Pet Trusts

by Bruce Fenton

Your family’s estate plan likely covers a broad range of contingencies dealing with the care of our property and most importantly, your dependents. However, it is quite likely that it does not include contingencies for dealing your pets needs.

Sad but true, we plan for everything in our lives but often fail to plan for our pets.

Some time ago I read about a will that left a significant amount of money to a named custodian for a dog … a truly wonderful gesture for the custodian considering the dog had been dead for a number of years.

Not all pets die sooner … many have very long life expectancies. Take Cockatoos; they might live up to 70 years, or that warm, cuddly ball python wrapping itself around your feet might live 40 years or more.

In an article in Financial Planning magazine, Arthur Kroll sets forth a number of excellent suggestions on how to ensure a pet is properly cared for in the event of the owner’s death or disability.

He suggests starting by selecting a willing and able caretaker in the event of the owner’s incapacitation. The owner should create a pet card (with a photo) identifying the pet and naming the caretaker.

The caretaker should be given appropriate information about the care and feeding, medications, emotional needs and behavioral issues.

Another appropriate suggestion is to write a living will for the pet. This document will instruct the veterinarian how far he/she should go to keep a pet alive in the case of serious injury or illness.

An integral component of any estate plan is a durable power of attorney. Pets are considered tangible personal property and the person named in the durable power should be willing to care for the pet. If not, the owner should prepare a second document dealing with the caretaker and compensation for care of the pet.

Some states have adopted enforceable pet trusts enabling owners to transfer funds for long term care into a trust. The named trustee is responsible for seeing to the proper care of the pet. To ensure that the funds are spent properly, the grantor of the trust must also name a third party to oversee the actions of the trustee.

In states where pet trusts are not enforceable, the owner may wish to set up a traditional trust that names the trustee as a contingent beneficiary. The trustee is a fiduciary with fiduciary obligations to the pet. As long as the pet lives, the trustee receives distributions from the trust for the benefit of the pet.

A word of caution … this type of planning is not common and requires the assistance of a competent and experienced professional. But, given the wide range of pets, extended life expectancies of some, and the love and devotion shared by owners, it is a part of estate planning that should not be overlooked.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Wealth Preservation Trusts

by Bruce Fenton

“Put not your trust in money, but put your money in trust,” advocated the late Oliver Wendell Holmes. Today, trusts play an important part for those wishing to preserve wealth for multiple generations, protect assets, and provide long-term solutions to care for those who are not able to manage their own affairs.

In the early 1900s, a handful of industrialists and entrepreneurs such as Rockefeller, Ford, and Carnegie had amassed tremendous fortunes. As these 20th Century entrepreneurs aged, preserving their estates from the ravages of estate and transfer taxes became a priority. They knew that when they died, and when their children died, the multi-generational estates would be heavily taxed.

Many of these successful families created separate trusts—legal entities designed to own property for future generations—with little or no future estate taxes. What they did, in the process, was create the dynasty or wealth preservation trust.

In today’s tax system, gift and estate taxes are levied every time assets change hands by gift or bequest at death. The dynasty trusts avoided those taxes by creating a second estate that can outlive most of the family members while providing for future generations. Unlike the more common revocable living trusts, these trusts are funded by making irrevocable gifts into the trust. This means that the person putting the property into trust—the trustor or grantor—gives up all rights to future benefits from trust assets.

By removing the grantor from any ownership interest, the trust accomplishes three important tasks. First, it removes the property from the estate of the grantor. Second, it removes the assets from the reach of creditors who might attempt to seize assets of either the grantor or the trust beneficiaries. Finally, the trust has a life that goes beyond that of the grantor.

The last two points make these trusts important planning tools for those grantors who wish to preserve wealth for trust beneficiaries who might not be able to manage their own affairs, such as a special needs trust for a disabled child or a family situation that could conceivably be the target of a future lawsuit.

In the last few years, states like Delaware and Alaska have adopted trust-friendly laws that make them attractive for trust creation and maintenance. Neither state imposes a state income tax on trust income. Both allow for trust life spans to continue in perpetuity and also allow “self-settled” trusts.

With self-settled trusts, the grantor or the settler of the trust can put property into a trust managed by an independent trustee who retains discretionary powers to pay out trust income to the settler. This allows an individual to place property into a trust and derive an income at the discretion of the trustee while shielding assets against “unknown future creditors.”

As a result of these trust-friendly laws, the trust business is big business in states like Delaware, where the DuPont family used trust laws to their advantage many years ago. A number of highly reputable trust companies operate within the state, helping those wishing to set up wealth preservation trusts or acting as independent trustees for existing trusts.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Dynasty Trusts

Sooner or later it dawns on us that taking our wealth with us when we check out is not an option. Leaving it to Junior who, with various body piercings, tattoos, and questionable friends, is interested in spending, not managing, the wealth, is also not an option. The English, about the time of Robin Hood, came up with a solution they called “uses”—we know this principal of law as “trusts.”

