One-size-fits-all estate plans are impracticable due to the differences and varying complexities in each person’s estate. It is imperative to tailor an estate plan to meet each client’s needs and goals, so the drafting attorney must understand the character of the assets in the client’s estate and the planning options best suited for each client. Because high net worth clients are often very protective of their assets, planning objectives and recommendations for clients with large estates will almost always differ and be more complex than those for other clients. When estate planning attorneys understand the different planning techniques appropriate for larger estates, including the advantages and disadvantages of each, they can help high net worth clients create a plan that not only facilitates a smooth transition of assets to beneficiaries after death but also helps to sustain the longevity of assets.
The limitations of staggered distribution trusts
Many estate planning attorneys have drafted staggered distribution trusts that direct the trustee to make distributions to the trust beneficiaries when they reach specific ages. This common planning strategy may be effective for clients who simply wish to have more control over the timing of the distribution of the trust assets after their deaths, but unfortunately, staggered distribution trusts do not fully protect estates from estate, gift, and generation-skipping transfer (GST) taxes or from creditors’ claims, including claims from ex-spouses of beneficiaries. Instead of trying to make staggered distribution trusts fit every client, other options should be explored, including dynasty trusts, grantor retained annuity trusts (GRATs), and domestic asset protection trusts (DAPTs). Each of these trusts requires the grantor to transfer assets outside of their estate to an irrevocable trust, thereby gaining a benefit such as creditor protection or estate and gift tax avoidance.
Learn more about planning for large estates by registering for our next Thought Leader Series webinar featuring Steven J. Oshins on May 11, 2021.
Plan according to your clients’ goals
Avoiding GST taxes and transferring assets to grandchildren
A dynasty trust is an irrevocable, long-term trust created to pass wealth from generation to generation without incurring gift, estate, or GST taxes for as long as assets remain in the trust. Because not all states recognize dynasty trusts, they may be unattractive to clients who do not have ties to one of the tier one states (Alaska, Delaware, Nevada, and South Dakota) that offer the protection that dynasty trusts provide. The client does not need to live in one of the tier one states to utilize a dynasty trust if a trustee or co-trustee resides in a state that recognizes the protection that a dynasty trust offers. A dynasty trust may be used in myriad ways to achieve a client’s goals. It may be established during life or at death to hold and protect assets for multiple generations, to provide creditor or spendthrift protection, or merely as an expedient tool for transferring assets to grandchildren. Regardless of the circumstances, the most common purpose for a dynasty trust is to take advantage of the GST tax exemption it offers and to transfer wealth across multiple generations.
Retaining an income stream
A GRAT is an irrevocable trust that allows a grantor to contribute assets to a trust and retain an annuity stream for a specified term during their lifetime. At the end of the term, any assets left in the trust are transferred to the trust beneficiary’s estate, gift tax-free. GRATs make sense for a high net worth client who needs an estate planning tool that can help reduce their ultimate estate tax liability while at the same time retaining an income stream during their lifetime. It is important to ensure that the term of the GRAT is shorter than the life expectancy of the grantor: If the grantor dies before the term ends, the trust property that remains in the trust at the grantor’s death will be included in the grantor’s taxable estate. The primary purpose of a GRAT is defeated if the grantor does not survive the term so it is imperative to assess the client’s mortality risk before setting up a GRAT. A GRAT is also not an effective way to minimize GST tax and thus is not the best estate planning technique if that is a concern.
Protection from creditors
DAPTs are gaining popularity as an estate planning tool and are now recognized in nineteen states. Through the creation of a DAPT, the grantor transfers assets to an irrevocable trust. The assets transferred to the trust are those that the client does not necessarily require to sustain their everyday life since the transfer must be made to a trustee who is not the grantor of the DAPT. Once the transfer is complete, the assets transferred will be shielded from potential creditor liability. The downside of a DAPT is that the assets, once transferred, will no longer be under the grantor’s control, but rather will be subject to the control and authority granted to the trustee under the terms of the trust. This is sometimes a hard pill to swallow for a grantor who has worked hard to accumulate assets. Like the other estate planning techniques, DAPTs are not appropriate for all clients. However, clients with larger estates can be great candidates for DAPTs because they may have accumulated wealth that does not need to be available to meet their living expenses. Further, if the client is in a type of business that is regularly exposed to creditors and creditors’ claims, a DAPT may make sense.
The careful planner should ask multitude of questions regarding the assets in a client’s estate and their goals for their estate plan when trying to determine if a large estate is involved and more complex planning is required. Is the client concerned, or should they be concerned, about estate, gift, or GST tax exposure? Does the client wish to retain an income stream during their lifetime? Are mortality risks a concern? Are future creditors or lawsuits an issue that should be addressed? Knowing what questions to ask, and what options to provide based on the answers, is key to providing a well-tailored estate plan that accomplishes all of the client’s goals.