Saving a Flawed Estate Plan

Given the unrelenting pace of change in the tax laws and in the economy, coupled with the ordinary changes in personal and family circumstances, any estate plan is bound to go out of date sooner or later. Sometimes planning failures may be remedied post mortem, sometimes not. Here’s a happy example.

Oskar Brecher died in 2016 with an estate of some $8 million. His last will and testament had been drafted in 1989. The federal estate tax had seen many important changes since then.

Brecher’s will left his surviving spouse the minimum amount needed to reduce federal estate taxes to zero, with the balance passing to a credit shelter trust, a routine approach to estate tax minimization at the time that his will was drafted. This was long before the major estate tax reforms of 2001, after which many states decoupled their death taxes from the federal template. Brecher died a resident of New York, which in 2016 had an estate tax exemption of $4,187,500, significantly lower than the $5,450,000 federal estate exempt amount.

Application of Brecher’s formula would result in a credit shelter trust of $5,450,000. A trust that large and not protected by the marital deduction would trigger a New York estate tax of $505,455, leaving $2,044,545 for the surviving spouse. The estate’s heirs petitioned to have Brecher’s will reformed, so as to reduce both federal and state death taxes to zero. In that case the credit shelter trust would be only $4,187,500, and the surviving spouse would receive $3,812,500.

The trust beneficiaries did not oppose the reformation, and the Surrogate’s Court granted the petition. Said the Court: “… reformation as a general rule is only sparingly allowed…however, the courts have been more liberal in their regard to petitions seeking reformation when that relief is needed to avert tax problems caused by a defective attempt to draft a will provision in accordance with the then tax law or instead caused by a change in law, subsequent to execution of the will, that renders a tax-driven will provision counterproductive. The central question in such a case is whether the clear wording of the subject instrument subverts rather than serves the testator’s intent.”

Moral of the story. This estate had a sympathetic judge. The better course is to have a professional review of your estate planning documents after major tax law changes. Relying upon a 37-year-old will is expecting too much from an initial estate planning consultation.

©2017 M.A. Co. All rights reserved.

Someone to Trust

How could someone who earned $650 million over 17 years be broke? That’s the question the actor Johnny Depp recently put to a team of forensic accountants and his new business manager, according to a Vanity Fair article (“How Did Johnny Depp Find Himself in a Financial Crisis?,” August 2017). The team determined that Depp’s business managers of 17 years were guilty of mismanagement, breach of fiduciary duty, and disbursing funds without Depp’s knowledge, and the team filed a lawsuit seeking $25 million.

The business managers, who never had been sued before, fired back with a lawsuit of their own. A partial list of why Depp went broke, according to them, was that Depp owned:

  • 14 residences, including a chateau in France;
  • a 156-foot yacht, which was expensive to maintain;
  • 12 storage facilities filled with memorabilia, such as collectible guitars and art;
  • $30,000 worth of exotic wines flown to him monthly; and
  • he employed 40 full-time employees, costing $300,000 per month.

As an example of his extravagant lifestyle, Depp spent $5 million for a memorial service for his idol, journalist Hunter S. Thompson. A 153-foot cannon was built at Thompson’s home to blast his ashes into the air.

The business managers seek damages of $560,000 and a statement by a court declaring that “Depp caused his own financial waste.” The trial is expected in January.

Adding guidance to an inheritance

Although Johnny Depp may be an extreme example of financial management failure, it is stories such as these that cause some wealthy parents to wonder about the financial capacity of their own heirs. Even responsible adults have been known to have moments of weakness when faced with a large inheritance.

That’s why so many are turning to trust-based inheritances. When the trust is administered by a professional trustee, such as us, the beneficiaries get financial management according to the terms of the trust, along with investment management of the trust assets. There’s no guarantee that a trust will last for a lifetime, but it does improve the odds for lifetime financial security.

By the way, Depp paid 10% of his income to his business managers and his lawyer, some $65 million over 17 years. Our fee for trusteeship is well below that percentage. Ask us for details.

