Thursday, June 23, 2005

Should You Have a Testamentary Trust for Your Beneficiaries?

When leaving property under your Last Will and Testament for your beneficiaries, whether you leave the property outright or in trust is a major consideration. Your decision will usually be guided by the amount of property you are leaving, but the following factors should also play a role in that decision:

First, minor children should never be left property outright, especially if the property is significant in value. Leaving property to the minor outright will result in one of two scenarios:

(1) A guardianship of the estate will have to be created through the probate court, which will oversee all aspects of the management of the property, including the investments, expenditures and distributions to the minor. The guardian will be required to file an annual accounting with the court and make sure that the accounts are always in balance. This is a costly and time-consuming process and should be avoided if at all possible.

(2) A custodial account will be created for the minor under the Uniform Transfers to Minors Act, but only if that option is provided for under the Will. If so, then the funds will be put into an account for the minor, and the funds must be given to the child when he turns 21 (18 in some states). The custodial account is more flexible and avoids the guardianship headaches; however, it can lead to problems if the child is not mature enough to handle the funds at age 21. If there is no provision for a custodial account in the Will, you only alternative is the guardianship option.

Second, if you were to die today, do you believe your beneficiaries will be able to adequately manage the funds you are giving them? Do they understand when and how to make investments? Can they live within a budget, or are they spendthrifts (i.e., would the money be blown on extravagant living)? Would they be easy targets for children, spouses, or friends? Leaving the property in trust for a beneficiary who has no financial acumen would allow a person or entity that you appoint as Trustee to manage these assets for them and hopefully allow for the extended use and benefit of the assets for the beneficiary.

Third, do your beneficiaries have any creditors or potential creditors? If so, leaving the property to them outright will subject that property to the creditors claims. Just because the property is inherited does not somehow exempt it from the payment of the just debts and expenses of the beneficiary. Leaving the property in trust will allow the money to be held separate and apart from the other assets of the beneficiary, and since the beneficiary is not deemed the owner of the trust assets (for legal purposes), the assets would not be subject to creditor claims.

Fourth, is the beneficiary in a contentious marriage or relationship? Take the following example: Dad dies, and leaves $500,000 to his son Rudy. Rudy is married to Jane. The property that Rudy has received from his dad is now his separate property. However, Rudy places the funds in a joint account, and over a period of time the funds are commingled to the point where it becomes difficult to tell what is Rudy's separate property, and what is their joint property. Jane later files for divorce, and because of the commingling, the property is ruled by the divorce court judge as joint and awards some of the funds to Jane. Another situation might be that after Dad dies and leaves all the property to Rudy, Rudy dies and has a Will leaving everything to Jane. Jane remarries and creates a Will that leaves everything to new husband Buck, cutting out Rudy's children. By leaving property to Rudy in trust, Dad could have guaranteed that the funds would have been segregated, and thus not awardable to the other spouse in a divorce action, and he could also provide what happens to the funds in the event of Rudy's death (e.g., it all goes to Rudy's children, in trust or outright, or it goes to charities, or even to Rudy's spouse--the point being Dad can make the call and not leave it to chance).

Fifth, will the gift to the beneficiaries create an estate tax problem for the beneficiary? Let's say Dad gives Rudy $1 million. The full value of that $1 million (plus any growth on that $1 million) will be includable in Rudy's estate when he dies. Depending on the estate tax exemption available to him in the year he dies, his estate could be paying unnecessary estate tax at his death. By leaving the property to him in trust, none of the property will be subject to tax in his estate, as long as it remains in trust. The property could grow to $10 million and still be exempt (in almost all cases) from estate tax. Rudy can still receive distributions and otherwise benefit from the trust funds; he just can't hold the property outright and exempt that property from estate tax.

For those persons who have adult beneficiaries who are financially secure, in good relationships and are smart money managers, the reasons are not as pronounced for having a trust created for those persons (other than for protection ultimately from estate tax or to ensure that the children of the beneficiary are taken care of on their parent's death). When thinking about your estate plan, take some time to consider any special circumstances that might be surrounding your beneficiaries and try to plan for those circumstances in a way that makes the most sense financially for that beneficiary. The use of a testamentary trust under your Will for that beneficiary can eliminate a great deal of concerns and problems after you are gone.