Leave kids money by trust or outright/tax implications

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it'smyjob?
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Leave kids money by trust or outright/tax implications

Post by it'smyjob? » Fri May 06, 2016 11:34 pm

I have been working on revising our estate plan (thank you bsteiner and others for past input), and am now struggling with the question of whether to leave money to our adult children via a trust or to give the money outright.

I am getting hung up on two main issues and would appreciate any insights or corrections to my thinking:

1. I have repeatedly heard that a Trust affords protection from creditors and a divorcing spouse. For this to be true, what limitations are there on distributions from the trust if the child is the SOLE trustee, as well as beneficiary? I have heard that distributions must be limited to an "ascertainable standard" and that this is usually defined as health, education, maintenance and support. But I need to know in real terms how the child would be able to use the money. Could he buy a house? a boat? use the money for the education of his own children? Start a business? Is a trust with the beneficiary as sole trustee definitely protected from creditors?

2. I know that trusts are subject to less favorable taxation due to the compressed rates. If income is distributed to the beneficiary, it will be taxed at his rate. I am assuming that distributions from a retirement account to the trust would be taxed at the trust's rate unless the trust then distributed the entire amount to the child. Is this true? The trust, as beneficiary of the IRA, would have an accelerated payout schedule compared to the payout stretch the child would have been able to take if he just inherited the IRA directly. If half the assets inherited are retirement accounts and IRAs, does a trust make sense?

In short, I am trying to weigh the benefits of the trust (asset protection from creditors and divorce) against the disadvantages (Limitations as to how the money can be spent in order to maintain asset protection, inferior tax treatment, trust administration costs and extra tax returns for life). I guess i am concerned about saddling my children with the administration of a trust for life when I have no experience with trusts myself.

afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Sat May 07, 2016 12:27 am

I share your curiosity about the beneficiary's acces to the trust if she is also the sole trustee.

At least at this point the trust can stretch the IRA distributions over the beneficiary's life expectancy. But the money will be taxed at trust rates if the income remains in the trust. Note that this is a problem only if the beneficiary is in a lower tax bracket. If the beneficiary is in the top tax bracket anyway, then there is no tax penalty. In fact, by keeping some income in the trust, it could be taxed at a.lower rate than it would be if distributed.
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peterinjapan
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Re: Leave kids money by trust or outright/tax implications

Post by peterinjapan » Sat May 07, 2016 2:05 am

Literally sat in a lawyer's office for 2 hours today signing new trust documents today. I *believe* that money going to proper beneficiaries will not be taxed, as it's money going to them properly through an estate? As long as it's under the $5 million amount.

it'smyjob?
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Re: Leave kids money by trust or outright/tax implications

Post by it'smyjob? » Sat May 07, 2016 11:31 am

Thank you, afan. I had gotten confused about the required payout schedule for the trust. You set me straight there.
peterinjapan, I believe you are concerned with estate tax. I am addressing income tax the beneficiary would pay when taking IRA distributions over time.

There is a good article describing IRAs and trusts in forbes:
http://www.forbes.com/sites/deborahljac ... 31d20b1da5

It actually quotes Bruce Steiner who makes some important distinctions. (He also has written an article that I need to take more time to digest. It is linked in my previous thread).

I would not be using a trust for the purpose of controlling the flow of assets to my children- they will be their own trustees. My only reason for considering the trust is asset protection. The funny thing is that I never even thought about that until the lawyers brought it up. Who are these creditors they need to fear? :) More important is the issue of a divorcing spouse. I thought that if my child inherits money and keeps it in a separate account, it would be safe in a divorce. Apparently, that is not so. Under what circumstances would that money be in jeopardy?

Does anyone know what limitations on distribution from the trust (with beneficiary as sole trustee) are required for the trust to be protected from creditors?

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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat May 07, 2016 1:19 pm

it'smyjob? wrote:
1. I have repeatedly heard that a Trust affords protection from creditors and a divorcing spouse. For this to be true, what limitations are there on distributions from the trust if the child is the SOLE trustee, as well as beneficiary? I have heard that distributions must be limited to an "ascertainable standard" and that this is usually defined as health, education, maintenance and support. But I need to know in real terms how the child would be able to use the money. Could he buy a house? a boat? use the money for the education of his own children? Start a business? Is a trust with the beneficiary as sole trustee definitely protected from creditors?


I am not a lawyer and have no legal training I have been researching the same issue. As I understand it, if the beneficiary (adult child) is sole trustee and has the ability to make discretionary distributions, a judge in a lawsuit or divorce settlement can order the child to exercise that power to pay out whatever the judge is ordering. Even if the trust limits distributions to an ascertainable standard (i.e. HEMS), there is still risk. A common protection strategy is to name the child as sole trustee, but allow the child to appoint an independent trustee and resign as trustee if necessary for asset protection. The child can choose to again act as sole trustee or co-trustee after settlement. I am not a lawyer, so keep in mind that this is only my understanding after some amount of research.

it'smyjob? wrote:2. I know that trusts are subject to less favorable taxation due to the compressed rates. If income is distributed to the beneficiary, it will be taxed at his rate. I am assuming that distributions from a retirement account to the trust would be taxed at the trust's rate unless the trust then distributed the entire amount to the child. Is this true? The trust, as beneficiary of the IRA, would have an accelerated payout schedule compared to the payout stretch the child would have been able to take if he just inherited the IRA directly. If half the assets inherited are retirement accounts and IRAs, does a trust make sense?


These are very valid concerns. There are two separate issues here a) preservation of the stretch payout and b) generation of taxable income within the trust. If the trust is written correctly as a "see through" trust (aka look through trust), the IRS will consider the ultimate beneficiary(s) in determining the ADP (applicable distribution period). This means that if you name your children as the sole beneficiaries of the trust, the payouts will be stretched based upon either the oldest child's life expectancy or, if properly split into subtrusts and so-designated on beneficiary designations, based upon each child's life expectancy. In order to pass the test with the IRS, there can be no non-individual contingent beneficiaries (e.g. estates, charities, non-qualified trusts, etc.). Regarding taxable income, the best solution is to convert the maximum amount possible to Roth IRA's during your lifetime and to have the Roth accounts name the qualified trust as beneficiary.

I consider the issues you are asking about to be of critical importance. Unfortunately, the IRS has not been very helpful and this has resulted in much confusion. As you educate yourself further, one of the first things you may wish to learn about with respect to retirement funds is the difference between a conduit trust and an accumulation trust. The former is more straightforward, but provides little in the way of asset protection. The later can provide significant protection, but is trickier to establish. I've met with several estate attorneys, in fancy offices, who have demonstrated little knowledge of these topics. Good luck! :sharebeer
Last edited by NMJack on Sat May 07, 2016 1:35 pm, edited 3 times in total.

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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat May 07, 2016 1:21 pm

it'smyjob? wrote:My only reason for considering the trust is asset protection. The funny thing is that I never even thought about that until the lawyers brought it up. Who are these creditors they need to fear? :)


And the answer is......

Anybody and everybody who finds out your child has some money and wants to take it for themselves!!! (Unfortunately, this includes the IRS but there isn't a trust that can fix that). :twisted:
Last edited by NMJack on Sat May 07, 2016 1:32 pm, edited 1 time in total.

JoinToday
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Re: Leave kids money by trust or outright/tax implications

Post by JoinToday » Sat May 07, 2016 1:31 pm

it'smyjob? wrote:
I would not be using a trust for the purpose of controlling the flow of assets to my children- they will be their own trustees. My only reason for considering the trust is asset protection. The funny thing is that I never even thought about that until the lawyers brought it up. Who are these creditors they need to fear? :) More important is the issue of a divorcing spouse. I thought that if my child inherits money and keeps it in a separate account, it would be safe in a divorce. Apparently, that is not so. Under what circumstances would that money be in jeopardy?