A trust is a legal entity that can own, manage, and dispose of property, according to applicable laws and the language of the trust document. A “trustor or grantor” who places property into the trusts by changing the ownership into the name of the trust creates a trust. A “trustee” manages the trusts, while a “beneficiary” receives the benefits.

In modern context, trusts are used to manage wealth for purposes of reducing estate, or gift taxes, caring for beneficiaries not capable of managing their affairs, and providing for the health and educational needs of future generations.

In feudal England, kings taxed the transfer of property from a nobleman to his descendants. To avoid these taxes, the good lords came up with the concept of “uses,” the trusts of the times, which gave rights of usage to descendants, but not ownership. This maintained a perpetual ownership, depriving current and future kings of taxes.

Kings reacted to these trusts as you might expect, by outlawing perpetual ownership. In 1681, the Law of Perpetuities was actually codified by Lord Nottingham, who held that a trust could exist only for the lifetime of the beneficiary, living at the time the trust was created. Later, the law was modified so that the trust could extend for 21 years after the death of a person alive at the time the trust was created. This remains the modern version of our current trust law, and the rule against perpetuities.

Lord Nottingham’s ruling, besides ensuring a flow of tax revenue for the King, was well grounded in social issues. If property was held forever in trust, there could be no market for the property. There could be no opportunity for entrepreneurial development. Wealth would remain in the hands of a few, leaving the poor without opportunity to better themselves.

Trust laws in the U.S. did not allow for these dynasty trusts until 1983 when South Dakota changed their laws to allow for the creation of dynasty trusts. Today, these trusts are now legal in 13 states: Alaska, Arizona, Delaware, Idaho, Illinois, Maine, Maryland, New Jersey, Ohio, Rhode Island, South Dakota, Virginia, and Wisconsin.

Not all dynasty trusts are created equal. Some states, such as Delaware, Alaska, South Dakota, and Illinois do not tax the income of trusts brought in from out of state, while they do tax residents. Alaska has a very aggressive statute that allows the grantor (person placing the property into the trust) to receive income from the trust while at the same time allowing the assets within the trust to grow outside of his estate. This places the assets outside the grasp of creditors and some potential future estate taxation.

Just when you thought we got rid of kings centuries ago, think again. In 1986 Congress created the Generation Skipping Transfer Tax (GSTT) which taxed a trust at the maximum estate tax rate, 55%, each time the last members of a generation drawing benefits from a trust died. Congress did allow for an exemption of $1.06 million that could be used at the time the trust is set up. This allowed a couple to put just over $2 million in the trust and have the trust avoid paying the GSTT, no matter how many generations in the future draw from it.

Such dynasty trusts, properly funded and managed, could allow a family’s wealth to benefit many, many generations, effectively allowing the creator the opportunity to control from the grave.

Special Needs Trusts

by Bruce Fenton

A Fathers’ Day column by Sports Illustrated® writer, Rick Reilly, brought to mind how important it is that we plan for special children who may need extra care throughout their lives. Reilly told the story of a father and his son, who together were able to accomplish remarkable athletic feats.

The son was born with a birth defect that rendered him unable to talk, or move any of his limbs. Rather than view his disabilities as a limiting factor, his father began including him on his runs, pushing a wheelchair…on his bike, sitting on the handlebars…and on his swims, towing the boy in a small dingy.

Despite the fact that his son has learned to get along as a functioning adult, he will still require special care throughout his life. In this situation, a Special Needs Trust (SNT) can play an important role.

Government programs in the form of Supplemental Security Income (SSI) and Medicaid are available to help disabled persons with poverty level necessities of life…income for food and shelter and medical care.

To qualify for these benefits the disabled person must be impoverished. The disabled and/or their family applying on behalf of a child must show financial resources do not exceed certain limits and the benefit recipients are allowed to retain only a a certain amount in assets, with some exceptions. A person with a disability receiving SSI, who accumulates more this amount in cash resources, may lose SSI and, possibly, Medicaid.

The disabled need more than poverty level benefits. Yet, if the disabled person has the assets to pay for extras such as out of pocket medical expenses, transportation, property insurance, eyeglasses, rehabilitation or pay for the purchase of goods and services that add pleasure and quality to life like videos, furniture or TVs…they could be disqualified for SSI and possible loss of health insurance.

Parents planning for the future of a child can usually manage their assets to care for their child on SSI. However this issue becomes critical when the parents pass on. If they leave estate assets directly to the child they risk his/her disqualification from SSI. An estate plan that passes assets to a testamentary trust for the special needs of a disabled child can protect that child’s ability to qualify for SSI benefits.

