Five Reasons to Protect Your Retirement Accounts

Your 401K or IRA may be your largest asset. Although these accounts were designed to provide additional income during your retirement, many people leave substantial amounts in their retirement accounts at their death. You can simply designate a beneficiary for these accounts. But there are several reasons why you may wish to provide some additional protections for your beneficiaries.

You have substantial amounts.  The more you have in your account, the more likely you will want to add protections. For small accounts, the benefits of the protections may not be worth the additional hassle of administering a trust. However, you should remember that in many cases, your beneficiaries will simply cash in the account, pay the taxes, and spend the money as they choose.

You believe your beneficiary may waste the funds.  If you are concerned about you’re your beneficiary will spend the inheritance, you should leave your retirement accounts in trust so you can provide oversight and instruction on how much they receive and when they receive it.

You are concerned about lawsuits, divorce, or other possible legal actions.  Inherited IRAs have very good creditor protection in North Carolina. However, required minimum distributions will not be protected. Also, your beneficiary is not forced to leave the funds in the IRA.

You have beneficiaries who receive assistance.  If one of your beneficiaries receives, or may qualify for, a need-based governmental assistance program, it is important to know that inheriting from an IRA may cause them to lose those benefits. A trust designed specifically to receive these assets can avoid disqualification.

You are remarried and have children from a previous marriage.  If you are remarried and have children from a previous marriage, your spouse could intentionally or unintentionally disinherit your children.  You can avoid this by naming the spouse as a lifetime beneficiary of a trust and then having assets pass onto your children after his or her death.

Any trust that is the beneficiary of a retirement account must be designed to hold these accounts. If the trust does not qualify as a designated beneficiary, your beneficiaries will receive the benefits of the trust, but may lose the ability to defer income tax on the account. 

You have worked hard to save the money in your retirement accounts. They provide you with the peace of mind that you have a safety net. You have the opportunity to ensure that these accounts can serve the same purpose for your beneficiaries. 

Tax Reform Proposal Released

On September 27, 2017, the Trump Administration, the House Committee on Ways and Means, and the Senate Committee on Finance released a tax proposal entitled “The Unified Framework for Fixing Our Broken Tax Code.” For individuals, the proposal aims to:

  • Reduce the number of tax brackets from seven to three (maybe), with rates of 12, 25, and 35 percent. It does not specify where the brackets start and end. It also says that “an additional top rate may apply.” So there may be four tax brackets.
  • Almost double the standard deduction from its current amount to $24,000 for married taxpayers filing jointly and $12,000 for single filers.
  • Repeal personal exemptions for dependents and increase the child tax credit to an unspecified amount and increase the income levels at which the child tax credit begins to phase out.
  • Expand the child tax credit concept to give a $500 credit to anyone caring for a family member who isn’t a child, regardless of age.  
  • Repeal the individual alternative minimum tax.
  • Eliminate most itemized deductions (including deductions for state and local income taxes), but retain tax incentives for home mortgage interest and charitable contributions.
  • Repeal the estate and generation-skipping transfer taxes. There is no mention of the gift tax. It also does not specify whether the plan would maintain stepped-up basis, which lets heirs revalue assets they get by bequest, minimizing or avoiding capital gains taxes. Some past proposals to eliminate the estate tax include provisions for carry-over basis, where heirs would owe capital gains taxes on inherited assets.
  • Eliminate the deduction for state and local taxes.

There are also several changes for businesses. Most of the businesses that we represent are either pass-through or disregarded entities, so I won’t go through many of these. However, here are some highlights:

  • The corporate tax rate would be lowered from 35 percent to 20 percent.
  • The corporate alternative minimum tax would be eliminated.  
  • The maximum tax rate for pass-through businesses—like partnerships, LLCs taxed as partnerships, and subchapter S corporations— would be limited to 25 percent instead of the individual tax rates that currently apply.

The Unified Framework is low on details. But the different interest groups have responded as expected. Conservative groups and politicians are hailing this as a historic opportunity. President Trump called it a revolutionary change and a “middle class miracle.” Speaker of the House Paul Ryan said that “[t]his is our best opportunity in a generation to deliver real middle-class tax relief, create jobs here at home, and fuel unprecedented economic growth.” However, progressive groups and Democrats are criticizing the proposal as benefiting the wealthy to the detriment of the lower classes. Senator Charles Schumer said it should be called “wealth-fare.” One commentator called the proposal a “$5 trillion love note to the wealthy.” Another said it is a solution looking for a problem.

There is no explanation of how to pay for the proposed tax cuts. Republicans say economic growth will compensate for lost revenue. Senator Patrick Toomey, who sits on the Finance Committee, said he was confident that a growing economy would pay for the tax cuts. This assumption is likely to be challenged.

Trusts and Taxes

When we design a trust, we want to make sure that it accomplishes your goals. Our focus is usually on balancing protections with access to trust property. But it is also important to understand how a trust will be taxed.

Trusts are categorized as either grantor trusts or non-grantor trusts, depending on how ownership and control over the trust are outlined. In some cases, we go to a lot of effort to ensure that a trust is either a grantor trust or a non-grantor trust. A grantor trust results in the grantor being responsible for the income tax liability of the trust, regardless of whether the trust income is distributed to beneficiaries or not. Grantor trusts are ignored for tax purposes.

Most of the time if we are creating a grantor trust, we want taxes allocated to the person who created the trust. But sometimes it is a good idea to tax the income to the beneficiary. We can design trusts to be grantor trusts as to the beneficiary. However, this probably weakens the creditor protection that the trust would otherwise provide.  

A trust that is not a grantor trust is a non-grantor trust. Non-grantor trusts are considered a separate tax entity. They are categorized as either simple or complex. A simple trust has three requirements. It must distribute all income to the beneficiaries. It cannot distribute principal. And it cannot make distributions to charities. Any trust that does not meet the requirements for a simple trust is a complex trust.

With a simple trust, all income is distributed to the beneficiaries. The trust reports all income, but is entitled to a deduction for the entire amount distributed to beneficiaries. The result is that the trust only pays tax on capital gains. With a complex trust, distributions can include ordinary income, dividends, capital gains and principal. The trust could also earn income that is not distributed, and there may be a deduction for distributions to charities. The result is that the allocation of the tax and any deductions between the trust and its beneficiaries can be quite complex.

