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Financial Planning > Trusts and Estates > Estate Planning

How Flexible Can You Be?

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In the estate planner’s tool chest of legal devices, perhaps none is more handy than the trust protector: A person or corporation who, depending on the terms of the trust, can swing into action to fix document errors or ambiguities, revise language to conform to changes in the tax law or mediate disputes among warring parties. In the year ahead, expect to see more of these handymen work their magic.

“There is now broad use of trust protectors,” says Raymond Benton, a certified financial planner and principal of Benton & Co., Denver, Colo. “This tool is part of an ongoing search for more flexible ways of doing estate planning.”

That search, say experts contacted by National Underwriter, has helped to bolster the use of a range of other innovative techniques in estate planning. Among them: The qualifying terminable interest property (QTIP) trust, which, when established with an A/B bypass trust, permits a surviving spouse to use trust property tax-free; the durable power of attorney, which may be employed in the event of a principal’s illness or disability to sign necessary legal documents; and universal and variable universal life policies to flexibly fund wealth replacement trusts.

Underpinning the pursuit of adaptable estate planning strategies is uncertain over the final disposition of the estate tax. Since passage of the Economic Growth and Tax Relief Reconciliation Act of 2001, Congress has made repeated attempts to repeal or reform the legislation’s quirky estate, gift and generation-skipping transfer tax provisions. Among other things, EGTRRA calls for an increase in the estate tax unified credit exclusion (now $2 million) to $3.5 million in 2009, followed by a one-year repeal of the tax in 2010 and–absent further legislation–reinstatement of the pre-2001 tax regime in 2011.

Sources say the uncertain fate of the estate tax has to some extent shifted the focus of estate planning from tax avoidance to equally important financial objectives. Chief among these are providing for the welfare of a surviving spouse, controlling the disposition of assets to be passed to heirs and protecting assets from creditors.

But advisors say they and their clients don’t expect the estate tax to go away. The consensus among those surveyed is that Congress will likely settle on a unified credit at or near the $3.5 million lifetime exemption that takes effect next year.

Says Benton: “It would be a great thing if [Congress] froze the exemption at the 2009 level. We’d know what we’d have to work with. And the amount is politically sellable. Both Democrats and Republicans would likely accept it.”

“Particularly during the past couple of years, people are beginning to realize that they should go ahead and plan,” adds Deborah O’Neil, vice president of AXA advanced markets at AXA-Equitable, New York. “And they need to make sure [the planning] incorporates the flexibility needed to address changes in the tax environment based on the laws Congress may pass.”

Whatever figure Washington decides on, however, may not be enough to spur the estate planning-challenged to action. If a 2004 survey by Pittsburgh, Pa.-based PNC Financial Services Group is any guide, that’s still a sizeable number. Of 792 affluent individuals polled (including 500 with more than $1 million in investable assets), 40% didn’t have a will and two-thirds didn’t have a professionally prepared estate plan. Additionally, 37% of those with $10 million or more had not taken any action to prepare for their financial futures.

What is more, most individuals who have implemented estate plans give heirs unfettered access to their money. Of 1,223 affluent people surveyed in a May 2007 report from PNC, just 30% instruct beneficiaries to meet specific requirements to receive bequests.

Interest in such “incentive trusts,” however, rises in tandem with wealth. More than half (57%) of those with $10 million-plus in assets and more than 4 in 10 (42%) with between $5 million and $10 million in assets require heirs to satisfy certain terms such as age, education or maintaining a satisfactory job before they are allowed to access their inheritance.

Financial professionals emphasize that such shortcomings can be fixed by building flexibility into the estate plan; and can be avoided altogether by taking a holistic approach to planning generally. That means supplementing an estate plan–often the final phase of the planning process–with a roadmap that fulfills other financial goals, such as charitable, retirement and business succession objectives.

David Sebastian, a certified financial planner and founder of The Physicians Wealth Management Group, a Parsippany, N.J.-based division of Summit Financial Resources, says legacy planning is only one component of a comprehensive wealth management solution he offers clients, most of whom are doctors. A top concern of many of these physicians, he says, is protecting their assets from creditors.

