March 01, 2001

Planning and Drafting from the Fiduciary's Perspective (2001, 15:02)

Planning and Drafting from the Fiduciary's Perspective

Probate and Property, March/April 2001, Volume 15, Number 2

By Marc S. Bekerman, Jo Ann Engelhardt and Isabel Miranda

"An ounce of prevention is worth a pound of cure." Although a cliché, this adage is a truth of great value in estate planning, both in formulating an estate plan and in drafting documents. Unfortunately, fiduciaries confront plans and documents that do not always achieve the desired results. This article highlights areas that fiduciaries regard as essential areas of concern in good estate planning.  

"An ounce of prevention is worth a pound of cure." Although a cliché, this adage is a truth of great value in estate planning, both in formulating an estate plan and in drafting documents. Unfortunately, fiduciaries confront plans and documents that do not always achieve the desired results. This article highlights areas that fiduciaries regard as essential areas of concern in good estate planning.

Identifying Distributees

In some states, the probate process includes serving notice of the proceeding both on the decedent's intestate heirs and on the distributees named in the will. Planners should obtain information about all of these persons during the drafting process. If a client does not know the names or addresses of his or her intestate heirs, the lawyer's next step varies among jurisdictions. In states where probate citation must be served on the intestate heirs after the testator's death, the lawyer may suggest an estate plan that limits the probate estate through the use of revocable trusts and beneficiary designations. In states where probate is less formal, this lack of information may have scant effect on the client's estate plan.

Lawyers must use their professional judgment in deciding how much information is necessary. If the potential heirs are the surviving spouse and his or her issue, names and addresses are usually sufficient. But if the heirs are further removed (siblings are tricky, cousins even trickier), counsel should obtain as much information from the client as possible. Finally, a lawyer should update names and addresses on a regular basis to make the probate of the will and the administration of the estate as simple as possible.

In establishing a family tree for the client, a planner should inquire whether any of the relatives identified are adopted. In addition, the family tree may show relatives of the "half- blood." In either case, it is important to determine whether the client wants to treat these family members as though they were born into the family and were full-blooded relatives. The estate planning documents should state explicitly the nature of the relationship and the testator's desire.

Lapsing Bequests

A practitioner should be aware of the consequences of a beneficiary's predeceasing the testator. Who will take the bequest in that event depends on state law. If state law treats the gift as lapsing, then a specific or general legacy will lapse into the residuary estate and a residuary bequest to the other residuary takers or into an accidental intestacy.

Many state statutes include anti-lapse provisions. These statutes provide that the bequest will go to the intended beneficiary's descendants, if the intended beneficiary was related to the testator to the degree required under the statute. The degree of relationship required varies. It may be limited to persons related as siblings or closer. It is important to remember that anti-lapse statutes rarely apply to distantly related relatives or to friends. Further, the statutes may not apply to family members that are not related to the testator by blood or adoption, such as a spouse or a stepchild. Finally, anti-lapse statutes usually apply only to wills and not to trusts and other documents.

Of course, a document can override an anti-lapse statute and provide for alternative beneficiaries. Indeed, even if the anti-lapse statute would carry out the testator's wishes, a careful drafter will provide the testator's intention within the document itself and not rely on a statute that could change in the future.

Changing Beneficiaries

In addition to lapsing bequests, planners should consider alternative beneficiaries in order to give additional flexibility in the use of post-mortem planning. Renunciations and disclaimers are particularly useful in the following situations:

  • to correct improperly drafted QTIP/marital trusts, 
  • to use the decedent's unified credit (or applicable exemption amount), 
  • to use the decedent's GST tax exemption and 
  • to allow for postmortem charitable planning.