Does anyone know what limitations on distribution from the trust (with beneficiary as sole trustee) are required for the trust to be protected from creditors?


I am not a lawyer, but this is my understanding
1. My understanding is that for a trust to provide the best asset protection, your child cannot be the sole trustee. Either someone else (friend or relative) or a bank/trust service needs to be sole trustee or joint trustee with your child. If your child is the sole trustee, the courts consider the assets to be the child's, and asset protection is lost.

2. With respect to divorcing spouse, I believe it is state dependent. In California, I was told (for assets outside of a trust) to title the account as "(your name), Sole and Separate Property". This is enough to protect it from a spouse -- but you need to make sure you never co-mingle joint and separate property (add jointly owned assets to the separate asset). Other states may be different. With respect to trusts, I believe as long as there is a co-trustee, the assets are protected from divorce. But I am not certain if states may consider distributions from the trust when coming up with alimony.

3. I think (but not certain) that as long as there are limitations placed on the distributions outlined in the trust, the trust will provide asset protection, but the child cannot be the sole trustee. If child is sole trustee, courts consider the money to be the child's, and asset protection is lost.

My lawyer placed language in the trust document to limit distributions in case of substance abuse, spendthrift, lawsuits, and maybe some other things. But I fully expect beneficiary to have easy access to the money. I have put together a letter outlining my wishes, and selected relatives as co-trustees, with Vanguard as corporate trustee if the relatives decide they don't want to do it.
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afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Sat May 07, 2016 2:15 pm

Interesting. Different state, but our lawyers said that friend or relative as independent trustee does not work reliably for asset protection. The courts can presume that the relationship is too close and the trustee will do whatever the beneficiary wants. That would eliminate the protection. They said we need a corporate trustee if we want the asset protection.

With respect to IRA my understanding of conduit vs accumulation has the difference in the protection of the distributions. In a conduit the annual distributions are fair game for the ex spouse, or whoever. In an accumulation trust, the distributions would be protected. We have not decided which to use. Our lawyer recommends conduit, saying that our heirs are.young enough that the share exposed each year will be small and not worth the hassle of the accumulation trust. That could change as we get older. Our attorney also cautions that- the law could change, there are proposals to eliminate the stretch altogether for nonspousal inherited IRAs, and the Clark case was specifically about bankruptcy. In theory, it is possible the conclusion might be different for a non bankruptcy case, although the language of the decision suggests the same outcome. Also unclear how state law would view it.

The trade-off between protection and hassle has us unresolved. Anyone have thoughts on whether the asset protection is worth tying heirs to a corporate trustee, with fees and bureaucracy for the rest of their lives?
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat May 07, 2016 2:29 pm

afan wrote:The trade-off between protection and hassle has us unresolved. Anyone have thoughts on whether the asset protection is worth tying heirs to a corporate trustee, with fees and bureaucracy for the rest of their lives?


afan - you may wish to re-read my earlier post. I believe that it is possible to name child as sole trustee, but to allow them to appoint an independent trustee and resign as trustee if a lawsuit or divorce is on the horizon. This does not have to be permanent. As you know, I share your concerns with the "fees and bureaucracy for life" that many/most trust grantors sign up for with an independent trustee.

I see you used the term corporate trustee. By default, those are independent and, by IRS rules, a relative or subordinate is not independent. I believe that a non-relative who is not "subordinate" to the beneficiary also qualifies as independent, although under cloud of a lawsuit a corporate trustee is likely the safer approach (a couple years of fees and expensive asset management is likely worth the cost in this scenario).
Last edited by NMJack on Sat May 07, 2016 2:37 pm, edited 1 time in total.

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Re: Leave kids money by trust or outright/tax implications

Post by JoinToday » Sat May 07, 2016 2:35 pm

afan wrote:Interesting. Different state, but our lawyers said that friend or relative as independent trustee does not work reliably for asset protection. The courts can presume that the relationship is too close and the trustee will do whatever the beneficiary wants. That would eliminate the protection. They said we need a corporate trustee if we want the asset protection.

I will have to check on this. I made it pretty clear to my lawyer I wanted asset protection. Lawyer said we needed a corporate trustee specified as primary or successor trustee, but didn't put restrictions on the primary trustees (relatives)

With respect to IRA my understanding of conduit vs accumulation has the difference in the protection of the distributions. In a conduit the annual distributions are fair game for the ex spouse, or whoever. In an accumulation trust, the distributions would be protected. We have not decided which to use. Our lawyer recommends conduit, saying that our heirs are.young enough that the share exposed each year will be small and not worth the hassle of the accumulation trust.

Our successor trustees have the option of either distributing or accumulating the dividends and RMDs in the trust. I wondered if the trust could hold on to the RMDs and dividends , but still issue a K-1 and have the beneficiary pay taxes like it was distributed.

....
The trade-off between protection and hassle has us unresolved. Anyone have thoughts on whether the asset protection is worth tying heirs to a corporate trustee, with fees and bureaucracy for the rest of their lives?


I struggle with the same thing. Seems like a giant umbrella policy would help mitigate lawsuit risk. Fees can be pretty big for a large trust. I have provisions to allow for decanting of the trust if the beneficiary and trustee agree.
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat May 07, 2016 2:37 pm

afan wrote:With respect to IRA my understanding of conduit vs accumulation has the difference in the protection of the distributions. In a conduit the annual distributions are fair game for the ex spouse, or whoever. In an accumulation trust, the distributions would be protected. We have not decided which to use. Our lawyer recommends conduit, saying that our heirs are.young enough that the share exposed each year will be small and not worth the hassle of the accumulation trust. That could change as we get older. Our attorney also cautions that- the law could change, there are proposals to eliminate the stretch altogether for nonspousal inherited IRAs, and the Clark case was specifically about bankruptcy. In theory, it is possible the conclusion might be different for a non bankruptcy case, although the language of the decision suggests the same outcome. Also unclear how state law would view it.


I believe that many lawyers like conduit trusts because they are much simpler to write. As long as the primary beneficiary is an individual, it doesn't matter who the contingent or successor beneficiaries are. The stretch is preserved. That said, you are correct about the asset protection drawbacks. If Washington changes the rules and eliminates the stretch, than a conduit becomes worthless. At that point, only an accumulation trust can provide any protection, albeit at a potential severe tax penalty. To my earlier point, if an accumulation trust can be funded with Roth assets, this tax penalty is much reduced. The implications of the Supreme Court ruling may not yet be fully understood. In the meantime, a trust is the only 50 state approach to ensure asset protection for inherited IRA assets.

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Re: Leave kids money by trust or outright/tax implications

Post by it'smyjob? » Sat May 07, 2016 4:01 pm

Thank you all. Some very insightful responses and clear explanations here.

NMJack wrote:
A common protection strategy is to name the child as sole trustee, but allow the child to appoint an independent trustee and resign as trustee if necessary for asset protection. The child can choose to again act as sole trustee or co-trustee after settlement.

This is indeed what my lawyer told me, but it is nice to see confirmation. I did read somewhere, however, that this needs to happen before the creditor lays claim to the trust assets.
I consider the issues you are asking about to be of critical importance.

Thank you. Everyone around me thinks i am nuts because I am researching this to death. But, if I am going to put something in place that my child will need to deal with forever, I want to be sure that it is actually accomplishing what I intend.

afan, your comment, "The trade-off between protection and hassle has us unresolved." says it all. That should have been the title of my post.

