Estate Planning Fails
Rather than write about the many public figures and celebrities who fail to put a solid estate into place, (Stan Lee, Aretha Franklin, Michael Jackson, Prince, John Denver, Thurgood Marshall, Heath Ledger, Sonny Bono and Howard Hughes among them,) I’m going to write about some of the top estate planning fails that you haven’t heard about, pointing out the main reason for the fail. The names, dates, genders and other associated facts have been changed, but the idea behind each of the fails remain as pertinent examples.
Family Business Economics
Consider Stan who is in a second marriage to Brenda, but she is not the mother of his two sons. His main income is from a family business where one son serves as the CEO. The other son is not in the business, as he is a doctor. Stan’s will (not a trust) puts everything into a testamentary trust after Stan’s death that sprinkles the income among the three beneficiaries, wife, CEO, and doctor. While Brenda needs the income from the business to pay her monthly bills, and she had been told that the income would be there for her, the will didn’t specify that her priorities came first.
Further, there were no shareholder agreements governing how the business would be run going forward. The CEO son choked off the income the business generated, and consequently how much income would be distributed by the trust, by taking a high salary and reinvesting profits for business growth. Doctor son wasn’t too happy with the arrangement either, as the trust didn’t distribute anything to him. The parties ended up in Court arguing over how the business should be run, as well as how the trust should distribute any business profits.
Probate Here and Probate There
April owned a residence in Florida as well as one in Boston, Massachusetts. Massachusetts has a high state-level estate tax. When the attorney advised April to create a revocable living trust that contained state-level estate tax planning and probate avoidance, April scoffed at the idea. She thought a simple will would do her just fine. Her estate was not above the federal estate tax exemption level, after all.
When April died, her family was shocked that two probate estates would have to be opened: the domiciliary estate here in Florida as well as an ancillary administration because she owned real property in Massachusetts. Further, Massachusetts imposed an estate tax on her residence there because its value was above the Massachusetts state-level estate tax exemption. Proper planning could have avoided both probates and avoided the Massachusetts estate tax altogether.
Grandfather wanted to leave part of his IRA account to his grandchildren, who were minors. His estate planning attorney counseled that a special Retirement Plan Trust could be used to benefit the grandchildren and stretch out the IRA distributions over the course of their lifetimes, or at a minimum be used for higher education, like college and graduate school.
Rather than create this special trust and prepare proper beneficiary designations (that must comply with the five federal income tax “identifiable beneficiary” rules, or else suffer adverse income tax consequences), Grandfather named his minor grandchildren directly on the beneficiary forms. Then Grandfather died. To get the custodian to make distribution to the minors, a court-ordered guardianship was required, including annual accountings filed to the Court by the guardians (the grandchildren’s parents). The Retirement Plan Trust would have avoided these unnecessary expenses.
Another IRA Fail
Similar to the situation above, but this Grandpa named his Revocable Living Trust as the beneficiary to his IRA and named his grandchildren as beneficiaries to the Revocable Living Trust. Grandma, however, was also a beneficiary. Grandpa did not want to create a separate Retirement Plan Trust. He thought it was “too complicated and costly.”
Because Grandma was the oldest beneficiary to the Revocable Trust, and because the trust and the IRA beneficiary designations otherwise did not comply with the five identifiable beneficiary tax laws, the IRA had to be distributed under Grandma’s life expectancy table. This resulted in much higher Required Minimum Distributions than the family otherwise would have wanted to take, also resulting in the application of higher marginal income tax rates.
In yet another classic IRA example, an attorney advised his client to name the client’s estate as the beneficiary to his IRA. The client’s will divided his estate among several beneficiaries, including client’s wife.
When one names one’s estate as the beneficiary to a qualified plan, such as an IRA, all of the untaxed income is realized in the year following the client’s death. The wife could not roll over the IRA and defer her share of it and the income taxes.
Very bad result.
Estate planning is more complicated than what many people realize, and although many attorneys say they practice estate planning, very few are actually board certified. In some of my examples above, the clients created the problem by not following sound advice. In my last example, the attorney failed the client. In every case, I’m sure the clients believed their situation to be “simple.” I hope these examples provided some insight into what can go wrong in even “simple” situations.