It is critical to draft alternative beneficiaries for all dispositions. Some of the reasons include:

  • impact of a testator's divorce (depending on state law, a former spouse may be automatically treated as having predeceased, or a new will must be executed to remove the former spouse; these automatic rules generally do not apply to gifts in trust); 
  • births after execution of the document (pretermitted heir statutes may remedy the situation in some but not all states); 
  • death after execution of the document (obviously calls for alternative beneficiaries, but also consider alternative fiduciaries); 
  • marriage/divorce (consider gifts in trusts if divorce is an issue for beneficiaries); and 
  • charities no longer in existence (provide a process for choosing a different charitable organization when charities cease to exist or lose their tax-exempt status).

Titling Assets

Estate planners often cause unnecessary difficulty for the fiduciary when they do not consider the potential conflict that may exist between the dispositive provisions they draft and the manner in which the client's assets are titled.

When conflicts arise between the will or trust and the title of an asset, generally it is because the drafting lawyer has prepared the instrument without a thorough review of the client's assets. In some cases, the lawyer may not even be aware of all of the assets owned by the client, either because the information was not requested or because the client was not aware that the asset needed to be disclosed (for example, life insurance or a power of appointment). The drafting lawyer may assume that all assets are held in the client's individual name and are subject to probate, in which case the will would govern where the assets go at the client's death. But many modern assets are held as nonprobate assets and are thus not governed by the terms of the will.

Problems may also occur on a client's death if the value of some or all of the client's assets has changed substantially since the will or trust was drafted. A joint account may have been depleted to pay medical expenses, or a once-"modest" home may be appraised at a higher or lower value as neighborhood dynamics change. Unfortunately, such problems may become obvious only when the fiduciary is obliged to reconcile the will and/or trust provisions with the titling of assets.

Contractual Obligations

Possible contractual obligations of a client, including prenuptial and postnuptial agreements, separation and divorce decrees and charitable pledges, need to be considered in the estate plan. Many business interests are held in the client's individual name and thus would normally pass under the terms of the client's will. But a planner must determine, for example, whether the interest is subject to a buy-sell agreement. If so, the estate owns the right to receive the proceeds of the buy-sell agreement.

Real Estate

Even individuals with modest means may have real estate as an asset of their estates. A difficulty for the estate planner is that real estate has the predictable tendency to be affected by unpredictable swings in market value. For this reason, the planner should review the client's assets and their values to ensure that the interest a beneficiary will receive continues to be in line with the client's desires.

A cooperative apartment is not technically real estate, but the problems associated with changes in market value affect the owner's co-op interest in much the same way that an owner's interest in real estate is affected. In addition, many co-op boards try to maintain tight reins over who can become a tenant. This effort may be of particular concern if the co-op is a major asset that a testator wishes to devise to a beneficiary whom the board may not find acceptable.

In addition to market value volatility, the fiduciary has other concerns when real estate is present in an estate. If the decedent held the property in his or her own name, the fiduciary must be especially concerned about potential environmental liability. The fiduciary should undertake appropriate due diligence before accepting the asset or perhaps should even consider refusing the appointment as fiduciary. If there is any concern about environmental liability, many planners suggest that the client hold the asset in a separate trust or in corporate form so that remediation costs, if they arise, will not be a drain on the balance of the estate.

Joint Accounts

Joint accounts with survivorship rights provide by their terms that the surviving owner will receive the account balance by operation of law. Thus, an individual cannot control the disposition of the joint account by his or her will or trust. The exception is the "convenience account," in which an individual gives someone access to the account (to write checks, for example) for the individual's benefit. At the individual's death, the account does not belong to the other party but instead is part of the individual's estate. Generally, an account is identified as a convenience account when it is opened.

Although the typical estate of a married couple will include joint accounts, planners should discuss with their clients the advantages and disadvantages of survivorship rights. In striving for simplicity, clients can often frustrate the plan contained in their wills or trusts if they place all their financial assets in survivorship accounts (especially if they do not inform their lawyer). For example, in an estate that exceeds the amount of property exempt from estate tax because of the unified credit or applicable exemption amount, it will be difficult to obtain maximum use of the credit if all assets are held in joint accounts with rights of survivorship.