©2017 M.A. Co. All rights reserved.

Debts and Death

Dear Garden State Trust Company:

What happens to my debts when I die?

—STILL PAYING THE MORTGAGE

 

Dear Still:

According to a study by the credit bureau Experion, released in December 2016, some 73% of consumers have debts when they die, including mortgage debt.  Some 68% have credit card debt; 37% have mortgage debt; 25% have car loans; 12% have personal loans, and 6% are still paying off student loans.  The average total debt at death for these consumers was $61,554.

That does not mean all these people died virtually bankrupt.  The study does not include an assessment of how large the estates were. Most likely, most estates were large enough to retire the debts.

At your death, your debts pass to your estate, just as your assets do. Your executor will be responsible for paying off those debts. All debts and taxes must be paid before any inheritance is distributed to your heirs.  

If there are not enough cash or life insurance proceeds in the estate to meet the debt and tax obligations, some assets may have to be sold to raise the money. This could include the family home.  If there is a mortgage on the house, the heirs may be able to take over the responsibility for paying the mortgage, to avoid a forced sale.

If you should die without any assets at all, your debts die with you.  But try not to let that happen.

Do you have a question concerning wealth management or trusts?  Send your inquiry to contact@gstrustco.com.

© 2017 M.A. Co.  All rights reserved.

The Trouble with Powers of Attorney

Reportedly the incidence of Alzheimer’s disease among those 85 and older is about 47%.  This population needs help with financial management.  Perhaps the most common tool to permit a family member to assist with handling an elderly person’s assets is the power of attorney.  Unfortunately, the power of attorney can also be an avenue that leads to financial abuse of the elderly.  Attorneys Martin Shenkman and Jonathan Blattmachr outlined steps that may be taken to head off such problems without compromising flexible financial management for the elderly person (“Powers of Attorney for Our Aging Client Base,” published in the July 2015 issue of Trusts & Estates magazine).  Among their recommendations:

  • Joint agents.  Checks and balances for the power of attorney may be created if more than one person must sign off on the exercise of the power. Although this may limit quick decisions in the event of an emergency, the tradeoff for greater security may be worthwhile.
  • Care managers.  An independent care manager may be hired to evaluate the elder periodically to report to the elder’s health care agent.  The care manager can determine whether the appropriate care is actually being provided to the elderly person.
  • No more gifts.  In the usual case, one who holds a power of attorney cannot make gifts of the elderly person’s property.  However, the power of attorney may be drafted to specifically allow for such gifts, if that is desired.  In the days when the federal estate tax kicked in at much lower levels, some estate planners routinely advised that gifting powers be included in a power of attorney, so as to begin putting an estate plan into effect and to control death taxes.  The authors make a persuasive case that, given today high federal estate tax exemption, such gifting powers should no longer be routinely included in powers of attorney.  The income tax benefits of holding property until death are far greater than the potential estate tax savings for all but the largest estates. What’s more, gifting powers have been a specific source of elder abuse.
  • Living trusts.  It is becoming more and more common for elderly clients to outlive their spouses, siblings, and friends. That creates a dilemma if there are no children nearby.  The authors suggest, “The use of a funded revocable trust that names an institutional co-trustee or successor trustee can provide a viable solution for clients fitting this profile.”

We are that “institutional co-trustee or successor trustee.”  It’s always nice to receive recognition of the value of our services from experts in estate planning.  We’d be very pleased to tell you more about how our services may benefit you and your family over the generations.  Please arrange for an appointment with one of our officers at your convenience.

© M.A. Co. All rights reserved.

 

Tax Reform Stalls

There has been surprisingly little progress on tax reform, given the high hopes that so many had last January.  On May 17 Republicans and Democrats from the Senate Finance Committee met with Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn.  The key takeaway seemed to be that the Senators want to pursue tax legislation on a bipartisan basis.  That means committee hearings and, most likely, a very protracted process.  Many already have suggested that tax reform can’t happen until 2018.  However, enacting major tax reform in an election year would be unusual, because so much attention must be invested in campaigning.