The SNT can be funded with contributions from grandparents, other family members, as well as from a parent’s estate. Laws regulating these trusts are constantly changing and tightening the eligibility criteria for receiving government benefits. The complex nature of SNTs requires an in-depth knowledge of the current legislation, and how it impacts people planning for their child with special needs in order to preserve eligibility. Setting up a special needs trust requires coordinated planning with an attorney knowledgeable in special needs planning who can draft a will and necessary trust documents. This is not for the “do-it-yourself” estate planner.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Conservation Easement

by Bruce Fenton

A few years ago, a sale of 7,000 acres of California coastal property to a Land Trust, coupled with a contentious ballot issue involving a public conservation agency focused attention on conservation of lands and public policy.

Public policy supports conservation of lands in its undeveloped state by providing both Federal and State income and estate tax breaks for owners who donate property or property rights to conservation organizations. Using the set tax breaks correctly in an estate plan can serve to keep land in a family that might otherwise have to be sold to pay taxes.

Land can be valuable to us in many ways. To an investor, the value of a parcel of land is in the profit to be made from its sale. To an owner of commercial property, the property's value is in the rents that can be collected for its use.

Due to the dramatic increase in property values in recent years, a family of otherwise modest means may own land of considerable appraised value. Upon the death of the last surviving parent, the heirs may face the obligation to pay state and federal estate taxes without having the financial resources to meet that obligation. Their only recourse may be to sell all or part of the land which was left to them, despite their own desires and the expressed wishes of their parents. In short, the failure to plan for the future of valuable family land after death may grant control over that land to the taxing agencies of government. Fortunately, there are alternatives.
By reducing the appraised value of land, the donation of a Conservation Easement to a Land Trust can reduce income and estate taxes. Since most of the appraised value of land is in its potential for development, the donation of development rights to a Land Trust leaves only the remaining value as taxable. This donation may also create a tax-deductible, charitable contribution in the year of the gift.

Thus, the donation of a conservation easement can protect land in two ways. First, it protects the conservation values of the land according to the specific restrictions contained in the conservation easement. And, second, it protects the integrity of the land from the threat of sale to satisfy estate taxes. Furthermore, this protection option can reduce income and property taxes for the parents while still living.

Since each conservation easement is individually written to address both the personal needs and the intentions of the donating landowner, land protected by a conservation easement can continue to be used by the donor’s heirs as the family has been accustomed. A family farm, for example, can be used, in perpetuity, for the production of crops and the pasturing of livestock. And, every bit as important, it can provide a home for the future generations of the family that has cared so deeply about its farmland.

Although Land Trusts have been protecting lands in the United States for over a century, most have been founded in the last 30 years. The earliest examples—such as the “Village Improvement Societies” of New England, the Maine Audubon Society (founded in 1843), and the Cincinnati Museum of Natural History (established in 1800)—were located in the eastern states. In 1965 there were 132 active Land Trusts all across the United States. By 1991 the number had increased to over 900, preserving nearly 3 million acres of valuable lands.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Incentive Trusts

by Bruce Fenton

Lets us look at the case of a couple seeking estate planning advice. They had worked hard to develop a successful family business, which they had recently sold. They wanted to pass on their sizable estate to their two children and several grandchildren and minimize estate taxes in the process.

After going over all their options for minimizing taxes in the transfer process, it became clear that they had another major objective. They wanted the wealth that they had created through their hard work and perseverance to go to their children without ruining their incentive to work and achieve their own financial goals.

This couple is not alone. The single wealthiest generation to live is about to pass on an estimated $9 trillion to their heirs. The number of “millionaires next door” continues to grow.

This wealth creates problems for many of those people who created it in the first place. The majority of this wealth was created from meager beginnings through a strong work ethic and a willingness to sacrifice today’s pleasures for tomorrow’s benefits. Passing these values to future generations is just as important as passing on the wealth.

The famous investor, Warren Buffet, quoted in the September 29, 1997 issue of Fortune magazine stated it best when he said, “The perfect inheritance is enough money so that they feel they could do anything, but not so much that they could do anything.”

By providing an inheritance to future generations that allows them not to work, you will hurt—rather than help—them. Estate planning that focuses on the impacts of inheritance and tax issues is beneficial to both generations.

Incentive trust planning can be used to overcome some of the negatives generated by the transfer of too much wealth. An incentive trust is designed to encourage behavior that the estate creator would like to see exhibited by his heirs. At the same time, an incentive trust also restricts the ability of the heirs to live off the inheritance.

The design of the incentive trust will usually contain provisions that provide income as a safety net. Language might express the trust maker’s desires that certain standards of living, education, capital for business development, and health needs be met from trust income first. Excess income not distributed can be allowed to accumulate in the trust and/or paid out to specific charities.

