Every family has complicated dynamics, but when significant wealth is added to the mix, things can get particularly difficult.
Planning for the modern-day family involves a myriad of sometimes sensitive issues. From the child who struggles with substance abuse issues to the "black sheep" daughter-in-law, each family member has a different set of circumstances that need to be addressed in the planning process. Planning for today's wealthy families requires the advisors to be well versed in a number of different planning options that will provide flexibility, protection and the opportunity to preserve and increase wealth over multiple generations. What follows is an examination of the issues and tools advisors should consider when addressing the needs of their client family.
Qualified Terminable Interest Property (QTIP) trusts are a key planning component for many married couples. QTIP planning is particularly effective in dealing with the spouses and children of first and second marriages. If, for example, a wife wants to set up a trust to support her husband and ensure that, upon his death, the remaining assets go to the children of a prior marriage, a QTIP trust may be appropriate.
QTIP trusts are also effective in the case of a first marriage not involving any stepchildren. A QTIP trust can provide financial support to the surviving spouse while insulating those assets from the reach of a future spouse, should the surviving spouse remarry. A QTIP trust can provide generous, minimal or no discretionary distributions to the surviving spouse. The trust, however, must provide mandatory distributions of net income to the spouse at least annually to defer estate taxes until the surviving spouse's death.
Lifetime QTIP Trust
A lifetime QTIP trust is useful for providing enough assets to fully utilize the estate tax exemption in cases where a less wealthy spouse dies first. In 2009, U.S. law allows $3.5 million of assets to pass to non-spousal beneficiaries free of federal estate taxes. A married couple can avoid the confiscatory 45% federal estate tax on up to $7 million of assets if they each are deemed to "own" $3.5 million of assets. A transfer of assets into a lifetime QTIP trust will allow the funding of the spouse's estate tax exemption amount and ensure the ultimate disposition of the trust assets upon the spouse's death. The lifetime QTIP trust has yet another benefit: If the beneficiary spouse dies first, the individual establishing the trust can retain an income interest in the lifetime QTIP trust for the balance of his or her life without causing those assets to be taxed in the estate.
To address the possibility that a spouse (including a beneficiary's spouse) may be different at the time of the creation of a trust than in the future, the use of a "floating spouse" definition in a trust can be a valuable tool. This type of definition can provide that a spouse will only be a beneficiary of the trust if he or she is married to and living with a specified beneficiary. If they divorce, the definition automatically will exclude that spouse from any further interests in the trust. This is especially important for irrevocable trust planning, where amending the trust after it is created is not an option.
Limited Powers Of Appointment
Under a typical trust arrangement, a trust will contain a "default" disposition that will generally provide for distribution equally to the individual's descendants in the absence of the exercise of a limited power of appointment by the beneficiary. The limited power of appointment can be provided in a "testamentary" format to be effective at the death of the beneficiary exercisable through his or her will, or in a "lifetime" or "inter vivos" format which can be exercised by the beneficiary during his or her lifetime. While the power of appointment in most cases will be created to be a "limited power" so as to ensure that the trust assets are not included in the power holder's taxable estate, limited powers of appointment can be drafted to be very broad or very narrow.
Many estate planners are advocates of structuring "two-generation" trusts that typically provide for assets to pass from the first generation ("G1") to the second generation ("G2"), perhaps in some sort of limited trust format that may make partial outright distributions at certain ages. This type of planning may be sufficient for smaller estates in which the value of the assets that are ultimately passed to G2, after the payment of estate taxes, may be, for example, $5 million or less, where it may be simpler to just distribute the assets to the children in G2. However, it may not be the most efficient planning from a transfer tax and wealth preservation standpoint when advising families with larger wealth.
Remove And Replace Powers
A multi-generational trust structure holds trust assets for the beneficiary's lifetime rather than distributing the assets to the beneficiary. While there are clearly several benefits to holding assets in a flexible trust for the beneficiary's lifetime, there are some potential burdens that should be considered and addressed. For instance, perhaps a beneficiary and the appointed trustee may not agree on certain issues. Mechanisms should be included in a trust arrangement to resolve such conflicts. One approach is to provide each beneficiary with a "remove and replace power," which would allow the beneficiary to fire the existing trustee and to hire a new individual or corporate trustee.
Beneficiary As Co-Trustee
In order to provide that the beneficiary has some input in the administration of the trust, a beneficiary can be named as a co-trustee to make certain investment decisions with the independent trustee. The beneficiary co-trustee should not have any ability to make decisions with respect to the distribution of trust assets in order to ensure that the trust assets will not be taxable in the beneficiary's estate, or subject to creditor's claims. If the creator of the trust wants the beneficiary to participate in distribution decisions, the beneficiary could be given the right to make distributions to himself subject to an "ascertainable standard" for the beneficiary's health, education, maintenance or support. Such an ascertainable standard may not be desirable, however, as it may forfeit some of the asset protection features provided by the multi-generational trust structure.