An irrevocable trust has long been a key component of many estate plans. But what if it no longer serves your purposes? Is it too late to change it? Depending on applicable state law, you may have several options for fixing a “broken” trust.
How trusts break
There are several reasons a trust can break, including:
Changing family circumstances. A trust that works just fine when it’s established may no longer achieve its original goals if your family circumstances change. Some examples are a divorce, second marriage or the birth of a child.
New tax laws. Many trusts were created when gift, estate and generation-skipping transfer (GST) tax exemption amounts were relatively low. However, for 2021, the exemptions have risen to $11.7 million, so trusts designed to minimize gift, estate and GST taxes may no longer be necessary. And with transfer taxes out of the picture, the higher income taxes often associated with these trusts — previously overshadowed by transfer tax concerns — become a more important factor.
Mistakes. Potential errors include naming the wrong beneficiary, omitting a critical clause from the trust document, including a clause that’s inconsistent with your intent, and failing to allocate your GST tax exemption properly.
These are just a few examples of the many ways you might end up with a trust that fails to achieve your estate planning objectives.
How to fix them
If you have one or more trusts in need of repair, you may have several remedies at your disposal, depending on applicable law in the state where you live and, if different, in the state where the trust is located. Potential remedies include:
Reformation. The Uniform Trust Code (UTC), adopted in more than half the states, provides several remedies for broken trusts. Non-UTC states may provide similar remedies. Reformation allows you to ask a court to rewrite a trust’s terms to conform with the grantor’s intent. This remedy is available if the trust’s original terms were based on a legal or factual mistake.
Modification. This remedy may be available, also through court proceedings, if unanticipated circumstances require changes in order to achieve the trust’s purposes. Some states permit modification — even if it’s inconsistent with the trust’s purposes — with the consent of the grantor and the beneficiaries.
Decanting. Many states have decanting laws, which allow a trustee, according to his or her distribution powers, to “pour” funds from one trust into another with different terms and even in a different location. Depending on your circumstances and applicable state law, decanting may allow a trustee to correct errors, take advantage of new tax laws or another state’s asset protection laws, add or eliminate beneficiaries, and make other changes, often without court approval.
Seek professional guidance
The rules regarding modification of irrevocable trusts are complex and vary dramatically from state to state. And there are risks associated with revising or moving a trust, including uncertainty over how the IRS will view the changes. Before you make any changes, talk to us about the potential benefits and risks.
© 2021 Covenant CPA
A charitable remainder trust (CRT) allows you to support a favorite charity while potentially boosting your cash flow, shrinking the size of your taxable estate, and reducing or deferring income taxes. In a nutshell, you contribute stock or other assets to an irrevocable trust that provides you — and, if you desire, your spouse (or others you designate) — with an income stream for life or for a term of up to 20 years. At the end of the trust term, the remaining trust assets are distributed to one or more charities you’ve selected.
When you fund the trust, you’re entitled to claim a charitable income tax deduction equal to the present value of the remainder interest (subject to applicable limits on charitable deductions). Your annual payouts from the trust can be based on a fixed percentage of the trust’s initial value — this is known as a charitable remainder annuity trust (CRAT). Or they can be based on a fixed percentage of the trust’s value recalculated annually — in what’s known as a charitable remainder unitrust (CRUT).
Generally, CRUTs are preferable for two reasons. First, the annual revaluation of the trust assets allows payouts to increase if the trust assets grow, which can allow your income stream to keep up with inflation. Second, donors can make additional contributions to CRUTs, but not to CRATs.
The fixed percentage — called the unitrust amount — can range from 5% to 50%. A higher rate increases the income stream, but it reduces the value of the remainder interest and, therefore, the charitable deduction. Also, to pass muster with the IRS, the present value of the remainder interest must be at least 10% of the initial value of the trust assets.
The determination of whether the remainder interest meets the 10% requirement is made at the time the assets are transferred. If the ultimate distribution to charity is less than 10% of the amount transferred, there’s no adverse tax impact related to the contribution.
NIMCRUTs can provide an income boost
By designing a CRUT with a “net income with makeup” feature — known as a NIMCRUT — you can reduce or even eliminate payouts early in the trust term and enjoy larger payouts in later years when you’re retired or otherwise need an income boost.
