From time to time, I like to write sample case studies to represent common legal circumstances related to estate planning. We have discussed family trusts on the blog recently, so I would like to present a case study example on this subject.
Meet William and Mary
William and Mary were married for many years. William passed away, and Mary is a lifetime beneficiary of a family trust created under William’s estate planning documents. As previously explained, a family trust is a “complex” trust for tax purposes. It is designed to achieve traditional “credit shelter” or “bypass” trust objectives by keeping certain financial assets out of Mary’s estate. It also provides creditor protection, as Mary’s creditors (if any) cannot attach the family trust assets, as Mary does not own these assets.
In William’s and Mary’s case, there were several reasons why the family trust was created, as described below.
Financial Threat Protection
William and Mary were aiming to protect against the following three (3) threats:
- Lawsuit: The surviving spouse could make a mistake (accident, miscalculation, error in judgment) that would lead to them being sued and threatening loss of all his/her financial assets.
- Divorce: The surviving spouse might get remarried and later divorced. The family trust would be protected from the divorce settlement, so that they could be passed onto the appropriate heirs from William and Mary’s original marriage.
- Nursing Home: William and Mary were both aging, and an eventual need to reside within a nursing home was a real possibility for the surviving spouse. They did not have sufficient long-term healthcare insurance, and so they feared the care costs might eat into their assets.
Therefore, a family trust was an effective estate planning option for William and Mary. The trust was funded by William’s assets up to his remaining estate tax exemption amount. When William died, Mary became a lifetime beneficiary of the trust. Even if Mary is trustee, the income and principal may still be distributed for her benefit without causing inclusion into her estate, if limited to the ascertainable standards of health, education, and maintenance. Subject to these standards, the amounts and timing are in the trustee’s discretion. William’s children may also be named current beneficiaries, and/or as remainder beneficiaries. Mary would retain control of the trust during her lifetime, with (as indicated above) its assets to remain protected for the children’s/descendants’ benefit when she passes away.
Since the family trust need not distribute income (unlike a marital trust), it can be retained in the trust and protected in case of a threat or potential threat. The trustee (Mary) also has the option to distribute some or all of the income to another beneficiary (one or more of their children/descendants) with reasonable discretion. The tax liability for the income would then carry to the beneficiary.
Family Trust vs. Basis Bump Trust
For William and Mary, the family trust was updated to become what we sometimes call a “basis bump trust” because it would contain a formula-limited general power of appointment (GPA). Their family trust granted Mary a GPA over the trust assets, with the specific power limited to:
- An amount of assets equal to Mary’s unused estate tax exemption, and
- Only to trust assets with built-in gain.
If Mary’s own estate is less than her estate tax exemption amount, certain family trust assets will be included in her estate for this “unused exemption” to apply. These assets will receive a step-up in basis upon Mary’s death, but the formula limitation excludes assets that would trigger either (a) an estate tax or (b) a “step-down” in basis.
Updating Your Estate Plan
It is recommended that a family trust (along with all estate planning details) should be reviewed and potentially updated at least once every two years. As our lives—careers, relationships, family situations, financial assets, health, etc.—change, it is important to continually update your estate plan to reflect your current lives and new current and future threats to your estate and heirs.
The William and Mary case study is just one hypothetical example to demonstrate a value of a family trust. To learn more about family trusts and/or to update your family’s estate plan, contact me today.
