Law News and Tips
I recently wrote a column in the West Newsmagazine about a new Missouri law designed to protect the elderly and disabled from financial predators. As I mentioned in the column, that law (which isn’t effective until 2017) is really designed to protect people during their lifetimes. It isn’t designed to recover assets.
The problem is that many times, families don’t discover that they’ve been hoodwinked until after mom and dad are gone, and so is the money. So the question is, what do you do then?
We’ve run into a number of cases recently where after the parents’ funeral, the kids find out that all the money is gone. Sometimes the house is even in someone else’s name. And that may not even be a relative, but some complete stranger.
The available remedies depend on when the assets are taken. If the assets are taken during the parents lifetime – deeds are changed, new names have been added to bank accounts or investment accounts, those kinds of things – then clients need to file what is called a “discovery of assets,” petition. In that kind of a lawsuit, the family can investigate what assets and accounts had belonged to mom and/or dad, who has them now, and why. The process of discovery involves questionnaires called interrogatories; subpoenas for documents and information; and deposition where you interview witnesses.
In some situations the re-titling may have been legitimate. For instance, maybe your mom or dad were perfectly competent and wanted to regard someone for everything they had done for them during their life.
However, in other situations, there may have been undue influence on the part of the perpetrator or a lack of capacity on the part of mom and/or dad in regard to the transfer or re-titling. In these situations your main witness is dead, and so gathering evidence is often circumstantial. These are not necessarily easy cases to prove, but depending upon the amount involved, the family may have no alternative. Since they can be difficult cases, clients need to be pretty certain of the facts before they commence litigation. What I mean by that is that you need to have a solid idea of the assets that are missing.
It may be that the assets were not transferred during the life of the parent(s), but only upon death, either by will or trust. If that is the case, then the clients have to bring a will contest or trust contest to have those documents set aside. These kinds of lawsuits, like a discovery of assets, action, or also difficult. You have to prove that the parent did not have testamentary capacity or that the perpetrator exercise undue influence. Since the perpetrator will certainly assert capacity and deny influencing the parent, it can come down to a “he said/she said” sort of argument.
With the Fourth of July upon us, it seems fitting to say something about the Declaration of Independence. Although people talk about it, I really
wonder how many know what it says. People have some vague idea what’s in the Bill of Rights, and maybe even something about the Constitution,
but the Declaration of Independence is kind of the forgotten document. It’s basically a list of grievances against the King of England.
Many of us have probably heard the opening of the second paragraph: “We hold these truths to be self-evident, that all men are created equal….” During the 1850s, many Southern politicians denounced the Declaration for that very phrase. They argued that it should be discarded. One even called that phrase in particular a “self-evident lie.”
Abraham Lincoln took another view of the Declaration. He felt that it was the lens through which all of our other governing documents – the Constitution and the Bill of Rights – should be viewed. It is as if those later documents were just a continuation or elaboration on the ideas set out in the Declaration.
I think that the first paragraph of the Declaration is just as important as any other section, and maybe even more so for our times. In it, Jefferson wrote, and the Second Continental Congress affirmed, that our right to separate from England and exist as a separate nation was based on “the Laws of Nature and of Nature’s God….”
Freedom is not licensed to do whatever we want. We are not “free” to kill, to steal, to harm others, or to drive 100 miles an hour in a neighborhood. Our freedom has limits.
According to the Founding Fathers, our freedom is based on natural law, which is universal – it applies equally to all people. These truths are not true for some people, but not all. These truths are true for all or we have no reasonable basis for our freedom. These truths are not subject to the vicissitudes of swiftly changing public opinion.
The poet Robert Burns once wrote a poem entitled, “To a mouse.” No one really remembers the poem, but it contains one of the most famous lines (or at least perhaps one of the most often quoted lines) of all poetry. In the original, it reads:
“The best laid schemes o’ Mice an’ Men
Gang aft agley ….”
