P R O B A T E & P R O P E R T Y
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But, alas, there is a different category of shortcomings not so easily detected or remedied. We may label these “design” or “people” mistakes:
• a QTIP trust that meets every statutory requirement but is simply the wrong kind of marital
transfer to use;
• a charitable remainder trust that is drafted perfectly but produces far less desirable results for the client than a smaller outright gift;
• a trustee succession provision that may assure that there will never be a fiduciary vacancy but leaves the fiduciary responsibilities in the hands of those who should not be trusted to walk the family dog; or
• a planning strategy that maximizes tax savings
but results in major family discord.
This point of concern for our profession finds parallels in many other places. The roof constructed by that master builder may not leak, but the house it covers may nonetheless be much too big for the lot or too small for the inhabitants it must hold. The Italian-cut sweater with a designer label may be beautifully crafted, but can’t the salesperson see that it is a sartorial mistake for a middle-aged buyer who never exercises? An excellent insurance advisor may be aware of the best-in-class insurance product but be blind to the fact that it simply does not satisfy the client’s real needs.
With the stage now properly set with these prefatory comments, the following is a brief review of some points in the planning process when planners want to be sure not to make big picture mistakes. Along the way, this article also mentions some opportunities to help clients get better results by avoiding certain kinds of planning traps.
Almost every idea on this list that is described as a potential mistake may, in fact, be a very good idea in certain circumstances. The challenge for a good planner is to try to forecast thoughtfully when a given idea is more likely to result in happy, rather than unhappy, results. Additionally, if the client gets what he or she wants, the result can hardly be deemed a mistake even if the advisor has reservations about the client’s decision. A major task for the estate planning professional is to find an effective way (within the client’s time and attention tolerance levels!) to educate him or her about the pros and cons of different choices so that the decisions made will be thoughtful and informed. Because the quality of the client’s estate plan will be directly related to the quality of the planning conferences with the client, much of this article concerns certain subjects that typically need to be considered during that important exchange of information.
Children in a Rowboat
The number one opportunity for an estate plan to go wrong occurs when parents tie the children to the same asset or when they require the children to do a job together as a group. This can happen when a surviving parent names several children to serve as executors of a complicated estate, to run the family business, to share an expensive house, or even to distribute assets of the family foundation. I refer to this as “putting children in a rowboat,” because that metaphor is one that clients easily grasp.
Imagine loading the children into a rowboat on a big lake and requiring them to agree on one destination when their rowboat can go in only one direction, no matter how many passengers it holds. A client might introduce the idea of the children’s common ownership of the beach house. An estate planner must ask whether that idea is likely to succeed. Will that joint ownership become divisive when one child thinks the group should pay for a new kitchen or wants to sell and move elsewhere? It is very difficult for children with different financial profiles, different values, or different residential states to be on the same track at all times with each other, not to mention their respective spouses. Plans that require children to agree among themselves when their parents are both gone are simply fraught with danger. Adding a majority vote provision to trump the statutory standard of unanimity for fiduciaries will often not solve the real problem because an outvoted child may simply end up disliking the others because they were “just looking out for themselves.”
There may not be many truisms in estate planning, but there is one goal that has prime importance for almost all clients: they do not want a legacy to result in their children avoiding one another. The possibility of having the children suing each other in court would be an even more horrible event. Don’t we owe the client at least a yellow flag, or sometimes a red one, when a suggestion is made to put the children in the same rowboat as fiduciaries or beneficiaries?
The “children in a rowboat” problem has arisen in one place that has really surprised me. The family foundation is an attractive idea to very wealthy clients because, after the parents have gone to their rewards, the children can have the joy of making grants to charity “as a family.” That has in fact worked in many cases. But far too often it has not worked—the process of making charitable gifts proved divisive because the children had different charitable interests, they disagreed on what Mama and Daddy would have done, or one child felt that his vote did not count.
What should the thoughtful advisor do when the client suggests putting the children in the same rowboat? The first step is easy: there should be a full discussion of the potential danger, especially the divisiveness that may result. Often, at this point, the client knows what to do: “My children don’t agree on anything today, and now that you’ve mentioned it, I know that I can’t leave it up to them to agree on anything after I’m gone.” If, after the yellow flags have been waved, the client still wants to name the children as co-fiduciaries or joint owners, the thoughtful planner should suggest ideas that will help the children work things out if getting along proves difficult. A mandatory buyout or sale provision may help. In the family foundation context, each child could have the right at any time to direct a pro rata portion of the assets to one or more charities of that child’s choice, including another private foundation. Parents can signal that they prefer allowing a division of assets to having those assets become a divisive factor in the family. No magic pill solves all such problems, but advisors have a responsibility to do everything possible to keep this particular disease from becoming worse if it cannot be prevented in the first place.
