Estate Planning: Issues with Trustee Selection

There are several potential tax issues to consider when selecting a trustee that is a beneficiary of the trust or the spouse. If your son/daughter is named trustee (or co-trustee), a distribution made to anyone else could be considered a taxable gift unless there is an ascertainable standard built into the trust instrument. This is a situation we would want to avoid. Because the trust would likely be set up in such a way that the child could authorize distributions to herself as trustee or co-trustee, the trust might be considered a §678 grantor trust subjecting her to serious income tax liability (which the ascertainable standard would not solve, but a jointly exercisable power of appointment could).

Aside from tax consequences, the child might not be the best suited to make objective decisions of the application or use of trust assets (despite the possibility that she is more than qualified to do so). This might not be a position that the parents want to put the child in (including the attendant fiduciary duties and potential liability therefrom). However, if a professional (lawyer, or professional trustee) and the child were to serve as co-trustees, many of these adverse potential consequences could be ameliorated with sophisticated trust instruments and a clear division of responsibilities. The family member's opinion and input on important distribution decisions can be a helpful guide to the professional trustee or lawyer in serving as a qualified, independent trustee. In either case, once both parents ass away, the importance of a professional trustee for the irrevocable trust(s) will be even more important than before because astute and prudent allocation of assets are critical to prevent potential losses to other beneficiaries in the form of tax and lost opportunity for appreciation of assets.

Note: it’s also important to verify the state in which each trustee is a resident in order to avoid unnecessary state tax issues. We would draft a standard savings clause to protect against this, but there is no such thing as undue prudence.

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None of this should be construed or relied upon as legal advice. The author is not a lawyer, and does not purport to bet. This is merely a discussion of issues that arise in trustee selection.

Estate Planning: The Benefits of Lifetime Trusts

The primary advantages of using lifetime trusts in estate planning for a very wealthy family are the estate tax efficiencies, the assistance in managing money for the children, income tax flexibility, and creditor protection. While their concern about being paternalistic is a common one, we can create the trusts such that the requirements are not overbearing in that sense while still retaining the positive features that would normally lead one to use such a strategy.

First, there are important estate tax efficiencies that are gained from utilizing lifetime trusts because of GST allocation problems and the avoidable problem of having to calculate taxes by aggregating personal net worth of the children with the inherited amount from the estate. Using trusts to assign certain assets directly to grandchildren (which might be a good idea in Jonathan’s case because he looks like he won’t be needing money from his parents in his lifetime) without subjecting those assets to a second round of estate taxation is very valuable.

Second, the practical consideration of managing the money in the estate after the survivor’s death is not one to be overlooked. A trustee is a professional subject to standards of prudent investing who can be trusted to make sound financial decisions for beneficiaries. Here, there doesn’t seem to be any overwhelming concern because of the relative success and responsibility-level of each of the children. In fact, Jonathan seems like he might do much better than a professional investor, and the girls might certainly perform or exceed that type of performance. However, the paternalism concerns can be balanced here by providing for mandatory (or completely discretionary) distributions or requiring a certain amount of the trust corpus to be wholly distributed by a certain age (or any permutation thereof). Trusts are incredibly flexible and can be adapted to almost any circumstance. For instance, if Sabrina wanted to take money out for a down payment on her first house, she could request it from the trustee who would almost certainly not unreasonably withhold (as long as the trust instrument was written to provide for such a contingency).

Third, the paternalism concerns also should be balanced by the desire to protect assets from creditors; this could be relevant in the case of divorce, professional liability (malpractice liability risk for Beth), and any kind of freak accident. Also, in the unfortunate case where one of the children suffers from a debilitating illness or disability and needs assistance form government agencies, a trust can help beneficiaries from losing access to those benefits.

Fourth, the use of a lifetime trust provides a significant amount of income tax flexibility by not forcing the beneficiaries to be responsible for a huge tax bill on a lump sum inheritance or on income generated by assets they inherit.

Of course, the avoidance of probate and the flexibility of a trust instrument (especially with a decanting provision) are critical benefits with which I am sure you are already well acquainted.

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Note: I am not a lawyer yet, and nothing on this blog should be construed as legal advice; it is merely policy analysis of certain aspects of estate planning.