Truths & Myths
Advisors play a key role in their clients’ financial lives. They are a trusted source for advice and information. Clients expect their advisor to educate and advise them on applicable estate planning issues. This article addresses some common myths regarding trusts and estate planning.
Myth – A person’s will is the only estate planning instrument necessary to settle most estates.
Control – While a will is a necessary component of an effective estate plan, it controls only the disposition of single name assets. The will does not direct the distribution of contractual assets where a specific beneficiary is named (life insurance, IRA, 401k, annuities, pensions, etc.). Nor does the will control the disposition of jointly owned assets. A will can handle simple bequests – outright distributions to beneficiaries, but it lacks key flexibilities, necessary in meeting sometimes complex family needs that are important to many testators. Three of these important flexibilities are: Avoiding probate, protecting privacy, and controlling assets after death.
Probate – Single name assets that pass and are controlled by the will are subject to the probate process, time table and costs. There is a lack of privacy in the probate process – an inventory of all assets passing by will, valued at the testator’s date of death must be filed at the courthouse – subject to public scrutiny. Attorney and executor fees and other filing costs are charged against probate assets (typically 3% to 8% of the estate value). Probated estates take time to settle – possibly years, and there are often delays in ultimate asset distribution.
Testamentary Trusts – In an effort to address family complexities and needs, a testamentary trust can be created within the will document that goes into effect at death. Typical needs met by a trust are continuing asset management by trusted advisors; ongoing care and support provisions; differentiation between income and remainder beneficiaries, generation-skipping distributions, charitable income or remainder trusts, etc.
Living Trusts – The maker or originator of a revocable or irrevocable living trust (established during life) enjoys much more control over the disposition of assets after death. Assets that pass via a living trust are not probated; not part of the public record and not subject to the costs and delays of estate administration. Trust assets pass to heirs outside of the will in a manner exactly as instructed by the trust document, meeting the distinct and varying needs of beneficiaries. For example, a trust can provide a life estate (income and principal as needed) for a surviving spouse with the remainder distributed to children or grandchildren at the spouse’s death. The flow and timing of asset distribution can be controlled – for example, 1/3 at age 18, 1/3 at 25, remainder at 30, etc.
Myth – Trusts only make sense for the ultra high net worth (estates greater than $11.2 million, the current estate tax exemption).
Estate Planning –
An appropriately drafted trust can be a critical estate planning tool for high net worth individuals – often saving significant sums in estate, gift and inheritance taxes. But, trusts can also be useful to people with more modest estates. A trust can assure that assets will not ultimately pass to the wrong (sometimes unknown) heirs (one of the hazards of jointly held assets). And, as stated above, a trust avoids probate, protects privacy and controls asset disposition among different types of beneficiaries.
Last, many testators (regardless of the size of their estate) have concerns about bequeathing money to beneficiaries with no strings attached. A well written trust (either living or testamentary) remedies those issues. The trust controls asset disposition after death. Simply put – trusts allow an individual to pass wealth to beneficiaries in the most efficient and expeditious manner (sometimes on a conditional basis if necessary).
Myth – A trust can be restrictive, limiting investment management options and beneficiary or key advisor involvement (such as the grantor’s attorney) in trust administration, decision making and distributions.
Fact – Corporate trustees chartered in a ‘trust friendly’ state (such as Tennessee) enable grantors to build in significant flexibilities, asset protections, advisor liability safeguards and tax cost savings by establishing Tennessee (TN) as the trust situs. TN trusts are so flexible that trust grantors can name particular advisors to perform specific tasks, such as investment management, trust protector, distribution advisor, business advisor, etc. These advisors are liable only for their specific duties and obligations.
Myth – Creating and funding a trust requires the involvement of a corporate trustee (like a bank trust department), potentially upsetting the advisor/client relationship.
Fact – Most trusts do not initially (or ever) require the involvement of a corporate trustee. However, when trusts become more complicated (multiple beneficiaries, division of principal and interest, unique family dynamics), grantors or testators often seek the unbiased expertise of a professional corporate trustee. A corporate trustee has the experience and administrative systems necessary to properly provide financial, tax and investment accounting for trusts.
The logistical framework for creating a trust is as follows:
1 – Trust document is drafted by an attorney to the specifications of the grantor or testator. If a corporate trustee is named, to assure total flexibility in the future, the trust document should contain a clause enabling a trust protector (without the fiduciary liability of the trustee) to make critical administrative adjustments, correct drafting errors or change the corporate trustee to another qualified institution.
2 – The trustee can be an individual (family member, a trusted advisor), or a corporate trustee or both. In a testamentary trust, the trustee has no responsibility or involvement until the testator passes away. The trustee for a living trust is customarily the grantor. At the grantors death, a successor trustee, named in the document takes over. As with testamentary trusts, the trustee can be an individual, corporate trustee, or both.
3 – Some corporate trustees (especially in ‘trust friendly’ states such as TN) can work with other advisors, offering ‘directed’ (as opposed to ‘delegated’) trust services. Advisor friendly trust companies are equipped to accept a data feed from the investment advisor’s custodian so that full trust accounting can be provided. The grantor’s selected investment advisor continues to manage the assets – the same as before the death of the grantor, maintaining total continuity. The trustee is responsible for administering the trust – executing the instructions in the trust document.
If a grantor has an established relationship with an advisor and wants the advisor to continue managing the portfolio after the grantor’s death, it is important for the grantor to choose a corporate trustee who is willing to work with outside advisors. The management of the trust assets and the administration of the trust are split – the investment advisor continuing to manage the assets; the corporate trustee, administering the trust – fulfilling the duties and obligations as provided in the document.