance sheet will suggest the anticipated potential funding level for a trust.
Funding is only the first stage of a trust’s life cycle; the stage that follows is administration – investing the trust’s assets and making distributions to its beneficiaries.
Designing a trust well requires taking into account the Life Stages of the beneficiaries during the trust’s term.
For instance, if clients are a married couple with young children, the trust might need to “financially parent” the children through primary and secondary school, and then possibly college and graduate school.
In contrast, if a married couple had adult children, the trust might be protecting assets for those adult children to help boost the children’s retirement savings.
It might also be protecting against claims of a child’s creditors, or against loss of assets to divorce by preventing commingling a child’s inheritance with marital property.
The Life Stages of a trust’s beneficiaries will suggest how long the trust should last, as well as the “exit strategy” for trust assets – the distribution stage of the trust’s life cycle.
Examples of distribution options for trust assets include:
- All at once. The trust might distribute its remaining assets among beneficiaries when its youngest beneficiary attained a specific age.
- Stages – at ages. The trust might make partial distributions when a beneficiary attained particular ages (such as 30, 35 ,and 40). This approach fits when clients believe maturity in financial decision-making comes with increasing age.
- Stages – at times. The trust might make partial distributions at particular times (such as 5, 10, and 15 years after funding). This approach fits when clients think good financial decisions come with opportunities to learn through experience, or even by making poor choices about the use of early distributions.
Another key variable in deciding on the best distribution design for a trust requires a Forecast of the remaining value of assets in the trust at the time of distribution, the number of beneficiaries at the time of distribution, and – by extension – the likely amount of distributions to each beneficiary.
Like any Forecast, uncertainty can’t be avoided, but reasonable forecasts aren’t impossible.
It’s important to align Forecasts of a trust’s remaining assets with its distribution design.
If a trust would be funded with $5 million and its pricipal purpose would be to pay for college and graduate school for a couple’s sole child, an outright distribution of remaining trust assets when the child attains age 25 may not be wise.
Similarly, if a family has four children, none over age 10, and the trust would be funded with $1.5 million, keeping remaining assets (after all the children are raised and educated) in separate lifetime trusts for each child may be more complicated than necessary.
Trust design should also incorporate Unexpected Events – occurrences that aren’t uncommon in the overall population, but tend to take any individual or family by surprise (such as divorce, an illness, the birth of a special needs child, or a spouse living much less than their life expectancy).
Simply put, the more Life Stages a trust’s administration will cover, and the more assets it will hold, the more closely clients should consider ways to make the trust adaptable to Unexpected Events.
With these variables in mind, it’s possible to evaluate on an individualized, case-by-case basis whether and how a trust might be helpful – even in situtations not dominated by estate tax issues.
Future posts will explore some of these situations, which include:
- Anticipating a spouse’s remarriage
- Planning to conserve family assets when a surviving spouse is very elderly
- Protecting family assets against a child’s divorce
- Using a trust as a substitute for a prenuptial agreement
- Defending against sons- or daughters-in-law who make unwise business or spending decisions
- An “asset protection wrapper” for a child’s inheritance
- Protecting a family’s core capital for grandchildren, when children seem unlikely to make good financial decisions
- Incentive trusts to encourage particular behaviors and choices by descendants
For each of these situations, when clients and their advisors thoughtfully consider Facts, Forecasts, Life Stages, and Unexpected Events, they’ll likely reach better estate and financial planning outcomes.