Each year, a NIMCRUT distributes the lesser of the unitrust amount (say, 5%) or the trust’s net income. The trustee can invest the trust assets in growth investments that produce little or no income, allowing the trust to grow tax-free and deferring distributions to later years. The deferred payouts accumulate in a “makeup account.”
When you’re ready to begin receiving an income, the trustee shifts the assets into income-producing investments. You can use the funds in the makeup account to increase your distributions beyond the unitrust amount (up to the amount of net income).
Handle with care
CRTs, CRATs and CRUTs require careful planning and solid investment guidance to ensure that they meet your needs. Contact us to discuss your options before taking action.
© 2021 Covenant CPA
In some cases, it may be desirable to move a trust to a more favorable jurisdiction. But moving a trust from one state to another can present significant risks, so don’t attempt to do so without considering all the benefits, limitations and risks, and obtaining professional advice.
Reasons to move a trust
There are many reasons for moving a trust to another jurisdiction, such as:
- Avoiding or reducing state income taxes on the trust’s accumulated ordinary income and capital gains,
- Taking advantage of trust laws that allow the trustee to improve investment performance,
- Extending the trust’s duration,
- Obtaining stronger creditor protection for beneficiaries, and
- Reducing fees and administrative expenses.
Many people retire to states with more favorable tax laws. But just because you move to a state with lower income or estate taxes doesn’t mean your trusts move with you.
For individual income tax purposes, you’re generally taxed by your state of domicile. The state to which a trust pays taxes, however, depends on its situs.
Can your trust be moved?
Moving a trust means changing its situs from one state to another. Generally, this isn’t a problem for revocable trusts. In fact, it’s possible to change situs for a revocable trust by simply modifying it. Or, if that’s not an option, you can revoke the trust and establish a new one in the desired jurisdiction.
If a trust is irrevocable, whether it can be moved depends, in part, on the language of the trust document. Many trusts specify that the laws of a particular state govern them, in which case those laws would likely continue to apply even if the trust were moved. Some trusts expressly authorize the trustee or beneficiaries to move the trust from one jurisdiction to another.
If the trust document doesn’t designate a situs or establish procedures for changing situs, then the trust’s situs depends on several factors. These include applicable state law, where the trust is administered, the trustee’s state of residence, the domicile of the person who created the trust, the location of the beneficiaries and the location of real property held by the trust.
The actual process of moving the trust may entail creating a new trust to which the existing trust’s assets are transferred, merging the existing trust into a new trust or modifying the existing trust to designate the new state as its situs.
Depending on the trust’s terms and applicable state law, the move may require court approval or the unanimous consent of the trust’s beneficiaries.
Understanding the risks
Depending on your circumstances, moving a trust can offer tax savings and other benefits. Keep in mind, however, that the laws governing trusts are complex and vary considerably from state to state. We can help you determine whether the benefits outweigh the risks.
© 2021 Covenant CPA
The “sandwich generation” is a large segment of the population. These are people who find themselves caring for both their children and their parents at the same time. As a result, estate planning — which traditionally focuses on providing for one’s children — has expanded in many cases to include one’s aging parents as well.
Steps to ease complex issues
Including your parents as beneficiaries of your estate may raise a number of complex issues. As you discuss these issues with your advisor, consider these five planning tips:
- Plan for long-term care (LTC) costs. The annual cost of LTC — which may include assisted living facilities, nursing homes or home health care — can reach well into six figures. These expenses aren’t covered by traditional health insurance policies or Social Security, and Medicare provides little, if any, assistance. To prevent LTC expenses from devouring your parents’ resources, work with them to develop a plan for funding their health care needs through LTC insurance, investments or other strategies.
- Make gifts. One of the simplest ways to help your parents financially is to make cash gifts to them. If gift and estate taxes are a concern, you can take advantage of the annual gift tax exclusion, which currently allows you to give each parent up to $15,000 per year without triggering gift taxes.
- Pay medical expenses. You can pay an unlimited amount of medical expenses on your parents’ behalf, without tax consequences, so long as you make the payments directly to medical providers.