President Trump’s tax proposals rolled out at the end of April, included the elimination of the federal estate tax, so that remains a possibility.  In a statement accompanying the presentation of the one-page proposal, economics adviser Gary Cohn said: “The threat of being hit by the death tax leads small business owners and farmers in this country to waste countless hours and resources on complicated estate planning to make sure their children aren’t hit with a huge tax when they die. No one wants their children to have to sell the family business to pay an unfair tax.”

Cohn clarified that the repeal of the estate tax would be immediate, not phased in over a period of years.  Democrats are likely to resist changing or eliminating the federal estate tax.

We are no closer to knowing the fate of the federal gift tax or the generation-skipping transfer tax, however.  It has been argued by some observers that the gift tax must be retained so as to protect income tax revenues.  No indication as of May on the fate of basis step-up, or the possibility of taxing unrealized gains at death.

What’s the hold-up?

One of the major stumbling blocks to getting to tax reform is the issue of “revenue neutrality,” the idea that all tax cuts must be offset by tax increases elsewhere in the Tax Code so that net federal tax collections remain unchanged.  That was the model for the Tax Reform Act of 1986; it was not the approach used for the Economic Recovery Tax Act of 1981, which helped to break a long period of stagflation.  In fact, ERTA turned into a bipartisan stampede once the ball got rolling.

The cause of tax reform may have been set back when Senate Majority Leader Mitch McConnell (R-Ky.) announced in May that only a revenue-neutral tax bill could pass the Senate.  He did not identify any “pay-fors” to offset tax breaks expected to foster better economic growth.  The proposal put forth by President Trump, even though it lacks critical details, has been judged to “lose” as much as $7 trillion over its first ten years.  

What happens when the stock market bulls realize that corporate tax reform is not in the cards this year?  Wait and see.

© 2017 M.A. Co.  All rights reserved.

Tapping Retirement Funds to Pay for College

Dear Garden State Trust Company:  

Should I withdraw or borrow from my 401(k) plan to help pay for my child’s college expenses?—PUZZLED ON FUNDING

Dear Puzzled: 

As a general rule, impairing your retirement savings to meet current spending needs is not a good idea, even for higher education expenses.  There are other sources of funds for education needs—in contrast, in retirement, when one is on a fixed income, borrowing to meet expenses is problematic. 

What you take out of your plan now can be hard to replace later.  It’s been estimated that it can take six to ten years to fully restore a retirement account that has been tapped to meet four years of college expenses.  In part, that’s because one misses out on the compounding of investment income during the period.  For longer time frames, the stock market has produced higher total returns than the interest rates on student loans.  The other part is that it can be hard to get back into the saving habit.

The better approach is to save for higher education early, separately from retirement savings, so as to put time on your side and minimize the need for loans when the college years arrive.

Do you have a question concerning wealth management or trusts? Send your inquiry to contact@gstrustco.com.

© 2017 M.A. Co.  All rights reserved.

Choosing a Trustee: Pro vs. Average Joe?

From the perspective of a trust officer, the benefits of a professional trustee are endless and obvious. Professional asset management, trust administration, and tax planning are the most commonly cited, but they don’t even scratch the surface in terms of the full job description. With such a wide array of services provided, we at Garden State Trust Company tend to hear only two recurring reasons against working with a professional trustee:

  • Fees for their services
  • Lack of familiarity between the family and the corporate trustee

Fees

Often times the first question asked by potential new clients is simple: “What are your fees?” An understandable question, as professional trustees do not work for free. Similar to an accountant, investment manager, or attorney, there is a cost in obtaining professional trustee services. However, as Einstein might say, “It’s all relative!” See below a more productive question that considers the alternative options.

Q: I’m fee conscious. How do the trustee costs compare between your company and my Uncle Joe?

