Family Money : How to Use Life Insurance, Living Trusts and Other Common Tools to Leave as Much as Possible to Your Loved Ones

Family Money Using Wills, Trusts, Life Insurance and Other Financial Planning Tools to Leave the Things You Own to the People You Love

SILVER LAKE PUBLISHING LOS ANGELES, CA Š ABERDEEN, WA

Family Money Using Wills, Trusts and Other Financial Planning Tools to Leave the Things You Own to the People You Love First edition, second printing 2004 Copyright © 2004 by Silver Lake Publishing Silver Lake Publishing 101 West Tenth Street Aberdeen, WA 98520 For a list of other publications or for more information from Silver Lake Publishing, please call 1.360.532.5758. Find our Web site at www.silverlakepub.com. All rights reserved. No part of this book may be reproduced, stored in a retrieval system or transcribed in any form or by any means (electronic, mechanical, photocopy, recording or otherwise) without the prior written permission of Silver Lake Publishing. The Silver Lake Editors Family Money Includes index. Pages: 308 ISBN: 1-56343-744-9 Printed in the United States of America.

ACKNOWLEDGMENTS The Silver Lake Editors who have contributed to this book are Kristin Loberg, Christina Schlank, Megan Thorpe and James Walsh. This is the ninth title in Silver Lake Publishing’s series of books dealing with risk and insurance issues that face people living in the United States and other developed countries. Throughout this book, we refer to insurance policy forms and legal decisions from the United States—but the spirit of the discussion about risk and insurance can apply beyond the jurisdiction of the courts cited. Some of the insurance policy language referenced in this book has been developed by the New Yorkbased Insurance Services Office (ISO). ISO policy terms are updated and modified regularly. Our references to the terms are intended solely to illustrate common issues and disputes. You may need to consult with a professional advisor before making decisions or investments related to a particular estate. This book is intended to make the concepts and theories of estate planning understandable to consumers. The Silver Lake Editors welcome any feedback. Please call us at 1.360.532.5758 during regular business hours, Pacific time. Or, if you prefer, you can fax us at 1.360.532.5728. Finally, you can e-mail us at [email protected]. James Walsh, Publisher Los Angeles, California

CONTENTS

CHAPTER 1

Who Is Family? And What Does That Mean?

1

CHAPTER 2

Attitudes and Aptitudes

37

CHAPTER 3

The Vehicles for Transferring Family Money

73

CHAPTER 4

Types of Investments

117

CHAPTER 5

Legal and Administrative Fees 149 CHAPTER 6

What Happens When Somebody Dies

177

CHAPTER 7

Taxes

211

CHAPTER 8

Problems and Problem People

251

TABLE OF CONTENTS

CHAPTER 9

277

Inheriting Money INDEX

303

CHAPTER

CHAPTER 1

1 WHO IS FAMILY? AND WHAT DOES THAT MEAN?

This book is about accumulating and protecting intergenerational wealth. Family money. The means of comfort, education and freedom—not just for yourself, but for numerous people who’ll come after you. You may think only rich people—the Kennedys and the Rockefellers—need to think about family money. That’s not so. Middle-class people can and sometimes do leave enough money to children and grandchildren to make their lives better. The trick is to start thinking strategically early. In North America, at the beginning of the 21st Century, we live in a consumer culture that argues against building family money. Media and marketers encourage you to spend what money you have— and some that you don’t. The government conspires with this effort in two ways. First, it promises to take care of you in your old age if you’re broke when you get there; second, it discourages family wealth by taxing any money you have left to leave others when you die.

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There are ways to get around these problems. And, despite Hollywood’s versions, most lawyers and accountants deal—at least in some capacity—with this getting around. One big reason lawyers are often obscure about what they do for a living isn’t that they’re afraid of lawyer jokes; it’s that they don’t want to spend a whole cocktail party answering arcane questions about wills and probate court. This book will deal with that hard stuff: technical matters about wills, living trusts, tax issues and powers of attorney. But, before we get into the details of whether you’re better off putting shares of the family business into a generation-skipping or charitable remainder trust, you need to ask yourself some more basic questions. These questions will get to the core of what constitutes your family—by blood, law or spirit. If it works right, this process leads you to an understanding of yourself and the people closest to you. And this understanding helps you make the appropriate decisions for handling the financial assets you accumulate—by inheritance, luck or hard work. Of course, there are complexities in every family. Some families bring their own problems—members who make bad decisions, members who don’t get along. Other families have external problems— weak or non-existent standing under the law...outright conflicts with social convention. And, more complex still, the size and shape of families change over time. Children are born, people die, relationships break apart. So, any definition of “family” has to be a multivariable proposition.

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To start this book, we’ll consider the fundamental questions of what constitutes family and how that influences the money decisions.

CONTROL

AND

INFLUENCE

Leaving abstract existential musings to French philosopher and 20th Century author Albert Camus, we agree with the psychologists who argue that life is best thought of as a series of concentric circles. You are the center circle; immediate family—the people closest to you—make up the ring immediately outside of you. Extended family and close friends are the next ring. Casual friends and respected acquaintances are next. The Interior Minister of Turkmenistan is on a ring somewhere farther out.

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The concentric circles reflect the intensity of your personal connection—physical, emotional, financial. They also reflect your influence and control.

Most of us can control our own decisions and actions—as long as there’s enough Prozac around. Strictly speaking, control ends there. Most of us can influence our immediate families, no matter how dysfunctional things may seem. We may have some slight influence on friends and acquaintances. As for the Interior Minister of Turkmenistan...well, central Asia is a long way away. What does this model of control and influence do? First, it should help you think more clearly about who fits where in the priorities of your life. This may not be a big deal if your life is devoted to a spouse and a few kids. But it’s more important if you’ve had several spouses and more kids...if your significant other isn’t—legally—your spouse...or if you’ve raised grandchildren, nephews, nieces or other family members in your own household. Second, it should be a reminder that your ability to control diminishes sharply as you move out from the center. Most of the problems with family money come when people try to use their resources to control the rings. By the time you’re finished with this book, you’ll have a very good idea of how bad this can make things. But you’ll also have a pretty good idea of how to avoid that trouble.

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The circles should remind you of who means most to you. Sometimes people forget. For example: In 1997, a Kentucky woman started several years of legal squabbles for her family by dying—and leaving all of her money to the actor Charles Bronson. Audrey Joan Knauer had never met the man whose Hollywood career reached its peak in a series of low budget action movies during the 1970s (Death Wish was the most famous of them). But she loved his work. At first, Knauer’s relatives weren’t too concerned about her will’s odd twist. They thought “all of her money” meant a few thousand dollars. Because she hadn’t worked in the last decade or so, her family had assumed she was practically broke. As it turned out, though, Knauer—who had earned a Ph.D. and worked as a chemist in the 1970s and 1980s—had numerous certificates of deposit and several bank accounts. In the weeks after she died, it became clear that she had more money than anyone thought—nearly $300,000, after taxes and legal fees had been paid. Bronson had already received more than half of Knauer’s money by the time her family figured out what was going on. In her handwritten will, dated April 1996, Knauer—who was 55 at the time—left all her financial assets to Bronson, whom she described as a “talented character actor.” The will stated that, if Bronson didn’t want the money, it would go to the Louisville Free Public Library.

