A common misconception is that estate planning, and in particular, the creation of trusts is only something that applies to wealthy individuals and families. This myth has been exacerbated by the increase in the estate tax exemption (i.e. the amount of wealth that can be transferred to the next generation before incurring an estate tax) over the past several years. When I started practicing law in 2001, the Federal estate tax exemption was $675,000, and the Federal estate tax rate topped out at 55%. Since that time, the exemption has increased several times and currently sits at $11.18 million per person or $22.36 million per couple (although the current law is set to expire in 2026 at which time the exemption will be cut in half) and the Federal estate tax rate is 40%.
While it may be accurate that the need for estate tax planning and tax shelter trusts are only necessary for eight figure estates (although this is debatable given the frequency at which the tax laws change), the benefits of using trusts for non-tax reasons are greater than ever. Some of the most important non-tax reasons to use trusts are: (i) maintain control over a younger or irresponsible beneficiary; (ii) protect assets from a beneficiary’s creditors (including divorce and lawsuit); (iii) assure that assets remain in the family; (iv) provide for business succession and governance of shared family assets; (v) incentivize beneficiaries to work hard; (vi) care for a beneficiary who is receiving governmental benefits without risking those benefits and (vii) probate avoidance.
For example, with divorce rates being so high today, many of my clients want to make sure that assets that they leave behind are ultimately only for the benefit of their children and grandchildren, and not at risk of being lost to a child’s spouse in the event of a divorce. Other clients fear that with children seeming to mature at later ages in today’s society, a child may squander his or her inheritance or decide not to graduate from college or seek out a job if they were handed a sum of money at too young an age.
Whatever the reason for wanting to create a trust, it is extremely important that the trust be drafted properly in order to accomplish its objectives. Most trusts require the trustee to make distributions to a beneficiary upon the beneficiary’s attainment of certain goals (graduating from college, buying a house, attaining a specified age, etc.). However, requiring distributions can have unintended consequences, including loss of creditor protection (even in divorce proceedings). In addition, the lack of flexibility in these trusts does not allow the trustee to adapt to changing circumstances. Instead of creating trusts with mandatory distributions, it may be wise to use a purely discretionary trust.
Unlike trusts with mandatory distribution requirements, discretionary trusts authorize (but do not require) the trustee to make distributions to a beneficiary at certain times or for certain purposes, or simply provide that the trustee can make a distribution for any reason the trustee deems to be in the beneficiary’s best interest. Discretionary trusts generally offer enhanced creditor protection and flexibility to adapt to future circumstances. Many clients worry that a trustee will not be able to capture their intent without providing specific requirements in the trust document. This is why I recommend that my clients write a letter of direction to their trustee. In many cases, using a discretionary trust with a letter of direction gives a client the best of both worlds – strong protection and flexibility along with a clear statement of their thoughts and goals. Of course, the letter is non-binding on the trustee. As such, it is important that the client feel that he or she can rely on the trustee to carry out his or her wishes as best as possible in a changing environment. My experience with clients is that they generally have a friend, family member, or trusted advisor who they can rely on.
Please feel free to reach out to me if you would like to learn more about this or have any questions. Finally, if you know anyone who needs help putting together their estate planning documents we are always looking to help new clients.