Notwithstanding this warning, sometimes it is not only desirable but necessary to put the children in the same rowboat. Consider this common situation: one child runs the family business (typically as a salaried executive while the parents own all the stock) and another child has nothing to do with that business, which represents most of the family wealth. If a majority of the stock is left to the child involved in the business, the other child who is given a minority interest may end up with a piece of paper that provides little current value. Forcing the children to “work things out” by giving them equal amounts of stock and putting them into deadlock may be the only practical alternative in some cases. This plan will work much better, however, if it also includes a mandatory or merely suggested method that allows one child to buy the other child’s interest if the two children cannot work things out. The threat of that possibility may lead the children to treat each other well enough so that the family business can be retained under terms that benefit both children or its value can be maximized for an ultimate sale.
Many pot trusts cause significant trouble for families. When the beneficiaries of such entities have very different needs and values, it is often difficult for a trustee to determine what is fair and appropriate in making investment and distribution decisions. For many years, the IRS’s policy concerning the kinds of trust modifications that could be made to old trusts without making them subject to the federal generation-skipping transfer tax blocked most strategies for addressing this problem. Fortunately, the Treasury issued final regulations regarding the effective date provisions for that onerous tax. Example 5 under Treas. Reg. § 26-2601-1(b)(4)(i)(D)(1) now charts the way that some pot trusts can be divided without terrible tax side effects. Now we have a statutory way to put some children out of the pot trust and into separate rowboats, a happy development for
Three related points. There is no rowboat problem when a client names two children as executors of an estate that consists of assets that are not likely to create problems. For example, if the estate consists largely of marketable securities, the children can probably (but not always!) get the job done harmoniously. Second, when fewer than all of the children are named as executors, it is very important to deal expressly with the right of those named to be compensated for their services. Although compensation of fiduciaries is often a troublesome matter, it presents especially discordant possibilities among siblings. The parents need to set the rules so that no child can fairly complain about the fee taken by a sibling. Finally, the rowboat metaphor does not cover one of the other high-risk situations involving children: naming one child as trustee of another child’s inheritance. That decision quite likely will guarantee that they will wind up disliking or even hating each other. Naming one child as trustee for another child is acceptable only if there is no other realistic alternative, and that is almost never the case.
In summary, the main thing to remember on this first point is simple: when a client suggests putting the children in the same rowboat, ask whether that plan will work well and whether the client should build in features that will reduce the pain if it does not.
The Overstuffed QTIP and Related Issues
In a typical estate planning conference with a married couple, there is a discussion of how the marital deduction works and the three most common forms of marital transfers: the outright gift, the QTIP trust, and the power of appointment marital trust. In a huge percentage of cases, the wealthier spouse opts to put everything except the house and contents into a QTIP trust. After all, if it is a certainty that the surviving spouse will always want these assets ultimately to benefit the children, why not assure that result from the outset?
Sometimes such a plan is best, especially when a second spouse who is not the parent of the testator’s children is involved. But often it is not the best plan. A planner should raise three primary questions with a client (especially one who holds most of the family assets) who wants most of the marital bequest to be held in a QTIP trust:
• Does the client realize that the QTIP form makes it much more difficult to implement strategies designed to reduce estate taxes when the surviving spouse dies?
• Does the client realize that the surviving spouse cannot appoint QTIP principal to the children while the surviving spouse is living, and so the children may be 70 before the remainder benefits them?
• Unless the surviving spouse is the sole trustee, does the client want to require the spouse to ask a trustee or co-trustee for money whenever the spouse needs or wants more than the net income?
A discussion like this almost always leads clients to change their minds about the all-in-QTIP option. The typical client will increase the amount left outright to the spouse or in a power of appointment marital trust. The planner’s job is to explain the pros and cons of the various forms of transfer so that the client has enough information to make a thoughtful choice. The advisor who lets the QTIP trust get overstuffed without this kind of discussion is not serving the client well.
