Estate planning too often proceeds based on assumptions that may no longer be true. Correcting some of these assumptions may cause planners to change their approach to certain planning issues.
Here are some approaches that may be helpful for advisors to consider when helping their clients plan for actions involving their estates:
LTC INSURANCE
As clients live longer, planning for long-term care costs is ever more important. From an estate planning perspective, covering these costs should be factored in before making gifts.
One common means of addressing these costs is using long-term care insurance policies. An estate planning attorney might well assume that if a client has such coverage, then there is more latitude available to make gifts to the client’s children to reduce state estate tax or accomplish personal goals.
This would be a reasonable assumption except for the fact that more than a third of all long-term care policies lapse before the owners ever use them. Specifically, men age 65 have a 32% probability of having their LTC policy lapse and women age 65 have a 38% probability of lapse.
It might seem that the logical reason that such policies lapse is that the client cannot afford the premiums, perhaps after an increase by the insurer that in the client’s mind is too significant.
But according to a brief published by the Center for Retirement Research at Boston College written by Wenliang Hou, Wei Sun and Anthony Webb, there is another, perhaps shocking, reason that many policies are allowed to lapse: cognitive decline. Unfortunately, holders with cognitive challenges who let policies lapse are likely to especially be in need of coverage.
What does this mean for estate planning? First, advisors need to make sure that planning for cognitive decline is in place. It is essential to have a durable power of attorney authorizing the agent to handle financial matters if the client cannot do so.
Further, steps should be taken to assure that the agent will know when to step in and what to do — that is, make sure that payments are made on bills that are vital, like long-term care premiums.
CHARITABLE GIVING
For many years, the existence of a U-shaped charitable giving curve has been assumed. Clients at the highest and lowest income levels give the most as a percentage of income to charity and the bulk of the clients in the middle give at a much lower rate.
Why the highest income earners give larger charitable gifts seems obvious — they can afford to give more.
But why do lowest income taxpayers give so much? One theory is that this can be explained by religious considerations, such as tithing, that are reflected in higher gifting percentages for the lowest earners. That explanation has been accepted by many for a long time, but it is no more real than a unicorn.
According to an article in the Nonprofit and Voluntary Sector Quarterly by Russell N. James III and Deanna L. Sharpe, the reality is that lowest income taxpayers give generously because of a wealth effect: they actually have a lot of wealth relative to their income.
This phenomenon has important implications in how advisors help clients with charitable giving. While experts frequently focus on the tax aspects of charitable giving, they may be missing a valuable planning point. For many clients, charitable giving is important for reasons that have nothing to do with income tax considerations.
Many client donors are quite concerned about achieving specific charitable purposes. Advisors can render them a great service by helping them arrange donor agreements with charities.
Some donors might benefit from financial forecasts to determine the maximum level of donations they can make without undermining their personal financial goals.
Others might benefit from insurance funding for some gifts.
Finally, with the estate tax exemption for a married couple nearing $11 million, most clients’ estates will never face a federal estate tax. Advisors should guide clients to make those donations while alive and remove them from wills. This can provide an income tax deduction when the bequest won’t provide an estate tax deduction.
Alternatively, those clients might gift assets to children who are in a higher income tax bracket and let the children make the charitable gifts instead.
REVOCABLE TRUSTS
Revocable trusts are an ideal tool to protect clients from the risks of aging, identity theft, elder financial abuse and more. Yet the courts and laws view a revocable trust as a mere substitute for a will. This may well have made sense historically, when revocable trusts were largely used to minimize or avoid probate.
Now, however, when revocable trusts are used to protect aging clients, if an issue arises with the actions of a trustee, there may be no current remedy unless great care has been taken in the writing of the trust.
If, for example, an elderly parent becomes incapacitated and the trustee of her revocable trust, behaves irresponsibly in the managing the trust, other heirs may have little recourse. The courts have held that beneficiaries of a revocable trust have no rights during the settlor’s lifetime. They have no property interests or standing during the settlor’s lifetime. However, beneficiaries of a revocable trust do have a statutory interest in the trust accrued before the settlor’s death, which they can enforce after the settlor’s death.
What can advisors do? Consider having the attorney include a trust protector in the revocable trust. The person in this role, as a fiduciary, should have legal standing to require an accounting and might also be given the authority to fire and replace a trustee.
While protectors are a new area of the law, this may be a valuable safeguard. Suggest that the attorney include a monitor provision in the revocable trust. This might, for example, have all monthly bank and other statements sent to a certified public accountant to create reports to be disseminated to a trust protector and other family members, even perhaps to the advisor.
INSURANCE TRUSTS
Trusts commonly include “Crummey power,” the right for beneficiaries to withdraw gifts to the trust for a period of time after the gift — say, 60 days. This mechanism makes the gift to a trust qualify under current law for the $14,000 annual gift exclusion.
There is no legal requirement that insurance or other trusts that have Crummey or annual demand powers must require that beneficiaries be given written notice each year. For larger estates that might be subject to estate tax or clients who might be very concerned that an irrevocable trust be respected, the formality of written acknowledged Crummey notices for all gifts should still be used.
For clients not subject to these issues, verbal notice probably suffices. As a safety measure, have beneficiaries sign a one-time written waiver acknowledging that they are aware of the powers of withdrawal but waive any future written notices. That can go a long way to simplifying annual administration of these trusts and make clients much happier.
CHANGING IRREVOCABLE TRUSTS
In the past, when explaining the concept of an irrevocable trust, lawyers commonly told clients that it was effectively carved in stone. Now, with more than 20 states permitting the decanting of trusts (merging an old trust into a new trust), even irrevocable trusts might be susceptible to significant change.
So when you are guiding clients with an old trust that is not optimal, no longer assume that some unfavorable provisions cannot be changed. They might be able to be updated to give the client a much better result.
A common example is an old trust that distributed all assets to children upon their reaching age 25. The client now realizes a longer term trust will provide better asset protection and divorce protection planning. It may be feasible to decant the old trust into a new trust that lasts for each child’s lifetime.
Martin M. Shenkman is an estate planner in Fort Lee, N.J.