We know it as, “The best laid plans of mice and men, oft go astray.”
People may do their best to cover all their bases (or maybe not), but inevitably something is overlooked. A person may plan to get all of their assets into joint names, with a POD or TOD beneficiary designation, or into a trust, but they miss something. Usually it is something small, but it can’t be ignored. So what to do?
As I discuss elsewhere in this book, probate can be kind of involved. So the legislature has authorized administration of a “small estate.” Small, of course, is a relative term. Depending on the state, “small” can mean less than $40,000 as in Missouri or up to $100,000 in Illinois ($150,000 in California). Generally these are net amounts after subtracting liens, but check applicable state laws. Regardless of the amount, a qualified small estate can be administered much easier.
In Missouri (as in several other states), we in effect have 2 tiers of small estates. The first tier is sometimes referred to as a “creditor’s refusal.” (Refusal refers to the fact that the court refuses to open a full-blown probate estate by issuing letters of administration that authorize the personal representative to handle the estate.) This is for estates of less than $15,000 consisting of only personal property (no real estate) and where there is no surviving spouse or unmarried minor children. In these estates, no published notice is required (more on that in a minute). In order to process a creditor’s refusal of letters, the creditor just has to file an affidavit with the probate court. As with any claim against an estate, the affidavit must be filed within one year for the date of the person’s death or it is void.
The second tier of small estates is sometimes referred to as a “spousal refusal,” although a surviving spouse is not actually necessary. This is for all estates under $40,000 (or whatever the local maximum is) where a creditor’s refusal does not apply. Notice of the administration is required to be filed in a local newspaper for 2 consecutive week. Notice is a somewhat technical requirement that varies depending on the legal proceeding involved. For regular lawsuits, it might involve a process server. When you don’t know who the other claimants might be or where you can find them, the law allows you to publish the notice in a newspaper of general circulation in the area where the legal action was filed. The idea is that you can’t take something from somebody unless you give them a chance to state their case. Once the notice has been filed, the affidavit then has to sit at court for at least 30 days.
At the end of this process, the court will sign off on the affidavit. You can take the affidavit to the bank or investment advisor and the funds released. If you’re dealing with real estate, you can take the affidavit to the title company as proof of your right to sell.
My client contacted me late one night. His brother was in the hospital. He had broken his legs in multiple places, but he was lucky to be alive. Fortunately he was unsuccessful in his suicide attempt.
I hope you never have to deal with this kind of thing, but more often than we care to imagine, families have to deal with a child, a sibling, a parent (or other elderly family member), or even a spouse who has some form of mental illness. The question often comes up after some incident maybe where the police have been called in. Hopefully you have specially trained police officers in your city who are wonderful!
The immediate question after an incident is whether the family member poses a threat of harm to themselves or others. If the answer is no, then once the immediate issue has been resolved, he or she goes free. There is really nothing further you can do.
If the answer to this question is yes (and attempted suicide would qualify), then a hospital can hold the person involuntarily for up to 72 hours for evaluation. After that they are released on their own or with some family member if they’re lucky. I wonder how many of the homeless people you see on the street had no family to take them in when they were released?
If the family member agrees to be admitted to a behavioral health facility on their own, then they can stay indefinitely. This gives the medical personnel more time to evaluate the patient and develop a treatment plan. The problem is that even with a good treatment plan, the patient must comply, and so often they stop taking their medicine once they start to feel better.
So what do you do when a family member refuses treatment altogether? What about when they have stopped taking their medicine? If they are able to carry on a basically “normal” life, then therapy can be successful. But sometimes, “normal” is not in the picture.
At those times, it may be necessary to seek a guardianship and/or conservatorship. A guardianship has to do with the person: their living situation and medical treatment. A conservatorship has to do with a person’s finances: their assets and bill paying. On occasion I have had someone appointed as just a guardian, but in my experience, the probate court prefers to appoint someone as both at one time.