JoinToday said, " I have provisions to allow for decanting of the trust if the beneficiary and trustee agree." Would this be problematic if the beneficiary is the sole trustee -in terms of asset protection? Presumably, if the trustee can empty the trust, the assets could be claimed by the creditor. Does anyone know about this?

I have a question about commingling of assets: If the child receives money outright, and it is kept in a separate (non-trust) account, but some funds are used for household maintenance (with spouse), do the remaining assets in the account take on the character of marital property? What I am getting at (in a very ineloquent way) is this: I understand that if a person takes separate assets and puts them in a joint account, those assets transferred are commingled and may be considered the property of both spouses. But, if one spouse routinely uses his separate assets for joint purposes, does that endanger the separate character of the remaining funds in the account in the case of divorce? I am trying to determine if the child's assets would be reasonably well-protected (in divorce) if they are kept in a separate account. Under what circumstances in a divorce would those separate assets be at risk?

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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat May 07, 2016 4:55 pm

it'smyjob? wrote:
NMJack wrote:
A common protection strategy is to name the child as sole trustee, but allow the child to appoint an independent trustee and resign as trustee if necessary for asset protection. The child can choose to again act as sole trustee or co-trustee after settlement.

This is indeed what my lawyer told me, but it is nice to see confirmation. I did read somewhere, however, that this needs to happen before the creditor lays claim to the trust assets.


I believe that is correct. However, I've been told that this is different than a similar situation where a person moves personal assets into an irrevocable trust once a lawsuit emerges. In that case, the assets can still be seized. In the situation we've been discussing in this thread, the target of the lawsuit never owned the assets (the trust did). Hopefully bsteiner or another expert can confirm some of this for us.

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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat May 07, 2016 5:05 pm

it'smyjob? wrote:Thank you. Everyone around me thinks i am nuts because I am researching this to death. But, if I am going to put something in place that my child will need to deal with forever, I want to be sure that it is actually accomplishing what I intend.


I feel your pain. For everybody like us who wants to take the time to actually learn the facts, it seems that there are ten others who are of the opinion that we should "just pay the lawyer and they'll know the right thing to do." I've learned enough, and consulted with enough estate attorneys, to confidently state that this is not what I am going to do.

It seems that the paradigm (and by extension the business model) out there with trusts is that rich people don't trust their kids/spouses/family and would rather have some old guy in a nice suit (i.e. somebody like them) take charge once God takes them home. Consequently, the trust templates are designed to provide income to initial beneficiaries but place equal emphasis on preserving principle for later generations. This necessitates an independent (paid) trustee. By having a third party hold tremendous power, it naturally leads to the following negative consequences:

a) profit opportunity for the trustee
b) distrust (no pun intended) between all beneficiaries and the trustee
c) profit opportunity for lawyers whenever a and/or b get ugly

I've read enough trust threads on the forum to encounter multiple actual cases that substantiate this.

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Re: Leave kids money by trust or outright/tax implications

Post by JoinToday » Sat May 07, 2016 6:28 pm

NMJack wrote:
it'smyjob? wrote:
NMJack wrote:
A common protection strategy is to name the child as sole trustee, but allow the child to appoint an independent trustee and resign as trustee if necessary for asset protection. The child can choose to again act as sole trustee or co-trustee after settlement.

This is indeed what my lawyer told me, but it is nice to see confirmation. I did read somewhere, however, that this needs to happen before the creditor lays claim to the trust assets.


I believe that is correct. However, I've been told that this is different than a similar situation where a person moves personal assets into an irrevocable trust once a lawsuit emerges. In that case, the assets can still be seized. In the situation we've been discussing in this thread, the target of the lawsuit never owned the assets (the trust did). Hopefully bsteiner or another expert can confirm some of this for us.


I have no basis other than common sense for questioning this, but it seems too easy for beneficiary to be sole trustee, and then if there is an auto accident (beneficiary at fault), someone hurts themselves on beneficiary's property, etc, beneficiary just appoints a co-trustee until the issue is resolved. Doesn't seem like it should be that easy. Seems like the assets are still under beneficiary's control, and judge may just force the beneficiary to dismiss the trustee and force a distribution. But I am not a lawyer.
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Sat May 07, 2016 6:29 pm

Re: trustees and asset protection. It seems to be a combination of state law and how safe you want to be. Our lawyers say giving a sole beneficiary the ability to appoint and replace corporate trustees is already risky for asset protection. Letting them appoint an individual, they said, would expose the assets. We did not get to the idea of appointing a different trustee temporarily, then resuming as sole trustee. They had ruled out the beneficiaries as trustees already. They were cautious about how one replaces a corporate trustee with another corp trustee, I doubt having an individual, particularly the beneficiary, in the mix would fly at all.

When we first created trusts, years ago, the conversation was very different. We were given fewer restrictions, relatives were acceptable as independent trustees and beneficiaries had more say in picking corporate trustees. Different times and different states. It sounds like you have more options.

I am resigning myself to paying Vanguard for trustee services when the time comes. Now my obsession is how many separate trusts are involved since Vanguard charges $2,500 per trust registration. In the grand scheme it does not matter much, but a lifetime of pinching pennies is not going to change.
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat May 07, 2016 7:29 pm

JoinToday wrote:I have no basis other than common sense for questioning this, but it seems too easy for beneficiary to be sole trustee, and then if there is an auto accident (beneficiary at fault), someone hurts themselves on beneficiary's property, etc, beneficiary just appoints a co-trustee until the issue is resolved. Doesn't seem like it should be that easy. Seems like the assets are still under beneficiary's control, and judge may just force the beneficiary to dismiss the trustee and force a distribution. But I am not a lawyer.


I suspect this may vary from state to state. While I understand that a judge may force a beneficiary-as-trustee to take a discretionary distribution; I can also understand that a judge may not be able to order an individual to appoint or remove a trustee. This is particularly true if the trust clearly states that the trust is not under court jurisdiction.

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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat May 07, 2016 7:35 pm

afan wrote:Re: trustees and asset protection. It seems to be a combination of state law and how safe you want to be.

Different times and different states. It sounds like you have more options.

I am resigning myself to paying Vanguard for trustee services when the time comes. Now my obsession is how many separate trusts are involved since Vanguard charges $2,500 per trust registration. In the grand scheme it does not matter much, but a lifetime of pinching pennies is not going to change.


I think you are correct. That said, I suspect we'll continue the conversation on how to deal with the mixed blessing of a corporate trustee. We may be years away from a BH aligned solution. That would be an independent trustee, who would charge a reasonable fee for actual trustee services while executing a low cost, index based, passively managed investment management. Maybe Vanguard is as close as we are right now. :(

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Re: Leave kids money by trust or outright/tax implications

Post by afan » Sun May 08, 2016 10:37 pm

There are states, including mine, where judges look not only at the language of the trust, but at the overall picture in deciding whether a trustee is independent. There have been decisions that an accountant trustee, who was not a beneficiary or grantor, was not independent because his firm had a long-standing relationship with the family that created the trust.

There have been decisions that the attorney trustee, although having complete discretion by the terms of the trust, had established a pattern of making regular substantial distributions to a beneficiary. This was enough to conclude that money in the trust was available to the beneficiary to satisfy creditors.

In my state, courts apparently have a lot of authority to look past terms of trusts to decide what is happening in substance and what they think is equitable. Since it is impossible to know where my heirs might end up living, I have to plan for conditions where it is difficult to protect assets. That is why we have been told to use corporate trustees. They cannot be a friend or relative. They must be an institution that regularly serves as a corporate trustee. Beneficiaries can remove and replace corporate trustees, but there is some language to make it a bit of a hurdle, so it does not appear that they can simply cycle through banks until they find one who will do what they want.