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In the will, which had been written on a list of emergency telephone numbers, Knauer seemed discontented with at least one relative. She wrote that “under no circumstances is my mother, Helen, to inherit anything from me—blood, body parts, financial assets.” This may sound extreme; but it was a pretty effective legal document. Knauer’s sister, Nancy Koeper, filed a lawsuit contesting the will in late 1998. The lawsuit made a common claim: that the money shouldn’t go to Bronson or the library because the will had been written when Knauer was “not of sound mind...nor mentally capable of making” reasonable decisions. So, the will went into probate—the time-consuming process of legal review. Knauer’s sister wanted the entire will declared illegal and the $300,000 distributed to the family. The Louisville Free Library wanted the will to be honored but modified to limit Bronson’s claims. The case was ultimately settled out of court. Bronson agreed to pay Knauer’s sister an undisclosed sum...but only part of the total he received. The library, which turned down an early settlement offer from Bronson, ended up getting nothing. Maybe Charles Bronson meant so much to Audrey Joan Knauer that he really belonged in her inner circle. Or maybe Knauer’s family meant so little to her that they were way out in the ring with the guy from Turkmenistan. But, if Knauer had thought more clearly about who meant what to her...even if she loathed her family, she probably would have given the library the first crack at the money. But not thinking clearly didn’t mean she was crazy. 6

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It’s hard to say what constitutes “sound mind”—as we’ll see in more detail throughout this book. And, for many people, it gets even harder when death approaches. That’s why it’s important to think about the concentric circles when you’re relatively young and relatively healthy.

MONEY

AND

LIFE

EXPECTANCY

When you start to think about family money, start by thinking about yourself—as critically as you can. In the course of your life, you can be both an asset to family money (by earning and investing well) and a liability (by spending lavishly or for a long time). How much as each will you be? That depends, in part, on how long your life lasts. In the 1,400 years from the fall of the Roman Empire to 19th Century America, the lifespan of an average person living in the most developed society increased just nine years—from 38 to 47. In the century since 1900, it has increased almost four times as fast—to nearly 80. University researchers and other longevity experts predict that life expectancy could expand as far as 110 or even 125 years in the coming century.

This trend has had—and will continue to have—a major impact on everything from the size and shape of families to the best strategies for individual investment plans.

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Life expectancy charts used by insurance actuaries usually follow a complex pattern of calculating the years a person has left, based on the age he or she has reached or when he or she was born. For instance, a 40-year-old male can usually expect to live until he’s 76; a 40-year-old female, until she’s 81. Some researchers say that 50 percent of baby girls born in 2000 will reach age 100. Current projections are based on relatively straightforward models with known variables. They don’t take into account potential breakthroughs in the biology of aging. More importantly, they have no bearing on how an individual lives—how many packs of cigarettes a day you smoke, how many banks you rob, how many quarts of bourbon you drink, etc. Nevertheless, governments and insurance companies who bet on long-term trends want to know how long people can be expected to live. So, demographers continue to develop more intricate computer models. If you assume mortality rates will not decline, by 2050 there will be 9.9 million Americans 85 and older—the current low estimate of the Census Bureau. But, if you assume that the impressive 18 percent decline in the death rate seen in the 1970s and 1980s will continue, there could be 27.3 million people over 85 years old in the U.S. by 2050. That’s the Census Bureau’s high estimate—and a potential nightmare for Social Security and Medicare. Nightmares for Social Security mean problems for most family finances.

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When Social Security was initiated in 1935, life expectancy at birth was about 61 years, and there were 40 workers to support each retiree. Today, according to federal figures, life expectancy is 76.9 years and there are three workers per retiree.

The system is financed by payroll taxes—6.2 percent of each worker’s paycheck goes to Social Security and another 1.45 percent to Medicare, for a total of 7.65 percent. Employers also kick in 7.65 percent per worker. So far, it has worked. But, with life expectancy rising and Baby Boomers poised to start retiring en masse around 2011, the system is headed for trouble. To forestall insolvency of the Social Security system (which includes the Old Age Survivors and Disability Insurance fund and the Medicare health insurance system), Congress has taken various steps. Most of them mean more work and fewer benefits for younger workers. For example: The federal government is pressing up the age at which a person may retire with full benefits to 67 from 65. In a society that finds a growing number of older people using a shrinking supply of financial and health care assets, everyone has to make some decisions about where they will allocate their personal assets. The society as a whole also has to make these decisions. One effect has already been felt: People are working longer. The median age of the work force in the United States increased 15 percent between 1980

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and 2000. And the average retirement age could increase several months per year over the next few decades as Baby Boomers gray, but stay in the work force. And this will remain the trend for a long time; a full 80 percent of Baby Boomers expect to work in retirement. HOW MUCH WILL YOU NEED? Most discussions about retirement planning focus on how much you will need to accumulate in order to live in comfort. Make the maximum contribution to your 401(k) or other tax-advantaged account. Invest wisely. Don’t borrow too heavily. These are all good points to remember...and they’ll help any person in any situation avoid mistakes.

For the purposes of this book, though, we are going to suggest you plan for retirement in another way— as if it’s a liability against (either real or potential) family wealth.

Don’t turn away. This doesn’t mean you’re going to have to live your last years as a hermit in a trailer without electricity or running water. It just means you need to think beyond your retirement to the ring or two outside of your circle. Of course, your retirement resources—like any money—are subject to some economic forces beyond your control. Prime among these: Inflation, which can wipe out thousands of retirement dollars every year.

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A drop of even a few tenths of a percentage point in the inflation rate can mean another year-plus of solvency; conversely, a rise of a few tenths of a point can rob years from your reserves.

This is a well-known reality for families with money: Inflation impacts people living on investments more directly than people living on earned income (which reflects moves in the cost of living more immediately). Sure, you can invest your money more aggressively—but aggressive investment means risk. Just ask all those people who were certain that eToys, Pets.com and JDS Uniphase were going to buy them compounds in Kennebunkport or Newport Beach. Invested money usually earns slow, steady returns. The steady part is great—and has the advantage of compounding growth; but the slow part can get hammered by a slip of the Federal Reserve’s hand. One reliable average of investment returns (for everything from savings accounts to hedge funds) in the U.S. between 1940 and 2000 was 10.3 percent a year. That’s pretty good. It means that an average person could pull $30,900 a year out of $300,000 in invested retirement money. That’s almost enough for a couple to live on from the mid-range sale price of a house in a mid-range metropolitan area.