In order to have a guardian and/or conservator appointed, a physician has to answer several questions in a sworn statement. The crucial question with regard to a guardianship is this: Does the family member lack the capacity to meet the essential requirements of food, clothing, shelter, safety, or other care, such that serious physical injury, illness, or disease is likely to occur? In other words, does the family member have enough sense about him or her to take an umbrella when it’s raining, wear a coat when it’s cold, or buy and prepare food when they are hungry?
For the appointment of a conservator, the principal question is this: Is the family member unable to receive and evaluate information or to communicate decisions to such an extent that he or she lacks the ability to manage his or her financial resources? Can he or she handle a bank account (which may be questionable for many normal people), make deposits, and pay bills.
If a person’s condition is such that he or she can’t do these things, then the probate court may be willing to appoint a guardian and/or conservator. It’s important to note that courts are reluctant to do that, so this is not necessarily an easy matter. At that time, the family member is now referred to as a “ward.” Once a guardian is appointed, he or she controls where the ward lives and what kind of medical treatment he or she gets. When a conservator is appointed, he or she will be responsible for handling the ward’s financial resources and paying his or her bills.
One of the problems with a conservatorship is that unlike with a trust or power of attorney, a conservator is usually only allowed to “invest” in government insured bank accounts or government securities. These investments typically don’t even keep you ahead of inflation.
Then there is the question of financial support. Many people with mental illness cannot support themselves. If they are able to get a job, they may not last long because of their behavior. But many of them can’t even leave the house for work.
Fortunately, there is a government program that can provide supplemental income for the mentally ill. This is under the Supplemental Security Disability Insurance program. Payments under this program are often referred to as “SSDI”. Although it is theoretically possible for an individual to obtain these benefits on their own, it can be a complicated process, even for people who are not disabled. For the disabled, it is probably beyond their ability. An experienced attorney can help.
The current state of the law is not perfect. There seem to be a lot of people who fall through the cracks. I can’t help but think that if we as a nation made mental health a priority, our streets would have fewer homeless people, we wouldn’t need his many prisons as we have, and mass shootings would be a thing of the past.
But we don’t seem to have a national resolve to cure mental illness like we do to find a cure for cancer or heart disease. We tend to treat the symptoms and not seek a cure for the illnesses themselves. I understand that we are very concerned about protecting people’s freedom and liberty, but it just seems that we are wasting human lives. For those with family members suffering from mental illness and for those who are themselves suffering from it, this is a great tragedy often resulting in wasted lives. How sad.
In the first part of this discussion on business planning, I focused on the planning that people need to do at the beginning of their business with a buy-sell agreement. Now I want to turn to the kind of planning that is more proper to estate planning at the end of one’s life.
The Big Transition
It has been estimated that over the next 30 years, an estimated $30 trillion (yes, that’s “trillion” with a “T”) will be passed from the baby-boom generation to the younger generations. For many people, that will consist of houses (some boats, and fewer airplanes), life insurance proceeds, investments, retirement assets, personal property items, and yes, their businesses.
About half of the US economy is made up of small businesses, however you define that. On just a numeric basis, the SBA estimates that 99.7% of all employees are employed by small businesses. That is a large number of small businesses. Now admittedly, a large portion of those businesses are businesses without employees, but that includes partnerships and LLCs. So there are still a lot of closely held businesses out there that could be passed down to the younger generation.
Beginning back in the 1990s, we began hearing a lot about how all of these family business owners were going to start planning to pass their businesses down to their children. Since those plans often involve life insurance, all of the life insurance agents were getting excited. The problem is I’m not seeing it.
I talk to a lot of small business owners. The first question in planning an estate with the business interest is whether any kids are in the business? If there are no kids, are there any key employees? If the client has neither, then they probably would just want to sell. If they enjoy running the business, then they may want to stay at the helm, die at the desk, and let others deal with the aftermath.