In many cases, we create trusts that become complex trusts upon the grantor’s death. These trusts provide valuable lifetime protections for children or other beneficiaries. But the taxation is not as simple as it could be if we did not provide those protections.  We have to balance these protections with the administrative burden of managing the trust. If you are leaving a child $50,000 it may make sense to leave that property in a grantor trust that allows unrestricted access and does not require a separate tax return. But this will depend on the facts of your situation. If creditor protection, divorce protection, or maintaining needs-based government assistance is are concerns, this may not be a good option. On the other hand, if you are you are leaving your child a much larger inheritance, he or she may be better off if there are more protection and flexibility, but a little extra accounting complexity. 

It is important to understand what you are doing when you create an estate plan. When our clients are fully informed, they tend to leave assets to their loved ones in trust. Understanding the basics of how a trust will be taxed should play into that decision.

If you have questions about whether or not a trust is the right tool for you, we would be happy to discuss this with you.

Will You Outlive Your Assets?

When I was about to turn 16, I had saved around $1,500. Most of it came from working in tobacco the three prior summers. I was excited to spend it all on a 1974 Volkswagen. A few years later, my wife and I used all of our savings for a down payment on our first house. We didn’t mind doing without a few things while we saved because owning a house was a priority.  But I don’t feel the same way about paying for a nursing home. It is not that I don’t think I should have to pay for it. I just don’t like the idea of working my whole life and saving to pay for something that I don’t really want. 

I hope I never need long-term care. Unfortunately, the odds aren’t in my favor. About 70% of people over the age of 65 will require at least a temporary stay in a long-term care facility. One-third of seniors will develop some form of dementia. These numbers have all kinds of implications. There are two related issues that I deal with every day. The first is that if you live long enough, someone will have to make decisions for you. The second is that there may come a time when you can’t live at home. You need to plan for both.

You should not assume that because you have a Will and power of attorney, you have sufficient incapacity protections in place. Incapacity planning is one of the most important components of an overall estate plan. I have seen the hurt feelings and permanent damage to families when a child files a petition to have a parent declared incompetent. I have seen the loss of dignity and control when that petition is granted. And I have seen both of those happen when the parent had a power of attorney in place. Dignity and control are two things that I value. So I have a detailed plan in place for the transition of decision-making authority upon my incapacity.

We can fix that problem as long as you have the ability to make decisions. But planning for long-term care is more complicated. It is important to understand that Medicare will only pay for certain short-term stays in a rehab facility. Longer stays are not covered. And Medicare never pays for assisted living. Your medical insurance also will not pay for long-term care either. That leaves three possibilities. You can pay for it yourself. You can purchase insurance to pay for long-term care. Or, if you qualify, there are several government programs that may help.

The eligibility rules for government programs aren’t fair or logical. I know of some people who have no money, but still do not qualify for help. And I know of others whom I would consider wealthy, but are receiving benefits. The VA has recently proposed new rules that would make qualifying for VA Aid and Attendance more difficult. It is hard for me to imagine that Medicaid can continue to provide the same level of coverage in the future. The number of senior citizens in North Carolina is projected to double between 2010 and 2030. The number of workers per every social security beneficiary will drop from the current 2.8 to 2.2 by 2035. We will have twice as many seniors, and fewer people working and paying taxes. It is probably not wise to rely on Medicaid to pay for nursing home care.    

Many seniors need assisted living rather that skilled nursing. In Wilson County, we have the same number of assisted living facilities as skilled nursing facilities. Medicaid does not help pay for assisted living facilities in North Carolina. The program that helps low-income seniors pay for assisted living is called State-County Special Assistance. There are very strict income limits for Special Assistance, and most people do not qualify. If you are a veteran who served during a period of war, or the surviving spouse of such a veteran, you may qualify for VA Aid and Attendance, which will provide some help for assisted living. These limited options for help leave the majority of people without government assistance for assisted living.   

Obtaining assistance to pay for long-term care of any type is already difficult, and will likely become more difficult. But this doesn’t mean that you should ignore long-term care planning. On the contrary, it means that you must plan for it. In order to do so, you must understand the legal, financial and tax issues involved. As part of your overall plan to pay for long-term care, you may wish to preserve certain specific assets, such as a family farm or a cash reserve, even under a worst-case scenario. You also may wish to purchase a long-term care insurance policy or some type of hybrid insurance policy to shift the risk to an insurance company. Or you may decide that you can self insure.

To make these decisions, you must evaluate several factors, including your income, your standard of living, the type and value of your assets, and family dynamics. You must understand the legal, financial and tax issues that affect your plan. And you must design a plan that takes all of these things into account.

If you don’t plan for long-term care, you are leaving your well-being to chance. You are also setting yourself up for the possibility of having to spend your life savings on a nursing home and still having the State Medicaid Agency force the sale of your house after your death. You need a team of advisors to help guide you through that process. We would be happy to be a part of that team.

Timing and Circumstances are Critical in Asset Protection

Several clients have contacted me over the last few months about protecting their assets from creditors after they have been notified of a potential claim against them. Unfortunately, when you need the protection, it is too late. 

A common misconception is that only wealthy families and people in high-risk professions need to plan for asset protection.  In reality, anyone can be sued and lose all of his or her assets. A car accident, foreclosure, job loss, medical crisis, business failure, or even a dog bite can result in a judgment against you. One of my clients with a modest income recently settled a lawsuit that could have resulted in the loss of his home.  

You are probably taking advantage of several basic asset protection strategies without knowing it. For example, the first line of defense against liability is insurance, including homeowner’s, automobile, professional liability, general liability, long-term care, and umbrella policies. In North Carolina, if you and your spouse purchased real estate while married, that property is not subject to either of your individual creditors for so long as you remain married. Keep in mind that if you purchased property jointly and then got married, you do not have this protection. You would need to re-title the property. You would also lose this protection if you are divorced or your spouse passes away. I once collected on a judgment after a couple divorced. Assets held in 401(k)s and IRAs are also excluded from creditors. In North Carolina and a few other states, inherited IRAs are also protected.

If you are a landlord, real estate investor, business owner, work in a high-risk profession, or have accumulated or inherited a significant amount of unprotected property, you may wish to consider more sophisticated asset protection planning.  

If you take the time to read the articles that I write, you will recognize that I have a pattern of bringing up trusts in just about everything that I write. Leaving your assets in trust can keep your children, spouse or other beneficiaries from having to worry about these issues. Protecting your money from your creditors is hard. Protecting your money from your beneficiaries’ creditors is not. One of the best gifts that you can give your children is an inheritance that protected from their creditors and predators. 

