When Dmitri remarried in 1989, he created a revocable trust for his wife and his two sons from his first marriage, his only descendants. The sons were to receive a distribution from the trust at Dmitri’s death, but most of the assets were to remain in trust for the life of the surviving spouse. At the survivor’s death, the trust would terminate in favor of the sons or their descendants. The sons were named the trustees of this trust.
Some 23 years later, Dmitri had a change of heart. In August 2012 he had the revocable trust restated, removing the sons as trustees, and he also removed the distribution to them at his death. The sons were very unhappy with this development, and they let their father know about it. They were particularly displeased with the choice of Celia Rafalko as successor trustee, as they believed that she was a close confidant of their stepmother. Dmitri took umbrage at their communications, which, he felt, impugned the character of his wife and showed a lack of confidence in his judgment.
Dmitri died in December 2012. In January 2013 one brother wrote to his stepmother proposing that they all agree to terminate the trust, splitting the principal equally among the brothers and the stepmother. He also asked that all records of trust administration be preserved carefully.
Unbeknownst to the brothers, Dmitri had a second restatement of the trust done in September, after the disagreement with the sons. This time the trust included an in terrorem clause, which disinherited any beneficiary who interfered with the administration of the trust. When they learned of the secret clause, the first son backed off on his suggestion, and the second son disavowed any knowledge of the suggestion to terminate the trust.
In accordance with the September trust, Rafalko sent the sons releases to be signed, in which they promised never to contest any aspect of the trust’s administration. They signed. Nevertheless, Rafalko warned the sons that she was going to consider whether they had violated the in terrorem clause. In May 2013 she told the sons that they were disinherited. This would have no effect on the stepmother’s trust interest, but it did result in Rafalko having the power to direct the trust assets to charities at the stepmother’s death.
The sons challenged their disinheritance, and the Virginia courts found that the trustee had acted in bad faith. Communication regarding a change in the trust’s administration is not the same thing as mounting a legal challenge to it, and the brothers instantly backed off when they learned of the in terrorem clause. As the purposes of that clause were fully achieved, the trustee’s further “punishment” of the sons was an abuse of discretion. The sons were also awarded some $45,000 in attorney’s fees, to be paid out of the trust.
© 2016 M.A. Co. All rights reserved.
Authored by Sean Rice
In the event of a personal injury litigation settlement, the mainstream solution has been to place some or all of the beneficiary’s proceeds into a structured settlement annuity contract. Reasons for this investment choice vary among those involved in the settlement process. Some cite the desire to protect the funds from creditors and predators. Others see safety and reliability in the monthly stream of income, while others simply express a lack of familiarity with alternative solutions such as trusts and professional trustees.
While annuity contracts can offer protection from acquisitive friends and relatives, the appeal of a guaranteed rate of return, and a reliable income stream, they can produce many significant disadvantages. While some structured settlements provide a lump sum payout in addition to the annuity, many settlements do not provide enough liquidity to access funds in case of an emergency or a large, important life event. This is due to the payout structure of an annuity. In exchange for a large, upfront one-time payment, the insurance company is legally obligated to make steady (typically monthly) payments to the beneficiary. These payments can begin immediately, or can be deferred for a certain period of time. But problems can arise when a beneficiary is in need of funds that exceed the distribution limits of the annuity contract. In these cases, the beneficiary may need to consider “surrendering” the annuity, or selling the income stream to a third party company. Either option may subject them to fees, early termination penalties, and potentially adverse tax consequences. With today’s rising costs for higher education, annuity contracts that are subject to any of these consequences can prove to be an impractical source from which to fund a minor beneficiary’s college expenses.
Annuity contracts are popular due to their promise of a reliable income stream over a long period of time. They can also be structured so that the payments from the settlement are received income tax-free by the beneficiary. While this may sound like a win-win situation, the sometimes less obvious issue is the “time value of money.” A simple calculation of the present value of many annuities often yields disappointing returns over time when one factors in inflation. If the true annuity yield is low, the income tax savings advantage for the annuity becomes irrelevant when compared to a higher-yielding, taxable investment. Annuity payments (hypothetically) growing at a guaranteed 3% return is a simple tradeoff: by agreeing to a modest but steady rate of return, the beneficiary is sacrificing potentially higher long-term yields compared to an actively managed, asset-allocation investment strategy.
Structured settlement annuities are sold as a way to make the funds last over the lifetime of the beneficiary, with some arguing that a lump sum can be spent quickly by the beneficiary. However, placing the funds into a trust and naming a professional trustee to manage those funds addresses both concerns. The trust can receive a lump sum settlement, rather than an annuity stream, and a trust company can serve as the unbiased professional trustee. The trustee has a fiduciary duty to manage the assets held in trust, and to follow the terms of the trust document on behalf of the beneficiary. The trustee assesses the risk tolerance, time horizon, and liquidity needs of the beneficiary, and formulates an appropriate investment strategy for the funds held in trust. The trustee can even provide for the beneficiary’s health, education, maintenance and support, is able to expend the funds necessary for key needs such as college tuition, a vehicle purchase, a home purchase, or medical expenses.
Trusts are an ideal solution for many different scenarios. If the beneficiary is a minor, instead of locking up the proceeds in a structured settlement, a professional trustee can manage a liquid, lump sum on his or her behalf. The trust can provide regular investment income, as well as discretionary distributions to provide for basic needs. Additionally, if the beneficiary is disabled and is (or eventually will be) eligible for governmental benefits, a lump sum settlement payout can be placed into a Special Needs Trust (SNT). SNTs allow for a beneficiary to receive supplemental support from the trust without reducing or eliminating their eligibility for means-based governmental benefits, such as Medicaid or SSI. If a settlement beneficiary is eligible for valuable governmental benefits, it is critical to ensure the proceeds of the settlement are made payable to a qualified, first-party SNT. Since the rules and regulations of SNTs are complicated, and following them correctly is so critical, naming a professional trustee instead of a family member is almost always the best solution.
Annuities can serve the needs of many individuals as a useful fixed income portion of their overall financial portfolio. But issues arise when large sums of money are placed into an annuity; sums that represent a huge portion of a client’s wealth or available resources, which is quite often the case in personal injury settlement situations. Creating a trust and naming a professional trustee provides the beneficiary with ongoing professional asset management and guidance. Moreover, the beneficiary will have access to both income and principal distributions to meet their needs, and they can benefit from creditor protection. Most importantly, beneficiary can take comfort in knowing that, over the years, they have a trusted fiduciary they can count on to guide them through life’s inevitable uncertainties.
Call Sean Rice at Garden State Trust Company to learn more about the many benefits of trusts.
© 2016 M.A. Co. All rights reserved.