You might have a client who wants to stay involved, but also wants to travel or have more personal time. In that case, he or she may want to sell the business, but have a long term consulting contract that includes an office with the desk. These can be difficult arrangements, though. It’s hard for people to give up the reins. There can be a lot of tension between the new owner and the “consultant.” This kind of arrangement requires just the right people.
And then you might have a client who just wants out. That’s when you clearly sell. Selling a business is beyond the scope of this discussion, but it’s an option to consider. It’s the now versus later option.
But let’s say that there is a family member or a trusted employee in the mix. Then there is another analysis you need to consider.
I recently had a client business owner come in to see me regarding his estate planning. The 800 pound gorilla in his estate planning closet was his business. That’s the way it is with most small business owners.
In reviewing their assets, they have a house. They have some investments. But their principal asset is their business. They often don’t even have a 401(k), an IRA, or any other kind of retirement asset. Their business is their retirement plan.
This client who came in has a son in the business, but his son had some unrealistic ideas about what it took to run the business. So we had to ask some very basic questions:
What if the business fails?
Can your son get a loan on his own?
Is your son willing to guarantee 100% of the loan and is the client willing to take back a subordinated part of the purchase price?
In that situation, the client had to get value out of the business. He was dependent on it for his retirement. He was not willing to just sell it to his son because he wasn’t sure that his son would make it.
He did not think his son would be able to get a loan. His son had little collateral because he spent everything.
Even if the son qualified for an SBA loan, he didn’t think his son wanted to guarantee the loan and risk everything.
In addition, an SBA loan would only cover 90% of the appraised value. The parents really needed 100% of the appraised value to make their retirement work. They could take back a subordinated note for the difference, but that was not really good enough. So the SBA loan option would not work.
In the end, the couple just decided to put the business up for sale. Their son was not happy, so they gave him some time to work out financing, but he couldn’t get it … at least not on his terms. The business ended up getting sold, and the son had to get another job.
These are the kinds of real life issues business owners face in planning their estates. It’s always a risk to sell the business to a family member. One client sold his business to a child and took back a note and security agreement. In his wife then moved to Hawaii… for a while, at least.
The child was either overwhelmed by running the business or she just didn’t put in the time (there are two versions to this story), but in any event, she started having trouble making the payments to her parents. Mom and dad moved to Florida to be closer and give some guidance. That didn’t work either. So mom and dad moved back to St. Louis, declared a default, and took the business back. Dad had to rebuild the business and sell it to a third party for a reasonable price. Needless to say, relations with her daughter were a little chilly after that.
The Other Kids
And then there is the problem of the other children. As I mentioned above, many times the family business is the main asset in the estate. Typically small business owners don’t put money away into retirement plans, so the business is the retirement plan. That can actually work since the proceeds from the sale of the business will be taxable at capital gains rates and not ordinary income rates, but that assumes that mom and dad can get their money out of the business as I discussed above.
So if we assume that the little Johnny is going to get the business, then the $1,000,000 question is “What about the other kids?” If Johnny pays cash (either out of his own pocket or from a loan), then the other kids get cash, and that may be what they want. They never trusted little Johnny that much anyway.
But what if the company is a cash cow and is on autopilot so that even Johnny can’t screw it up? Maybe the kids want a piece of the action. Does Johnny want them meddling in “his” business?
In the alternative, what if Johnny can’t pay what the business is worth or mom and dad decide to just self-finance the sale? Then the other kids don’t get cash; they get a piece of a promissory note. Hopefully it is secured by the business, but do the other children really trust their inheritance with Johnny?
As with many estate plans, there is not a one-size-fits-all solution. A lot depends on the many intangibles and variables in the family and the business itself. Do the children get along? Do they like and/or trust each other in the business setting? Is the business doing well with a bright future or is it struggling? If it is struggling, is this a temporary problem or long term? Once you answer some of these questions, you can begin to put together a real plan.
