At Decker Retirement Planning, we know how important trusts are in retirement. Over the last three decades, we’ve seen a lot of things happen—situations that could have been prevented if better estate planning solutions had been implemented.
As specialists in retirement planning, we believe the best estate planning solutions are developed when financial advisors, who are fiduciaries, are paired with estate planning attorneys. We have relationships with attorneys who specialize in estate planning, and we also work with our clients’ attorneys. Either way, both perspectives are important.
The Three Ways Your Estate Passes Through to Heirs
1. Probate
What is probate? Probate is the court’s legal way of moving estate assets through as they’re passed from one generation to another due to a death. When an estate is closed, it is closed and cannot be reopened. In that regard, probate is helpful in finalizing matters.
It’s important to know that some states are “friendlier” than others when it comes to probate. For instance, in our opinion, Utah and Washington are probate-friendly. On the other hand, California and New York are not. What “friendly” means to us is that probate court is handled fairly quickly and for a reasonable cost, as opposed to being an expensive, long, drawn-out process.
2. Wills
Wills specify what happens to your tangible assets, like homes, cars, jewelry, artwork, furniture, with some exceptions. Exceptions like retirement accounts, including your IRAs, your 401(k)s, your Roth accounts, and your SEP.
All of your retirement accounts and insurance policies have primary and contingent beneficiaries with specific instructions on who gets account funds upon your passing. These instructions take precedence.
Retirement accounts have nothing to do with either your Will or trust, and usually a large amount of assets are held in them. Upon presentation of a death certificate, your beneficiaries will receive them as inherited IRAs or stretch IRAs—whatever you specify.
Your Will typically “catches” everything that’s not in your retirement accounts or insurance policies.
3. Trusts
Many people think trusts are necessary to avoid probate. At Decker Retirement Planning, we think they are important, and we often recommend them as we work together with your attorney to develop your overall estate planning solutions. However, as fiduciaries, we also want to help ensure they really are needed, that the right ones are put in place, and that they are structured and funded properly, to your best financial advantage.
Reasons to Use Trusts in Estate Planning
1. To Protect Blended Family Members
Blended families, in particular, should consider the revocable family living trust. When two people are married and bring children from other spouses into the family, things are often great during the marriage. There is the promise that “everything will be divided equally.”
However, we’ve seen that attitude change completely after one spouse dies; we’d even go so far as to say it changes 90% of the time. The surviving spouse gets ticked off at the other spouse’s children and cuts them out of the Will, and obviously, the deceased spouse can’t do anything about it.
With revocable family living trusts, once one spouse predeceases the other, the trust becomes irrevocable; therefore, the inheritance distribution instructions do not change.
2. To Protect Real Estate in Probate-Unfriendly States
If real estate is an important part of what will be distributed to heirs, it should probably be held in a trust instead of going through probate, especially in certain states, because a trust doesn’t die when you die. It survives, therefore property in the trust can be distributed very quickly and easily.
3. To Counteract the Lottery Effect
If you have large assets and few (or young) heirs, you should consider a trust, so you can help ensure your heirs don’t blow through their money all at once. The lottery effect is real, and when people inherit a huge sum of money all at once, in one lump sum, it can destroy their lives. Sometimes, the lottery effect causes divorce or causes someone to quit their job. Friends and family swoop in out of the woodwork asking for handouts or seed money for risky business deals. Sadly, people can spend through all their millions of dollars within a short four to five years.
Staggered distributions allowed by a trust are a great way to counteract the lottery effect. You can specify when each person receives their inheritance—for instance, as an example, you could specify that each person receives 20% of their total inheritance every five years.
“Beach Bum” Trusts / Trust Requirements
Speaking of staggered distributions, there is another way you can structure a trust that we like to call a “beach bum trust.” This is where you distribute assets based on W-2 or 1099 earnings. With a beach bum trust, if Johnnie or Sally think they’re going to be turned into a trust fund baby, they’re mistaken. Instead, the more they work and earn, the more they inherit, because those 1099s or W-2 earnings are matched dollar-for-dollar (or two for each dollar earned, or whatever you decide). The point is, they’re incentivized to work instead of do nothing.
Similarly, if it’s important to you for them to marry or you want to help them buy their first home or car, then you can specify distribution of a certain amount of money for life milestones, like their first child, etc.
Minor’s Trusts / Special Needs Trusts
Sadly, parents sometimes predecease their children when the children are very young. That’s why we usually recommend that a minor’s trust be set up for distribution of assets to your children under 18 (or 21 years old, depending on your state’s definition of age of majority). Choosing trustees for this type of trust is very important, for they will ensur your financial wishes are implemented.
Staggered distributions after age 18 are usually recommended, due to the lottery effect discussed earlier. Even $200,000 is a lot of money for a young person to handle with wisdom, and you can help them by doling out their inheritance in smaller chunks.
Along the same lines, if you have a child with special needs who cannot take care of himself/herself, you can set up a special needs trust, so they’re able to live on funds distributed in a manner that will help ensure the money goes to living expenses, facilities, and caretakers you’ve set up, so they can live as normal of life as possible.
Dynasty Trusts
Another type of trust we’ve seen to be highly beneficial for some of our clients is the dynasty trust, which is also called a generation-skipping trust. This type of trust often comes into play when your children have done very well financially and don’t need to inherit your money, but you find out your grandchildren may be hit with a 48% penalty because of the generation-skipping tax.
To legally avoid this exorbitant tax rate, you can set up a dynasty trust that is per stirpes, meaning it stays with the bloodline. The trust is created while you’re alive, but is only fully-funded after you die. The dynasty trust can “live” for years through many generations, over a hundred years, or as long as the money lasts. You can designate portions of this trust to be available to your grandchildren, great-grandchildren, great-great-grandchildren, etc. Often, these trusts are used for educational expenses like tuition, books, and other university costs.
Keep in mind, a dynasty trust doesn’t preclude wealth transfer of a part of your estate to your adult children. You can still designate a portion of your estate to go to them, even if they’re well off.
What to Watch Our For
Sadly, we’ve seen trusts recommended to people who didn’t need them. We’ve also seen people spend a lot of money to setup trusts, then never fund them. That’s why, as fiduciaries and financial advisors specializing in retirement, we work closely with clients and their attorneys to help ensure they’re setting up the right types of trusts which are 1) beneficial to their overall estate plan and 2) funded correctly and at the right time.
For instance, here’s something big to watch out for. Most states have spousal estate tax exemptions. In your Will and/or trust language, you want to make sure you preserve these! Through the decades in reading through many estate documents, we have found that roughly 1/4 of the time this specific language has been left out, and we’ve asked for it to be added in.
To understand how the loss of a spousal exemption can impact you, let’s say you and your spouse’s estate is valued at $5 million when one of you dies. If the spousal exemption is $2 million (the exemption amount varies by state) and isn’t preserved, the surviving spouse will owe state taxes on the entire $5 million, instead of the $3 million difference.
At a tax rate of 18% (the tax rate varies by state), that’s $900,000 versus $540,000. That is a lot of money for leaving a few words out of an estate planning document! And that’s just one of the reasons why we work very closely with both you and your attorney in creating effective estate planning solutions.
Conclusion
If you have questions about trusts, want to review a trust, want to go over trust ramifications, or want to see if a trust is right for you, we can help provide guidance and solidify the process by referring or working with your current attorney to create customized estate planning solutions.
Call Decker Retirement Planning at 855-425-4566 today.
