There’s At Least One Estate Planning Mistake In Every Family

Estate Planning professionals hear the stories all the time. They know they will hear them almost every time they meet with a new client. In the meetings, the estate plannning professional can see the signs in the hesitation and increased discomfort of the clients.

The fact is, almost every family has at least one. There’s a child who hasn’t turned out the way the parents hoped. It’s even true in the families of most estate planning professioanls. It’s not something you should try to hide. In fact, you should be candid with the estate planning specialist, because there are steps that can be taken to make things better.

There are many types of problem children. What they have in common is that their parents would like to provide some financial assistance, either now through gifts or later through their estates, but aren’t confident the problem child will make good use of the money or property. They don’t want the money to be wasted or corrupt the child.

You should tell the estate planner your concerns, so the planner can suggest strategies such as these.

Estate Planning Strategy#1

Make gifts indirectly. You probably know the annual gift tax exclusion allows you to make gifts of up to $14,000 to any person in 2015. The exclusion amount stays the same for 2016. You can make gifts up to $14,000 to any number of people you want during the year, and spouses can give jointly up to $28,000 per person. Gifts up to this amount aren’t included in taxable gifts for the year, so they don’t use your lifetime estate and gift tax exemption. Gifts greater than the annual exclusion reduce your lifetime estate and gift tax exemption.

Your estate planner might encourage you to make annual gifts to the children to reduce the value of your estate, or you might want to make gifts so the children can benefit from some of your estate now instead of waiting for you to pass.

Fortunately, you don’t have to give money or property directly to a person. Instead, you can pay bills for the problem child, purchase things for him or her, or take similar actions. That way, you’re not taking the risk the cash or property will be used the wrong way.

Some people make gifts of family vacations. They might pay all the expenses to bring the family to a nice location and stay there for a few days or a week. Others pay a major share of the costs. For example, you might pay for the cost of staying at a nice resort but let the family members pay the cost of transportation and perhaps the food and recreation at the location.

The annual gift tax exclusion becomes an unlimited amount when you directly pay for qualified education or medical expenses. Make payments directly to a school or to a medical professional, and you can give an unlimited amount without worrying about gift taxes or how the child might spend cash.

Estate Planning Strategy #2

Custodial accounts. When the child still is a minor, you can put money or property into a custodial account, known as either a Uniform Gift to Minors Act (UGMA) or Uniform Trust to Minors Act (UTMA) account. The gift qualifies for the annual gift tax exclusion, but an adult has control of the account. I’m not a big fan of these accounts, because the adult is in control only until the child reaches the age of majority, which is 18 in most states. After that, the child has legal control of the money.

Estate Planning Strategy #3

Create family limited partnerships. The FLP has grown in popularity over the years. Originally it was established to remove the value of assets from an estate at a lower gift tax cost. You create a limited partnership and transfer assets to it in exchange for interests in the partnership. Then, you give some or all of the limited partnership ownership interests to your children. You and your spouse are the general partners. Because the limited partnerships have limited marketability and each child is a minority owner, the shares are valued at less than a pro rata share of the assets in the FLP. That reduces gift taxes. The tax reduction strategy still works, though the IRS is planning to stop it.

The FLP has other uses, and dealing with the problem child is one of them. You can put assets in the FLP and give each of the children limited partner shares. Because you and your spouse are the general partners, you control what is done with partnership assets. You manage them and also decide on distributions from the partnership. The problem child has an ownership share but can’t do much with it. In addition to avoiding misuse of the assets, the FLP might be a way to help the child learn to be more financially responsible by becoming somewhat involved in decisions.

For the FLP to work in the long term, you need to establish who would become the general partner after you and your spouse. You probably don’t want to use the FLP to protect the property during your lifetime only to leave it at risk after your passing.

Estate Planning Strategy #4

Marital agreements. Sometimes the concern is not so much the problem child as the problem child’s spouse or marriage. Would you like a big part of your estate to end up in the hands of someone you never knew? That could happen if you give property to one of your children and the property is divided in a divorce. A marital agreement, either a premarital or postmarital agreement, provides protection against that and is very flexible. You should want your child and his or her spouse to enter into one that says any gifts or bequests received by one of the spouses remains the spouse’s separate property and is not part of the marital estate. Some people say they won’t make gifts or bequests to a married child who doesn’t have such an agreement in place.

Estate Planning Strategy #5

Protective trusts. Perhaps the most common and comprehensive way to help a youngster while saving the wealth from potential destructive actions is to put it in a trust with protective provisions. There are a number of different provisions that can be put in trusts.

? Spendthrift clause: This standard clause says creditors of the beneficiary can’t force payouts from the trust or be paid directly from the trust. Even if the beneficiary is bankrupt, the creditors still cannot invade the trust. Once distributions are paid from the trust to the beneficiary, the creditors can try to claim them. Not all states allow the spendthrift clause, and many limit it to $500,000 or so of the trust’s value.

? Discretionary clause: This clause gives the trustee discretion over payments of income or principal to the beneficiary. The trustee determines both the amount and timing of all payments. This provision can work when the trustee knows your wishes well and especially when you provide written guidelines for the trustee.

The discretionary clause can leave the trustee and beneficiary as adversaries, and you can’t anticipate all possible situations ahead of time and give the trustee guidance on each possibility. So, it is a clause to be used carefully. A corporate trustee who is not familiar with your family also might not be able or willing to use the discretion effectively. It’s likely you would need an individual who knows the family to serve as trustee.

? Milestone or stepping stone trust: Trusts with this provision initially pay the beneficiaries only income. The annual income payment might have a limit or might be restricted to payments for certain expenses, such as education and medical care.

The beneficiary receives more income or principal distributions when certain milestones are met, such as reaching a certain age, graduating from college, being employed for a certain number of years, or virtually any mile-stones you want to set. The entire trust might be distributed upon reaching one milestone or in stages as different milestones are reached.

The milestone trust allows the beneficiary to learn how to handle money and to mature in general before receiving the bulk of the wealth. It also encourages the beneficiary to be useful and productive.

? Emergency clause: This is a variation of the discretionary clause. The trust is set up to initially pay income and principal to the beneficiary under some schedule or terms. But under the emergency clause the trustee is allowed to withhold payments when he considers it to be in the best interests of the beneficiary. Some people spell out the circumstances under which payments should be withheld. Others realize that they cannot anticipate every circumstance, so they give the trustee a broad, general power. Payments to the beneficiary resume when the situation that caused suspension of the payments is resolved and the trustee concludes a distribution again is in the beneficiary’s best interests.

There are no guarantees that the problem child won’t waste money. But if you want an opportunity to help while protecting your wealth, consider these strategies.

RW December 2015.