Although this focuses on QTIP planning issues, consider a design feature that needs more attention than it often receives, especially in states that have not adopted total return statutes for trusts. The standard QTIP trust provides that the spouse gets all of the net income and also principal needed for support in reasonable comfort. If the standard trust portfolio geared to long-term growth produces 3% of trust accounting income per year, a $5 million QTIP will assure the surviving spouse of only $150,000 per year. To get more, the spouse must receive trust principal. If a bank is involved, that will require approval by the corporate trustee’s committee on encroachments. The “invasion of principal” may also create tensions between the spouse and the remainder beneficiaries (e.g., stepchildren). From a design perspective a planner should ask whether the terms of the trust should require or permit a minimum distribution each year to the surviving spouse. For some of those clients who like this idea, it is easy to solve the drafting problem by adding the following “unitrust” provision to the standard language that provides to the spouse all net income plus principal needed for support in reasonable comfort:
Because I want my spouse, irrespective of need, to have the right to receive annually not less than _______% of the trust assets, valued annually, I direct my Trustee on the written direction of my spouse to make such additional annual distributions to my spouse as may be required to satisfy that _______% minimum distribution standard after considering other distributions made to my spouse under this paragraph; and this right shall lapse annually.
The trust cannot simply use the percentage payment sentence alone because the QTIP statutes require payment of all (net) income to the spouse at least annually. Because the percentage payment may be less than the net income, the drafter must make sure that, in any event, all income will be distributed to the spouse at least annually.
The Clueless Fiduciary
When an estate or trust administration becomes really messy, the “clueless fiduciary” is often to blame. This character, who could also be referred to as the “inadequate executor” or the “hopeless trustee,” comes in many forms:
• the dutiful spouse who becomes paralyzed because of inexperience and an unwillingness to pay an accountant or lawyer $250 or more an hour to get the job done properly;
• the child serving as trustee who fancies himself to be an investment genius and feels no need to consult with anyone concerning his fiduciary duties, although he has had no prior experience with trust administration;
• the trust “specialist” in a startup bank who has had a short cram course on estates and trusts after moving from the lending department; and
• the excellent lawyer or superb accountant who is first class in a specialized area of knowledge (real estate, income tax) but who presumes to handle a complicated estate or trust administration alone even though he or she has never actually done so and knows little about the subject area.
We do our clients a disservice by blithely accepting their suggested line-up of fiduciaries without a bit of interrogation. Imagine how outraged we would be if we told a doctor about a medicine we wanted to take and the doctor prescribed it, notwithstanding the fact that he knew it was likely to produce dreadful side effects. Clients should similarly be outraged if we let them prescribe a questionable fiduciary choice without a realistic discussion. The “meek husband” or “the dutiful wife” or anyone else is not necessarily a bad choice as fiduciary, provided the designee has good judgment about the necessity of using competent advisors and is willing to pay for their services. I simply have a suspicion that we do not engage in enough discussion about the selection of fiduciaries. Although it can be difficult to ask pointed questions when dealing with this issue, the client’s excellent plan can become
a disaster in the hands of the clueless fiduciary if we avoid a candid
In selecting fiduciaries, many clients focus solely on individual relatives and friends, because they have a resistance to naming a bank. If one suspects that the individuals being considered are not likely to do a good job, one should mention the corporate fiduciary as a possible player, even in those cases in which the client has expressed reservations about naming a bank. Although there are good and less good bank trust administrators (as is true of lawyers), often the corporate fiduciary is not merely a good idea but the best choice. Winston Churchill once said that democracy was the worst form of government except for all the others that have been tried. That is often true about banks as fiduciaries. For every bad bank experience I have heard about, I know of ten other situations in which individuals messed up more. In most cases in which a bank is named, I suggest having an individual co-fiduciary with power to change banks. We sometimes simply must put a corporate fiduciary on the agenda for discussion even with the client who initially expresses a disdain for banks. In addition to banks, skilled individuals (often former trust officers, or lawyers) may be hired to act as fiduciaries or advisors to fiduciaries, and they should also be remembered when this topic is being discussed with the client.
The choice of fiduciaries is one of the critical issues in good planning. I suspect that we need to have more candid and thoughtful discussions with our clients on this subject in an effort to reduce the number of clueless fiduciaries that are lurking in the plans we help put in place.
Robert G. Edge is a partner with Alston & Bird LLP in Atlanta, Georgia