Powers of Attorney and Title

A recent case illustrates how an attorney-in-fact may be able to change title to an individual's property. The principal in Wabner v. Black, 7 S.W.3d 379 (Ky. 1999), gave his attorney-in-fact the power to change ownership of certain certificates of deposit, which she did, placing the assets in a joint account in her name and the principal's name. After the principal's death, the executors sued the attorney-in-fact to recover the balance in the account. The court upheld the attorney-in-fact's power to change ownership of the asset. The question of whether the agent acted with the requisite good faith was left to a jury to decide.

Retirement Accounts

Retirement accounts are arguably one of the most difficult assets to incorporate into a "standard" estate plan. Clients and planners alike sometimes misunderstand the estate and income tax implications of ownership and distribution of these accounts. The rules governing the accounts imposed by the IRS and by plan providers are sometimes confusing. Retirement accounts-whether they are IRAs, employer-sponsored plans, 401(k) plans, profit-sharing plans or other retirement vehicles-are usually not controlled by the owner's will or trust. Although a discussion of the dispositive and tax implications of beneficiary designations is beyond the scope of this article, it is important to note that a surviving spouse has rights and options available as the 401(k) beneficiary that are not available to non-spouse beneficiaries. These rights include the ability to roll over the account and treat it as his or her own.

The fiduciary must carefully review these assets. Litigation arises in many cases because a plan participant was married more than once and both the former spouse and the current spouse claim plan proceeds. In general, a former spouse is not entitled to plan proceeds unless a Qualified Domestic Relations Order (QDRO) has been entered into incident to the divorce decree. But clients routinely neglect to change the beneficiary designations of their IRAs and retirement plans after divorce. The fiduciary is often left to untangle the conflicting claims of current and former spouses.

The reported cases do not provide consistent results. In Schultz v. Schultz, 591 N.W.2d 212 (Iowa 1999), the plan participant and his wife were divorced. The decree dissolving the marriage gave the husband ownership of the account, but he never changed the beneficiary designation from his former wife. At his death, she successfully claimed the account as against the current wife. In contrast, a line of other cases holds that if a former spouse waives rights to the plan benefits as part of the divorce proceedings the designation naming that former spouse will be disregarded. A state statute may create the same result. See Jonathan A. Levy, An Update on Making Retirement Benefits Payable to Trusts, Prob. & Prop., Nov./Dec. 2000, at 24; and Richard S. Franklin, A Recipe for Success: Ten Tips for Planning the Distribution of Large IRAs, Prob. & Prop., Mar./Apr. 2000, at 6.

Dispositions of Tangible Personal Property

One of the most laborious parts of estate planning and administration is the disposition of the testator's personal property. Personal property is usually disposed of in a pre-residuary clause, but it will become part of the residuary estate if there is no specific provision or if the bequest lapses.

Under the common law doctrine of incorporation by reference, which is followed in most American jurisdictions, a will may refer to a writing in existence when the testator executes his or her will. Rather than listing the bequests in the will itself, the testator may refer to a memorandum that lists bequests of tangible personal property. This doctrine is of limited utility to estate planners, because in most states a document incorporated by reference cannot be changed after the client executes the will, unless the will is republished by the execution of a codicil.

Often a testator will want to make changes to the items listed on the memorandum without having to re-execute the will. Some states have created by statute a mechanism to allow testators to make frequent changes in bequests of tangibles. In these states, a testator may refer in his or her will to a separate instrument that specifically lists the bequests of tangible personal property. This instrument is often a letter or memorandum and may be updated by the testator even though it would not meet the requirements for admission to probate. In any event, the use of a separate writing may create problems as well as provide advantages. For example, the fiduciary may be faced with two undated writings showing different dispositions of the same item.

Even if the personal property is to pass to the residuary beneficiary, it is usually preferable to create specific bequests for personal property, since specific bequests do not carry out distributable net income to the beneficiary for fiduciary income tax purposes. In order to qualify as a specific bequest for this income tax rule, the gift must be identifiable as to kind and amount. In many estates the planner will want to avoid creating income tax consequences for distributions of tangibles.