- Set up trusts. There are many trust-based strategies you can use to assist your parents. For example, in the event you predecease your parents, your estate plan might establish a trust for their benefit, with any remaining assets passing to your children after your parents die. Another option is to set up trusts during your lifetime that leverage your $11.7 million exemption. Properly designed, these trusts can remove assets — together with all future appreciation in their value — from your taxable estate. They can provide income to your parents during their lives, eventually passing to your children free of gift and estate taxes.
- Buy your parents’ home. If your parents have built up significant equity in their home, consider buying it and leasing it back to them. This arrangement allows your parents to tap their home’s equity without moving out while providing you with valuable tax deductions for mortgage interest, depreciation, maintenance and other expenses. To avoid negative tax consequences, be sure to pay a fair price for the home (supported by a qualified appraisal) and charge your parents fair-market rent.
Find the right balance
As you review these and other options for assisting your aging parents, be cautious of pitfalls. For example, if you give your parents too much, these assets could end up back in your estate and potentially be exposed to gift or estate taxes. Contact us for help in addressing both your children and parents in your estate plan.
© 2021 Covenant CPA
Traditionally, estate planning has focused on more technical objectives, such as minimizing gift and estate taxes and protecting assets against creditors’ claims or lawsuits. These goals are still important, but affluent families are increasingly turning their attention to “softer,” yet equally critical, aspirations, such as educating the younger generation, preparing them to manage wealth responsibly, promoting shared family values and encouraging charitable giving. To achieve these goals, many are turning to a family advancement sustainability trust (FAST).
Typically, FASTs are created in states that 1) allow perpetual, or “dynasty,” trusts that benefit many generations to come, and 2) have directed trust statutes, which make it possible to appoint an advisor or committee to direct the trustee with regard to certain matters. A directed trust statute makes it possible for both family members and trusted advisors with specialized skills to participate in governance and management of the trust.
A common governance structure for a FAST includes four decision-making entities:
- An administrative trustee, often a corporate trustee, that deals with administrative matters but doesn’t handle investment or distribution decisions,
- An investment committee — consisting of family members and an independent, professional investment advisor — to manage investment of the trust assets,
- A distribution committee — consisting of family members and an outside advisor — to help ensure that trust funds are spent in a manner that benefits the family and promotes the trust’s objectives, and
- A trust protector committee — typically composed of one or more trusted advisors — which stands in the shoes of the grantor after his or her death and makes decisions on matters such as appointment or removal of trustees or committee members and amendment of the trust document for tax planning or other purposes.
It’s a good idea to establish a FAST during your lifetime. Doing so helps ensure that the trust achieves your objectives and allows you to educate your advisors and family members on the trust’s purpose and guiding principles.
FASTs generally require little funding when created, with the bulk of the funding provided upon the death of the older generation. Although funding can come from the estate, a better approach is to fund a FAST with life insurance or a properly structured irrevocable life insurance trust (ILIT). Using life insurance allows you to achieve the FAST’s objectives without depleting the assets otherwise available for the benefit of your family.
A flexible tool
A FAST is a flexible tool that can be designed to achieve a variety of goals. How you use one depends on your family’s needs and characteristics. Properly designed and implemented, a FAST can help prepare your heirs to receive wealth, educate them about important family values and financial responsibility, and maximize the chances that they’ll reach their potential. Contact us for additional details.
© 2021 Covenant CPA
Your estate plan may include several different trusts. The reason is that various types of trusts can accomplish a myriad of estate planning goals. Thus, it’s critical to understand the role of a trustee.
The trustee’s duties
The trustee is the person who has legal responsibility for administering the trust on behalf of the interested parties. Depending on the trust terms, this authority may be broad or limited.
Generally, a trustee must meet fiduciary duties to the beneficiaries of the trust. He or she must manage the trust prudently and treat all beneficiaries fairly and impartially.
This can be more difficult than it sounds because beneficiaries may have competing interests. For example, under a trust’s terms, a spouse in a second marriage may be entitled to annual income while the children of the deceased’s first marriage are entitled to the remainder. The trustee must balance out their needs when making investment decisions.
In some instances, the trustee is granted the discretion to distribute or withhold the distribution of trust funds. For example, this discretionary power may be intended to protect assets from the beneficiary’s creditors or safeguard funds until the beneficiary reaches a certain age. The trustee in such a discretionary trust should be sympathetic to the intent of the trust and legitimate needs of the beneficiary.
