“Guardian Angel” Trusts: The New Wave of Estate Planning
By: Bryan M. Etter, Esq.
Introduction to Estate Planning Benefits
What is Estate Planning? That’s a question that far too few of our community members ever get around to asking themselves. When they do, the most typical answers presumably are along the lines of “something that extremely wealthy people do.” This vastly under-inclusive description originates from a common misconception—that the goal of Estate Planning is to minimize federal and/or state Estate Taxes. While mitigating the threat of Estate Taxes is a primary objective of a select few, “Asset Protection” and the ability to customize distribution wishes are foundational interests that nearly every parent who owns a dollar should at least be made aware of. At a minimum, the purpose of this article is to open the eyes of the hard-working, family oriented majority, as to the overwhelming importance of Estate Planning.
Estate Taxes: The Empty Threat
Estate Taxes are a tax on property transferred from a deceased person to their heirs.1 Any time the word “tax” rudely barges into a conversation, it’s only natural for participants to put themselves on high alert and seek cover. In that case, certain Estate Planning tools (i.e., ILITs, IDGTs) can serve as “pixie dust” for high net worth individuals, with the ability to remove assets from one’s taxable estate.2 When the fact pattern lends itself, Irrevocable Trust planning can save an estate representative the trauma of having to write quite the painful check.
The good news is that the federal estate tax exemption is $5,490,000 per person ($10,980,000 per married couple) in 2017.3 Therefore, this tax is only levied on estates well in excess of what most Americans would consider an astronomical threshold—high level executive, athlete and entertainer territory, in the majority’s perception. Since federal Estate Taxes are only levied on very large estates, only .2% (2 out of every 1,000) of estates cut a check of any amount to the IRS after a person passes away.4 Although the State of Connecticut also enjoys putting on its creditor hat, as it imposes its own tax on estates in excess of $2,000,000 per person, Estate Taxes only comprised .87% of the total Connecticut tax burden as of 2014.5 It is clear that the vast majority of us could stop reading right this minute if Estate Planning had nothing more to offer than a shield against taxation.
Wills: Why Your Children are Left Exposed
Now that we’ve diffused the idea that Estate Tax avoidance reins king, and humbled ourselves in the process, let’s turn our attention to the opposite end of the spectrum, and squash an Estate Planning bug—the Will. Wills, and even certain trusts that call for “outright” distributions, are grossly deficient when it comes to protecting assets for the next generation. “Everything will go equally to my children,” without any associated trust language, results in lump sum inheritances completely devoid of legal protections or direction. For example, if a young boy’s parents pass away tragically when he is 12, everything he inherits from them will instantly become available for him to spend as he pleases the day he turns 18 years of age.6 It isn’t difficult to envision how this scenario could result in highly negative outcomes. Young adults aren’t generally known for their decision-making prowess under perfect circumstances, let alone when they have unbridled access to funds without the oversight and support of their natural parents. We are doing our children a terrible disservice if we fail to capitalize on the phenomenal tools that reside on the fingertips of our community’s Estate Planning attorneys.
Revocable Living Trusts: Becoming Your Family’s “Guardian Angel”
If Irrevocable Trust planning is “too much” in many circumstances, yet simple Wills are “too little,” where is the appropriate middle ground for the average Connecticut resident? In many cases, the Estate Planning “sweet spot” is Revocable Living Trust (“RLT”) planning, with built in “continuing lifetime” trusts for the Grantor’s (i.e., the creator of the trust) children. When skillfully crafted, this marriage of Estate Planning tool and design structure has the capacity to achieve a pair of immensely powerful goals—Asset Protection for the beneficiaries, and customized control over distributions for the RLT Grantor.7
A. Asset Protection for Trust Beneficiaries
“Asset Protection” is a term generally applied to proactive legal actions that limit the ability of one’s creditors from accessing one’s property.8 In this context, the term does not refer to protections afforded to assets owned by an RLT during the Grantor’s life. The revocable nature of the document is evaluated as the Grantor retaining too much control over the trust assets to grant immediate lifetime protection. Generally speaking, there is an inverse relationship between control and protection.9 The result—creditors may “step into the shoes” of the Grantor regarding the ability to access funds, thus eroding any protection prior to the Grantor’s death. So how do we structure the RLT to create those highly desired shields against divorce, lawsuits and creditors, relating to assets transferred to the next generation? While there are no bullet-proof, “black and white” rules, the most protective RLTs are those that employ an Independent Trustee to make fully discretionary distributions to trust beneficiaries.10 That said, creative alternatives are at our disposal in order to maintain a high level of protection without entirely sacrificing convenience.