Inflation eats directly into the value of investment return, though. How much inflation should an aver-

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age couple expect? One survey of economists published in 2001 expected the low inflation of the 1990s to continue through the 2000s—at about 2.7 percent per year.

Net 2.7 percent out of the average 10.3 investment return and you’re bringing home an inflation-adjusted $22,800 out of $300,000 in investment principal. That’s a 26 percent chop off of gross investment income. If the average couple is going to keep its principal for heirs, it’s going to have cut one out of every four dollars from its budget. Welcome to life at the financial margins. And things get worse if hard economic times mean higher inflation. During the recession of the early 1980s, the U.S. saw steady inflation of more than 10 percent. What happens if inflation hits 12 percent? Then, on an inflation-adjusted basis, the average person losing $5,100 on his investments— has to dig into principal to pay bills.1 That has bad effects for years to come, even when times get better. This is part of the reason why people with a lot of invested money—even though they are rich and should feel secure—act so conservatively about money. It’s a natural instinct in preserving principal and the earning power of the principal.

1

In truth, this is a bit of an exaggeration. The returns on most conservative investments rise with inflation...though not always fast enough to make up the difference. All in all, inflation erodes the buying power of people living on invested income. 12

CHAPTER 1

So, even though the number of North Americans with at least $1 million in investable assets grew 2.4 percent to 2.54 million in 2000, almost half of the Americans asked think that $1 million is not enough to retire comfortably.

More than half of people between the ages of 50 and 53 surveyed by the Amercian Association for Retired Persons (AARP) expect an inheritance of some sort to help smooth their retirement. This means that many Americans—already near retirement age—are positioning themselves as net consumers of family money. This is a bad sign for their children and grandchildren. Which brings us back to the center circle. You need to think in terms of making your own retirement happen without drawing more from the family system than you’ve contributed. REACHING

ACROSS

G E N E R AT I O N S

Family money is like a time warp. It doesn’t matter where you are in your own life’s course—you need to do all you can to contribute to the overall family account. If you contribute effectively when you’re in your 30s, you’ll be able to withdraw more for yourself when you’re in your 70s without reducing the balance left for your grandkids. If you help your dad manage his money when he’s getting too old to do it well for himself, you’re making money available for your kids’ graduate school tuition.

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Reaching across generations can be a kind of immortality. Of course, some people twist that reach into a bad thing. In February 2001, the Supreme Court of New Jersey issued its decision in The John Seward Johnson 1961 Charitable Trust. The case was one of the messiest family money disputes in the history of American law. The case was merely one link in a long chain of lawsuits, all involving a dispute among the offspring of J. Seward Johnson, son of the founder of the Johnson & Johnson Corporation. In this episode, the beneficiaries of one of Johnson’s several trusts challenged the legal status of one of his granddaughters. Fellow family members claimed that the girl in question wasn’t really Johnson’s granddaughter—and therefore wasn’t entitled to a share of a $350 million trust fund. Johnson’s son, Seward Jr., divorced his first wife in 1965. During the divorce proceeding, Seward Jr. acknowledged in writing that he was the father of a child named Jenia Anne Johnson—who was known by her nickname “Cookie.” Specifically, Seward Jr. submitted a statement that read: To Whom It May Concern: The Undersigned, John Seward Johnson, Jr.,...hereby unequivocally acknowledges paternity of Jennie Anne Josephine Johnson...born of Barbara E. Johnson at Princeton, New Jersey, on January 11, 1961. Later, Seward Jr. claimed that he had agreed to acknowledge the daughter quickly, without paternity tests, in order to expedite the divorce. That prob-

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ably seemed like the easiest way to make a bad situation better. But Seward Jr. was part of one of the wealthiest families in America—so any decision he made about family structure was going to impact hundreds of millions of dollars of family money. There wouldn’t be any easy out. On December 20, 1961, Seward Sr. created an irrevocable charitable trust (the 1961 trust), naming four of his six children and 11 grandchildren as the trust’s measuring lives. Cookie was named as one of those grandchildren.

In a trust, a measuring life refers to the lives of individuals named by the founder whose deaths terminate the trust.

With hundreds of millions in family money to manage, Seward Sr. had decided to use a series of charitable trusts as the means of moving the money to his children and grandchildren. Under the tax laws in place at the time, this was the best way to minimize the amount his family would have to pay the government. The 1961 trust was funded with 4,600 shares of Johnson & Johnson common stock. Its terms directed the trustees to pay all net trust income to “educational, religious or charitable organizations” until January 10, 1997, or the deaths of Seward Sr.’s four named children and 11 named grandchildren—whichever came first. After that, the trustees, in their “absolute and uncontroled discretion,”

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would distribute the trust’s proceeds to Seward Sr.’s four children—Seward Jr., Mary Lea Johnson Ryan, Elaine Johnson Wold and Diana Melville Johnson Stokes—and “their spouses, and their issue, or any one or more of them.” After Seward Jr. began divorce proceedings against Barbara—but before the court entered the final divorce decree—Seward Sr. created another charitable trust on December 31, 1963 (the 1963 trust). The language of the 1963 trust generally tracked the language of the 1961 trust, except that the 1963 trust expressly excluded Cookie. The more time that passed from Seward Jr.’s divorce, the less committed he seemed to treating Cookie as his daughter. At one point, he described her and her younger brother as “children of other men.” But he never went as far as legally disavowing Cookie, either. He seemed content to let her status hang in murky uncertainty. But this murkiness couldn’t continue forever. In the mid-1990s, as the 1961 trust’s expiration date approached, the trustees sought instruction from the New Jersey court on several subjects, including:

•

the interpretation of the term “issue” and who comprised that group; and

•

whether the trustees’ understanding of the class of beneficiaries was correct.