A: Great question! First and foremost, Uncle Joe should be entitled to compensation for his services as a fiduciary, in addition to reimbursement for expenses incurred related to his duty as trustee. Is Uncle Joe an experienced investment manager? If not, he may be best suited to hire a professional investment manager (0.75%-1.5% annually). How about taxes? Has Uncle Joe been exposed to proper fiduciary accounting rules and regulations? Hiring an accountant is most certainly prudent (many accountants charge $500-$1,000 to file the annual 1041 fiduciary income tax return, in addition to their hourly rate for providing trust accounting services). What happens when Uncle Joe needs guidance as to the administration of trust? It would be wise for him to seek legal advice from a trust and estates attorney ($300-$500/hr rates)

Let’s do a cost comparison.  Keep in mind that individual trustees in New Jersey are generally entitled to a statutory fee/commission schedule for their services as trustee equal to 0.5% on the first $400,000 of assets, and 0.3% on amounts over $400,000. In addition, Uncle Joe would be entitled to 6% of any income generated from the trust assets. Conversely, professional trustees are instead (generally) entitled to their published schedule of fees.

$1M Trust Example Chart

As you can see in this example, even the most conservative estimated costs of hiring investment management services produce a higher total annual cost to the trust than the total fees of a professional trustee. Also, it should be noted GSTC’s cost for filing the annual 1041 tax return is significantly lower than the average cost for an individual seeking accounting services. Additionally, an individual, less-experienced individual trustee may need to seek legal guidance more frequently than a professional trustee when it comes to properly administering the trust document.

Family Familiarity

Q: I want an experienced trustee, but I also want someone who is close to my family. What do you suggest?

A: A common knock on professional trustees is their unfamiliarity of the specific dynamics of a particular family. A fair point during the first meeting, but this argument fizzles over time as the relationship develops. In these types of situations, we may recommend a co-trustee arrangement between a family member trustee and the professional trustee. The family member trustee is able to be the eyes and ears on the ground, and relay the news and needs of the beneficiary to the professional trustee on a regular basis. Meanwhile, the family benefits from having an objective, professional trustee available to handle the investment management, accounting, and daily administrative duties that otherwise might be burdensome or impractical for the family member trustee. Most importantly, should the individual trustee become incapacitated or pass away, the professional trustee is readily available to continue the administration of the trust for the family without interruption.

Serving as a trustee is an ongoing commitment and, for many individuals, an unfamiliar job in which they have had little to no experience. Aside from the fiduciary obligations, family dynamics can put individual trustees in difficult situations. The trustee may have a close relationship with a beneficiary who is making incessant requests for distributions that the trust creator would have never approved. This can potentially cause uncomfortable situations between trustee and beneficiary that both parties would prefer to avoid. A co-trustee arrangement with a professional trustee can help alleviate these types of issues. Let the professional trustee be the “bad guy” who is saying no to the constant requests for a Porsche from an 18-year-old trust beneficiary.

Q: What services do professional trustees provide?

A: A professional trustee takes on an extraordinary role. Held to a higher fiduciary standard than an individual trustee (family member, friend, e.g.), a corporate trustee holds a duty of care and loyalty to the beneficiaries. In addition to the duty to manage the assets, coordinate the tax preparation and filing, and administer the trust document properly, trustees are of service to the beneficiaries. Whether they’re planning and paying for higher education, coordinating the sale and purchase of a new residence, or simply arranging for the payment and installation of a new kitchen appliance, the roles of a trustee are endlessly defined. For many beneficiaries, their trusts are their main financial source and, as a result, trustees take on an enormous responsibility.

Garden State Trust Company possesses capabilities and expertise in the investment management, financial planning, and fiduciary administration areas. When one considers that all of these services are included in our annual fee, it pales in comparison to the cumulative, a la carte professional expenses hired by an individual, inexperienced trustee. Additionally, consider the fact that the trust responsibilities and liabilities fall on the shoulders of the trustee. Not only does the individual trustee need to take the time to seek out competent professionals to perform the necessary work, but they need to ensure the work is done correctly and in a timely fashion. This can involve many phone calls, emails, and meetings on an ongoing basis. Often times, individual trustees can only contribute part-time attention to their role as trustee. After all, they have jobs, children, parents, and all of life’s obligations to worry about each and every day.