The decision about naming a trustee is similar to the dilemma of choosing an executor. The responsibilities require great attention to detail, financial acumen and dedication. Because of the heavy reliance on investment expertise, choosing a professional over a family member or friend is generally recommended. At the very least, make it clear to the trustee that he or she may — and should — rely on professionals as appropriate.
Reasons for choosing an alternate
It’s not enough to designate someone as trustee. It’s absolutely essential to also designate a “successor” (or an “alternate”) in the event that your top choice is unable or unwilling to fulfill the responsibilities. For instance, what happens if your trustee predeceases you? Or what if your designated trustee declines to accept the position or subsequently resigns if permission is allowed by the trust or permitted by a court? This further accentuates the need to name backups for this important position.
Without a named successor, the probate court will appoint one for the estate. For a trustee, the trust will often outline procedures to follow. As a last resort, a court will appoint someone else to do the job.
Practical suggestion: Choose the “next best” person to step in. Make sure that he or she is on board with your decision. Similar to the discussion about naming a power of attorney, consider whether you should name a professional as a backup. Contact us with questions.
© 2021 Covenant CPA
For years, life insurance has played a critical role in estate planning, providing a source of liquidity to pay estate taxes and other expenses. Today, the gift and estate tax exemption has climbed to $11.4 million, so estate taxes are no longer a concern for the vast majority of families. But even for nontaxable estates, life insurance continues to offer estate planning benefits.
Replacing income and wealth
Life insurance can protect your family by replacing your lost income. It can also be used to replace wealth in a variety of contexts. For example, suppose you own highly appreciated real estate or other assets and wish to dispose of them without generating current capital gains tax liability. One option is to contribute the assets to a charitable remainder trust (CRT).
As a tax-exempt entity, the CRT can sell the assets and reinvest the proceeds without triggering capital gains tax. In addition, you and your spouse will enjoy an income stream and charitable income tax deductions. Typically, distributions you receive from the CRT are treated as a combination of ordinary taxable income, capital gains, tax-exempt income and tax-free return of principal.
After you and your spouse die, the remaining trust assets pass to charity. This will reduce the amount of wealth available to your children or other heirs. But you can use life insurance (a cost-effective second-to-die policy, for example) to replace that lost wealth.
You can also use life insurance to replace wealth that’s lost to long term care (LTC) expenses, such as nursing home costs, for you or your spouse. Although LTC insurance is available, it can be expensive, especially if you’re already beyond retirement age. For many people, a better option is to use personal savings and investments to fund their LTC needs and to purchase life insurance to replace the money that’s spent on such care. One advantage of this approach is that, if neither you nor your spouse needs LTC, your heirs will enjoy a windfall.
Finding the right policy
These are just a few examples of the many benefits provided by life insurance. We can help determine which type of life insurance policy is right for your situation. 205-345-9898 or email@example.com.
© 2019 CovenantCPA
If your estate includes forms of intellectual property (IP), such as patents and copyrights, it’s important to know how to address them in your estate plan. Although these intangible assets can have great value, in many ways they’re treated differently from other property types.
2 estate planning questions
For estate planning purposes, IP raises two important questions: 1) What’s it worth? and 2) How should it be transferred? Valuing IP is a complex process, so it’s best to obtain an appraisal from an experienced professional.
After you know the IP’s value, it’s time to decide whether to transfer the IP to family members, colleagues, charities or others through lifetime gifts or through bequests after your death. The gift and estate tax consequences will affect your decision, but also consider your income needs, as well as who’s in the best position to monitor your IP rights and take advantage of their benefits.
If you’ll continue to depend on the IP for your livelihood, for example, hold on to it at least until you’re ready to retire or you no longer need the income. You also might want to retain ownership if you feel that your children or other transferees lack the desire or wherewithal to exploit its economic potential and protect it against infringers.
Achieving your objectives
Whichever strategy you choose, it’s important to plan the transaction carefully to ensure that your objectives are achieved. There’s a common misconception that, when you transfer ownership of the tangible medium on which IP is recorded, you also transfer the IP rights. But IP rights are separate from the work itself and are retained by the creator — even if the work is sold or given away.