Thirty-five years had passed. The “children” described in the 1961 trust were elderly—or had died. The “grandchildren” were adults, some in middle age, with children of their own. The value of the

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trust was then estimated at $350 million. Seward Jr. couldn’t keep his equivocation about Cookie’s status in limbo with this much money at stake. At an early conference on how the 1961 trust would be handled, Seward Jr., his second wife and their two children challenged Cookie’s inclusion as a member of the class of eligible beneficiaries. Cookie’s cousins, Eric Ryan and Hillary Ryan (children of Seward Jr.’s deceased sister Mary Lea) made a similar challenge. Despite the challenge, the trial court held that Cookie’s status as a child of Seward Jr. had been conclusively and legally established in 1965. The court further determined that she was an eligible beneficiary under the 1961 trust. The Ryans and Seward Jr. appealed. The appeals court ruled that Seward Jr. was barred from contesting Cookie’s legitimacy. In effect, the court told him that he couldn’t renege on the legal acknowledgment he’d made in the 1960s. But the question remained open about whether the Ryans—the cousins, who had never acknowledged Cookie’s legitimacy—could question it now. The New Jersey Supreme Court agreed to make a ruling on this point. THE

S TAT E

PARENTAGE

ACT

In 1983, the state legislature had enacted the New Jersey Parentage Act, which established the principle that “regardless of the marital status of the parents, all children and parents have equal rights

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with respect to each other.” It was also intended to provide a procedure to establish parentage in disputed cases. Specifically, the statute states: A man is presumed to be the biological father of a child if...[h]e and the child’s biological mother are or have been married to each other and the child is born during the marriage, or within 300 days after the marriage is terminated.... The state supreme court noted that, as indicated by the legislative history, “[t]hese presumptions are intended to facilitate the flow of benefits from the father to the child.”

The presumption of legitimacy is one of the strongest rebuttable presumptions known to the law. Most courts require that it be honored unless overcome by what the New Jersey court called “the strongest sort of evidence.”

With that established, the court ruled: We agree with the trial court that the Parentage Act essentially forecloses a thirdparty attack on [Cookie]’s parentage. The Act broadly accepts proof of paternity as “adjudicated under prior law,” as well as in a host of other settings.... Nor are we persuaded that the doctrine of probable intent requires a contrary conclusion or further proceedings.

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Probable intent is a concept that courts apply to trusts or contracts whose wording is unclear. But the state supreme court ruled that this wasn’t so in the Johnson case.

The Ryans argued, Cookie’s exclusion from the 1963 trust indicated that Seward Sr. did not intend her to be a beneficiary of the 1961 trust. But the state supreme court concluded that the inference of contradiction between the 1961 and 1963 trusts formed an insufficient basis on which to question Seward Sr.’s intent, which was unambiguously stated in the 1961 trust. Finally, the court had to consider the dispute in the framework of fundamental fairness (a big deal in family money cases). On these matters, it wrote: Although the social opprobrium once associated with being a child born out of wedlock has dissipated, the presumption in favor of legitimacy remains strong. Courts continue to rely on that presumption to promote our “oft-expressed policy of supporting the integrity of the family unit and protecting the best interests of the child... [and the] child’s right to family identification.” Similarly, the doctrine furthers the public policy of favoring the establishment of legal parenthood with all of its accompanying responsibilities.

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By design, the presumption of paternity in the New Jersey Parentage Act was intended to prevent “rumor, innuendo and whispers of illegitimacy from creeping into the serious process of determining paternity.”

In essence, the Ryans’ claim required the court to balance the re-examination of Cookie’s legitimacy against their right to question that legitimacy and thereby increase their economic gain. With what sounds like some contempt, the court wrote: ...the purported economic right to become eligible for an unspecified share of trust proceeds occupies a lower place in the hierarchy of rights as compared to a putative father’s right to the parent-child relationship. ...[Cookie] cannot be Seward Jr.’s daughter for only some purposes. By operation of law, the adjudication of Seward Jr.’s paternity cements [Cookie’s] status as an eligible beneficiary under the 1961 trust absent clear language to the contrary within the trust itself. Cookie’s lawyers said that the ruling made a strong statement about the integrity of family. “Once a husband and a wife acknowledge the parentage of a child or it is determined in court, other people cannot intrude and raise questions about a paternity,” said attorney Robert Del Tufo.

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As we mentioned before, this case was only one of many involving the Johnson family. Seward Sr. had made some problems himself, in terms of family integrity, by marrying a Polish-born woman half his age—who’d worked as a cook and maid on his $30 million Princeton estate. Thirty-nine days before his death, Seward Sr. amended his will, leaving most of his estate to his new wife. His children, including Seward Jr., contested this will. That trial started the tabloid interest in the family’s affairs. The Polish wife considered Seward Sr.’s children as greedy wastrels who squandered millions in inheritance. Stories of drug abuse, incest and suicide attempts filtered out from depositions and testimony. The heirs called family servants to testify—supported by taped recordings of the Polish wife’s tirades. In her heavily-accented English, she sounded like a cartoonish caricature of a wicked stepmother (even though she was younger than most of Seward Sr.’s children). When all was said and done, the case was settled one day before it was considered by the jury. Seward’s new wife walked away with $350 million; the children split more than $40 million. O L D - FA S H I O N E D

NOTIONS

The lawsuits and legal battling that took place within the family in the years after Seward Sr. set up his trusts make some people glad that they don’t have as much money—and as many problems—as the Johnson & Johnson heirs.

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This may be part of the reason that some very rich people—most notably, investor Warren Buffett and software mogul Bill Gates—have said publicly that they intend to give most of their billions to charity. They want to avoid the generations of money battles that have beset families like the Johnsons.

But most people don’t have so much money to worry about. And they do want to leave what they have to children, grandchildren or other family members— without creating small-scale versions of the Johnsons’ problems.

The main lesson learned from the fight over Cookie Johnson’s legitimacy is that legal status matters a lot when it comes to money matters. Although American society judges out-of-wedlock births less harshly than it did before the 1960s (there’s less “social opprobrium,” as the New Jersey Supreme Court called it), the fact remains that outof-wedlock or illegitimate births do make money issues more complex.

When out-of-wedlock births occurred primarily among poor people, these complexities didn’t much matter. But, as single-parenting becomes more common among middle-class and wealthier people, the problems become a bigger issue.

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This is tough work. It’s easy for television writers to make fun of social conventions and single motherhood in a show like Murphy Brown. But real life deals with harder truths. Not all single mothers are as wealthy as that TV show’s lead character—and, in the real world, children born outside of marriage have no immediate status as heirs of their fathers. This was part of the reason the New Jersey Parentage Act was designed to support children trying to establish paternity—not deny paternity, as Cookie Johnson’s cousins were trying to do. Not all fights over legitimacy involve hundreds of millions of dollars. More often, courts have to grapple with more mundane families—and more ordinary financial matters. The January 2001 Ohio Supreme Court decision Estate of Vaughan dealt with more mainstream—but no less agonizing—facts. The case actually started 20 years earlier. In 1980, Deborah Ferrante filed a paternity suit against William R. Vaughan in juvenile court. Ferrante wanted to establish that Vaughan was the father of her daughter, Angel Vaughan. At a hearing in October 1980, Vaughan entered a plea denying that he was Angel’s father. Several months later, in early 1981, Angel’s parents reached an agreement about the child. Vaughan entered a plea acknowledging paternity. Based on this, the juvenile court determined Vaughan was Angel’s father and ordered Vaughan to pay Ferrante expenses for pregnancy and childbirth as well as previous and current child care costs.

