Most Americans pass up one of the top benefits of US law for their children or other heirs. They do not leave their property to be inherited in a trust that protects against financial reversals, divorce, legally avoidable taxes and even against the mistakes of their children.
Fred & Frita Fail to Protect. Fred and Frita go to their estate planner. Their estate planning lawyer asks:
Lawyer: “How do you want to leave your inheritance to your three children?”
Fred: “I don’t want to control from the grave. We could leave some of when they get say 30 years old and then the rest when they are older.”
Lawyer: “How about at 25 they get one third, 30 one third and 35 one third? This is what everyone else is doing.”
Fred: “Sounds good to me.”
Frita: “What if one of them gets in trouble or gets divorced?”
Lawyer: “Some of the money will be protected up to age 35.”
Frita: “Well, if that is what everyone else does, I guess it is okay.”
Fred and Frita sign a trust that says that one third goes to each child when the child is 25, another one third when the child is thirty and the remaining one third when they are 35. They have three children: George, Gary and Nancy.
When Fred and Frita both die, George, Gary and Nancy are all over 35 years of age and they get their inheritance directly and not in trust. Each of them puts their inheritance of $1,000,000 into their personal bank and investment accounts.
Scheming Dana Gets Half. Dana, George’s wife, cajoles George to put his $1,000,000 into a joint account with his wife Dana. Dana says: “We are in this together, aren’t we?” Two years later, Dana divorces George to be with her lover of the last five years. Because the $1,000,000 is in a joint bank account with Dana, in the divorce case, Dana gets one half ($500,000) because usually marital assets are split 50/50. Dana’s divorce attorney makes a winning argument to the court that the $1,000,000 became a marital asset when George put the money into a joint marital account with Dana.
Gary loses everything-including his inheritance. Gary starts a high tech company and borrows $2,000,000 to pay employees, rent and other business expenses. Mega Company copies his technology but in a way that Gary would have a hard time winning an infringement lawsuit against the larger company. Also, Gary does not have the estimated $400,000 to fight the legions of lawyers of Mega Company. At age 55, without a job, Gary loses everything, including his $1,000,000 inheritance because the $1,000,000 is in his bank account and the bank lender takes Gary’s inheritance to pay back the loan. Gary files bankruptcy and has a hard time finding a job because of his bad credit and age. He lost his home, his wife leaves him and he can’t pay for the college education of his children.
Nancy pays estate taxes that could have been avoided. Nancy founds an advertising agency and marries into a wealthy family. Due to the size of their estate, Nancy and her husband Andrew will pay estate taxes when they both die. Nancy grows her $1,000,000 inheritance to $4,000,000 during her lifetime. When Nancy dies, because of her inheritances and the value of her business, Nancy’s estate pays nearly $3,000,000 in federal and state estate taxes.
Her tax advisor had told her that if Nancy had inherited the $1,000,000 in a lifetime trust from her parents, she would not have had to pay any estate taxes on the value of the assets left to her by her parents and could have passed on the $4,000,000 to her children tax free. But, when Nancy got the money outright, it was too late to use that planning tool.
Patty, one of Nancy’s children has disabilities and Nancy had planned to leave the $4,000,000 to Patty for her care for life in a trust for Patty. But, because Nancy living trust creates the trust for Patty, instead of under the trusts of Fred and Frita, the money was part of the taxable estate of Nancy. Most of the money never makes it to the Patty trust because it has to go to pay estate taxes. If Fred and Frita had set up a lifetime trust for Nancy, the $4,000,000 could have been available for Patty’s care, free of estate taxes in Nancy’s estate.
Harry protects his only daughter–from herself. I first met Harry in the conference room of a nice assisted living facility where he was living. In his late 80s, Harry had been a careful steward of his earnings and money and had a very capable financial advisor who produced good returns over the years. The advisor had managed to grow $500,000 to about $2,000,000. Harry saved his entire lifetime, even when he was news paperboy. His wife and oldest daughter had already died. His remaining family was his daughter and her daughter.
“My daughter is really terrible with money”, said Harry, sadness in his voice. “I pay the rent for her apartment with her boyfriend and daughter. If I send the money directly to her, she will spend it and get evicted. I have to send the money directly to the landlord.”
I had reviewed his trust that was prepared by another lawyer.
I said: “Harry, I have read your trust and if you pass, your daughter immediately gets all of your money. Your daughter could spend all of your savings in three months”.
Harry: “No, she would spend it three weeks.”
Harry instructed me to change his trust so that his daughter’s inheritance would last the joint lifetimes of his daughter and his only grandchild, with the investments to be done by his trusted financial adviser. Now that Harry has passed, his money continues to be carefully invested and his daughter will receive a significant monthly check for the rest of her life. She can’t blow her inheritance.
Mary is protected against a bad marriage. Oscar and Harriet have two children, Mary and Mike. Oscar and Harriet set up life time discretionary trusts for their two children. Mary’s marriage seems to be going well. However, after Oscar and Harriet die, Mary’s husband Felix becomes a drug addict and after multiple attempts to dry him out, Mary concludes Felix is a hopeless case and divorces him. In the divorce court, Felix attempts to get part of the $1,500,000 in the trust Mary’s parents set up for her. However, the court does not award anything from Mary’s trust, but divides the joint property of Mary and Felix 50/50. With the $1,500,000 trust, Mary has enough for a fresh start and a good retirement.
Alex survives bankruptcy. Alex is a go getter and founds a successful high tech business. Within three years, he has 20 employees and annual sales of $8,000,000. He takes out a $4,000,000 bank loan secured by his business assets to rapidly expand his business. His technology is overtaken by the latest high tech gadget and Alex’s business collapses. Alex owns $6,000,000 with assets of $800,000 (outside his trust). Alex files bankruptcy. The major asset of Alex is the $2,000,000 in a lifetime trust he inherited from his parents. The bankruptcy court liquidates all of the assets of Alex outside of trust Alex inherited from his parents. Alex has lost everything-except the $2,000,000 in trust from his parents. Alex can start over and live well due to the far sighted planning of his parents.
Is your plan like so many that it fails to protect your children or heirs from creditors, bad marriages or themselves? Contact us to see if you have maximized the protections for the next generations. firstname.lastname@example.org.