A great deal of creativity can be exercised by the trust maker to provide for other payouts. For example, payouts can be structured to match income goals achieved by the heirs. Perhaps the maker wishes to reward those who obtain certain education goals with payments from the trust.
The remainder of the trust becomes a pool of capital from which family members can borrow or use for business development. In no case can they live off the trust.

Setting up incentive trusts can overcome many of the negative impacts surrounding substantial wealth transfer. Doing so avoids the old adage in estate planning, “The first generation makes it, the second generation manages it, the third spends it and the fourth starts over again.”

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Passing the House Along

by Bruce Fenton

Giving the family home to the kids may not be your idea of prudent estate planning, but in fact, passing the family home or a second home on to the next generation can have definite tax advantages. A Qualified Personal Residence Trust (QPRT) can be used for this purpose.

A QPRT allows the older generation to make a future interest gift to the younger generation of a primary or secondary home at a discounted value for gift and estate tax purposes. Since it is a gift of a future interest, the grantors (Mom and Dad), may retain the right to use the property for a term of years.

Current estate tax laws have increased the amount of one’s estate that can be transferred to a non-spousal heir. The plan of Congress was to eliminate the estate or transfer tax by 2010. However, due to the sunset provision of the law, on January 1, 2011, the estate tax comes back.

Given the fact that the Federal Government is operating in the red it is entirely foreseeable that estate taxes may never go away. After all, the easiest people to tax are those who don’t complain, as is the case with those deceased! Given the fact that Congress will need the money, it makes sense to me to plan that some type of transfer tax will always be with us, justifying the use of a QPRT as an estate-planning tool.

The mechanics of a QPRT are fairly straightforward. The grantor, or maker, of the trust is the owner of the home. The children are typically the beneficiaries of the trust.

The grantor gives the property to the trust. However, the grantor reserves to right to use the property for a set number of years he determines. The right to use and enjoy the property is assigned a value as determined by current IRS valuation tables. This value is subtracted from the current value of the property and the remainder is considered to be the taxable transfer.

At the conclusion of the term, the property is then owned outright by the trust and may be distributed out of trust to the beneficiaries, or remain in the trust as property of the trust.

The trust or the beneficiaries of the trust may sell the property, use it themselves, or even lease it back to the grantors, provided the lease is at fair market value. If they elect to sell the property, their tax basis is the tax basis of the grantor plus any gift taxes paid.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Generation Skipping Trust

by Wendell Cayton

He sits in his study, surrounded by the trappings of wealth acquired by a lifetime of hard work, musing about his successes; successes that have allowed him to build a very lucrative business, raise and educate his children, and now offer him time to enjoy his grandchildren.

A Generation Skipping Trust (GST) provides a unique estate planning opportunity for those like him who have accumulated wealth and wish to see it passed to future generations. A GST, properly funded, can reduce estate taxation and solve a variety of wealth transfer problems.

Typically, wealth transferred between generations is subject to estate taxation of up to 55% at each transfer. However, by skipping over the first generation and leaving wealth to the second generation, the transfers are taxed once instead of twice.

In his case, he wishes to skip over his children and leave a portion of his sizable estate to his grandchildren.

At a 50% tax rate, a total tax of 75% on a grandparent's wealth would be paid by the time it gets to the second generation. However, a special part of the tax code allows grandparents to skip the first generation with up to $1 million per grandparent, and leave it to the second generation, paying the estate or gift tax only once.

He and his wife can each set aside $1 million in trust for the second generation. If set up properly, the trust can allow the first generation to have income from the property while they live. At the death of the income beneficiary the principal passes to the next generation.

This type of planning solves a variety of other planning problems as well. First, consider the case of the first generation children who do not handle wealth well. A grandparent can give the children rights to income only from the trust and leave the principal to the grandchildren. This ensures that the first generation will not squander the family fortune.

Perhaps of greater concern to grandparents is the risk that a son/daughter-in-law may end up with the family money through divorce or death of the child, remarry, and pass the family wealth outside the direct bloodlines. Again, by providing an income-only interest, this can be avoided.

If the first generation children are involved in business activities that carry a high risk of creditor claims, or they are asked to sign personal guarantees for banks or other lenders, a Generation Skipping Trust provides an ideal solution for protecting family wealth from these claims.

While generation skipping provisions are usually written into most living trusts, typically, funding does not take place until the death of the grandparents.

Our grandfather can create a real family dynasty of wealth if he acts to fund the trust before his and his wife’s deaths. By setting up the trust and funding it with a life insurance policy on their joint lives, the parents can leverage the $2 million by ten times or more.

The money from the life insurance is all tax free: The income earned from the proceeds may be used to benefit first generation children, and remain free from creditors or a disaffected spouse. Doing so, he has provided for the management of his legacy into the future generations and has minimized the amount of his hard work that could be paid to 250 million strangers through the estate tax system.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.