One common practice in the disposition of personal property is a specific bequest of the property equally to each member of a class (such as children). Often this procedure works well, but if the members of the class cannot agree on a plan of distribution, then the provision usually leaves the division of property to the fiduciary. Of course, this fallback is of little assistance when one or more members of the class are also the fiduciaries. In these instances, it would be beneficial to draft a formula or plan of distribution (e.g., to draw lots or distribute in age order).

Another practice that is becoming more common because of the nature of the modern family is to give a class of items to a group of beneficiaries. For example, a testator may leave all of his tangible personal property to his second wife, except for any family heirlooms that he leaves to the children from his first marriage. Even though the testator probably considers the description "family heirlooms" easily definable, deciding what items belong in the class can complicate estate administration and potentially lead to litigation. Worse yet is a description of items as being of "significant sentimental attachment." The client and the lawyer should try during the client's lifetime to ascertain what items of personal property should fall into the defined class.

Finally, the planner should consider alternative dispositions if one or more beneficiaries are minors. Some alternatives include granting the fiduciary the power to retain the property until the minor attains maturity or allowing the fiduciary to turn over the property to an adult with whom the minor lives. With some careful planning, an estate may be able to avoid the time and expenses of the appointment of a guardian.

Tax Apportionment Clauses

As with improper asset titling, an estate that is planned without regard for the effects of a tax apportionment clause creates a nightmare for fiduciary and beneficiary alike. Like an abatement or a debt payment clause, the tax apportionment clause is in effect a dispositive provision, because its application can shift assets (the dollars used to pay taxes) from one beneficiary or another.

When assets are transferred from an estate subject to estate tax, federal law applies to apportion tax regarding certain assets, and state law provides an apportionment scheme for virtually the balance of a testator's assets. The testator can provide a plan for apportionment that will override the statutory plan. When the will is silent about tax apportionment, however, state law will govern the apportionment process. Some states provide, for example, that the tax due will be equitably assessed against all interested parties. There is no requirement that a will or trust contain a tax apportionment clause; moreover, the "best" result may be achieved by reliance on the federal and applicable state statutes.

Many wills have "boilerplate" tax apportionment clauses that direct all taxes to be paid from the residue of the estate, but a client generally selects those persons he or she wants to benefit most as the residuary beneficiaries. Requiring that the residue pay all the taxes will be particularly troublesome when an estate includes both probate and nonprobate assets or has both taxable and nontaxable beneficiaries and when asset values at the testator's death differ substantially from their values when the will was drafted.

In the case of Stickley v. Stickley, 497 S.E.2d 862 (Va. 1998), the decedent's will directed that all taxes, including those relating to assets passing outside of the will, be paid from the residuary estate. The residuary estate was insufficient to pay the necessary taxes. The court held that the will's clear language overrode the Virginia apportionment statute, so that apportionment would not apply. Thus, the taxes completely wiped out the residuary gift.

In many states, the typical client's estate plan includes both a will and a revocable or irrevocable trust or trusts. Obviously, the fiduciary's job is made more difficult if the drafting lawyer does not coordinate tax apportionment language between or among the various dispositive instruments.

Patterson v. United States, 181 F.3d 927 (8th Cir. 1999), concerns a commonplace drafting and planning technique that combines a pour-over will with a revocable inter vivos trust. The will provided that all taxes, including taxes on property passing outside the will, would be paid from the residue of the estate. The will also stated that the trustee of the revocable trust could pay some or all of the taxes due from assets held in the trust. The revocable trust included a marital provision and stated that its value would be computed without reduction for taxes or expenses. This apparent conflict was resolved by the court's exempting the marital provision from bearing a share of the taxes.

