The best estate planning satisfies the goals of two constituencies:
- The generation doing the planning (clients); and
- The generation(s) that will benefit from it (beneficiaries).
Clients should make the ultimate decisions about where and how to transfer wealth. However, they can often achieve better results if their estate planning meets their beneficiaries’ goals. In addition, estate planning works better when beneficiaries understand how strategies work and why indirect transfers in trust can be better than outright gifts or bequests.
Typically, attorneys and other advisors only explain planning alternatives to their clients. Those clients then make planning choices without any input from beneficiaries, even when clients believe they have responsible adult beneficiaries. This lack of input occurs even when the clients’ goals include wanting their planning to please their beneficiaries.
Fallacy of Outright Transfers
Most clients start the planning process believing that outright gifts and bequests will work best for their beneficiaries. They also believe that their beneficiaries would prefer outright transfers to transfers in trust. But this isn’t necessarily true. Planners should explain the risks of outright transfers to clients. In my experience, once clients understand the benefits of transfers in trust, they prefer them.
However, clients often remain concerned that their beneficiaries will believe that a transfer in trust, rather than outright, won’t work well for the beneficiaries. Addressing this concern involves convincing clients to permit their attorneys to explain to beneficiaries the risks of outright transfers and the benefits of transfers in trust.
Planners can also explain how good drafting can provide as much flexibility and control for beneficiaries as desired by the beneficiaries, but only to the extent acceptable to the clients.
Risks of Outright Transfers
Outright transfers expose beneficiaries to the unnecessary risks that:
- the property could be lost to claims by creditors;
- the property could be lost to a future ex-spouse (clients may love their beneficiaries’ spouses, but that love fades quickly after a divorce, especially if the ex-spouse seeks to take property from the beneficiary);
- inherited property could result in unnecessary estate or gift taxes when the chosen beneficiary dies or gives it away; and
- wealth will be lost to imprudent investments or spending by beneficiaries (clients with confidence in the judgment of particular beneficiaries may not choose to protect against imprudence).
These risks can generally be eliminated by leaving the property in well-drafted trusts customized for each beneficiary.
Giving Control to Beneficiaries
To the extent clients want, trusts can give beneficiaries control (in most cases after the clients have died) over investments and control over distributions. (Control over distributions that benefit the beneficiary may require a technically independent third party’s consent or approval to enhance creditor protection and keep property out of the beneficiary’s taxable estate.)
Further, clients can limit the level and timing of beneficiary control by, among other restrictions, limiting amounts or timing (often by age) of permissible distributions, limiting acceptable investments, limiting permissible appointees (see next paragraph), delegating decisions on these or other matters to trusted relatives/advisors. Clients can either dictate the limits they want to provide or engage with beneficiaries to develop limits acceptable to both the clients and beneficiaries.
Clients can also determine where and how property will pass when the first-level beneficiary dies (or no longer wants the property). The trust can specify the terms of such passing, or clients can allow beneficiaries to choose where and how the property would pass through limited powers of appointment. Many clients will choose to structure limited powers in a way that keeps the property in the chosen bloodline.
Although these trusts for beneficiaries need to file income tax returns, most of the income distributed within 65 days of the end of a taxable year gets taxed to the respective beneficiaries rather than the trust.
Administrative Benefits
The benefits of leaving property in trust depend on good drafting and proper trust administration.
The chances of sound administration rise materially when the beneficiaries understand both the benefits of keeping the property in trust and how the trust should be administered. Trusts will work better when drafting counsel has explained these issues to beneficiaries.
Improved Outcomes
Participation can comfort clients in planning for the benefits of substantial gifts or bequests in trust, rather than outright when clients know that beneficiaries appreciate the trust benefits and flexibility given to them. It also improves the chances that gifts or bequests will be administered properly.
My experience shows that clients and beneficiaries value this kind of participatory planning.