When I was young, my mother often told me, “Remember Fred: blood is thicker than money.” As a 10 year old, I had no idea what she was talking about. Now I wonder what happened in the family that had made such an impression on her. I’ll never know now.
But needless to say, she was right. As with most estate plans, I don’t think you know if it is successful until mom and dad have been dead for several years. Then you can ask, “Are the kids still celebrating holidays together?” If not and it is because of hurt feelings from the estate plan, then it wasn’t a good plan. If so, then the plan worked well … or at least as well as could be expected.
Selling your business is complicated. Plus, things happen so quickly it's one thing you should NOT put off. Contact Fred TODAY about your situation:
The first consultation is free. Or call him now at (314) 241-3963
Check out Fred's other BLOG post focused on Business Law & Business Planning. Here are a few:
For business owners, many times their largest asset is their business. If the owner is going to plan his or her estate, they have to take the business into account. This discussion can be divided into two parts. The first part has to do with planning at the time of the formation of the business. This is where there is more than one owner, and none of the owners wants to be in business with their co-owner’s spouse. This is what we will look at in this article. The second part has to do with family planning and planning for death with wills and trusts. I’ll look at that in the next article.
BUY SELL AGREEMENTS
When two or more people go into business together, they are focusing on sales, production, costs, profits, and those kinds of things. Most of their focus is on the short term, immediate issues. That is understandable, but potentially risky.
If you’re old enough, we can trade stories about people we know who died early and many times suddenly. If you’re not old enough to know people who suddenly died, listen to your elders.
Business owners who fail to plan for a potential death run the risk of ending up in business with the co-owner’s spouse. Typically, the spouses are not involved in the business, but of course, they have a lot of advice for you after the fact. I don’t think I’ve seen a time when things have gone well. When an uninvolved spouse becomes active in the business due to a sudden death it usually means the end of the company. Planning for this eventuality is really important.
In this discussion, I am generically talking about business law and buy-sell agreements whether we are dealing with a C-corporation, an S-corporation, and LLC, or a partnership. I will simply refer to them as businesses. These ideas apply to them all.
PLANNING FOR DEATH OR DISABILITY
Although the title to this section sounds kind of ominous, this really is an important part of planning for a business. If an owner were to die suddenly, the surviving owner or owners need to have a way to buy back their deceased co-owner’s interest in the business and oftentimes to provide funding to transition to a new manager of some sort.
Typically in buy-sell agreements, the estate of a deceased owner will be required to sell his or her interest back to the business or the other owners (a discussion of which one is right for a particular business is beyond the scope of this article). The first question is value: how much is the business interest worth? Once that is determined, then the owners need to plan on how to pay the purchase price. Many times that is funded by life insurance which is the best way to handle this. If there are no life insurance proceeds or insufficient proceeds, the deficit can be paid over a designated period of time. It is important that all of this is worked out in advance. Otherwise, you can have an ownership meltdown at a time when you least need that to occur.
Disability is a little more complicated. That can be funded with a disability policy payable to the company or it can be paid out of the company profits. Also, if there is a life insurance policy with cash value, you can use the cash value to purchase the business interest. In any event, this will probably need to be paid out over time.
RIGHT OF FIRST REFUSAL
Finding a business partner in the first place is really tough. You really don’t want to be in business with just anyone. Will they be honest? Will they work hard enough? Do they know what they are doing? Another aspect of a buy-sell agreement is what is called a right of first refusal.
Since business owners don’t want to be in business with just anyone, they will usually prohibit each other from selling the business interests – whether shares of stock, units (or whatever) in an LLC, or a partnership interest – to third parties. However, the courts will not enforce just an outright prohibition. That kind of restraint on trade is not welcome in American business. The typical way to prevent such a transfer is to impose a “right-of-first-refusal.”