Several state apportionment statutes explicitly provide that the benefit of the marital deduction applies to the spouse, so that no tax shall be apportioned to the marital gift. For example, a Florida statute so provides; it also states that if there is a conflict between a will and a trust, the will provisions govern, subject to certain exceptions. See Fla. Stat. Ann. § 733.817 (West Supp. 2000). When no controlling statute resolves the conflict, the fiduciary must rely on case law. One pragmatic judicial solution to conflicting tax clauses contained in a will and a later trust was to allow the direction in the most recent instrument to control. M atter of Estate of Meyer, 702 N.E.2d 1078 (Ind. App. 1998).

Although the GST tax is outside the scope of this article, planners and fiduciaries should consider how this tax will affect the tax allocation equation. For example, if a client has utilized his GST exemption fully and then creates an irrevocable life insurance trust with skip persons as beneficiaries, there may be substantial GST tax payable. Depending on the wording of the tax allocation clause, that burden may be borne either by the beneficiaries that receive the insurance or by others that never receive the asset.

Powers Clauses

A testator (or grantor) may grant a fiduciary any powers he or she pleases; however, in the absence of such grant, state law will determine the fiduciary's powers. These default statutes may not be sufficient, so it is imperative that the fiduciary be granted powers to address the particular circumstances in the estate. For example, absent specific language in the instrument, a personal representative in some states may not:

  • bind the estate contractually; 
  • create debts binding on the estate; 
  • purchase real estate; 
  • borrow; 
  • mortgage or encumber real property; or 
  • continue a business, except in the short term to prepare it for sale (to do so subjects the fiduciary to personal liability for losses or debts incurred).

If a client owns real estate, it may be advisable to grant broad powers to the fiduciary, especially the powers to:

  • retain or sell; 
  • mortgage or encumber the property; 
  • abandon the property; and 
  • execute a long-term lease on the property.

If there is the possibility that the property may qualify for a conservation easement, the executor must be given the power to create the easement if it is to be created postmortem.

If a client has an interest in a closely-held business, the fiduciary should be granted the following powers:

  • to continue to run the business, without incurring personal liability for doing so; 
  • to liquidate the business; and 
  • to borrow to continue the business, or to lend from business assets.

The powers granted to the fiduciary should be broad, so that the fiduciary is not limited to the terms of a conservative default statute. The following powers should be tailored to the specific client's needs:

  • the right to remain undiversified (especially critical for closely held business owners and corporate executives/entrepreneurs who hold concentrated positions in their own company stock); 
  • the power to employ and pay investment advisors, bookkeepers, etc.; 
  • the power to borrow/lend securities; and 
  • the power to exercise stock options and to borrow to do so.

The fiduciary should be given the authority to allocate receipts and disbursements between principal and income. In addition, the personal representative should be allowed to elect to take deductions against the estate tax return or the fiduciary income tax return without the need for equitable adjustments.

If the GST exemption is not allocated by the deadline for filing the estate tax return, a statutory default will allocate the exemption. Like many default rules, however, this statute may not serve the wishes of the decedent. Therefore, the instrument should include language that allows allocation between testamentary and inter vivos transfers. The instrument should authorize the fiduciary to treat beneficiaries differently (i.e., to allocate the exemption in a non-pro rata manner). Further, the document should exonerate the fiduciary for allocation decisions except for gross negligence and give the fiduciary the power to create a reverse QTIP.

The fiduciary should be granted the power to distribute assets in kind. In the absence of this provision, the estate, the trust or the beneficiaries may face unnecessary income tax consequences.

Conclusion

This article has described just some of the areas every estate planner should consider when preparing an estate plan. Keeping fiduciary issues at the forefront not only may make fiduciary administration more efficient and effective, but it will also help the planner create a plan that will carry out the client's wishes. Addressing these issues during the client's life is crucial, because they cannot be addressed after the client's death.


Marc S. Bekerman is a Vice President and Isabel Miranda is a Senior Vice President with U.S. Trust Co. in New York and New Jersey, respectively. Jo Ann Engelhardt is Managing Director of Bessemer Trust Company in Palm Beach, Florida.