Call us if you would like to discuss asset protection strategies for yourself or your beneficiaries.

Knowing What Could Go Wrong

I have noticed two general perspectives on how to plan for wealth transfer at death. The first group has one objective – do it as simply as possible. The second group analyzes the potential risks, balances that risk with the expense and administrative hurdles of protecting from those risks, and comes to a reasoned determination of the level of protections that they wish to provide.

It is my job to move clients from the first group to the second. If my clients are comfortable with the risks that they are taking, then I am comfortable too. You can’t decide how to plan unless you know what might go wrong. A simple and straightforward estate plan may be the right prescription for you. But a “simple” plan is a solution, not an objective. 

When I first meet with new clients about estate planning most of them have not even considered the possibility of placing any protections around the assets that they will leave their beneficiaries. The first reaction to the concept of a trust is often negative. They think trusts are for rich people. They imagine that trusts are expensive to create and maintain, that their children will have limited access to their inheritance, and that a bank trust officer will control their property. Many clients have said that if they leave their assets in trust, their children will think they don’t trust them. So they have never considered anything other than outright distributions. Most people don’t necessarily want to leave distributions outright. They just have bad information and don’t know that there is an alternative that can protect their children and give them control without adding significant expense.

I will not go through all of the possible benefits of leaving assets in trust. But trusts are versatile tools that can accomplish all kinds of different things. They are the Swiss Army knife of estate planning. You can choose how they are taxed, who makes decisions about trust assets, when the decision-maker is removed, who gets the benefit of the trust, how long the trust lasts, and what kind of protections they provide. You can create trusts that protect your children all kinds of potential problems and still leave them in control of the assets.  

Unless you are leaving small amounts to competent, responsible adults, I believe that some type of trust is usually a better option than outright distributions. There are three reasons to leave outright distributions. The first is that you do not believe that the risk of any of the potential problems happening to one of your beneficiaries justifies the extra administrative hassle of administering a trust. The second is that you do not believe that the additional costs of setting up the trust is justified by the level of risk. The third is that you just don’t care if the money you worked for is lost.

I can’t quantify the risk of your child getting divorced, filing bankruptcy, being sued, having a stroke, suffering a debilitating injury or being diagnosed with a life-threatening illness. But I have seen all of these things happen many times. Even if the chances of one of these problems negatively affecting one of your children may be low, the potential consequences could be severe.  

Leaving assets to your children in trust doesn’t show that you don’t trust them. It shows that no matter how life treats them, their parents cared enough to make sure their inheritance was protected. If you want to consider the best way to protect your beneficiaries, we will be glad to explain the details. 

When an Unfunded Revocable Trust is Better than a Will

In most cases, a fully funded revocable trust is the most comprehensive way to structure an estate plan. If you have very few assets, or almost all of your assets are retirement accounts, that may not be the case. But for the middle-class people, a revocable trust based estate plan is the best way to go. For a revocable trust to work the way it is intended, it must be funded. You will still get some benefit from an unfunded trust. But you won’t get the most out of it.

A lot of my clients come in with an old unfunded trust. Most of them don't know why the trust wasn't funded. If your revocable trust has outright distributions at death, there are little or no benefits to having an unfunded trust. But if you are leaving assets to your beneficiaries in trust, an unfunded trust gives you flexibility and some level of privacy.

Some estate planning attorneys will say that if you are not going to fund the trust, you may as well have a will. But I approach this a different way. If you are going to do a Will with trusts for your beneficiaries, why not make a separate trust the beneficiary of your will? You can either have a long will with a trust that will be permanently on display in the Clerk's office, or you can have a pour over will that says "I leave all of my probate assets to the trustee of my revocable trust." With a fully-funded trust, everything remains private. With an unfunded trust, your assets will be listed in an inventory in the court file. But who gets them and how they get them will not be public.

A trust-based plan also gives you flexibility. Just because you don't fund your trust now doesn't mean you never will. If you have a will-based plan, you can't decide to fund the trust later, because the trust is not funded until your death. But with a trust-based plan, you can fund it at any time. If you partially fund the trust, you can make modifications later without having to re-title the assets. This means that if you do not believe that you can make the necessary investment to create and fund a trust will all the features that you would like, you can still create a simple revocable trust now, partially fund it, and make modifications in the future.

If you decide to make your trust the beneficiary of a life insurance policy or retirement account, naming sub-trusts created under a revocable trust are safer beneficiaries than testamentary trusts created under a will. The revocable trust exists now. It will continue to exist unless you revoke it. But if you leave assets payable to a trust created under your will, that trust may never be created. If you change your will and forget to change your beneficiaries, or if your will is never located, the asset will be paid to your estate. Both life insurance and inherited

IRAs are protected from your creditors. If they are paid to your estate, you lose that protection. There could also be serious tax issues if your retirement accounts have to be paid to your estate. Also, some financial institutions will not allow testamentary trusts created under a will to be beneficiaries of their accounts.

It is always best to fund the trust. But if you choose not to re-title assets now, you should consider an estate plan that gives you the flexibility to maximize its potential at a later time.

It's April and We Still Have No Guidance on Changes to VA Aid & Attendance

I meet with someone just about every week who needs assisted living or in-home care, but does not have the money to pay for it. Unfortunately, most of the time, they also make too much money to qualify for help through the state. If the person needing care is a veteran who served during a period of war or the surviving spouse of a veteran who served during a period of war, VA  Aid & Attendance can be the perfect solution. The income and asset limitations are more lenient than either Medicaid or Special Assistance. There is no estate recovery.  And at the present time, there are no gift penalties and no look-back period. There are many planning opportunities for qualified veterans. 

More than two years ago, the VA published a proposed rule that would significantly change VA planning. It would amend the portion of the code of federal regulations that would create a 3-year look-back period and a transfer penalty.  The VA did not initially give any guidance on when the proposed rules would come into effect. However, in October 2016, a VA staff member stated that because of the complexity of the rule and the large number of comments received, the VA did not anticipate publishing the final rule before April 2017. It is now the end of April and the rule is not in effect. The newest unofficial estimate is that it may come into effect later this year. 

