Tried and True Trust Provisions May Not Always Be The Best Fit

iStock_000009163885XSmallOld habits die hard but recently I have found myself re-thinking some of the basic tenets of tried and true estate tax planning involving revocable trusts. This article discusses one such tenet, with others to follow in subsequent posts.

Trusts that are designed to minimize estate taxes typically subdivide into two separate shares upon the death of the person who created the trust. In Massachusetts, the first $1,000,000 of the client’s assets are allocated to one share, which our office refers to as the family trust (and other lawyers label as the bypass or credit shelter trust), and the client’s remaining assets are allocated to the other share, called the marital trust.

The tax laws require that the surviving spouse be named the sole beneficiary of the marital share and receive distributions of all of its income. Discretionary distributions of principal also can be made, if desired. In contrast, the tax laws do not mandate the terms of the family trust. The family trust typically is for the primary benefit of the surviving spouse, but also can include the decedent’s descendants (children and grandchildren) as beneficiaries. The trust usually gives the trustee the authority to distribute trust income and principal to one or more of its beneficiaries for their health, education, maintenance and support. The surviving spouse often serves as the sole trustee of both trust shares.

Based on these general rules, if Charlie Client died owning $1,200,000 of assets, $1,000,000 of Charlie’s assets would be allocated to the family trust, and $200,000 would be allocated to the marital trust. My concern involves the terms of the family trust under these circumstances, in particular the presence of Charlie’s children as co-beneficiaries with Charlie’s wife. In many situations the family trust will be larger than the marital trust and yet the smaller of the two funds (the marital trust) ends up being the share that is dedicated exclusively for the benefit of Charlie’s wife.

Although this approach makes sense for a young family, where providing for the children is as important a goal as providing for the surviving spouse, what about later in life, when the children are adults and leading their own lives? Most couples tell me that when they reach this stage of life their primary goal is to take care of each other. However, in estates of modest size the typical trust structure runs counter to this because it puts most of the client’s funds in a trust that includes children and grandchildren as co-beneficiaries rather than dedicating those funds for the exclusive benefit of the surviving spouse.

To further complicate matters, unless specifically waived by the trust, the trustee of the family trust will be required to provide an annual accounting of the trust’s finances to the children as beneficiaries so that the children will know how the trust funds were invested and spent or distributed among the spouse and children. Could this information cause some of the children to put pressure on their mother or father, as trustee, to curtail what might be perceived as overly generous trust spending for their parent’s support, or to change the trust’s investment approach to a more aggressive growth oriented approach rather than one that emphasizes safety and income? Fortunately, in most families the risk of conflict is low, but often times the undercurrent is still there even if not spoken. And the risk is exacerbated if step-children are included as trust beneficiaries with the surviving spouse.

Given these dynamics, would it make more sense to name the surviving spouse as the sole beneficiary of the family trust as well as the marital trust? The surviving spouse would still have the ability to provide assistance to children and grandchildren by making gifts to them from the spouse’s personal funds even if they no longer were beneficiaries of the trust. Alternatively, you could change the trust allocation formula and allocate all of the trust assets to the marital trust, and then give the surviving spouse the right to re-allocate some of the assets to the family trust in the spouse’s discretion (a complicated topic for a future blog article!).

Each family may have different answers to these questions. What’s important is that the options get discussed. The tried and true approach may continue to make sense, but at least the options will have been explored and the resulting trust will end up being tailored to the client’s family needs and priorities. Duck


About Andy O'Donnell

Andy is a partner of the firm, practicing in the areas of tax law and estate and business planning. He is the former chair of the Trusts and Estates Group, and he currently serves as a member of the Management Committee.
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