Gideon Rothschild, Esq., partner, now retired, with the New York City law firm Moses & Singer LLP. He is a past chair of the Real Property Trust & Estate Law Section of the American Bar Association. MosesSinger.com/gideon-rothschild
Whether you are wealthy or not, a well-designed trust can make your financial planning much more successful. Trusts can ensure that your assets will go to your intended beneficiaries rather than giving unnecessarily to creditors, former spouses, estate taxes, long-term-care bills or other threats.
Unfortunately, many trust documents contain language that limits their ability to protect assets—and no one notices the problem until it is too late. If you don’t have a trust, there’s a good chance that you should have one. And if you do have a trust, make sure that it does not include certain terrible mistakes…
Mistake: Ignoring trusts altogether because of today’s high federal estate-tax exemption. Keeping assets safe from estate taxes has long been one of the major reasons to create a trust. But with the federal estate-tax exemption now at $5.45 million (and twice that for couples), very few families have to worry about this threat.
What some people still don’t realize is that federal estate taxes were never the only reason to create a trust. Trusts also can safeguard assets until heirs are old enough to manage money responsibly. They can protect assets from state estate taxes—some states still have relatively low estate-tax exemptions, as low as $1 million in some cases (and just $675,000 in New Jersey), although several states are raising their low exemption levels. And failing to use a trust to protect assets from various potential costs can end up being a very expensive mistake.
Example: A New York man left a $1 million estate to his wife. She later required a lengthy stay in a nursing home, which ate up virtually all of those assets. Had the man instead left his money to an “irrevocable” trust that named the wife as beneficiary, Medicaid would have paid most of her nursing home bills, keeping the money in the family.
Better: Speak with an estate-planning attorney about the possibility of setting up a trust to protect potentially vulnerable assets…not just if you have enough assets to trigger federal estate taxes.
Mistake: The trust terminates when beneficiaries reach a predetermined age or at some other specified date. It is very common for trusts to terminate when beneficiaries reach a particular birthday—often 18, 21, 25 or 30—with all remaining assets distributed to beneficiaries then. That’s because when people set up trusts, their primary goal often is to ensure that assets remain safe until young heirs are old enough to handle money maturely. But a trust set up this way does nothing to protect the assets from other threats and could dump a large sum of money into a beneficiary’s lap at an inopportune moment, such as when a spouse is about to file for divorce or when a lawsuit or bankruptcy looms.
Better: Ask your estate-planning attorney to not include a termination date in your trust. Instead, grant the trust’s beneficiaries broad powers to replace the trustee when those beneficiaries reach an age when they are likely to be responsible—perhaps 25 or 30. That way, beneficiaries continue to receive the asset protection provided by the trust but also have some ability to manage and utilize the assets as they see fit, including selecting a new trustee whose thinking is in line with their own if necessary.
Mistake: Using the word “shall” in trustee directions. Trusts often contain language dictating that the trustee “shall” distribute assets to beneficiaries in particular amounts at particular times. Trouble is, the word “shall” ties the trustee’s hands—it means that he/she must distribute the assets as directed even if it is obvious that doing so would be foolish, perhaps because the beneficiary expects to soon declare bankruptcy and the money would just end up in the hands of creditors. (If a trustee tried to not make a distribution under these circumstances, creditors could take the trustee to court and likely force the distribution.)
Better: Change trust language to say that the trustee “may” distribute assets and/or income in a specific amount and/or after the beneficiary reaches a certain age. This lets the trustee know that your intention is that he make this distribution, but it also gives him the option of not doing so if it doesn’t make sense for some unforeseen reason. If a creditor tried to force such a distribution in court, he almost certainly would fail—courts respect the authority of trustees to not make distributions when the word “may” is used. Using the word “may” does give the trustee great power over the trust assets, but if you also give beneficiaries the power to change trustees, that power is unlikely to be abused.
Mistake: Choosing a family member or friend as trustee. This is extremely common because most people do not want to pay a professional trustee and because most people have at least one family member or close friend whom they trust to handle this task responsibly. But even if the family member or friend selected truly is honest (which is far from certain—plenty of seemingly reputable family and friend trustees have been caught stealing trust assets), disagreements between trustees and beneficiaries often create family discord or end long-standing friendships. And because these amateur trustees often have little or no experience in this role, they sometimes make costly mistakes, some of which may result in crippling IRS penalties.
Better: Choose a professional trustee. Not only will this trustee be much better equipped than an amateur to handle the responsibilities of the role, but also your beneficiaries will be able to sue for breach of fiduciary duty if he fails to do so. (Beneficiaries could sue a family member trustee, but such a lawsuit likely would devastate the family.) To keep the costs of this professional trustee in check, use the trustee services offered by a trust company that also will manage the trust’s investments (see below for details).
Adding trust provisions to a simple will is likely to cost $1,000 to $3,000. If you use a professional trustee, you also will have to pay ongoing fees. If you use the trust services of the bank and trust company that also manages the trust’s investments, the annual fee for trustee services might be 0.20% or 0.25% of the assets under management (in addition to an annual fee of perhaps 1% for asset management). These fees will vary depending on a number of factors including the investment company selected and size of the trust’s investment portfolio.