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Vaughan died in May 1981. As a result, the juvenile court entered an order canceling its award of child care maintenance and support costs to Ferrante. In July 1981, Vaughan’s mother, Jacqueline Bradshaw, filed an application to administer her son’s estate. She identified Angel and herself as heirs to Vaughan’s estate. The court appointed Bradshaw as administrator and ordered that a fiduciary’s bond be posted. Safeco Insurance Company of America, as surety for Bradshaw, provided bonds in the amount of $71,000.

Surety bonds play a big role in estate management— especially when the estates are complicated. In short, a surety bond is a kind of insurance policy against mismanagement or malfeasance related to monies that may be distributed among several people. Courts require these bonds in certain situations.

In September 1981, Ferrante filed paperwork requesting that the probate court appoint her as Angel’s guardian—for the purposes of negotiating with Vaughan’s estate. This was normal procedure. Then, in March 1982, she didn’t want to be the guardian anymore so the probate court terminated the guardianship. A few days after that, Bradshaw— Vaughan’s mother—asked the probate court to amend the list of heirs, making her her son’s sole heir. Vaughan’s estate was quickly settled and the probate court discharged Bradshaw and Safeco.

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Did Ferrante and Bradshaw make some kind of deal to remove Angel from the estate? The court papers, of course, didn’t say anything about that. But it would seem to be a logical inference.

Almost 16 years later, in May 1998, Angel Vaughan—having reached legal adulthood—filed a motion to reopen the estate of William Vaughan. She petitioned the probate court to vacate its judgment of March 1982, amending the list of heirs. She also asked the court to hold Bradshaw and Safeco liable for monies that should have been paid to her. The probate court rejected Angel’s motion. So did a trial court. She appealed—and the Supreme Court of Ohio agreed to consider the case. The supreme court’s main issue: whether a juvenile court admission of paternity is the equivalent of a probate court legitimation. In other words: We are asked to decide whether William Vaughan’s juvenile court admission of paternity conferred rights of inheritance upon [Angel] and thereby established her as the sole heir of Vaughan’s estate. Angel claimed that Vaughan’s open-court admission that he was her biological father resulted in the establishment of the natural parent-child relationship, which would vest her with rights of inheritance by and through him. The supreme court disagreed, and noted those circumstances under which a child born out of wed-

25

W H O I S F A M I LY ? A N D W H AT D O E S T H A T M E A N ?

lock could inherit from the natural father. Those circumstances included: 1) when the natural father designates the child as his heir at law; 2) when the natural father adopts the child; 3) when the natural father provides for the child in his will; 4) when the natural parents of a child born out of wedlock marry; and 5) when the natural father, with the consent of the mother, formally acknowledges in probate court that he is the father of the child. William Vaughan had done none of these things— his admission in juvenile court didn’t meet any of the law’s requirements. The Ohio court held that Vaughan’s admission of paternity during a juvenile court proceeding didn’t constitute a legal admission of parent-child relationship “sufficient to vest [the] child with rights of inheritance.” Angel was out of luck. Clearly, the law can be pretty harsh when it comes to determining who’s family. That’s why it’s important—especially for people with blended or nontraditional families—to make a clear statement of inheritance. And, as we saw in the Charles Bronson case, this doesn’t have to be a formal legal document. (We will consider the mechanics of wills in Chapter 3.)

26

CHAPTER 1

DOWN,

NOT

S I D E WAY S

Even people whose families have a traditional structure are occasionally surprised with an inheritance decision that goes against their plans. So, no one can afford to be thoughtless about their estate planning. In most states, probate law assumes a much more limited notion of what “family” means than people who get their legal training from television shows might guess. The August 2000 Oklahoma Appeals Courts decision in Estate of Dale J. Smith dealt one person a familial shock. Dale Smith and Joe Smith were brothers. Jim C. Smith was Dale’s only child. Dale and Joe owned a total of approximately two-thirds of the shares of stock of Wood Oil Company, an Oklahoma corporation. Together, they had controling interest in the company—separately, neither owned enough shares to control.

The brothers had signed a shareholder’s agreement— essentially a contract between them—that stated certain terms under which they had purchased and would keep or sell their shares. Joe claimed that these terms included an option for him to buy Dale’s Wood Oil shares in the event of Dale’s death.

When Dale died in 1999, his son Jim was named personal representative (Oklahoma’s version of an administrator) of the estate. So far, that was fine.

27

W H O I S F A M I LY ? A N D W H AT D O E S T H A T M E A N ?

The trouble started when Jim told his uncle that he wasn’t going to sell his father’s shares in Wood Oil. Joe filed a lawsuit contesting Dale’s will. Jim asked the court to dismiss his uncle’s contest on the ground that Joe was not a “person interested” in the estate, as required by law. On the other hand, Joe’s theory was that, because his brother’s will granted Jim the power to sell his stock, Joe’s rights under the shareholder’s agreement were violated. This made Joe a “person interested.” The probate court noted that, although “[a]ny person interested in a will may file objections...[to be] determined by the court,” not every person is a “person interested.” That was for the court to determine. The court—which was limited in its scope to considering the issues related directly to Dale’s estate— couldn’t find anything in the estate documents that suggested his brother had an option to buy his Wood Oil shares. In fact, it didn’t find anything that gave Uncle Joe any legal standing in the estate. Oklahoma law granted status instantly to spouses and children—but didn’t give any special legal position to siblings of people who’ve died. It agreed with Jim and denied Joe’s contest. Joe appealed, arguing that the shareholder’s agreement he and Dale had signed should be included in the estate. This argument failed to convince the appeals court. It concluded that Joe would have to sue Dale’s estate separately: Whether Joe or [Dale’s son] is successful in the independent action relating to the va-

28

CHAPTER 1

lidity of the stockholder’s agreement is not material to this appeal. Dale’s stock in the oil company is a part of the property of the estate. That stock is subject to the restrictions contained in the stockholders agreement, if it is valid. Otherwise, those restrictions will not be enforceable. This is somewhat similar to the rights of a creditor whose claims are disputed. So, Dale’s will would stand. As far as the probate court was concerned, the Wood Oil shares were property like any other property—and Jim was in charge of what would happen with them. To support its ruling, the appeals court referred to the 1933 Oklahoma case McVoy v. Lewis, in which a surviving sister, nieces and nephews contested a dead woman’s will. The will granted all of the decedent’s property to her grandchildren, because she had outlived her own children. When the case reached the Supreme Court of Oklahoma, the court made the following points: 1) the only persons who may contest the probate of a will are persons having an interest in the estate of the deceased; 2) in its legal sense...“issue” means descendants, lineal descendants, offspring; and 3) in [Oklahoma] statutes, grandchildren, being lineal descendants, inherit to the exclusion of a sister, nieces and nephews of the deceased. This is why many lawyers wearily chant “inheritance flows down, not sideways” when extended fam-

29

W H O I S F A M I LY ? A N D W H AT D O E S T H A T M E A N ?

ily members want to raise legal complaints. Unless they are specifically named in a will, trust or other legal document, siblings, cousins, in-laws and the like are not considered “family.” DIVORCE

AND

MONEY

There’s no doubt that the social changes of the second half of the 20th Century brought about important changes in the way people live. Many social critics argue that one of the key changes has been more liberal attitudes toward marriage and divorce. The easing of legal barriers and social stigma allows people to get out of bad marriages more quickly. On a social and psychological level, easier divorce may be an improvement in the way people live. But on a financial level, divorce remains a major problem. It has been well established that divorce creates financial hardship for everyone involved, but especially for women and young children.