The asset protection seems to be decreasing over time based on court cases, and we were told to be as conservative as we are willing if we want protection that will be good for decades.

So being one's own trustee and appointing an independent trustee when things get dicey would not appear to work. Some of these cases are under appeal but were upheld at the appellate level. Perhaps the state Supreme Court will restore some protection, but we would rather err on the safe side.

I would.love to hear what the estate lawyers on BH have to say. Gill? bsteiner?
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sun May 08, 2016 11:34 pm

afan wrote:I would.love to hear what the estate lawyers on BH have to say. Gill? bsteiner?


+1 This is a critical issue. I live in a very conservative state, and am hopeful that this can and will work to my benefit in this area. I don't see an independent, corporate trustee as a value-added service. I instead see a person/industry focused on profit opportunity at the direct expense of my family.

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Re: Leave kids money by trust or outright/tax implications

Post by JoinToday » Mon May 09, 2016 2:46 am

afan wrote:There are states, including mine, where judges look not only at the language of the trust, but at the overall picture in deciding whether a trustee is independent.......

There have been decisions that the attorney trustee, although having complete discretion by the terms of the trust, had established a pattern of making regular substantial distributions to a beneficiary. This was enough to conclude that money in the trust was available to the beneficiary to satisfy creditors.

In my state, courts apparently have a lot of authority to look past terms of trusts to decide what is happening in substance and what they think is equitable.


afan: do you mind sharing what state you are in, or perhaps send me a PM?

I find the above to be quite unsettling. Picture this: your children are doing reasonably well financially without your help. They inherit $5M, and all the distributions (with a corporate trustee) are essentially discretionary money for your kids (used for vacations, car, nicer house, etc). You have set the trust up to provide asset protection. And to have a judge order a distribution??? :twisted:

I specifically state in my trust that children can request a distribution and trustee should use judgement in making distribution, but trustee should make distribution unless there are issues of lawsuit, bankruptcy, drug or alcohol addiction. I want the money to be very easily accessible to beneficiaries, yet provide asset protection. What good is the money if the trustee puts excessive limits on distributions?
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Mon May 09, 2016 3:26 am

I think we are poking at the core of something here. Something very sensitive to many people/institutions. Something very important. Is it possible to use a trust to protect our assets for the benefit of our families, or are they just mechanisms to provide profit to those who create and manage them? :?

it'smyjob?
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Re: Leave kids money by trust or outright/tax implications

Post by it'smyjob? » Mon May 09, 2016 1:49 pm

NMJack wrote:I think we are poking at the core of something here. Something very sensitive to many people/institutions. Something very important. Is it possible to use a trust to protect our assets for the benefit of our families, or are they just mechanisms to provide profit to those who create and manage them? :?


This is, in fact, the essence of my indecision. I have sent a few specific questions to my lawyer to try to get at an answer: is this plan really going to protect assets? I agree with some of the comments above- it seems too easy for a sole beneficiary to simply remove him/herself as trustee when creditors come running, and thereby protect the assets. In trying to educate myself, I have looked around a bit on the web, and found one case where trust money had been used to purchase land and build a house. Yet, because of some of the details of the situation, the divorcing spouse was able to claim half (or at least some) in a divorce. I am not about to spend the time to educate myself on potential divorce laws my non-married children may encounter. At this point, I am thinking of leaving the money outright.

afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Mon May 09, 2016 3:06 pm

There.are still.estate tax reasons to use a trust rather than leaving it to them outright.

We are viewing the inheritance as.protection from unforseen bad luck, chronic illness or having a special needs child. Our heirs seem to be well able to support themselves and they are not the mansion and sports car type.


Hoping they get through life having this if they need it, but not needing it. Then the trusts go to their kids, and our kids set up GST trusts themselves.

Apparently complete discretion by a corporate trustee is the safest for asset protection, even better than HEMS. Any language that obligates the trustee to make distributions can be read as forcing the trustee to share with an ex spouse.
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it'smyjob?
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Re: Leave kids money by trust or outright/tax implications

Post by it'smyjob? » Mon May 09, 2016 5:15 pm

Yes, the estate tax benefit is a consideration- especially if they end up in a state where the state estate tax is high.

afan, my feelings regarding the purpose of this money mirror yours. But I do worry that inheriting a substantial sum might rob at least one of my children of their drive.

My lawyer did get back to me. He stated that the assets are protected when in trust- even if used for large purchases-with the beneficiary as sole trustee. He is a member of the American College of Trust and Estate Council, and I see his name on the lists of the best lawyers in my area. So, I should be comfortable trusting his advice. But seeing contrary opinions expressed here gives me pause. It does seem that a corporate trustee would be safest.

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Mon May 09, 2016 5:49 pm

it'smyjob? wrote:My lawyer did get back to me. He stated that the assets are protected when in trust- even if used for large purchases-with the beneficiary as sole trustee. He is a member of the American College of Trust and Estate Council, and I see his name on the lists of the best lawyers in my area. So, I should be comfortable trusting his advice. But seeing contrary opinions expressed here gives me pause. It does seem that a corporate trustee would be safest.


Do you live in a conservative state? I think this very much depends upon each state's laws. I know that protection of IRA assets varies widely by state. I'm guessing protection of trust assets may be a direct parallel. I've been told that in my state a beneficiary can resign as trustee even once a lawsuit is on the horizon and the trust assets will be protected.

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Re: Leave kids money by trust or outright/tax implications

Post by newbie001 » Mon May 09, 2016 8:34 pm

Asset protection is primarily a state law issue, although federal law can be very important in some situations (e.g., bankruptcy). In my state (TX), a beneficiary can be the sole trustee of a trust and still have protection from creditors provided distributions are limited to an ascertainable standard. I can't say what the law is for other states. Of course, once money gets distributed from a trust to a debtor-beneficiary, the general rule is that it's fair game at that point.

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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Mon May 09, 2016 9:45 pm

afan wrote:Apparently complete discretion by a corporate trustee is the safest for asset protection, even better than HEMS. Any language that obligates the trustee to make distributions can be read as forcing the trustee to share with an ex spouse.


afan - do you know if your state has adopted the Uniform Trust Code? The following link may help:

http://www.uniformlaws.org/Act.aspx?title=Trust%20Code

If so, you may find the information contained within the UTC Section 504E to be of interest. It is on page 93 in the linked .pdf. I'm not a lawyer, but if I'm reading it correctly it basically says that a beneficiary/trustee has the same amount of asset protection as an independent trustee.

http://www.uniformlaws.org/shared/docs/ ... ev2010.pdf

it'smyjob?
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Re: Leave kids money by trust or outright/tax implications

Post by it'smyjob? » Mon May 09, 2016 11:34 pm

NMJack wrote:
Do you live in a conservative state? I think this very much depends upon each state's laws. I know that protection of IRA assets varies widely by state. I'm guessing protection of trust assets may be a direct parallel. I've been told that in my state a beneficiary can resign as trustee even once a lawsuit is on the horizon and the trust assets will be protected.


No- not a conservative state. Also, not one that has adopted the UTC- for what it's worth.

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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Mon May 09, 2016 11:55 pm

it'smyjob? wrote:
NMJack wrote:
Do you live in a conservative state? I think this very much depends upon each state's laws. I know that protection of IRA assets varies widely by state. I'm guessing protection of trust assets may be a direct parallel. I've been told that in my state a beneficiary can resign as trustee even once a lawsuit is on the horizon and the trust assets will be protected.


No- not a conservative state. Also, not one that has adopted the UTC- for what it's worth.