Professional trustee fees can actually be a bargain when you compare them to the alternative expenses required by an inexperienced individual trustee. Individuals can benefit from partnering with experienced, professionals who efficiently and accurately perform all of the services required as a trustee. This partnership allows the family to preserve and grow their personal relationships while the professionals preserve and grow their wealth.

Living Trusts & Financial Privacy

Remember when “hidden treasure” resided in chests buried by pirates? Today’s precious assets may be invisible to the naked eye until retrieved from a hard drive.

Case in point, Pirate Latitudes, an adventure yarn set in Jamaica in the 1600s, found in computer files left by author Michael Crichton.

Although Crichton is best remembered for Jurassic Park and other techno-thrillers, in 1975 he wrote another historical adventure, The Great Train Robbery. HarperCollins published Pirate Latitudes in November 2009, more than a year after the author’s death.

Crichton died in 2008 of throat cancer. Five times married, he left a prenup and a living trust. Here is what is known at this date about the John Michael Crichton Trust:

It was a revocable living trust created in May 1998.

It has been amended three times.

That’s all.

We have no indication of the size of the trust or the identities of the beneficiaries.

Crichton’s will was filed with the probate court, but one lawyer observed: “The main significance of this probate is really to nominate who’s going to be in charge.  There are really no assets in this estate; it’s all in the trust.”

Among the many reasons for having a living trust, financial privacy is likely the one most important for celebrities such as Crichton.  However, there are more advantages to considered.

You remain in charge

When our clients place investable assets in flexible trusts, they give us their instructions in an attorney drawn trust agreement. Under the terms of that agreement, they retain the right to cancel the trust or change their instructions. Nothing’s tied up.

From a practical standpoint, then, our trust clients maintain exactly as much investment control as they wish, just like the clients who have their personal investment accounts or IRAs with us.

Typically, we provide professional management or guidance tailored to each trust client’s needs and preferences. 

Always, our role as trustee is to do exactly what our trust clients have instructed us to do. There’s no doubt whatsoever about who’s in control. If any client ceases to be satisfied with our services, he or she is perfectly free to terminate the trust or employ another trustee.

Put our experience to work for you and your family

If you would like to learn more about our personal trust services and how they might help you do more with your financial assets, we invite you to meet with us in person.

We look forward to discussing your goals and requirements.

© 2015 M.A. Co. All rights reserved.
Any developments occurring after January 1, 2015, are not reflected in this article.

Emotional Investing

We like to think that since the advent of modern portfolio management practices, investing in stocks and bonds has become a cerebral, analytical process with no room for emotion. The truth is that most investors, even institutional investors, are buffeted by emotional turbulence from time to time, and that truth is reflected in the volatility of the financial markets.

But if a little emotionalism when it comes to investments is unavoidable, too much emotion can be hazardous to your wealth. Here are four symptoms of problem emotions, financial behavior that is inconsistent with sound investment practice.

Fear of loss.  Investors are generally motivated by fear or by greed. Behavioral scientists have learned that, for many people, the pain of loss is larger than the sense of satisfaction from a gain of the same size. Similarly, some investors will accept larger risks in order to avoid a loss than they will in seeking a gain.

Taken to an extreme, fear of loss leads to investment paralysis.  An excessively risk-averse investor may park funds in ultra-safe, low-yielding bank deposits or short-term Treasury securities until a decision is made, accepting long periods of low returns. Or winning investments may be sold off too quickly in an attempt to lock in gains, while losing investments manage to stay in the portfolio indefinitely.

Following the herd.  It’s difficult to be a contrarian, to find value that everyone else has overlooked. Many people find it easier to go with the crowd, to own the current hot stock or hot mutual fund. At least that way, if the investment does poorly, one has plenty of fellow sufferers with whom to commiserate.

But when “crowd” is defined as one’s family and friends, the crowd’s investment goals may be very different from one’s own.