I was more cautious about VA planning last fall. At this point, it does not seem likely that the new rules will be implemented anytime soon. While every case is different, in most cases, I am suggesting that clients move forward with VA planning. If you or a loved one are a veteran who served during a period of war and needs assisted living or in-home assistance, please call us at 252-289-9800 to set up a time to discuss this opportunity. 

A Short Comparison of Wills and Revocable Trusts

I explain the differences between will-based plans and revocable trust-based plans to just about every day. This summary will not go into great detail, but will cover the basics.  

Things that Revocable Trusts Can Do that Wills Cannot

  • Avoid guardianship. A revocable trust allows you to designate when, who and how someone takes over if you become incapacitated and unable to manage your own affairs. Wills only become effective when you die, so they are useless in avoiding guardianship proceedings during your life. If you have a will-based plan, you will have to rely on a financial power of attorney for incapacity planning. Because powers of attorney do not take away your ability to make financial decisions upon your incapacity, an incompetency proceeding could still be necessary.   
  • Bypass probate. Property held in a revocable trust does not pass through probate. Your trust doesn’t die with you. A new trustee takes over. The probate process is essentially a way to transfer title. A will has no effect until it is probated. Therefore, property that passes using a will must go through probate.  Probate is a public process and can be costly and time consuming. In most cases, it is preferable to avoid probate.  
  • Maintain privacy after your death. Wills are public documents; trusts are not. Anyone, including your inquisitive neighbor, can discover the details of your estate if you have a will. Trusts allow you to maintain your family’s privacy after death. 
  • Help protect you from court challenges. Although court challenges to wills and trusts occur, a person who is disinherited by a trust will have a harder time contesting the trust because they won’t have a right to get a copy of the trust document. Under North Carolina’s trust code, a trustee’s duty to give information about the trust is to the beneficiaries only.
  • Help you organize Your assets. You don’t have to have a trust to organize your assets. But if you fund the trust, you have to organize. You will review all of your beneficiary designations and title to all of your assets. You may end up consolidating assets. We often refer to trusts as buckets. When you fund your trust, you will inventory your assets and put them in the bucket. This takes some of the burden off of your Successor Trustee or Executor.

Things that Wills Can Do that Revocable Trusts Cannot 

  • Name guardians for children. A revocable trust cannot be used to name guardians to care for minor children. Should you choose a revocable trust-based plan, your will can designate your choice of guardian. You can also use a designation of standby guardian to facilitate this transfer upon your death or disability.
  • Ensure that the court supervises the estate administration. This is something that we generally try to avoid. But in some cases, it may be preferable to have the court approve each distribution and supervise your Executor.  
  • Protect your spouse’s assets from the costs of long-term care. Revocable trusts don’t mix well with Medicaid planning. One of the tools that we use to protect the last surviving spouse from having to spend all of his or her assets on a nursing home is a special needs trust. For some unknown reason, this only works for trusts created in wills.  

Things that Both Wills and Trusts Can Do

  • Allow revisions to your document. Both wills and revocable trusts can be revised whenever your intentions or circumstances change so long as you have the legal capacity to execute them. 
  • Name your beneficiaries. Both wills and trusts allow you to name beneficiaries for your assets.  You will controls only assets in your individual name that do not pass automatically at your death. Your trust will only transfer those assets that have been transferred to your revocable trust. 
  • Provide asset protection for beneficiaries. Trusts and wills can be crafted to include protective sub-trusts which allow your beneficiaries access but keep the assets from being seized by their creditors such as divorcing spouses, judgment creditors, and a bankruptcy trustee. The difference is that if the trusts are created in a will, they also become a public record.

We discuss the differences between wills and trusts in detail with our clients. We look at each client’s goals, financial situation and family dynamics to design an estate plan tailored to their needs. If you would like more information about which type plan may be right for you, we would be happy to discuss this with you.  

Life Insurance and Irrevocable Life Insurance Trusts

Life insurance can significantly leverage your wealth. It is a cost-effective way to help your loved ones deal with the financial consequences of losing you. In most cases, the build-up of internal cash value in a life insurance policy is not subject to current income taxation. Similarly, the receipt of death benefits by the named beneficiaries is generally not considered income.

Fortunately, North Carolina also provides significant protection of life insurance proceeds from your creditors. By statute, insurance on your life is not available to pay your creditors so long as it is payable to someone other than your estate. If you want to be extra cautious, make sure your insurance policy proceeds are payable to your spouse or children. Article X, Section 5 of the North Carolina Constitution protects all life insurance paid to your spouse or children from your creditors.  

The proceeds of a life insurance policy may provide a means to satisfy mortgages or pay other debts, such as the costs of your last illness or your funeral expenses. Life insurance can also be used to equalize inheritance to your beneficiaries when you leave a business, a farm or other assets to one child. It may also be used to provide funds for a surviving business partner to buy your ownership interest. In some cases, life insurance proceeds are invested to provide a source of support for your heirs. It may also provide liquidity to for the payment of federal estate taxes.

A decade ago, estate tax planning often drove the estate plan. However, in the current era of fairly high estate tax exclusions, estate planning is usually focused on the best way to protect your beneficiaries and enhance their lives. There is a great deal of flexibility in how to handle life insurance in non-taxable estates.

But for estates with assets greater than the applicable exclusion, life insurance may be an essential component of the estate plan. This is particularly true in taxable estates with little liquidity. You can’t pay estate taxes with land or an interest in a closely-held business. But your gross estate for estate tax purposes consists of the value of all property that you owned or in which you had an interest at the time of your death.

If you have any “incidents of ownership” in a life insurance policy at death or have transferred those incidents of ownership during the past three years, your gross estate includes the death benefit proceeds of your life insurance policy. The current maximum estate tax rate is 40%. So if you have a taxable estate, the effective value of a life insurance policy owned in your name is reduced by 40%. That is a good reason to remove your life insurance from your estate. There are several ways to remove the life insurance from your taxable estate.