Thanks for the response. I'm beginning to think that those attorneys exclusively recommending an independent trustee, strictly for asset protection, may either be a) behind the times, b) overly cautious or c) have a vested interest in steering clients toward corporate trustees. I did read something related to the UTC that suggested that prior to adoption of the UTC (maybe 15 - 20 years ago?), beneficiary/trustees were at risk to their creditors with regard to asset protection. Maybe we need bsteiner to find and share another court case horror story as an example of how a beneficiary-as-trustee can go horribly wrong.

I recently learned that the main reason for the HEMS standard, at least in my state, is not for asset protection but instead to avoid the trust assets being included within the primary beneficiary's estate. We may need another year of two of these threads..... :sharebeer
Last edited by NMJack on Mon May 09, 2016 11:59 pm, edited 1 time in total.

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Tue May 10, 2016 8:46 pm

newbie001 wrote: Of course, once money gets distributed from a trust to a debtor-beneficiary, the general rule is that it's fair game at that point.


Which leads us to the spendthrift clause.... :beer

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Re: Leave kids money by trust or outright/tax implications

Post by afan » Wed May 11, 2016 11:37 am

I am not a lawyer. From what I have read, even states that adopt the UTC do it within the context of their existing law and court opinions. They need not adopt every feature. This means that one has to look at the law in the state, not just the UTC.

My state has adopted its version of UTC, but the need for corporate trustee for best asset protection remains.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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Re: Leave kids money by trust or outright/tax implications

Post by afan » Wed May 11, 2016 1:51 pm

Apparently, the best asset protection comes with a corporate trustee and that trustee having full discretion about distributions. If the trustee is obligated to make distributions (which can occur depending on how the HEMS provision is worded), then creditors can demand a distribution to the beneficiary, and then to the creditors. But a beneficiary trustee definitely cannot have full discretion while maintaining any protection or keeping the money out of the beneficiary's estate for estate tax purposes. So the beneficiary trustee can be given the right, but not obligation, to make distributions for HEMS. Even this creates more risk than having a completely independent corporate trustee.

http://www.huschblackwell.com/~/media/F ... rustee.pdf

The exact law in a given state depends on what features of the UTC the state has adopted, as the article above discusses.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Wed May 11, 2016 4:54 pm

Thanks for posting that. That is a great summary of the impact that each state's own laws provide. Some of the earlier text is straight out of the UTC link that I provided a few posts back. My state has not adopted the UTC, but has its own laws that mimic 504(e) and actually extend the protection for a beneficiary/trustee. I find it interesting that the article specifically recommends that for states without 504(e), or similar, the beneficiary/trustee should resign before "a creditor attaches the trustee-beneficiary's interest in the trust." That seems to address a worse case scenario (i.e. no 504e type protections under that state's laws) by suggesting that there is still plenty of time for a beneficiary/trustee to resign and appoint a corporate trustee. That is, it's not to late even once a lawsuit emerges.

afan wrote:Apparently, the best asset protection comes with a corporate trustee and that trustee having full discretion about distributions.


I agree with this for states that have not adopted 504(e) or similar (as outlined in the article). For other states, I believe that it is clear that the corporate trustee provides no protection beyond what a beneficiary/trustee already has under that state's laws. Am I missing something? :confused

afan wrote: But a beneficiary trustee definitely cannot have full discretion while maintaining any protection or keeping the money out of the beneficiary's estate for estate tax purposes.


Check the Arizona law mentioned in the article. Apparently, in that state, a beneficiary/trustee can have complete discretion and still be protected from creditors. I believe you are however correct about the estate tax implications.

afan wrote: So the beneficiary trustee can be given the right, but not obligation, to make distributions for HEMS. Even this creates more risk than having a completely independent corporate trustee.


Are you stating this for all states or just those that do not have 504(e) or similar in that state's laws?

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Re: Leave kids money by trust or outright/tax implications

Post by afan » Thu May 12, 2016 5:31 am

The problem is that I don't know where my heirs might end up years after I die. Maybe they will be in a state with strong asset protection, maybe not. If I want the money protected I need to plan for the worst case, not the beat. State laws change. Judges make decisions that could cost a fortune to contest with no certainty of prevailing. I could write the trust go be fine under current law in one state only to have them move somewhere else and it no longer works.

I don't think the creditor has to have a court order requiring payment from a trust for it to be too late for the beneficiary to resign as a trustee. I think the issue of when it is too late would be decided by a court, at great expense to the trust, and likely it would be long before the case got that far. Again, I am not a lawyer, but I think it would be similar to fraudulent conveyance rules-too late once the beneficiary knew or suspected they were going to be sued.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Thu May 12, 2016 11:15 am

afan wrote:I don't think the creditor has to have a court order requiring payment from a trust for it to be too late for the beneficiary to resign as a trustee. I think the issue of when it is too late would be decided by a court, at great expense to the trust, and likely it would be long before the case got that far. Again, I am not a lawyer, but I think it would be similar to fraudulent conveyance rules-too late once the beneficiary knew or suspected they were going to be sued.


I guess we could extend the unknowns to a court ordering even a corporate trustee to disburse funds in a lawsuit. The main point I was focusing on was that under current law in 504(e), or equivalent, states; a corporate trustee appears to provide no more protection than a beneficiary-trustee already has. Leaving the option for the beneficiary-trustee to resign and appoint an independent trustee, provides belt-and-suspenders assurance at reasonably low risk/cost/hassle. Regarding the fraudulent conveyance rules, my initial assumptions were the same as yours. I have since been guided by a competent local attorney that they are not the same. I guess the key issue is that trust assets, in most situations, are never considered the property of the beneficiary. Fraudulent conveyance rules are focused on property owned by a defendant that are transferred elsewhere with the specific purpose of avoiding their seizure in a lawsuit.

Another thing to keep in mind. Just as some states legislate so as to be "tax friendly," to compete with other states for business and retirees; the same is true of trust laws. Some states write their trust laws in order to attract and/or retain wealthy families who desire the asset protection. We don't read about that nearly as much, but it does come up. Great discussion! :sharebeer

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Re: Leave kids money by trust or outright/tax implications

Post by furnace » Thu May 12, 2016 12:55 pm

it'smyjob? wrote:afan, my feelings regarding the purpose of this money mirror yours. But I do worry that inheriting a substantial sum might rob at least one of my children of their drive.


Have you thought about setting up a foundation and letting a low-drive child run it, with the rest of the family as board members?

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Re: Leave kids money by trust or outright/tax implications

Post by afan » Fri May 13, 2016 8:12 pm

Re: losing drive- In my case this does not seem to be a problem. Kids already have substantial assets. The pay the taxes every year, but otherwise treat them as if they do not exist. I would use the word "burning" to describe their ambition. I am more worried about burn out than laziness.

Re: individual vs corporate trustee. This seems to reflect a big difference in state statutory and common law. My state seems to be going very heavily towards creditors, particularly in divorce cases. My ACTEC lawyer publishes regularly on these issues and tells me we are substantially safer with corporate trustees.

From my own research, not guided by the lawyer, I am now wondering what happens if the trust is in state A and the beneficiary is in state B, where they are sued. In theory each state is supposed to give full faith and credit to the judgements of the courts of the other state. Apparently, States are allowed to substitute their own laws if following the judgements of the other state's courts would be against public policy in the home state. That seems to offer a.chance to claim that state A's strong asset protection laws are against the creditor protection policies of state B.

When there is money at stake it becomes worthwhile to spend a lot of money litigating and forcing the beneficiary to waste money fighting back. For our situation we are resigned to the corp trustee. Maybe we should move to a safer state.