Suppose, for example, that you leave to your child a film, painting or written manuscript. Unless your estate plan specifically transfers the copyright to your child as well, the copyright may pass as part of your residuary estate and end up in the hands of someone else.
Revise your plan accordingly
If you own patents or copyrights, you probably have great interest in who’ll take possession of your work after you’re gone. Addressing IP in your estate plan can give you peace of mind that your wishes will be carried out, but the law surrounding such property can be complex. Discuss your options with us by calling 205-345-9898.
© 2018 Covenant CPA
No matter how much effort you’ve invested in designing your estate plan, your will, trusts and other official documents aren’t enough. You should also create a “road map” — an informal letter or other document that guides your family in understanding and executing your plan and ensuring that your wishes are carried out. Your road map should include, among other things:
- A list of important contacts, including your estate planning attorney, accountant, insurance agent and financial advisors,
- The location of your will, living and other trusts, tax returns and records, powers of attorney, insurance policies, deeds, automobile titles, and other important documents,
- A personal financial statement that lists stocks, bonds, real estate, bank accounts, retirement plans, vehicles and other assets, as well as information about mortgages, credit cards, and other debts,
- An inventory of digital assets — such as email accounts, online bank and brokerage accounts, online photo galleries, digital music and book collections, and social media accounts — including login credentials or a description of arrangements made to provide your representative with access,
- Computer passwords and home security system codes,
- Safe combinations and the location of any safety deposit boxes and keys,
- The location of family heirlooms or other valuable personal property, and
- Information about funeral arrangements or burial wishes.
The road map can also be a good place to explain to your loved ones the reasoning behind certain estate planning decisions. Perhaps you’re distributing your assets unequally, distributing specific assets to specific heirs or placing certain restrictions on an heir’s entitlement to trust distributions. There are many good reasons for these strategies, but it’s important for your family to understand your motives to avoid hurt feelings or disputes.
Finally, like other estate planning documents, your road map won’t be effective unless your family knows where to find it, so it’s a good idea to leave it with a trusted advisor. Contact us at 205-345-9898 to start your road map.
© 2018 Covenant CPA
There’s no law that says you can’t prepare your own estate plan. And with an abundance of online services that automate the creation of wills and other documents, it’s easy to do. But unless your estate is small and your plan is exceedingly simple, the pitfalls of do-it-yourself (DIY) estate planning can be many.
Dotting the i’s and crossing the t’s
A common mistake people make with DIY estate planning is to neglect the formalities associated with the execution of wills and other documents. Rules vary from state to state regarding the number and type of witnesses who must attest to a will and what, specifically, they must attest to.
Also, states have different rules about interested parties (that is, beneficiaries) serving as witnesses to a will or trust. In many states, interested parties are ineligible to serve as witnesses. In others, an interested-party witness triggers an increase in the required number of witnesses (from two to three, for example).
Keeping abreast of tax law changes
Legislative developments during the last several years demonstrate how changes in the tax laws from one year to the next can have a dramatic impact on your estate planning strategies. DIY service providers don’t offer legal or tax advice — and provide lengthy disclaimers to prove it. Thus, they cannot be expected to warn users that tax law changes may adversely affect their plans.
Consider this example: A decade ago, in 2008, George used an online service to generate estate planning documents. At the time, his estate was worth $4 million and the federal estate tax exemption was $2 million.
George’s plan provided for the creation of a trust for the benefit of his children, funded with the maximum amount that could be transferred free of federal estate tax, with the remainder going to his wife, Ann. If George died in 2008, for example, $2 million would have gone into the trust and the remaining $2 million would have gone to Ann.
Suppose, however, that George dies in 2018, when the federal estate tax exemption has increased to $11.18 million and his estate has grown to $10 million. Under the terms of his plan, the entire $10 million — all of which can be transferred free of federal estate tax — will pass to the trust, leaving nothing for Ann.
While even a qualified professional couldn’t have predicted in 2008 what the estate tax exemption would be at George’s death, he or she could have structured a plan that would provide the flexibility needed to respond to tax law changes.
Don’t try this at home
These are just a few examples of the many pitfalls associated with DIY estate planning. To help ensure that you achieve your estate planning objectives, contact us to review your existing plan at 205-345-9898.
© 2018 Covenant CPA