The simplest – and most dangerous – way to remove life insurance from your estate is to have a third party, such as a child, own the policy. The premiums could be funded with a bonus if that child works in your business. But when a child buys a policy on your life, there are several potential problems. Perhaps the most significant is problem is that you lose control of ownership and beneficiary designations in the case or your child’s death or disability. You want to make certain that the policy ends up in the right hands in those cases. Specifically, you don’t want the policy coming back into your hands. You also want to make sure that someone else, such as your child’s spouse, doesn’t have the ability to change the beneficiary designation. Although the proceeds are protected from your creditors, they are not protected from your beneficiary’s creditors. If that child owes money when you die, his or her creditors will be paid from the proceeds. Leaving the policy to a child will cause estate tax inclusion in his or her estate. Of course, if they have to spend it on estate taxes, that won’t matter. But if your child died in a car wreck six months after you, before the estate tax was paid, that entire amount would be a part of his or her estate. Another consideration is that if the benefits are paid to a child, and that child pays debts that would have been attributable to other children, there could be a gift tax issue. Finally, there is no way to take advantages of Generation Skipping Transfer Tax saving strategies with this kind of ownership. So having a child own an insurance policy is somewhat dangerous. 

Another common alternative is to let your business own the policy. However, there are several concerns with this option as well. Creditors of the business could make claims against the policy value. Also, premiums paid by the company are not deductible. Should the company ever wish to distribute the policy, there could be tax implications. Generally, death benefits payable to the business are not taxed as income. However, there are situations in which they could be. And although the death benefit will generally not be considered a part of your estate, it will increase the value of your business interest, which will be part of your estate. So there are concerns with this method as well.  

The safest alternative if you have a taxable estate is an irrevocable life insurance trust (“ILIT”). An ILIT is a trust that is designed specifically to hold life insurance policies and keep them outside your estate. The trust normally receives cash gifts from you during your lifetime, and the trustee uses those gifts to maintain a life insurance policy on your life. When structured correctly, the value of the property transferred to an ILIT is removed from your gross estate for estate tax purposes. The property is not subject to estate tax or to your beneficiaries’ creditors or predators at your death.

If existing policies are gifted to an ILIT, you must live at least three years from the date of transfer to have the death proceeds excluded from your taxable estate. Therefore, when possible, it is best to replace existing policies with new policies which are owned from the outset by the ILIT trustee. However, there are more advanced strategies to avoid this three-year inclusion issue, such as a sale to the trust.  

Each time a premium payment is made through the trust, the trustee must send certain notification letters to each of the beneficiaries, including any minors. These are referred to as Crummey notices. Crummey was the 1968 decision by the Ninth Circuit Court of Appeals that approved of this procedure. The purpose of these notices is to ensure that the funds paid to the trust are considered completed gifts. The gift tax exclusion applies only if these notification letters are properly sent each time a premium contribution is made to the trust, or a policy is transferred into the trust. Your trustees should keep a file containing all of the notification letters.

If you have or may have a taxable estate, life insurance may be necessary in order to provide liquidity to pay estate taxes. Although ILITs are inflexible and require maintenance, they overcome many of the problems of the other forms of ownership

ABLE Accounts Now Available in North Carolina

There are several tools that can be used to protect assets for a beneficiary with special needs who is receiving need-based government assistance, such as SSI and Medicaid. These include first-party Special Needs Trusts (SNTs), Third-Party SNTs, Pooled Trusts, and, most recently, ABLE Accounts. ABLE stands for the federal law approving these accounts – the Achieving a Better Life Experience Act. ABLE Accounts have been available in North Carolina since January 26, 2017.

The Benefits

ABLE Accounts allow certain individuals to set up a special type of 529 account to hold assets to supplement their government benefits. There are several benefits that ABLE Accounts provide:

  • The assets held in an ABLE Account grow tax-free, much like a standard 529 college savings account.
  • They are neither difficult nor expensive to set up. An account can be opened at www.NC.savewithABLE.com. The maintenance fee is $45.00 per year.
  • ABLE account balances less than $100,000 are excluded from the owner’s SSI resource limit.
  • Even if the account balance exceeds $100,000, the account owner not be disqualified from Medicaid because of the account balance. SSI benefits will be suspended until the owner is under the resource limit.  
  • There are several investment options to choose from.

The Drawbacks

Although ABLE Accounts are a valuable tool in certain situations, there are also certain limitations:

  • ABLE Accounts are only available for those whose disability was present prior to age 26.
  • If the account balance exceeds $100,000, the owner’s SSI benefits will be suspended until the balance is reduced under the resource limit. In no case may an account balance exceed $420,000.
  • There is a $14,000 annual contribution cap on these accounts.
  • The funds can only be used to pay for limited expenses that are not provided for by other government benefits like food stamps, HUD and Section 8 assistance, SSI, and Medicaid.
  • After the owner’s death, any remaining balance in the ABLE Account will be payable to Medicaid up to the value of Medicaid benefits that the owner has received. It is important to understand this. ABLE Accounts are treated much like first-party SNTs in this regard.  

When ABLE Accounts Might Be a Good Fit

Prior to the existence of ABLE accounts, small inheritances, gifts, or injury settlements created problems for those receiving benefits. If the amount received was not large enough to justify setting up a SNT, the money would have to be spent down or it would cause a disqualification. If your mother passed away leaving your special needs child $10,000, or your special needs child received $7,500 from a personal injury case, an ABLE Account may be a great choice.

When you May Want to Stick with a Third-Party SNT

Third-party trusts are not funded with the special needs person’s money, and do not require a Medicaid payback provision. Any time that you can control when a person with special needs receives a gift or inheritance, a third-party trust is preferable. The key to a third-party trust is that the gift must go to the trust before it goes to the beneficiary.

If your mother is still living, but plans to leave your special needs child $10,000, there is not a good reason to subject that gift to the ABLE Account’s Medicaid payback provision. Instead, your mother can create a third-party SNT in her Will for the benefit of your special needs child. Or you could set up a standalone irrevocable SNT for your child. Then you, your mother, and others could leave assets to that trust. Because it is not funded with your child’s money, there is no payback provision. Because it is irrevocable, anyone can make a gift to the trust without being concerned that you will revoke the trust and use the money for your own benefit.

When a First-Party SNT May Still Be Your Best Option

Once a beneficiary receives money, such as an inheritance or settlement funds from an auto accident, those funds will cause disqualification from certain benefits unless they are placed in a first-party SNT or an ABLE Account. These are vehicles that allow the beneficiary to keep his or her funds and still qualify for benefits. However, the government wants a chance at getting their money back if the funds aren’t used. Therefore, there is a payback provision.    

In many instances, an ABLE Account will be preferable to a first-party SNT. However, any time that a special needs beneficiary receives more than $100,000 or a countable asset other than cash, a first-party SNT may be the preferred choice.  A first-party SNT can hold real estate, certificated securities, brokerage accounts, and tangible personal property. A trustee will be appointed to manage a SNT. And there is no limit on the amount that may be held in a SNT. 

