Rigid, Inflexible Estate Plans Can’t Change with The Family, Law, and Taxes; Failure to Plan for Horrible Accidents, Relatives Gone Bad, or Ever-Changing Tax Law. Estate Planning Mistake #10.

The world is changing at a dizzy pace. New cell phone apps entice us to get an upgrade every year. What happens in China can now hurt us on Main Street. We used think boys should  stay out of girl’s locker rooms, but now many say that certain boys have a right to shower with the girls.

Congress, state legislatures, federal and state agencies, and city councils meet to pass new laws all the time because the hundreds of thousands of existing laws were not enough.

The pace of change is accelerating.

Your estate plan must allow for the unexpected and inexplicable, too. It must allow your trusted loved ones to change the plan after your death or incapacitation as life and the law change.

Here’s a story—ripped from recent headlines—of what happens when the best-laid plans go awry.

10 years ago, Mary and John put together what they thought was the perfect estate plan, complete with Will, trust, powers of attorney, and beneficiary designations. Everything that could be was owned by the trust. It was a solid plan, but not a flexible one. What they and their attorney forgot was to build flexibility into the plan to allow for changes in the family, tragic accidents, changes in the law, and evolving tax legislation.

Things started to go horribly wrong when John and Mary were returning from a birthday party for Julie, their four-year granddaughter. A drunk driver ran a red light and smashed into John and Mary’s car. John died at the scene and Mary survived, but in a coma.

John and Mary had divided their assets equally into two trusts, as they had to do to save taxes prior to the 2013 tax law changes, but they never updated their trusts. All of John’s assets went to the John trust. Because of the tax allocation formula used in the John Trust, there was an immediate income tax of $350,000 on sales commissions owed to John for sales he had closed for his company. All of John’s remaining assets went into a Family Trust under which Mary was the only beneficiary. Similarly, all of Mary’s assets went into Mary’s Trust under which she was the only beneficiary.

Susan, the oldest daughter, takes over as Trustee. Betty, another daughter and the mother of Julie, needs $18,000 for necessary dental work for Julie. Betty recently lost her job and health care with Mega Corp which moved her job overseas. Betty asks if John or Mary’s Trust could pay for the dental work for Julie; at Julie’s birthday party, Mary had said that she would pay to have Julie’s teeth fixed.

Susan consults the lawyer and the financial planner. The family financial planner runs the numbers and finds there is plenty of money to take care of Mary’s needs for the rest of her life in the Mary and John Trusts. But, the lawyer says that because Mary is the sole beneficiary of the Mary and John Trusts, Susan is legally banned from using the money to fix Julie’s teeth.

The trust documents do not give Susan discretion to use assets in either trust for the children or grandchildren of John and Mary even though there is enough to take care of her parents. There is no one who has the power to change the trust documents and add Julie as a beneficiary even though doing so would not hurt Mary. A more flexible plan would have given Susan the power to use the money for the children and grandchildren of Mary as long there was enough money to take care of Mary by giving Susan the discretion as to how to use the funds with Mary as always the primary beneficiary.

Worse yet, given the setup of the John and Mary Trusts, Mary will never qualify for government benefits to pay for her nursing home costs until the trust assets are practically exhausted, potentially leaving the heirs with little or nothing.

Susan gets her dream job as first cellist with the Hong Kong symphony. Susan can’t continue to serve as Trustee as she will be out of the country most of the time. Betty is not named as a successor trustee because at the time John and Mary signed the trusts, Betty was going through a gruesome divorce. Susan’s brother Jeb is not named as a trustee because he has tax liens and is not good at handling money. As a result, there is no Plan B for Trustee should Susan be unable to fulfill her role. The trust documents do not give Susan or her siblings the power to name a successor trustee. There is no Trust Protector named who could name a successor trustee.

Susan files a court case requesting that a professional Corporate Trustee be appointed, but Betty and Jeb fight Susan over it, estranging the previously close siblings. After $53,000 in legal fees, the Court appoints ABC Trust Company to serve as Trustee, manage Mary’s ongoing care and make all distributions for her. The price is right: only $22,000 a year. Control is out of the hands of the family.

This situation could have been avoided by giving Susan or the siblings as a group the power to name a successor trustee. As a backup, a Trust Protector could have named a successor trustee. Susan could have named Fiona, Mary’s beloved sister, Trustee. Fiona would take good care of Mary as long as Fiona’s expenses were covered by the Trust at a much lower cost than the minimum fees of ABC Trust Company.

Mary then dies. There is $2,300,000 remaining in the John Trust and $1,100,000 remaining in the Mary Trust. Due to the inflexible directions in the Trust, the trustee has to spend money first from Mary’s Trust before spending anything from John’s Trust, compounding the potential income tax on the assets in the John Trust. Because the assets in the John Trust have increased by $1,000,000 since Mary died, this $1,000,000 gain is subject to nearly $300,000 in state and federal income taxes when Mary dies.

This situation was completely avoidable.

If Mary and John had updated their trusts, or if they had established a Trust Protector with the power to amend their trusts after their death or disability for tax planning purposes, then the $300,000 in taxes would have been completely legally avoided.

Mary had inherited $43,000 from her mother. Because Mary’s documents did not allow her agent under her power of attorney to transfer assets to Mary’s Trust, when Mary died, the trust company had to appoint a local attorney to probate the $43,000. The legal and accounting costs to probate the $43,000 were $15,000
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After paying all of the expenses and taxes, $3,000,000 remained to distribute to Susan, Betty and Jeb; that is, $1,000,000 to each of them.

However…

Susan has married Harry, a wealthy Chinese businessman, and they don’t need the $1,000,000. Susan and Harry’s attorneys advise them that for tax and asset protection purposes, Susan should not receive the $1,000,000 outright. Instead, Susan wants the $1,000,000 go into trust for Julie, Betty’s daughter.

The trustee of the John and Mary Trusts advises Susan, Betty, and Jeb that the trustee must distribute the $1,000,000 outright and free of trust to each of them and to no one else. The trust documents reflect John and Mary’s concerns to not “control from the grave” the inheritances of their children. But, because John and Mary did not build in options in their trusts, they are indeed controlling from the grave-negatively. The inflexibility of the trust documents do not give Susan, Betty, and Jeb the option to make their own plans as to what is currently best for each of them personally, or for their family now or in the future.

The trustee distributes $1,000,000 outright to Betty who is now in a second shaky marriage. Betty’s husband pressures her to put the $1,000,000 into a $2,000,000 beach house that they cannot afford and he wants it owned jointly by him and Betty. Betty will probably capitulate to try to keep the peace and the marriage.

Jeb has tax liens and $800,000 owed in failed real estate investments. He was thinking of going bankrupt to wipe out most of his debts, but moved too slowly. It is too late. Instead, he loses all of his $1,000,000 inheritance to pay tax liens and bank creditors.

In contrast, a flexible estate plan would have allowed Susan to place her $1,000,000 in trust for Julie without paying any gift taxes; Jeb could have protected his inheritance against creditors. Betty could have avoid the marital claims of her new husband.

It is a family financial tragedy, and we see it all the time. Inflexible wills and trusts do not allow the family to adjust to inevitable change and the families inevitably suffer as a result.

Contact us to build flexibility into your estate plan. We can’t anticipate future changes, but we can design appropriate responses to those unforeseeable events today.

Future-proof your estate plan by calling or emailing us at info@wealthcounsellors.com.