This hard reality reflects some little-realized legal and financial facts—namely, that marriage exists primarily in legal and financial contexts as a conduit for transferring wealth from spouse to spouse, and from parent to child. Although divorce is well established in the law, it still makes smooth transfer...not so smooth.

The May 2001 Delaware Chancery Court decision Doris Mitchell v. Betty DiAngelo offers a good example about how deep this instability can go. And how long it can last. 30

CHAPTER 1

Carl Jones and Betty DiAngelo were married in 1951. They had no children together. In June 1968, Betty sought a divorce in order to marry another man. Carl’s attorney arranged for her to go to Alabama, where she obtained a written divorce decree dated June 28 and signed by an Alabama judge named F.O. Whitten. She married her second husband in Georgia the next day. Shortly before she left Delaware for Alabama, Betty signed a written agreement with Carl that stated his payment to her of $5,000 would be a complete settlement of all of her rights to their marital property. He got the home, and by August 1968, Carl was identified as a “divorced man.” Betty and her second husband lived together until his death in 1987. Betty then began to collect Social Security benefits and a veteran’s pension as that man’s widow. She married for a third time in 1990— but that marriage ended in divorce a year later. Carl never remarried and had no children. He died without a will in early 2000. When Betty learned of Carl’s death, she calculated that she would be eligible to receive higher Social Security benefits as Carl’s surviving spouse than she was receiving as her second husband’s surviving spouse. She applied for an adjustment with the Social Security Administration. As part of the adjustment, the Social Security Administration asked for a copy of the Alabama divorce decree. When Betty wrote to Alabama for a certified copy of the divorce, she discovered that

31

W H O I S F A M I LY ? A N D W H AT D O E S T H A T M E A N ?

the state had no official record of her divorce from Carl and that Judge F.O. Whitten had been imprisoned for issuing fraudulent “quickie” divorces. Suddenly, Betty had a whole new legal strategy to pursue. She filed legal papers in Delaware, claiming right to 100 percent of Carl’s estate—as his widow. She argued that, because the divorce decree was void, her subsequent marriages were also void. And that she was Carl’s wife when he died. On the other side, Carl’s family members (led by his sister, Doris Mitchell, who was the administratrix of his estate) argued that Betty should be prevented from denying the validity of the Alabama divorce and her later marriages—and, thus, from inheriting Carl’s money and property. Furthermore, Mitchell argued, the Property Settlement Agreement Betty and Carl signed as she was leaving served as a release of all of Betty’s claims against Carl’s estate. The Delaware court agreed with Mitchell. In its ruling, the court pointed to The Uniform Probate Code, which provides that: a surviving spouse does not include (1) an individual who obtains or consents to a final decree or judgment of divorce from the decedent or an annulment of their marriage, which decree or judgment is not recognized as valid in this State...; (2) an individual who, following an invalid decree or judgment of divorce or annulment obtained by the decedent, participates in a marriage cer-

32

CHAPTER 1

emony with a third individual; or (3) an individual who was a party to a valid proceeding concluded by an order purporting to terminate all marital property rights. Put simply, the court held that subsequent marriages compromise a person’s status and right to make a claim on the estate of a previous spouse— even if there has been an invalid divorce. The court said: ...ubiquitous change in public attitude toward divorce in the last half century, and the vastly different set of laws now in effect in this and other states, is reflected in more modern opinions in the area. In making its decision, the court pointed out the unique and troubling aspect about Betty DiAngelo’s claim: She had waited more than 30 years—and until Carl had died—before she asserted any claim to a greater share of their marital property. The court wrote that there would be a fundamental unfairness if Betty were allowed both to ignore her divorce and remarriage and to avoid the effect of her agreement to renounce her statutory right to Carl’s estate. She had lived her life since 1968 as though she were divorced from Carl and fully enjoyed the benefits of that divorced status. Now that Carl was dead and her marital duties to him had terminated extra-judicially, it was too late for her to assert her rights as his spouse. In the court’s final words, “...between Betty and Carl, equity and good conscience dictates that they be left where they put themselves...in 1968.”

33

W H O I S F A M I LY ? A N D W H AT D O E S T H A T M E A N ?

L I N E S B L U R I N M A N Y WAY S Joe Smith’s assumptions about having a role in his brother’s estate—or Betty DiAngelo in her first husband’s—show that the “ubiquitous change” in the social meaning of family isn’t only about falling apart. It’s also about non-traditional coming together. In a time of less certainty, some people will assume family ties that don’t exist. The February 2000 Delaware state court decision Susan Wagner v. Gordon Hendry involved yet another variation of assumed familial ties. Briefly stated, the parents of a young man decided to help out and facilitate the purchase of a home for their son and soon-to-be daughter-in-law. They made several business arrangements under the assumption that Susan Wagner, their son’s fiancé, would be a part of the family. But when Susan called the engagement off and moved out, those business transaction became a source of legal trouble. Susan wanted her share of the down payment back, and had to drag her case to court. She eventually got some of the money back, but it wasn’t easy. The deal had simply been too complicated and too conditional to do anyone involved good. Susan Wagner and her potential in-laws had agreed to a business deal that would have required a lot from family members—and they weren’t family.

34

CHAPTER 1

CONCLUSION The purpose of this chapter has been to offer you some tools for thinking clearly about what your family is...and who belongs in it. We’ve also tried to show how strict and conservative a view most financial institutions, laws and courts take in defining “family.” Again, it’s important to stress that the law’s strict constructions aren’t just part of some political agenda. They go deeper than that. More than most people would like to admit, families exist to channel resources (cultural, intellectual—and financial) smoothly from one generation to another. It serves little purpose to rant against hard rules. The strict constructions of “family” in money matters are facts of financial life that must be recognized and dealt with effectively. The rest of this book will concentrate on strategies and tactics for doing so.

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W H O I S F A M I LY ? A N D W H AT D O E S T H A T M E A N ?