Thus, Sebastian does a steady business setting up such creditor-protected vehicles as the dynasty trust (also known as the generation-skipping transfer tax or multigenerational planning trust), which extends the benefits of an estate plan beyond children to grandchildren or future generations. He also frequently recommends disclaimer trusts, which contain provisions enabling a surviving spouse to secure trust income while “disclaiming” ownership of a portion of the estate. There is, too, the family (a.k.a., credit shelter, B or bypass) trust, which can take possessions of assets equal to the applicable exclusion amount upon the death of a first spouse and provide for income and discretionary distributions of principal to a surviving spouse.

However, Chris Cooper, a certified financial planner and president of Chris Cooper & Co., Toledo, Ohio, says that since EGTRRA’s passage, fewer middle income clients have turned to this vehicle as the exemption limit has climbed.

“With the $2 million exemption, more clients can avoid the estate tax. And in estates that have these trusts, we’ve haven’t been funding them,” says Cooper. “Given the time, paperwork and expense, it hasn’t been worth it to the families involved. Of course, for the $10 million-plus estate, these trusts may still make sense.”

Cooper adds that the Deficit Reduction Act of 2005 restricted the use of gift and estate transfer techniques implemented for the purpose of securing Medicaid benefits. Among other provisions, the legislation tightened loopholes that allowed people to game the system by transferring assets to their children so they can qualify for Medicaid.

Cooper says he is, however, seeing greater use (particularly on the East and West coasts, where home values remain high) of qualified personal residence trusts or QPRTs, a popular asset protection device; as well as of joint revocable trusts (particularly among married couples), which offer a cost-effective alternative to establishing individual spousal trusts. Clients are also doing more intentionally defective grantor trusts, an irrevocable trust that is made “defective” for favorable income tax treatment, but which escapes gift and estate taxes.

The vehicle is a popular gifting technique for, among other things, third-party financing of large life insurance policies residing inside irrevocable life insurance (wealth replacement) trusts. Assuming IRS requirements are met, premiums paid to defector grantor trusts to fund such policies can circumvent the $1 million lifetime gift tax exemption limit.

AXA Equitable’s O’Neil also sees more widespread use of third-party financing, as well as of another technique used to reduce gift taxes: private split-dollar life insurance plans, an arrangement wherein two parties share the cost of funding premiums paid to an irrevocable trust, but in a way that limits the annual gifts to the economic value (term cost) of the insurance protection provided.

David Culley, an advisor and vice president of Nease, Lagana, Eden & Culley, Atlanta, Ga., says the firm’s estate planning practice has grown substantially in recent past years, to the point where it now constitutes about 75% of the business. For the firm’s high net worth clients–most have estate ranging in value from $25 million to $250 million–a wealth replacement trust is usually part of the package.

“As we go through the estate planning process, life insurance usually comes to the top of the discussion because of the simplicity of the ILIT and the certainty that life insurance delivers,” says Culley. “The insurance can be used to pay estate taxes, equalize estates among heirs or replace assets gift to charity. So the ILIT is usually an end product.”

O’Neil agrees, adding: “Life insurance is good for more than just paying taxes at death. It can be used to help a surviving beneficiaries keep from liquidating important family heirlooms or property. And in some cases, insurance can do double or triple duty: protect the family, provide supplemental retirement income and fund other anticipated expenses, like starting a business.”

For Cooper’s less affluent clients, life insurance also often plays a prominent role, but generally not as part of an ILIT. Many of his clients are heterosexual and gay couples in domestic partnerships who, because they don’t qualify for the unlimited marital deduction afforded married couples under federal law, turn to life insurance as a way to retire estate taxes upon the death of one or the other partner. To that end, Cooper often will recommend that the partners cross-own insurance contracts–each purchasing a policy on the life of the other–an arrangement similar to the use of insurance inside buy-sell agreements between business owners. When one partner dies, the other collects the death proceeds income- and estate-tax-free.

More often than not, says Cooper, the key issue to be addressed in estate planning is not restrictive federal laws respecting nontraditional relationships, but the unwillingness of financial institutions to honor the intent of estate planning documents. When language is less than precise, funds intended for heirs can be sent into indefinite limbo.

How to bullet-proof the documents? “You’ve got put to more words in them and make sure they updated at least annually,” says Cooper. “The financial services professional absolutely needs to be involved in document creation and review. You can’t just leave it to the attorney to deal with this issue.”


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