Hair-trigger reflexes. Markets move on news. In many cases, the first market response is an overreaction, either to the up side or to the down. Sometimes “news” is only new to the general public, and it’s already been reflected in the share price through trading by those with greater knowledge. The true importance of any news event can only be discerned over the longer-term.

Generally, it’s better to watch the market react to news than to be a part of the reaction. Remember that market dips may present the best buying opportunities but they’re also the toughest times, emotionally, for making a commitment to an investment.

Betting only on winners.  Some 85% of the new money going into domestic equity mutual funds goes to funds with MorningStar ratings of four or five stars, according to one estimate. This may be one reason that the government requires this disclosure for investment products: Past performance is no guarantee of future results. The disclosure is required because it is true.  High returns are usually accompanied by high risks; ultimately, those risks may undermine performance.

Abnormal returns, whether they are high or low, tend to return to the average in the long run. Investing on the basis of the very highest recent returns runs a significant risk of getting in at the top of the price cycle, with a strong chance for disappointment.

The alternative approach

To avoid impulsive decisions that may be tainted with emotion, one needs an investment plan.  The best way to moderate the impact of stock and bond volatility in difficult markets is to own some of each. Assets do not move up down in lockstep. When stocks rise, bonds may fall. Or at other times, bonds also may rise when stocks do. The movements of each asset class can be mathematically correlated to the movements of the other classes. Portfolio optimization involves the application of these relationships to the investor’s holdings.

Expected returns need to be linked to the investor’s time horizon. Longer time horizons give the investor more time to recover from bad years, more chances to be in the market for good years.

© 2017 M.A. Co.  All rights reserved.

Home Office Deductions: The Easy Way & The Hard Way

Beginning in the 2013 tax year, the IRS gave taxpayers a choice when it comes to the home office deduction.  To avoid the necessity of detailed recordkeeping, a new “safe harbor” deduction was created for home offices.  The simplified deduction was set at $5 per square foot of the home office space, up to a limit of $1,500 (300 square feet).

The existence of the new safe harbor and relief from recordkeeping does not change the other requirements for taking the home office deduction.  The office must be used regularly and exclusively for business.  The office should either be the principal place of business or used for administrative or management activities when the taxpayer has no other office for handling those chores.  An office kept for the convenience of the employer, such as a salesman who lives away from company headquarters might have, also will qualify.

In many cases, the actual expenses for the home office will be greater than the safe harbor.  These may include, for example, a share of utilities and insurance costs. For example, the IRS reported that for the 2010 tax year, the average home office deduction was $2,600, so many people will find the safe harbor limit too low.  The taxpayer may choose the traditional route of actual expenses instead of the safe harbor. What’s more, that choice may be made for each tax year, without regard to the choices made in earlier years. Thus, the taxpayer may alternate between methods, choosing the one most favorable each year.

The somewhat harder way

With the traditional method of calculating the deduction, a proportionate depreciation deduction is permitted for the office space. The amount of the depreciation is recaptured and taxed as income when the house is later sold.  The safe harbor alternative does not generate depreciation recapture.

The deduction for the home office may not exceed the net income of the business.  If the business is showing a loss for the year, the loss may be carried forward when the traditional method of calculating the deduction is used.  However, the carryover is not permitted with the safe harbor approach. What’s more, any carryover loss created from the actual home office expense calculations may not be deducted in years in which the safe harbor is elected.

Although the simplified deduction was intended to make life easier for taxpayers, the reality is that many taxpayers will have to figure the deduction both ways to decide which is the better way to go.

The IRS reports that the number of taxpayers claiming the home office deduction has held steady over the last six years, at roughly 3.4 million.  The aggregate value of the deductions claimed has dipped, falling from nearly $11 billion in 2010 to $9.5 billion in 2014 (most recent available data).  Most of the reduction in deductions occurred in 2013 and 2014, suggesting that there was, in fact, a significant shift to the easier way of claiming the home office deduction. The IRS does not break out those figures.

© 2017 M.A. Co.  All rights reserved.