Don and Theresa were married fifteen years, each had children from a prior marriage. They lived at a Continuing Care Retirement Community (CCRC) that required ongoing monthly payments that included life care. The couple agreed that if Theresa survived Don, his estate would pay $1,500 toward her monthly expenses for the rest of her life.
“I want you to put that in my trust,” Don instructed, “then leave the rest to my two children in equal shares.”
“How much should I carve out of your estate from which to pay the monthly amount?” I asked.
“You don’t understand,” Don continued, “I want my estate to pay $1,500 a month until she dies, the rest will go to my children.”
“Do your children have to wait until Theresa’s death to inherit?” I asked.
“No!” Don said, looking increasingly exasperated.
“Well, in order for your personal representative to know how much to distribute to your children at your death, we need to know how much to carve out of your estate to hold from which to pay the $1,500 a month,” I explained.
“How should I know that?” Don said, scratching his head.
How much, indeed.
Planning Ahead
I have seen several will and trust documents that don’t make sense because they call for distributions over an unknown time period, such as in this example, for the life of Theresa. Unless we know exactly how long Theresa is going to live, it’s only a guess how much to hold aside for her care.
The issue becomes even that much more complex when it’s laid out as an obligation under a nuptial agreement. It becomes even more complex as in one case that I encountered the monthly stipend was to increase annually by Consumer Price Index.
The way I tackled it in one case was to create a formula at the time of Don’s death. The first step directed the trustee use the Social Security Administration’s Actuarial Life Table to estimate Theresa’s life expectancy at the time of Don’s death. Then, a conservative internal rate of return on the investments over the period was used, and a CPI estimate added to that to determine the amount that would be carved out to make the distributions.
In case Theresa had a condition that would affect her life expectancy, the trust required her to be medically examined after Don’s death and to share that report with the Trustee. If that exam indicated an issue that would adversely affect her life expectancy, then the trustee was directed to use a life insurance morbidity table in determining the amount to carve out from which to pay the monthly payments.
You can see that there are a number of variables involved. Another option I drafted into the document let the trustee purchase a commercial annuity rather than make the calculation. Because Don wanted whatever was left at the end of Theresa’s life to be distributed to his children, the annuity would have to include a remainder provision.
Avoiding Taxes and Alternatives to Monthly Amounts
Another issue that had to be addressed is how the monthly amounts were to be satisfied. Since income trapped in an irrevocable trust is taxed at a higher federal tax rate, the ordinary income would be first distributed to Theresa, then capital gains, then the principle.
I bring up this case because in another that landed on my desk the clients had attempted to draft these provisions themselves using an online program. It was an expensive mess for the family.
Rather than promise a monthly amount, spouses in this situation could always agree to set aside a specific dollar amount to satisfy the obligation. That dollar amount may be too much or not enough, but in doing so, the trustee would be absolved from making the inquiries necessary to calculate the carve out.
Sometimes what seems like a simple direction can be anything but. That’s why it’s so important to seek competent, experienced legal advice. Next time you want a monthly or annual amount distributed to a beneficiary, consider the issues and alternatives that might be much easier to administer.
© 2021 Craig R. Hersch. Learn more at floridaestateplanning.com