36

CHAPTER

CHAPTER 2

2 ATTITUDES AND APTITUDES

You’ve considered your notions of family—and made some basic decisions about who’s in that group. The next step in effective planning is to do some critical thinking about what kind of person you are and what kind of people your family members are in terms of money management. And don’t just laugh this off by saying “broke” or “incompetent.” The purpose of this step is to make decisions about managing family money that are realistic, given your own tendencies and those of the people who’ll inherit your family’s resources.

With members of the World War II generation passing their assets to Baby Boomers...and the Baby Boomers, in turn, passing assets to their children, more money will pass from one generation to another in the first half of the 21st Century than the rest of American history combined.

37

ATTITUDES AND APTITUDES

No matter how unprepared you may feel, you’re going to pass some kind of financial legacy onto your loved ones. It might as well be well thoughtout. Managing family money, like parenthood, is a responsibility that often forces self-centered people to become less self-centered. So, you need to ask yourself: What kind of money person am I? To prevent this question from spinning out of focus, consider how your finances relate to each of the following common issues:

•

Timeliness. Do you adjust your plans with the birth of children and grandchildren; sale of a business, home or other large asset; marriage or divorce, death of a family member; change in guardian or relocation? Any of these everyday facts of life can render your financial plans out-of-date.

•

Organization. Do you have a detailed inventory of what you own, what you owe and where accounts or assets are located? Wills and trusts often include these inventories; but they can become obsolete as circumstances change. That’s why smart planners keep separate asset inventories...and update them at least once a year.

Make sure everything is on the list—cash, liquid investments, business interests, loans or notes, real estate, collectibles, personal papers, etc.

38

CHAPTER 2

•

Clear (or clearly-defined) title. Do you know precisely who owns the assets in your estate? For example: How is the title to any real estate structured? Are you the sole title holder? Are you a joint tenant with a spouse? These matters control how the assets are transferred.

•

Communication. Do your family members know what you want? Many problems arise because beneficiaries or distributees (the heirs getting the money) don’t know what the grantors (people leaving the money) wanted.

The confusion may begin before your death, if you become incapacitated. This is why living trusts are useful; they state how you wish your affairs to be handled if you can’t speak for yourself. Without something like this in place, you may force family members to make quick, unprepared decisions about your medical care...and the family’s resources.

•

Beneficiary designations. How you define who gets family money can become an issue itself. Part of this is mechanical: Naming a revocable trust as a beneficiary will usually force accounts to be liquidated and subject to income tax after you die. Part of this is personal: Naming specific heirs often means someone doesn’t like the result.

•

Life insurance. Simply buying a policy with an X dollar benefit isn’t enough. 39

ATTITUDES AND APTITUDES

Setting up the right structure can almost double its value. If you name your spouse as beneficiary, proceeds will go to him or her tax free at your death because of the marital deduction—but any money left will be taxed at your spouse’s death. If you transfer ownership of the policy to an irrevocable trust—while you’re still kicking—the proceeds will go to the trust when you die...and it pays less tax (usually).

•

Gifts. One of the smartest ways to transfer money is to give it to family members slowly and steadily. You can give up to $10,000 per year to any person free of gift tax. (If you’re married, each spouse can give $10,000.) Some people are hesitant to do this because they think it means losing control. It doesn’t have to; but it will require financial discipline over a long time...so you hope.

We’ll consider all of these matters in more detail as we proceed through this book. The point of this exercise is to help you realize what kind of money person you are. Have you made plans that deal with the seven issues we just described? If you answered “yes” to all seven, you’re a conscientious planner who’s already ahead of the game; if you only answered “yes” to one or two, you don’t like thinking about money—and you need to start. There are two kinds of people: accumulators of wealth and distributors of wealth. The two are simply different sorts of people—different attitudes and

40

CHAPTER 2

inclinations. Accumulators are savers and planners by nature. Distributors spend more than they save. Of course, there are exceptions to that solute stance. It seems more accurate to say that different people— at different stages in life—may be savers or spenders. It’s certainly easier to accumulate when you’re single and unencumbered than when you’re putting a couple of kids through college. And even incorrigible distributors of wealth want to leave their worldy goods to the people they care about most. After all, someone who’s spent more than he or she has saved over the course of a lifetime should have a lot of cool stuff.

You can be a spender and a planner. In fact, if you are a spender, you need to make a concerted effort to plan...precisely because it may not come naturally to you. If you’ve never done anything about any of the issues we described in the previous couple of pages, reread those pages. There will be more information about what to do about each topic in the coming chapters.

A

TOUCH

OF

AGGRESSIVENESS

Instilling the right attitude about family money in your family members requires a certain aggressiveness about using resources and financial devices. The January 2000 Louisiana Appeals Court decision in William Brockman v. Salt Lake Farm Partner-

41

ATTITUDES AND APTITUDES

ship et al. shows how one family thought creatively about using trusts to a practical end. And, despite the courtroom losses that it suffered, the family’s attitude toward using family money influenced others. Salt Lake Farm Partnership was a hunting club, formed as a corporation in the late 1970s when Travis Oliver purchased a 3,200-acre tract of land. Oliver assembled 10 other men, all avid hunters, to acquire the land and develop it for hunting. Each of the original members, including Ralph Brockman, put up $20,000; the club financed the balance of the $1.8 million purchase price. Sometime prior to 1982, Ralph Brockman transferred his share to a trust on behalf of his two sons and named his brother, William Brockman, trustee. In 1982, the Salt Lake corporation restructured as a partnership. In addition to hunting dues, each partner was liable to make an annual capital contribution or capital call of up to $20,000; but, upon unanimous vote of the partners, a capital call of more than $20,000 could be required. On the club’s books, these contributions would be kept in a partner’s capital account. The Articles of Partnership stated that, if a partner failed to meet a capital call, “the Partnership shall liquidate that Partner’s interest.” Upon liquidation, the partner would get back 70 percent of his capital account, with the balance forfeited to the partnership. During the 1980s, Oliver purchased 80 acres of land to the north of the Salt Lake tract. Although

42

CHAPTER 2

Oliver didn’t grant a lease or right-of-way to the club, he allowed members free use of his adjacent tract for ingress and egress. This became the main thoroughfare to the club’s property. Incidents in other business dealings between Brockman and Oliver were straining their relationship by the late 1980s. By 1991, some partners had withdrawn from Salt Lake, reducing the number of partners to seven. This was also when the club’s bank loan was due to expire—so, the partners would have to refinance. In order to refinance, a $60,000 capital call was necessary. Final vote on the matter was set for a meeting in September 1991. Prior to the vote, Ralph Brockman called and sent memos to partners, expressing his dissatisfaction with the direction Salt Lake was taking. He wanted a formal, permanent right of way across the Oliver property as a precondition to voting for the refinancing. Oliver assured him this would be arranged. Neither Ralph nor William Brockman was able to attend the September 1991 meeting; after receiving official notice of the meeting, Ralph gave a written proxy to another friend and Salt Lake member. The friend cast the Brockman Trust’s vote in favor of the capital call, which passed unanimously. William Brockman received formal notice of the capital call on October 3, 1991; Ralph, who’d been traveling, received it a few days later. But Ralph wasn’t content with how things had gone while he’d been away. He felt that the lease Oliver offered the