What happens with a right of first refusal is that when one co-owner receives an offer to buy his or her business interest, that co-owner must present that offer to the other owners and give them the right to buy the selling owner’s interest on substantially the same terms. The remaining owners can pay the purchase price over time, but they still have to buy the co-owner’s interests. The remaining owners can buy the selling owner’s interest either directly or through the business or both, depending on how you set up the buy-sell agreement. An important aspect to remember though is that no matter what, all of the selling owner’s interests that are being sought must be purchased by the remaining owners or the company. You can’t only buy a part of the interests being offered.
There is a lot involved in setting up a business when there are multiple owners, and the buy-sell agreement is an important part of it. In the next article, I will look at estate planning more specifically.
The first consultation is free. Or call him now at (314) 241-3963
Check out the second part of this BLOG post: Business Planning Part II. Business Planning II it's worth a few minutes to read. You may know many of the key points in these articles it's worth reviewing them, especially if you're planning
to buy or sell a business or separate from your business partner.
Most married couples own their property, whether real estate, bank accounts, investments (other than retirement accounts), or just about anything else, as “joint tenants.” The full terminology for that is “joint tenants with right of survivorship.” What this means is that when one owner dies, his or her interest in that property passes to the survivor automatically without the need for probate.
In other blog articles I’ve written, I’ve discussed why joint ownership can be a bad thing. With a bank account (where federal law applies), either joint owner can (and yes, they have) cash out the entire account and hightail it for the hills. With other assets (where state law applies), neither joint owner can do anything without the other joint owner joining with them. In addition, if either joint owner gets sued, that account or piece of property can be taken to collect the debt.
In the case of a married couple, things are a little different. When a married couple owns property jointly, it is treated as “tenancy by the entirety” (“TBE”) property. What that means is that the TBE property cannot be taken to collect a debt against one of the spouses, but not the other. This law is a way to protect marriages and families. Marital property could only be taken to collect the joint debt of a married couple, but not the separate debts of married individuals. That’s why a mortgage company always requires both spouses to sign off on the mortgage and loan.
Until 2011, property held by a husband and wife in a joint trust lost that TBE protection. Although it didn’t seem to make sense, if a husband and wife transferred their TBE assets into a joint trust, the transferred assets lost the TBE protection. Go figure. We planned around that with nonprobate transfer options, but it was not really a good solution.
In 2011, the Missouri legislature fixed this oddity. They created what are called “Qualified Spousal Trusts” (“QSTs”). A QST is a joint trust (and it doesn’t matter when it was created) between a husband and wife. The trust must provide either that: (i) the trust assets are held and administered in one trust for the benefit of both spouses, the trust can be revoked by either or both spouses during life, and each spouse has the right to receive trust distributions; or (ii) the trust assets are held and administered in separate shares of a single trust for the separate spouses, with each share revocable by either spouse individually with respect to his or her share, and each spouse has the right to receive income from their separate share. Although this is kind of complicated, it’s a great idea.
The one quirk in Missouri law for QST’s was that to obtain TBE protection in a QST, the property had to be transferred into the trust as TBE property. What that meant was that assets transferred into a QST as separate property did not receive TBE protection.
It’s funny how many non-TBE assets people receive: direct deposit paycheck; pension payments; Social Security payments; and IRA distributions, just to name a few. When non-TBE assets were mixed with TBE assets, it looked like the QST protections were lost, although I never saw those cases. Still, it was a potential problem.
The way we got around this dilemma was that we had spouses keep their joint checking accounts out of the QST. We have the spouses designate their joint checking account as the recipient of all of their non-TBE payments. And then we had the clients put a transfer-on-death beneficiary designation on their checking account so that on the death of the second of them to die, the checking account would automatically rollover into the QST it was kind of an involve strategy, but it worked.
We all kind of figured that the legislature would get around to resolving this odd situation, and over time, they did. Beginning in 2015 married couples could transfer non-TBE assets (whether real estate, bank accounts, or investments) into a QST and still receive TBE protection. This really simplifies the process for married couples with a joint trust. I like when we can simplify things for clients.