A brief summary of the issues as I understand them.

http://www.margolis.com/our-blog/how-to ... tion-trust
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Fri May 13, 2016 11:54 pm

afan wrote:For our situation we are resigned to the corp trustee. Maybe we should move to a safer state.

A brief summary of the issues as I understand them.

http://www.margolis.com/our-blog/how-to ... tion-trust


MA? Probably among the most liberal states in the nation. I understand your pain (and, need for a corporate trustee). Fortunately, by dumb luck, or more likely the grace of God, I am in a state on the other end of the spectrum. Good luck afan. :beer

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Re: Leave kids money by trust or outright/tax implications

Post by FBN2014 » Sat May 14, 2016 3:08 pm

I've read this thread started by it'smyjob? with some interest since I serve as trustee of a family trust as well as being a beneficiary. I am not an attorney but I've dealt with enough family drama in my role as trustee to know what will work and what won't as I've had to employ attorneys to assist me in my role as trustee. A trust written up properly by competent counsel will most certainly protect beneficiaries from creditors, divorce or a myriad of other situations that could arise in the future that you cannot even think of. That being said, be very careful who you use to write your original documents. Any licensed attorney can write a will or trust. That doesn't mean that they are competent. You wouldn't go to a cardiologist if you had cancer even though both are called Doctor and have a medical degree.

The size of your estate and the family circumstances dictates to me whether it makes sense to have the assets in trust. Do you have a special needs child? Do you have a child who has had drug problems, been in bad relationships, do you have children that have had financial problems or a child who is a spendthrift, do you want to put educational milestones as a condition of distribution, do you want the children to receive their inheritance as a lump sum or do you want to set age milestones, do you have grandchildren that you want to leave a legacy to? The scenarios go on and on and you as the grantor set the distribution scheme for the trust. You can use the HEMS (health, education, maintenance and support )standard or allow the trustee total discretion to distribute.

I understand that you are very concerned about the ongoing costs, taxes, outside trustee fees, extra administrative tasks, etc. If you have good reasons for setting up a trust then these costs should be the least of your concerns. The compressed trust tax rates can be dealt with by using tax efficient Index funds, ETFs, and municipal bond funds which bogleheads all espouse here on the forum. I think its wise to inform the trustee and perhaps other beneficiaries in advance as to what will happen when you are gone and also write in your own hand (have it notarized) why you are setting up the trust and how you would like to see it administered. It can avoid family conflict once you are gone and if a trustee is ever challenged it can give them supporting evidence that the trustee is carrying out your wishes.

Here's a scenario as to why trusts are needed for anyone with significant assets. Your child has inherited your estate and then the child's spouse dies in an accident. He/she received the inheritance outright and then remarries a gold digger who wipes out the inheritance within a few years. Think it could never happen, think again. Here's another one - your child buys an investment property and hires a contractor to repair the house. Contractor slips and falls and suffers a massive concussion and dies 2 days later. Yes, perhaps there was a liability policy in place but the contractor's family sues for $20 million and a sympathetic jury awards $10 million wiping out your child's inheritance. Need I go on.

Don' be penny wise and pound foolish. We live in a litigious society. The divorce rate is 50% for first time marriages, around 70% for second marriages. There are men and woman who prey upon the lonely through dating websites, facebook, social media, etc. They are looking for people who have inherited large sums of money through generous inheritances. I'm not making this stuff up because I or a family member have lived it but survived because the trust was in place. We don't live in a Leave It to Beaver society anymore and not wanting to think about it doesn't mean it won't happen. I thank my deceased parents all the time that they had the foresight to spend the money and set up the proper trusts to protect their legacy and their family. Has it been a hassle to me as the trustee, yes on occasion a major hassle, but in the long run it was necessary. I recommend you read this excellent book as it gives a great overview of why trusts are necessary in today's world and gives real world scenarios that the attorney has witnessed in his own practice. I hope you make the right decision, good luck.

http://www.amazon.com/Living-Trust-Advi ... ving+trust

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Re: Leave kids money by trust or outright/tax implications

Post by afan » Sat May 14, 2016 6:15 pm

I would not take too much comfort in being in a creditor friendly state. First, you may know where you are going to live for the rest of your life, but this is a question of where your heirs will be living decades from now.

Second, as I noted above, there is a possibility of a conflict between the law in the state where your heir may be and where the trust is. This article touches on this

http://www.csun.edu/sites/default/files/13-48-1-PB.pdf

The Full Faith and Credit Clause
The Full Faith and Credit clause of the Constitution provides that each state has to
give full faith and credit to the laws of every other state.45 This means that if a California
court refuses to recognize the protection of a DAPT and enters a judgment for the
creditor, the creditor may be able to enforce the judgment against the trustee of the
DAPT, even if that trustee was located in the DAPT jurisdiction.
However, even under the Full Faith and Credit clause the states are not required to
recognize the laws of sister states that are contrary to their own public policy.46
Consequently, a DAPT jurisdiction court may refuse to enforce a California judgment
because it was entered under trust laws substantially different to those of the DAPT
jurisdiction.
At this point the analysis becomes quite circular. A creditor argues in California
court that the court should apply California law and not Alaska law to an Alaska trust
because Alaska trust law violates California public policy against self-settled trusts. In
turn, Alaska refuses to recognize the California judgment because it violates Alaska
public policy in protecting self-settled trusts.
This analysis should lead the practitioner to one inescapable conclusion. Until the
application of the Full Faith and Credit clause is litigated in the context of a self-settled
trust, the risk is too great that a DAPT would not afford the debtor with the required
protection.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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Re: Leave kids money by trust or outright/tax implications

Post by bsteiner » Sat May 14, 2016 9:19 pm

Providing for a child in trust rather than outright keeps the inheritance out of the child's estate for estate tax purposes, and better protects the inheritance against the child's creditors, predators and spouses, and Medicaid.

When the estate tax exclusion amount was much lower, keeping the inheritance out of the child's estate was a major benefit for most clients. It's still important for many of our clients, though others aren't concerned about that.

Given the current level of the estate tax exclusion amount, the key benefit for most clients is protection against spouses. Inheritances are in the pot for equitable distribution (division) on divorce in about a quarter of the states. In the remaining states, if the inheritance is commingled with the child's other assets, it may end up in the pot. Also, a child could outlive his/her spouse and remarry, and in most states a surviving spouse is entitled to a share of the child's estate. You don't know in what state a child will be living at the time of the child's divorce or death.

For less wealthy clients, the protection against Medicaid is a benefit.

Other creditors are less of a concern to most clients, with the principal exception being if a client's child is a doctor.

As to how to structure the trust, about half the states have enacted the Uniform Trust Code, though there are variations in it from state to state. Some states have enacted the provision that's been quoted, whereby the trust assets are protected even if the beneficiary is a trustee and may distribute to himself/herself, so long as the trustee/beneficiary can't make distributions to himself/herself except for an ascertainable standard. Without that provision, creditors might be able to compel distributions to the extent of the ascertainable standard. However, even in a state that has this provision of the UTC, if a trustee/beneficiary has the right to make distributions to himself/herself for an ascertainable standard, if he/she ever goes into a nursing home and wants Medicaid, Medicaid may take the position that the trust assets are available, in which case the beneficiary won't be able to get Medicaid.

Our approach is to preclude a beneficiary from participating in distributions to himself/herself. Where a client wants the beneficiary to effectively control the trust, the co-trustee or co-trustees are people who are likely to favorably consider the beneficiary's wishes, and we give the beneficiary (after reaching a specified age) the power to remove and replace his/her co-trustee, provided the replacement trustee isn't a close relative or subordinate employee. That way, we don't have to limit the trustees' discretion to an ascertainable standard. Limiting the trustees' discretion to an ascertainable standard makes a trust inflexible.