Maybe You Need Several Tools

There is no one-size-fits-all planning strategy for families with children with disabilities. It requires a thorough review of your financial and family status and your concerns and wishes. When planning for a child with special needs, we often have a Plan B. You may wish to create a third-party trust in your Will or revocable trust, as well as a standalone third-party trust. But if your special needs child received $1,000 for Christmas, an ABLE Account may be a perfect solution.   

 

Talking to Your Family About Your Estate Plan

Talking about death and disability with your family is difficult. It is one of the reasons that people put off planning their estate in the first place. But once you have gone through the step of crafting your estate plan, it is important that the people involved in the plan understand how it works.

If you have a 20-year-old estate plan, your circumstances have changed. So have a lot of laws. If you told your 16-year-old granddaughter you were going to leave her your piano, but your Will was written before she was born, she might not get the piano. When estate planning documents are not updated, your family members might all have different ideas about what you wanted.  This could result in both conflict between your beneficiaries and a disposition of your assets that is different than you wanted. But if your intentions regarding your estate were made clear in an updated Will or trust, and you have met with your family to discuss your wishes, this can be avoided.

The first step to minimize these problems is to communicate your intentions thoroughly in your Will or trust and keep it updated. We also encourage our clients to write a letter of instruction to their beneficiaries that is not part of their Will or trust to explain their goals and values. Remember that passing along wealth is different from passing along the values, work ethic and generosity that enabled you to acquire, grow and share that wealth in the first place. That is a life-long project. But those final instructions can be meaningful and important. 

If we prepared your estate plan, you have put careful thought into which assets go to which beneficiaries and why. You have thought about what risks each beneficiary faces, and what you will do to mitigate that risk. You probably have a relationship with a financial advisor and a CPA that understands your family and your values, and with whom you would like your family to continue to work with.  When those details are first revealed to your beneficiaries after they just attended your funeral, it can create misunderstanding, conflict, hurt feelings, and even litigation.   

No matter how goof of a job you do in writing, nothing can clarify your thoughts like a conversation. You don’t have to talk about numbers. How much you reveal to your beneficiaries about your estate depends on the circumstances. Ages, personalities and relationships will dictate the scope of your discussion. Some people bring in their children and go over every details of their assets. Others are much more private. The numbers are likely to change. And you don’t want to unintentionally have a negative effect on your child’s work ethic or give your child a sense of entitlement by showing them large numbers. What we want your beneficiaries to understand is the structure of the plan. When your family doesn’t appreciate the rationale behind your estate planning choices like the use of lifetime trusts, this lack of understanding can lead to conflict and resentment among family members. Most of our clients use lifetime trusts, and it is important that their beneficiaries understand how the trusts work, what protections the afford, and their level of access to the assets.

I have had several meetings with beneficiaries who did not like the fact that their parents left assets in trust, left some of their wealth to a charity, or left certain assets to someone else. But more often than not, they appreciate the insight into their parents’ thinking and planning. Many have even come back in to do a new estate plan themselves. And even when they didn’t like their parents’ plan, at least they were prepared. Leaving $1M in trust to a relative with income to be paid out monthly for life is a blessing. But it may not feel like a blessing if your beneficiary was expecting an outright distribution.

Families can be forever damaged over who gets the farm, the beach house, or even grandma’s dining room table. The china and silverware that nobody uses can even cause problems. Sometimes it is a good idea to have this discussion around your kitchen table. But I am always happy to be involved in the conversation, so I can explain any technical issues. I always encourage my clients to bring their beneficiaries back in so we can explain their roles. Preventing big problems in the future is always worth a little discomfort now. 

USDA Will Allow Transfer of Certain CRP Land to New Farmers, Facilitating Farm Transition Planning

On Dec. 29, 2016, the U.S. Department of Agriculture (“USDA”) announced that beginning in January 2017 it will offer an opportunity for early termination of certain Conservation Reserve Program (“CRP”) contracts. Technical teams at USDA will determine which properties can terminate from the program with little impact on the overall conservation efforts. Detail of the new program are expected to be available in January 2017.

In 2015, USDA formed a Land Tenure Advisory Committee, which was asked to identify ways USDA could modify its programs and regulations to help new farmers with access to land, capital and technical assistance. This early termination program was implemented based on recommendations from that committee.  According to USDA, access to land remains the biggest barrier for beginning farmers. 

Normally if a landowner terminates a CRP contract early, he or she is required to repay all previous payments plus interest. However, the new policy waives this repayment if the land is transferred to a beginning farmer. This should facilitate farm transition planning by making it easier for farmers to transfer land to the next generation of farmers.

CRP enrollment is now close to the cap of 24 million acres. Therefore, the early termination program will also allow USDA to replace land that is now ready to be productive with other land that has a higher conservation value. Eligible land coming out of CRP will also have priority enrollment opportunities with CRP Grasslands, the Conservation Stewardship Program or Environmental Quality Incentives Program. 

What a Trump Presidency May Mean for Your Business and Estate Plan

Both the incumbent Republican leadership and President-elect Trump have put a significant emphasis on tax reform. Donald Trump’s tax plan is similar to the Tax Reform Task Force Blueprint created by House Republicans in June 2016. Both plans would eliminate the alternative minimum tax, simplify and lower income tax brackets, repeal the estate tax, and reduce taxes on businesses. But implementing these proposals may not be very easy. Republicans do not have the 60 votes necessary in the Senate to stop a Democratic filibuster or to stop the legislation from being blocked in the budget reconciliation process. Both parties may work together for a bipartisan tax reform package. However, Republicans could also wait for the 2018 elections in hopes of increasing their majority in the Senate.
 
Trump’s tax plan would simplify and reduce rates on corporations. It would reduce the business tax rate from 35% to 15% and eliminate the corporate alternative minimum tax. But most of my clients’ businesses are organized as pass-through or disregarded entities. Therefore, changes in individual income tax rates, rather than corporate tax rates, would affect those business owners. President-elect Trump’s tax plan would reduce the current seven tax brackets to three brackets with tax rates of 12 percent, 25 percent, and 33 percent. It would also eliminate personal exemptions and increase the standard deduction to $30,000 for joint filers and $15,000 for single filer. Trump's plan would cap itemized deductions at $200,000 for tax payers who are married filing jointly and $100,000 for individual filers. It would also eliminate the 3.8 percent Obamacare tax on net investment income and the alternative minimum tax. Most analysts believe that the Trump plan would lower income taxes for most people, but not everyone. It would likely be unfavorable for married couples with more than two dependents and for single taxpayers with more than one dependent. But the plan also includes an expanded deduction for child care expenses. So that may offset the lost personal exemptions for some families.
 