Things are tough enough without adding extra administrative layers. It was nice of our legislators to make life a little easier.
I got a call from a client the other day. It was about her father … well, sort of.
Years ago her father wrote a trust. It provided that on his death, his trustee was to pay off his debts (that’s inescapable) and then split his estate between his children in equal shares. Each share was to go in trust to the child. If one of the children died, then his or her share was supposed to go in trust to his or her children.
When he wrote the trust, life was great. His kids were healthy, happily married, and gainfully employed. What could go wrong?
Things happen though. After dad died, one of my client’s brothers died. His share went to his son in trust, and my client was the trustee. But she was getting older, and she had health problems. The successor trustee was the nephew’s mother.
I didn’t find out the details, but at some point, the sister-in-law kind of went off the tracks. She had developed a drug problem (all too common nowadays). It was pretty serious. She was resorting to some pretty sad means to support her habit.
Her son was living with an uncle. Because of a positive drug test, baby # 5 had been taken at birth by the state. She was in pretty desperate straights and in no condition to be in charge of someone else’s money.
I told my client that things weren’t as hopeless as she might have thought. Under certain circumstances, the law allows “interested persons” to amend a trust even after the grantor has died.
The amendment cannot be contrary to the grantor’s original intent. In addition, it has to be something a court could allow. You can clear up unclear provisions. You can change the authority of the trustee. You can appoint new trustees. You can approve certain activities of a trustee.
The problem my client had was that in order to change the trustee, the daughter/mother had to sign off on the agreement as the parent/guardian of the minor grandson. We could get all the other “interested persons” to sign off, but we weren’t sure about the mother.
It turned out that with very little resistance, she agreed. I think she understood that this money was for her son’s college. Her maternal instincts won out. She let the uncle become the successor trustee.
This is what’s called a “non judicial settlement agreement.” It is permitted by the law to fix relatively minor, undisputed sorts of things. They can be pretty useful when life gets in the way of planning. They can’t fix everything, but it’s better (and much less expensive) than going to court. There are times when you can’t avoid court, but it’s probably best to try to minimize that sort of thing.
Mom and dad had been married for many years. They have three children whom they love very much. The oldest, John, is married with the family. John and his wife don’t have much, but they’ve been making it. They’ve never asked for anything from mom and dad and have always been ready to help.
Their second child is Susan. Susan also is married with four children. Her husband has a good job and has been able to provide for the family, so Susan was a stay-at-home mom and raised the children, bringing them by for their grandma and grandpa to spend time with. Great joy for mom and dad.
Their youngest son was Jason. Jason has had a tough life. His career never took off. His ex-wife got everything in the divorce. Mom and dad have financially bailed Jason out fairly often. They have spent a lot of money on Jason, and he was finally getting to a more stable point in his life.
When mom and dad came to see me, they were sort of conflicted. They equally loved all of their kids, but it seemed to them (to different degrees) that Jason already had received his inheritance. Dad felt stronger about that than mom. And there was some resentment of Jason by John and Susan. When mom and dad did the math, they actually discovered that they had already given Jason much more than John and Susan would receive on their deaths.
In the end, mom and dad decided that Jason had already received his inheritance. They decided to leave their estate only to John and Susan. Mom was torn about this because she knew Jason would feel cheated, but she hoped that over time, he would understand. Still, it was a very difficult decision.
The law allows people to do basically whatever they want with their property on their deaths. They can disinherit any one or more or even all of their children.
However, where a child is disinherited, you need to be careful. If you don’t even mention them in your will or trust, the validity of the will or trust comes into question. A person must be competent, and one requirement for competency is that the person must know the “natural objects of their beneficence.” Good phrase, huh? Learned it in law school. It means a person must know the people who would ordinarily receive that person’s inheritance. If you don’t mention all of your children, then that raises a question of competency.