While it's sometimes appropriate to have a corporate trustee, it's not necessary. If appropriate, a child's co-trustee(s) can be one or more of the child's spouse and the child's siblings. They probably won't charge commissions (fees) for acting as trustees. The trust will have to file annual income tax returns, but if the trustees invest in a small number of mutual funds, the income tax returns won't be very complicated.

There's often some additional income tax cost since trusts reach the top bracket (39.6% on ordinary income, 20% on qualified dividends and long-term capital gains, and the 3.8% net investment income tax) at $12,400. However, ignoring retirement benefits, if the trust invests in index funds and tax-exempt bonds, it won't have much income or gains, and the income will mainly be qualified dividends. Also, the trustees can consider income taxes in deciding on distributions, though any amounts distributed will lose the protection of the trust.

Retirement benefits are more complicated. Conduit trusts rarely make sense, since they force out all of the IRA distributions. They may be small in the early years, but they become very large in the later years. Roth conversions during lifetime are a good way to avoid the tradeoff between making distributions and giving up the asset protection and accumulating the IRA distributions and paying income tax at higher rates.

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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat May 14, 2016 9:24 pm

FBN2014 wrote:I understand that you are very concerned about the ongoing costs, taxes, outside trustee fees, extra administrative tasks, etc. If you have good reasons for setting up a trust then these costs should be the least of your concerns.


Least of your concerns? I don't agree. A corporate trustee may take 1%. They may then hire a financial advisor to "manage" the funds. That's another 1%. Then, this financial advisor, obligated by prudent investor rules has to exercise his/her special skills at active management. This adds another 1% in excessive expenses (either high ER mutual funds or the costs of buying and selling and buying and selling and....). We're up to 3% already, and that's if any of the above don't decide to exercise their "trustee powers" to buy high cost, high commission annuities, life insurance, etc. Some/most trusts even leave the door wide open for puts/calls/hedge funds/and many other things that I don't understand but make me nauseous.

No thank you!! A 3% drag will, at best, bring a trust's assets down to keeping pace with inflation. At worst, it will suck the trust dry of assets in 20 years, leaving all these other issues irrelevant. :annoyed Feel free to point out any facts that I may have missed. :beer

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Re: Leave kids money by trust or outright/tax implications

Post by bsteiner » Sat May 14, 2016 9:37 pm

NMJack wrote:... A corporate trustee may take 1%. They may then hire a financial advisor to "manage" the funds. That's another 1%. Then, this financial advisor, obligated by prudent investor rules has to exercise his/her special skills at active management. This adds another 1% in excessive expenses (either high ER mutual funds or the costs of buying and selling and buying and selling and....). We're up to 3% already, and that's if any of the above don't decide to exercise their "trustee powers" to buy high cost, high commission annuities, life insurance, etc. Some/most trusts even leave the door wide open for puts/calls/hedge funds/and many other things that I don't understand but make me nauseous.

No thank you!! A 3% drag will, at best, bring a trust's assets down to keeping pace with inflation. At worst, it will suck the trust dry of assets in 20 years, leaving all these other issues irrelevant. Feel free to point out any facts that I may have missed.


While there's some cost to a corporate trustee, it's nowhere near 3%. They'll generally charge about 1%, or somewhat more for small trusts and less for large trusts. Sometimes a corporate trustee is appropriate.

They'll invest in a diversified manner, usually by buying individual securities, though if the amount they invest in a particular asset class is too small to use individual securities they'll sometimes use their own mutual funds or low-cost ETFs. If they use their own mutual funds, they'll credit their management fee at the fund level against their trustee's commissions (fees), though you'll pay the other expenses of the fund. I've never seen a corporate trustee buy an annuity (though I have a couple of cases where individual trustees bought annuities). I've never seen a corporate trustee buy life insurance unless that was the purpose of the trust, and in any event no one can buy life insurance on someone else's life without the insured's consent. I've never seen a corporate trustee buy puts or calls, though put options might occasionally be a way to hedge against a concentrated position that for some reason can't be quickly sold. Some corporate trustees recommend hedge funds for a portion of a large trust, but I've never seen a corporate trustee invest in a hedge fund if the family didn't want them to.

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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Sat May 14, 2016 11:21 pm

bsteiner wrote:While there's some cost to a corporate trustee, it's nowhere near 3%. They'll generally charge about 1%, or somewhat more for small trusts and less for large trusts. Sometimes a corporate trustee is appropriate.

They'll invest in a diversified manner, usually by buying individual securities, though if the amount they invest in a particular asset class is too small to use individual securities they'll sometimes use their own mutual funds or low-cost ETFs. If they use their own mutual funds, they'll credit their management fee at the fund level against their trustee's commissions (fees), though you'll pay the other expenses of the fund. I've never seen a corporate trustee buy an annuity (though I have a couple of cases where individual trustees bought annuities). I've never seen a corporate trustee buy life insurance unless that was the purpose of the trust, and in any event no one can buy life insurance on someone else's life without the insured's consent. I've never seen a corporate trustee buy puts or calls, though put options might occasionally be a way to hedge against a concentrated position that for some reason can't be quickly sold. Some corporate trustees recommend hedge funds for a portion of a large trust, but I've never seen a corporate trustee invest in a hedge fund if the family didn't want them to.


Bruce, Thanks for weighing in. I may have exaggerated to make a point, but the fact is that in most trusts written today, there is ample opportunity for a corporate trustee/investment manager/fund manager to "tax" the trust's assets 1% to 3% or more. It is the layer upon layer of fees that add up. Your description of how a corporate trustee will invest supports my point. Had you just stated that they will invest in an index fund and let it ride, I wouldn't challenge your point. "Buying individual securities" and "use of their own mutual funds" are examples that support my position. As for the other options; if my trust allows it, I'll assume (hopefully in error) that an opportunistic corporate trustee will use them to the maximum extent that they personally may benefit.

afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Sun May 15, 2016 10:13 am

bsteiner,

Thanks for joining in. It is always worrisome when those of us who are not attorneys are telling each other what we think we know about the law.

My concern about the identity of the trustee arose from reports of cases, particularly divorces, where the courts essentially rejected the Independence of the trustee. They found the beneficiary to have enough control of the trust assets to make them available for the ex spouse. The commentaries then suggested that this outcome would have been avoided had the trustee been truly independent, i.e. corporate.

Would having the beneficiary as sole trustee, but with no right to distribute to him/herself, requiring appointment of an independent cotrustee to make any distributions to the beneficiary, giving that trustee complete discretion work for asset protection and estate tax concerns if the cotrustee were a friend or relative? Would there be a risk of a court finding them not to be independent, which would not happen if the cotrustee were corporate? Could a relative be independent if there is some, improbable, way the relative could become a beneficiary? Say beneficiary's spouse and children predecease her and there are no grandchildren. If the beneficiary's brother would then become a beneficiary himself, does that rule him out as independent?

Governing law- The trust is set up in an asset protection friendly state X. Years later the beneficiary is living in a creditor friendly state, Y, where courts routinely look to trust assets in divorce. The ex spouse gets an order in state X, and the trustee in state Y, has to fight it. Who wins? What if the trustee is in yet another state, Z. Do the laws of state X, Y or Z control the outcome? Is there a unique answer, or would it depend on the details of the situation? How much might it cost to fight it out in multiple states? When dealing with an individual beneficiary and an individual trustee, it appears there is no way to know where they will be living years from now. Would a corporate trustee have any advantages here?