I have written before about the proposed changes to section 2704, which would affect discounted gifts of closely held businesses. We previously thought that these new rules could become effective as early as January. However, the political landscape has changed. There is now a strong sentiment that the proposed regulations will not be implemented anytime soon. At a hearing on the proposed regulations held on December 1, 2016, only one of the 36 speakers supported the proposed regulations. This was the largest crowd ever to attend a Treasury public hearing.  Congressman Warren Davidson (R-OH) and Senator Marco Rubio (R-FL) have also introduced bicameral legislation called the Protect Family Farms and Businesses Act, which would nullify the rules. Discounting is still a viable planning tool for now.

Estate tax repeal has long been a Republican priority. Chances of success are probably greater now than ever. At the current exemption levels ($5.49 million per individual in 2017), the estate tax affects very few people. About 99.8 percent of Americans will never pay estate taxes.  Full estate tax repeal would just extend the current trend to the remaining 0.2 percent. Given that some current Democratic senators have voted for estate tax repeal in the past, there is a possibility that estate tax repeal will pass in 2017.   
 
If this plan passes, there will be a strong incentive to keep taxable estates in the family and postpone capital gains as long as possible through the use of dynasty trusts. These are trusts that are designed to remain in existence for several generations without incurring transfer taxes, such as estate, gift or generation skipping transfer taxes. The use of dynasty trusts is limited by the Rule Against Perpetuities. This is a centuries-old rule that requires every trust to terminate within a prescribed time frame. North Carolina has modified the common law Rule Against Perpetuities. The N.C. Court of Appeals, in Brown Bros. Harriman Trust Co. v. Benson, has approved the use of dynasty trusts in North Carolina. The Court said that a trust “may remain valid in perpetuity” as long as it complies with certain statutory requirements. So N.C. residents would be able to use dynasty trusts to avoid taxes.
 
A bigger issue for most people is the step up in basis. When the estate tax was repealed briefly in 2010, so was the step up in basis. The Trump plan would eliminate a step up in basis on capital gains exceeding $10 million. Contributions of appreciated assets into private charities established by the decedent or their relatives would be disallowed. With the proposed capital gains tax rate of 20 percent, the tax on inherited assets over $10M would be considerably less than the 40 percent estate tax rate under current law. And because the capital gains tax would presumably only apply to appreciation, taxpayers would not be taxed on the full value of their gross estate.
 
At this point, we can only guess at what a Trump presidency means for estate and business planning.  Until the future becomes more clear, we have to continue to plan for uncertainty and flexibility. Basic planning for wills, trusts, powers of attorney and medical directives will not change. The probate process will not go away. You will still need to plan for minor children, businesses, out-of-state property, asset protection and second marriages. You will also need to ensure that your beneficiary designations are up-to-date and that you have carefully planned for your retirement benefits.

What Have You Been Waiting For?

I have recently been reading a book of Dietrick Bonhoeffer’s reflections on Advent and Christmas. Bonhoeffer waited in prison for 18 months before being tried and sentenced to death by Nazis without witnesses against him or a defense. So he knew something about waiting. He wrote that “[w]aiting is an art that our impatient age has forgotten.”

If Bonhoeffer thought people were impatient then, he wouldn’t believe what has happened to our society over the last 10 or 15 years. Technology has allowed us to accomplish more than ever before. But it has also changed the way we think and act. Twenty years ago I did not have a mobile telephone. If I had internet, it was dial up. When I went on vacation I actually took the week off. Now I can work from anywhere in the world. I check my email before breakfast. I often leave the newspaper in the driveway and I check the news on twitter. I am always trying to accomplish more. And when I accomplish more, I try to find ways to become even more efficient.

Advent is a celebration of waiting. In the third chapter of Genesis, God promised the serpent that Eve’s offspring would crush him. Later in Genesis, God told Abraham that through him all people would be blessed through his offspring. Isaiah, Micah and Zechariah all told of the coming of a king. Galations 4:4 says that that God sent his Son “when the fullness of time was come.” But it took thousands of years for the time to come. Millions of people spent their whole lives waiting.  

Bonhoeffer says that the only people who can wait are those who “carry restlessness around with them.” He says that if you are satisfied you can’t wait. I think he’s saying that you aren’t waiting unless you have something to wait for. With regard to Advent, he says that it can be celebrated only by those “whose souls give them no peace, who know that they are poor and incomplete, and who sense something of the greatness that is supposed to come. . .” So during Advent we celebrate the wait for first incarnation and we wait for the mystery and the greatness that is to come.  

The impatience and uneasiness that we live with every day should help us embrace the spiritual uneasiness of Advent. I am fortunate to be able to work with all types of people. Some are young and some are old. Some are in good health and some have debilitating illnesses. Some are rich and some are poor. I help people plan for new babies, new businesses, retirement, charities and the next generations of their families. We are all waiting for something.  We all carry restlessness around with us. We are restless because we have so many things to accomplish. We are restless because we don’t know what tomorrowholds. We are restless because we know that we are incomplete. We are restless because we sense something of the greatness that is to come. 

I hope you take the time over the next week to think about what you are waiting for.        

Special Needs Fairness Act Overwhelmingly Passed by House

On September 20, 2016, the U.S. House passed the amended version of the Special Needs Trust Fairness Act. This proposed legislation would correct an obvious error in current law. At present, first party special needs trusts must be created by the disabled person's parent, grandparent, or guardian, or by a court. The current law does not allow a disabled person who is mentally competent to create the trust. The new law would correct this error.  The few people who are opposed to the bill seem to be more concerned about other items that were thrown in than about the underlying purpose of the bill. The proposed law has now passed both the Senate and the House. But because the House added some additional provisions, it must be passed by the Senate again

Act Now if You May Qualify for Veterans Aid & Attendance

VA  Aid & Attendance can be a tremendous benefit for certain veterans who served during a period of war. There are income and asset limits for Aid & Attendance qualification. However, at the present time, there are no gift penalties and no look-back period. Although giving away all of your assets without the guidance of competent legal counsel can have disastrous effects, there are powerful planning opportunities for qualified veterans. But those planning opportunities will soon become more limited. 