But even if you mention them, that may not be the end of things. After the death of mom and dad, Jason may feel that John and Susan made mom and dad write him out of the will. Since he has nothing to lose, he could bring a will contest or trust contest based on undue influence. There are plenty of attorneys who could take that case, for one reason or another.
Under these circumstances, I recommended that mom and dad leave Jason something. It had to be an amount or percentage that Jason could not ignore. And the will or trust would include what is called an “in terrorem” clause. That clause says that if you sue, you lose everything. So be afraid; be very afraid.
IRAs and 401(k) plans are great. Amounts an employee contributes to them are tax-deductible up to certain limits. Amounts contributed to them by employers don’t even get included in taxable income when they’re contributed.
And then the amounts in these accounts grow tax-deferred. Even though amounts withdrawn are taxable, when taken out, the tax-deferred growth super-boosts your investment return, while the assets are sheltered in these accounts.
Once an account owner reaches 70 ½ years of age, he or she must begin taking the “required minimum distribution” (“RMD”). You calculate this RMD by dividing the amount in your account by your life expectancy. It’s kind of creepy, but the IRS has determined your life expectancy for you. That’s so kind of our government isn’t it?
When you die, if you’re married, your surviving spouse has the right to roll your IRA or 401(k) over into his or her own name. Assuming the surviving spouse is younger, then they can recalculate the RMD and extend the payment a little more. And all the while the money in the account continues to grow tax-deferred. Great benefit!
When I meet with couples, their biggest asset (or at least one of their biggest assets) is usually their retirement account. But the problem is that if the account owner doesn’t plan carefully, on the death of the surviving spouse, some of the benefits can be wasted.
For instance, I have had a number of estates where the couples failed to name a beneficiary of a retirement account. In that situation, the IRA is payable to the decedent’s estate. When that happens, all the IRA assets must be distributed within five (5) years, and all of these distributions will be fully taxable. You can lose 40% of the account value in pretty short order. It seems a pity to waste all those lifetime tax savings that way, but people do it when they don’t plan.
If people have a charitable inclination, a good plan is to have retirement assets payable to the charity. Although the retirement assets are taxable income to the recipient, since a tax-exempt entity is, well, tax exempt, no taxes are due.
If an IRA owner has children, a lot of people will just name the kids as the beneficiaries. This creates what is called an “inherited IRA” that can be stretched over the life of the recipient, which is a good thing.
But inherited IRAs can also be problematic. If the designated beneficiary dies before the IRA owner dies, then depending on the wording of the designation or the policies of the IRA administrator, the retirement assets may or may not go to the deceased beneficiary’s children and the measuring life will probably be that of the deceased beneficiary.
Inherited IRAs also present another problem. One of the laws that govern IRAs is the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. (Where do they come up with these names?). Under that law, an employee’s IRA is protected from bankruptcy. That much was pretty clear.
For several years after that, people wondered if the law also protected inherited IRAs. In the 2014 case of Clark v. Rameker, the Supreme Court decided that the law did not protect inherited IRAs. If inherited IRAs are not exempt from bankruptcy, I wonder if they are protected from a beneficiary’s creditors at all. I haven’t seen any cases on that, but it seems like a logical extension of the Clark case.
The way to protect inherited IRAs from a beneficiary’s creditors is to have the IRA paid to a trust. Now it can’t be just any trust. If the IRA can be used to pay the debts of the decedent, trust, or probate administration expenses, court ordered family allowances, various taxes, or other things, then the trust is not qualified and the taxes will be due within five (5) years.
In 1999, the IRS gave us some magic language to qualify a trust to receive IRA benefits. So in order for a trust to qualify, it must include this magic language. In addition, the trust needs to contain what’s called a spendthrift clause. This simply says that the assets of the trust cannot be used to pay the debts of the beneficiary.
An IRA paid to a properly drafted trust will protect the inherited IRA from the beneficiary’s creditors over the life expectancy of the beneficiary. It’s a good plan.