An Independent Trustee is one who is not related to the trust beneficiary, and does not stand to inherit any property under the trust.11 The more independent the Trustee, the less control is thought to be in the hands of the beneficiary—a textbook fact pattern to inflate protection. Perhaps even more important than the selection of Trustee is the level of discretion granted to make trust distributions. To achieve the highest level of protection of trust assets, a Trustee should be granted broad discretion “as to whether and when distributions may be made to beneficiaries.”12 Trusts should be drafted with permissive distribution language (i.e., “may” as opposed to “shall” or “must”) to achieve “discretionary” status. If the Trustee is forced to distribute for any reason, such as a mandatory payout of 50% of trust principal upon reaching age 35, then creditors can compel such distribution and attach to it.13 While the beneficiary is at the mercy of the Trustee’s discretion, the fact that the beneficiary cannot unilaterally compel a trust distribution provides an extreme degree of Asset Protection.14
At first glance, the potential for major inconvenience caused by a third party serving as the gatekeeper for trust funds may strike some as a deterrent. That concern, while significant in theory, should not cause a great deal of angst. A savvy Estate Planner can provide creative solutions so that a family can have their cake and eat it too. One of my favorite scenarios to help preserve Asset Protection when a client prefers their adult child to serve as their own Trustee is a “safety net” called a Trust Advisor. When an independent Trust Advisor may remove and replace beneficiary-Trustees with an Independent Trustee, and that ability is exclusive to the Trust Advisor, the Asset Protection needle moves in our favor.15
Additionally, protection may be preserved if a beneficiary-Trustee successfully plays within the rules of pre-defined standards for making distributions of trust property. The most common “ascertainable standard” is Health, Education, Maintenance and Support (the “HEMS” standard), which is designed to give the Trustee parameters regarding the Grantor’s intent as to how trust funds should be used.16 The fact that distributions are “restricted” to the HEMS standard appeases the courts, although the term “maintenance” in particular can be viewed as extremely broad. So, while the courts require the beneficiary’s absence of control as a condition of granting protection as a general rule, layers of nuance may be leveraged to achieve the desired outcome without overly burdening or restricting the next generation.
B. Customized Control over Trust Distributions
Asset Protection has now been well established as a recommended primary focus of Estate Planning. If protection is the cake, the ability to customize distribution rules to specifically fit the Grantor’s values and family dynamics is the icing. An RLT can be thought of as a blank canvas, and the role of the Estate Planning attorney is to help the Grantor paint the most beautiful picture possible for its family. If the Grantor wishes to see trust funds expended for life experiences, such as travel, then language to that effect can appear in the trust, which guides the Trustee when exercising its discretion.17 If maintaining family harmony and close relationships in the future is wearing on the Grantor’s mind, language can appear that incentivizes the beneficiaries to meet the Grantor’s goals. The ability to customize distribution language is at the core of trust planning, and represents a golden opportunity to not just pass “stuff” to the next generation, but to truly leave a legacy as a caring and positive influence.
Estate Planning is far more than the “cookie cutter” creation of documents designed for tax avoidance and wealth preservation solely reserved for the rich and famous. It is a multi-faceted exercise that the vast majority of our community members should engage in. Protecting what we have, whether it’s $1 or $10,000,000, for the benefit of the ones we care for the most, is at the heart of this legal practice area. The opportunity to leave custom wishes within one’s RLT that truly reflects their values, so that the parenting role can continue from the grave, further injects exponential value into the Estate Planning process. Capitalizing on these core Estate Planning benefits is a screaming declaration of love for one’s family—one that signifies that a “Guardian Angel” will be with them as the pages of life continue to turn.
2 The practice of transferring assets into an Irrevocable Trust is what some legal professionals consider “true” Asset Protection planning. In addition to removing assets from the Grantor’s estate for Estate Tax purposes, said practice can also shield assets from the infinitely threatening auditing power of the Medicaid (Title XIX) system, subject to a 5-year lookback period. For purposes of this article, “Asset Protection” refers to protective benefits enjoyed by estate beneficiaries after the Grantor has passed away, to the extent the value of the decedent’s estate hasn’t been eroded by gifting, spending, etc.
3 http://www.natlawreview.com/article/2017-estate-gift-and-gst-tax-update-what-means-your-current-will-revocable-trust-and; This exemption can be “burned down” by lifetime gifts in excess of the current annual gift tax exclusion of $14,000, and is also indexed for inflation.
4 Joint Committee on Taxation, “History, Present Law, and Analysis of the Federal Wealth Transfer Tax System,” March 16, 2015, https://www.jct.gov/publications.html?func=startdown&id=4744.
7 Attorney Bryan M. Etter of Wiley Etter, LLC has branded these tools as “Guardian Angel” Trusts, due to the powerful protection and control benefits discussed in depth hereinafter.
12 Black’s Law Dictionary 1400 (6th ed., West 1990), supra n. 3, at 1510.
13 Peter Wendel, “Wills, Trusts, and Estates” (7th ed. 2005).
14 Restatement (Second) of Trusts §157(a) (2000), supra n. 4, at §155 cmt.
15 Stephen E. Greer, “The Alaska Dynasty Trust,” 18 Alaska L. Rev. 253, 272 (2001).
16 Internal Revenue Code Section 2041(b)(1)(A).