On January 23, 2015, the VA published a comprehensive rule that would amend the portion of the code of federal regulations that covers net worth, asset transfers, and income exclusions for needs-based benefits.  One of the proposed changes would create a 3-year look-back period and a transfer penalty.  

The VA did not initially give any guidance on when the proposed rules would come into effect. However, on October 6, 2016, a VA staff member stated that because of the complexity of the rule and the large number of comments received, the VA does not anticipate publishing the final rule before April 2017.

There is no indication as to whether the new rule would be retroactive or whether it would effect pending applications. Whether or not to use current planning tools is a decision that each applicant must make. But it is clear that VA planning will become much more difficult after the new rule is published.   

Don't Disinherit Your Special Needs Child

If you have a child with special needs, you face unique challenges when planning your estate. Depending on your child’s disability, he or she may one day rely on means-tested federal programs, like Supplemental Security Income (SSI) and Medicaid, to help pay for basic needs like food and shelter. These programs have income and asset limits, and lots of rules.
 
If you treat your disabled child like your other beneficiaries, you could make him or her ineligible for those benefits. That would be a waste of your assets, and could leave your child without the financial resources necessary to live the same kind of lifestyle you have been able to provide.  Unfortunately, this leads some parents to disinherit a child. This leaves your child in the same position. Medicaid and SSI will pay for only a very minimal standard of living.  
 
The cheap and dangerous way to handle this problem is to leave assets to another child along with unofficial instructions to “take care of” your special needs child. This may work on a short-term basis. But it is a risky long-term plan. Should your beneficiary develop financial problems or a change of priorities, your special needs child will suffer the consequences. If your beneficiary passes away or become incapacitated, those assets may no longer available to your special needs child. Finally, this can just become a burden to your other children.  
 
A much better option is to set up a Special Needs Trust for your child.  This trust lets you leave your special needs child an inheritance without jeopardizing his or her eligibility for benefits. The funds are protected, and can be used to supplement your child’s standard of living.  Special Needs Trusts are complicated. So you need the help of an attorney who is experienced in this area. There are different types of special needs trusts, and they are frequently drafted incorrectly.  
 
Special Needs Trusts can be incorporated into your Will.  However, your Will becomes a public record when it is probated.  This means that anyone can find out their details of the trust. This could put the vulnerable beneficiary of your special needs trust at risk for being harmed by financial predators. If your beneficiary has a high risk of exploitation, you may not want your child’s trust and the amount of money that goes into the trust to be a public record. A special needs trust that is established outside a will, in either a revocable living trust or a standalone special needs trust can remain totally private. No one other than the people who need to know the trust details can have access to them.
 
If you have a loved one with special needs, we can help you evaluate the alternatives and help you plan appropriately for the future.

Estate Planning for Young Families

Many couples in their 20s and 30s put off estate planning because they either don’t think they need an estate plan or don’t think they can afford one. Neither is true. Even a healthy young adult can suddenly become incapacitated or pass away due to an accident or illness. While this is not likely, if you have a spouse or children, it is irresponsible to not plan for this possibility. And it does not have to be expensive. A young family can start with basic legal documents and term life insurance, then update and upgrade as their financial and family situation changes.
 
Protecting Your Children When Both Parents Pass Away

If you are a parent of a minor child, your biggest estate planning concern is who will raise your children if both you and your spouse pass away. The chances of that happening are small. But you take that chance every time you get in a car together. If both parents do pass away, a Court will appoint a guardian for any minor children. Our statutes say that parents are presumed to know what is in the best interest of their children and that a recommendation in your Will “shall be a strong guide for the clerk in appointing a guardian.” If that happened, both the Clerk of Court and your family members would like to know what you wanted. Leaving these instructions in your Will can also keep your family members from fighting over this issue. A lot of young parents don’t do an estate plan because they can’t decide who should raise their children if  they aren't around. Putting off the decision doesn’t make the issue go away. You can always change your mind. 
 
You also have to be concerned about your child’s financial future. The first thing you have to do is ensure that your child inherits sufficient assets. If you don’t have a lot of assets, that probably means a term life insurance policy. Unless that life insurance is left to the trustee of a trust that you create in your estate plan, a Court will have to appoint someone to oversee your children’s inheritance. There is a good chance that this will be a stranger to your family. And that stranger will be paid to handle your child's money. Another problem with a guardianship is that your children will receive their inheritance when they reach the age of 18. 
 
All of these problems can be avoided by creating a testamentary trust for your children. You can designate that your life insurance be paid to your trust, specify who will manage that money and how the money should be managed, and decide when your children may take control of the assets. All of this can be established for less than one year’s guardian fees.  
 
Protecting Your Surviving Spouse After Your Death
 
While it is not often that both parents pass away leaving young children parentless, we all know young mothers or fathers who lose a spouse due to a car wreck, cancer or some other tragedy.  This raises a different set of problems. But financial problems should not be one of them. If you depend on your spouse’s income or will have to pay for someone to take over responsibilities that your spouse handled, you should plan for a way to replace that income or pay for extra services. This is another situation in which life insurance may help. Guaranteeing the financial stability of your family might cost less per day than your cappuccino. 

Most people who are married want their assets to go to their surviving spouse at their death. Some assets will transfer automatically to the surviving spouse by beneficiary designations or because of how title was held. But for other assets, the outcome is not so clear. If you have two or more children, current N.C. law provides that the surviving spouse is entitled to the first $60,000 in personal property that is subject to probate, and 1/3 of the remaining property. Your children split the remaining property equally.  If you have real estate in your name only, your minor children will end up owning a portion of that property as well. Your will or trust can avoid that problem. 

Protecting Your Family if You Become Disabled

There is always a possibility that you could become disabled or incapacitated. If that happens, your spouse will not automatically have the authority to make decisions for you. Everyone needs to have financial and medical powers of attorney for this purpose.  If you are married or have children, this is even more important.  Financial and medical powers of attorney give someone else legal authority to make important decisions when you are unable to do so for yourself. If you are married, you will probably name your spouse. But even if you are healthy and young, you should also name a backup. You should also consider a living will and a HIPAA authorization. If your employer does not provide it, you may also want to consider disability insurance.
 
If you are young and have a family, you owe it to your spouse and children to make sure they are taken care of if you are suddenly removed from their lives.