Would the situation be helped by creating the trust in an asset protection friendly state, even if there were no other relationship to the state? Delaware, Nevada, Alaska, New Hampshire???

Is there any role for LLC's or LP's to address these concerns?

Another question in this thread- if the beneficiary is the sole trustee, but has a successor trustee named can the beneficiary avoid a creditor getting access to the trust holding by resigning as trustee, thus ending the beneficiary's control over the trust? At what point would the beneficiary have to resign for this to work? As long as it is before a court order to take money from the trust? Or would it have to be much earlier in the process?

Income taxes- If the beneficiary is already in a high tax bracket, would there be any tax disadvantage to retaining income in the trust? Say the beneficiary is in the top bracket. Then income distributed would be taxed at the top rate when the beneficiary received it. It would be taxed at the same rate if left in the trust, right? If left in the trust, some of the income would be taxed at lower rates, and only the amount over $12,400 would be taxed at the highest rate, correct? If this is right, then the most tax conscious approach would be retain the first $12,400 in trust to take advantage of the lower tax rates. The income above that would be taxed at the same rate inside or outside the trust, correct?




Regarding trustee costs- since Vanguard will serve as trustee for far lower cost, with investment management included, there is no reason to pay more. Unless the trust holds things that Vanguard will not manage. In that case, you pay more, but you get more. One could separate the real estate, or whatever, from the marketable securities and have two trusts. One would hold the illiquid assts, plus enough money to pay the trustee fees. The other trust would hold everything else.

We are looking at a setup like this, with the expectation that the trustee would dispose of the illiquid assets as quickly as would be prudent. Then you pay a high price for managing the high cost asset and Vanguard prices for the rest of the trust. For a $1 M trust, the total cost for Vanguard would be a bit over 1%. For a $10M trust it would be just under 0.3%. That would not include the mutual fund expense ratios, but those would be less than 0.1%. Total less than 0.4%. I could live with that if it were accomplishing something useful.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

bsteiner
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Re: Leave kids money by trust or outright/tax implications

Post by bsteiner » Sun May 15, 2016 7:34 pm

afan wrote:bsteiner,

Thanks for joining in. It is always worrisome when those of us who are not attorneys are telling each other what we think we know about the law.

My concern about the identity of the trustee arose from reports of cases, particularly divorces, where the courts essentially rejected the Independence of the trustee. They found the beneficiary to have enough control of the trust assets to make them available for the ex spouse. The commentaries then suggested that this outcome would have been avoided had the trustee been truly independent, i.e. corporate. ...


The trust assets themselves are protected since the trust isn't a party to the divorce. While there are cases going both ways (see the Tannen case in New Jersey and the Pfannenstiel case in Massachusetts), we tell our clients to assume that the income of the trust, or the amount the beneficiary was receiving from the trust before the divorce, will be taken into account in determining the amount of alimony and child support the beneficiary will receive or will have to pay. Also, the beneficiary's children are usually discretionary beneficiaries of the trust and can request distributions, and if they do, the trustees have to consider their needs.

afan
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Re: Leave kids money by trust or outright/tax implications

Post by afan » Mon May 16, 2016 9:22 am

Bruce,

Thanks for that. Would the Tanen case have avoided a long and I assume expensive court fight if the trust had not instructed the trustee to "support" the beneficiary? It ultimately turned out the way the grantors would have wanted, but only after spending ??how much?? in legal fees.

The Pfannenstiel case differed in that the outcome was not what the parents would have wanted, and there were still the costs just to get to that decision. I gather that case is still on appeal (dollars continuing to fly out the window)?

Any thoughts about the other questions I posted?

Thanks
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

bsteiner
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Re: Leave kids money by trust or outright/tax implications

Post by bsteiner » Mon May 16, 2016 11:21 am

afan wrote:Bruce,

Thanks for that. Would the Tanen case have avoided a long and I assume expensive court fight if the trust had not instructed the trustee to "support" the beneficiary? It ultimately turned out the way the grantors would have wanted, but only after spending ??how much?? in legal fees.

The Pfannenstiel case differed in that the outcome was not what the parents would have wanted, and there were still the costs just to get to that decision. I gather that case is still on appeal (dollars continuing to fly out the window)?

Any thoughts about the other questions I posted?


These cases tend to turn on their facts.

In Tannen, https://scholar.google.com/scholar_case ... i=scholarr, in Wendy's trust, the trustees had discretion to provide for her beneficiary's health, support, maintenance, education and general welfare, after taking into account her other financial resources. In the children's trusts, the trustees could distribute for necessary items. Both trusts provided that distributions were not intended to relieve the parties from their legal obligations to support their children.

Enumerating purposes raises the question as to whether the trustees have discretion to say no, or merely discretion to determine the amount reasonably needed for the enumerated purposes. On the other hand, the provision that the trustees are to take into account the beneficiary's other resources, and that the trusts were not intended to relieve Wendy and her husband from their obligation to support their children was helpful.

In Pfannenstiehl, http://law.justia.com/cases/massachuset ... 906-1.html, the trustees were obligated to provide for the husband and others, and the husband was receiving substantial distributions which were used by the couple for their lifestyle.

While these cases turn on their facts, they arise in the context that matrimonial courts want the richer spouse to provide for the poorer spouse, and they want parents to provide for their children, and they don't like attempts to avoid providing for the poorer spouse or for the children.

I think the wife's case in Tannen would have been stronger if the trust were fully discretionary. (There were some other facts that weren't clear, and I think that trying to bring in the trustees as parties was a mistake.)

I think the husband's case in Pfannenstiehl might have been better if the trust were fully discretionary. However, the fact that he had been receiving substantial distributions which were used by the couple for their lifestyle is an important fact, especially in Massachusetts which takes a broad view of what assets and income are taken into account.

I don't think the identity of the trustees should matter, assuming that the beneficiary, if he/she is a trustee, has no power to make distributions to himself/herself.

I don't think the other issues you raise are important. The trustees aren't parties. The issue in the divorce is how much alimony the beneficiary has to pay or will receive, and the extent to which the distributions the beneficiary has historically received, or would receive if the trust were to distribute its income, are to be considered.

As to income taxes, trustees may consider income taxes, and anything else they think relevant, in deciding on distributions. You are correct that often the tax cost of accumulating income isn't all that great, so that trustees may want to accumulate income unless a beneficiary needs a distribution. Of course, that will vary from case to case.

If Vanguard is to be a trustee, you'll need a co-trustee for any real estate. As your numbers illustrate, traditional banks and trust companies are close in cost to Vanguard for smaller trusts and for large trusts, but in the middle there's likely to be more of a difference in cost.

NMJack
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Re: Leave kids money by trust or outright/tax implications

Post by NMJack » Mon May 16, 2016 12:53 pm

Bruce - I'm struggling to reconcile the following two comments you've made:

bsteiner wrote:As to how to structure the trust, about half the states have enacted the Uniform Trust Code, though there are variations in it from state to state. Some states have enacted the provision that's been quoted, whereby the trust assets are protected even if the beneficiary is a trustee and may distribute to himself/herself, so long as the trustee/beneficiary can't make distributions to himself/herself except for an ascertainable standard.


bsteiner wrote:I don't think the identity of the trustees should matter, assuming that the beneficiary, if he/she is a trustee, has no power to make distributions to himself/herself.


Does your second quote only apply where states have NOT adopted section 504(e) of the UTC or similar? This is important to several of us since if the first is true in our particular state, we can avoid a corporate trustee and allow our responsible adult children to act as sole trustee. This would have obvious financial advantages over a long period of time as well as providing more flexibility in how the trust funds are distributed.

Thanks.

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