Wealthy Client, Problem Child

The explanations in the scenario below should not be construed as legal advice or legal representation. The information is merely an attempt to give a summary explanation of various estate planning documents and procedures and there function according to California law. Due to the rapidly changing law in this area, we cannot guarantee the accuracy or reliability of information in the scenario below.

Successful Stan is a single 60 year-old executive living in California and looking to retire in the next couple years. He has three children from a prior marriage, Albert, Bob and Chris who are all adults now. Stan received an inheritance following the death of his father five years ago and used this money to pay off his house and invested the rest. Although Stan is doing well, his kids are running into some complications. Recently, Bob and his wife have been having marital difficulties, but they’re going to counseling. And in the last few years, Chris has repeatedly run into problems with drugs and has had difficulty holding a job for more than 6 months. Stan had a Will drafted following the split from his wife 8 years ago that names his oldest son Albert as Executor and leaves Stan’s property to his three sons equally. Stan now owns the following assets:1.   3 bedroom house            $2,250,000
2.   Retirement Accounts       $1,000,000
3.   Various Stock accounts   $2,000,000
4.   Mutual Funds                     $450,000
5.   Checking Account                $50,000
6.   Savings Account                $200,000
7.   Lexus Automobile               $50,000

Total Estate Value:  $6,000,000

I.    First, lets examine the implications of how this estate would pass at Stan’s death with only his Will in place as stated above. (Then, we’ll see how a qualified attorney could have saved Stan’s estate a considerable amount of money and administrative hassle using a revocable living Trust and other estate planning techniques).

    A.    Probate: Stan owns all of the property above in his name alone (not in joint tenancy or some other fashion) and so his estate will need to be probated. (Note that the Retirement Plan would likely pay to named beneficiaries and would NOT be probated so we’re likely only looking at $5,000,000 of probate assets here). Probate? Yes, having a Will alone does not let you avoid the probate procedure in California. A Will merely directs the court on how you want your assets to be distributed. The probate process is still required here to inventory Stan’s assets and be sure they are distributed accordingly. (Property held in a Trust, however, does avoid probate). Therefore, just for the court to allow Albert to divide the estate equally between himself and his two brothers, a court procedure is required and it could cost approximately $63,000 in attorney’s fees alone. This cost doesn’t include other expenditures such as courts costs, filing fees, etc., and remember, this distribution was already explained in Stan’s Will.

    B.    Potential Divorce and Drug Dependency Issues: Aside from probate, an obvious problem exists in that Stan’s Will leaves one-third of his estate to his son Chris who currently has drug problems! This outright distribution to a potential drug addict should raise alarm bells in any sensible individual. And Bob’s situation should cause concern too. If Bob inherits the money and inadvertently converts it into a community asset subject to claims by a spouse in divorce, much of his inheritance might be lost. The lesson here is that Stan made a common mistake by not updating his Will to accommodate changing circumstances in his children’s lives.

        1.    Question:  Is your Will current?

        2.    Question:  Would your estate potentially pass to individuals with drug or mental problems?

3.    Question:  Do you want to better protect your child’s inheritance from in the event the child divorces?

    C.    ESTATE TAX!! In 2015, if your estate is valued at over $5,430,000 you are subject to a very expensive tax. In this scenario, with an estate worth $6,000,000 you’re looking at approximately $228,000 of estate tax alone! The tax rate is 40% on every dollar over and above your exemption limit and so the IRS benefits at the expense of Albert, Bob and Chris who each could have inherited approximately $76,000 more if Stan planned properly and avoided this expensive tax!

        1.    Question: Do you really know what your estate is worth?

        2.    Question: Is the Estate Tax something you should be concerned about?

II.  Instead of the above scenario, let’s assume Stan sought advice from a qualified attorney and set up a Trust and backup Will before his death.

    A.    Probate: Stan could have transferred his assets into the Trust and out of his estate. This means that at his death, Stan’s estate would not own enough assets to be probated (ie: fewer than $150,000 of assets). Instead,the Trust owns the assets and so Stan avoids the cost of probating the assets. Although administering the Trust still requires expenses to be paid as well as an attorney’s assistance, this distribution arrangement should save Stan’s estate thousand’s of dollars when compared to a probate proceeding.

    B.    Drug dependency issue: Secondly, with a Trust, Stan has the ability to set aside Chris’ share of the estate until Chris is ready to spend the money appropriately. Stan’s options to arrange for Chris’ benefit using a Trust are many. Stan could require Chris to complete a drug test before receiving the money; he could require Chris to work for the money by having Albert (the Trustee) pay Chris a sum equivalent to what Chris makes by working in a year; Stan could defer Chris’ inheritance for a specified period of time; or, Stan could leave the payment decision entirely up to Albert (or a 3rd party Trustee) to determine when and how much money Chris should receive. (Remember, as Trustee, Albert would be subject to strict duties as a fiduciary for as long as the Trust remained in effect. Any improper activity on the Trustee’s part is subject to legal action and so the issue of Albert disobeying Stan’s wishes and absconding with the money could get him sued).

    C.   Protecting an Inheritance for a Divorcing Beneficiary. Although an inheritance is presumptively separate property under CA law, many beneficiaries convert these assets into community property by depositing inherited proceeds into joint or co-owned accounts. Stan could have instead set up ongoing Trusts to hold each child’s inheritance for his benefit and provided better protection from creditors and claims in the event of divorce. This type of arrangement would have better protected against the kind of mistakes that occur in simpler estate plans, but they require assistance from experienced professionals.

    D.    ESTATE TAX!! Contrary to popular belief, assets in a revocable living Trust do NOT avoid the estate tax so any estates worth over $5,430,000 in 2015 would be subject to an estate tax currently. However, if Stan had utilized the services of a qualified attorney, he could have been instructed on how to transfer some assets tax-free during his life in order to lower the amount of his taxable estate. Or, Stan could have arranged to transfer these excess assets over the exemption limit to a charitable institution of his liking. This would benefit an organization of his choosing instead to the IRS. Other options include more advanced life insurance Trusts and even charitable Trusts if necessary. The main point is that a qualified estate planning attorney can show you many different options to help you avoid estate taxes.

Conclusion

Like many individuals, Stan believed he had appropriately accounted for his estate by having a Will drafted which set out his desires. Unfortunately, his simple arrangement led to thousands of dollars of estate taxes and probate fees that an experienced attorney likely could have avoided. Therefore, it appears that a Trust would have led to a much more suitable and cost effective arrangement for Stan’s needs.