43

ATTITUDES AND APTITUDES

club for the access road didn’t meet his demand for a permanent right-of-way. Ralph offered to pay only $30,000 from the trust on the capital call. In November, Salt Lake offered Ralph $78,000 for the trust’s capital account. He declined the offer. Salt Lake terminated the Brockman Trust’s interest on December 11, 1991. William Brockman filed a lawsuit against Salt Lake, Oliver and several other members in January 1992. The trust sought 70 percent of its capital account and other expenses. Alternatively, on the theory that the termination was invalid, the trust asked for a judgment dissolving the Salt Lake partnership. The case went to trial, and through the testimony of the Brockmans, the Brockman Trust made the following arguments:

44

•

Consent to the $60,000 capital call was invalid because a proxy had been granted by Ralph Brockman, who was not the trustee.

•

Consent was also invalid because the trust’s vote was specifically conditioned on acquiring a permanent rightof-way across the Oliver Tract.

•

After the September 1991 meeting, Salt Lake did not promptly mail meeting minutes to the Brockman Trust, thus keeping it in the dark and denying it the ability to act more quickly to protect its interest.

CHAPTER 2

•

Salt Lake undervalued the Brockman Trust’s capital account.

Because Ralph had consistently voted the partnership shares that were owned by the trust, the trial court had a hard time accepting these rather sly points. It issued directed verdicts rejecting all the Brockmans’ claims. They appealed. The appeals court wasn’t much more sympathetic. It ruled that reasonable jurors would have inevitably concluded that William delegated legal voting authority to Ralph, and that Ralph therefore had the apparent authority either to cast this vote himself or grant a proxy to a trusted friend and partner. The appeals court did rule in favor of the Brockman Trusts on one count. It wrote: Even though the trust failed to prove fiduciary breaches, intentional misdeeds and the right to be reinstated into Salt Lake, it showed that upon termination it was owed 70 percent of its capital account. The trust introduced sufficient evidence to cast doubt on [Salt Lake]’s final calculation. So, the trust could make the case for a larger reimbursement from Salt Lake. Despite Ralph Brockman’s untenable claims, he had been smart and aggressive about putting his partnership shares in the trusts for his sons. THE

EFFECTS

OF

COMPOUNDING

Although there may not be any profound moral distinction between spenders and savers, savers have

45

ATTITUDES AND APTITUDES

one key tactical advantage over spenders. They tend to be on the winning side of compounding. Compounding is the most important financial tool you can use. In short, it is the progressive effect that earning interest (or, on the other hand, paying interest) has over a long period of time. It’s like putting two rabbits in a room and coming back to find that they’ve multiplied to 20. The longer you’re out of the room, the more rabbits you get. Money works the same way. If you put it in the right place and give it time, it will multiply.

For the saver, incremental growth is the key to accumulating wealth. Usually, the effect of compound earnings over 20 or 30 years of steady investment will mean as much—if not more—than any individual investment decision.

For the spender, the flip-side advice is: Avoid debt. Compounding can work against you as steadily as it can for you. The paths to many personal bankruptcies are paved with finance charges. And financing finance charges. If you’re moving balances from credit card to credit card...or to equity lines or other loans...stop financing new purchases. Take the credit cards out of your wallet. If you don’t trust yourself even then, cancel all but one or two accounts or pay cash. If you’re able to put away some true savings (after you’ve paid off your consumer debt) at the end of

46

CHAPTER 2

each month, congratulations—you can skip the next few pages. If you don’t have enough money to pay your bills at the end of each month, or if you want to save more than you are now, there are only two ways to fix your problem: make more or spend less. Earning more is tough and usually relies on external factors (the job market or investment market). Spending less is the best way to improve your financial health. First, ask yourself: Where does all of your money go? Answering that question takes a bit of work, but it’s a key step to building family wealth. KEEP

D E TA I L E D

RECORDS

There are long books dedicated to the practice of making household budgets. We suggest a mechanically simple process for checking your finances. To start, buy a small receipt book. A notebook will work...a day-planner is great. Also, buy one packet of blue pens and one packet of red ones. Keep one red pen and one blue pen with your receipt book at all times. Second, for one month, collect receipts for every dollar you spend. From whatever tomorrow is to that same numbered day next month, ask for a receipt or make one for yourself every time you hand anyone cash, a check or a credit card. Third, tally your expenses. Put the receipts in the receipt book at least once a day. Using the red pen,

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ATTITUDES AND APTITUDES

list the expenses—amount, date and party paid— in the book at least every other day…in a clear, chronological order. Include everything—from the 50 cents you gave your daughter for an ‘NSync sticker to the $2,500 check you wrote for this month’s mortgage payment. Include deductions taken from your paycheck...and note the fees added to things like mortgage payments. Fourth, make a note in blue of every deposit you make into your bank account (if you have multiple accounts, focus this effort on whichever one you use primarily). Count every kind of deposit in this list—salary, bonus, dividends, transfers from other accounts, loans from college friends, money from your aunt. Try to keep the deposits in chronological order with the expenses...but don’t sweat it if the order gets a little mixed up. The main point is to include everything. Keep these records for the full month. Resign yourself to being an anal-retentive bean counter. At the end of one month, it’s time for analysis. The main question: How do the blue total and red total compare? Don’t be surprised if the red total is larger. This is usually explained by credit cards, lines of credit and interest expenses. If you net out payments (usually by check) to consumer finance companies, you should end up with numbers that come close to matching.

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A caveat: If credit card charges account for more than 20 percent of your total expenses, you’re probably using the things too much...and should be cutting back.

Once you’ve balanced the account, you can begin to characterize the ways you spend your money. Go back through your list of red expenses and give each expense one of the following numeric codes: 1—Shelter. This includes rent on your studio, mortgages on your homes. Insurance. Furniture. Repairs and maintenance. Utilities. No taxes—they go in their own category. 2—Transportation. This includes car payments, car insurance, gasoline, repairs and maintenance. Bus or train fares, the chauffeur’s salary. The ’66 Triumph you’re spending weekends restoring probably fits somewhere else. 3—Food. This includes groceries and kitchen-related expenses like water service, etc. This should not include the costs of eating out, though some people count prepared food they bring home. It should definitely not count discretionary items like gourmet coffee on the way to work each morning. 4—Health. This includes health insurance premiums, if you pay them yourself or they are deducted from your pay-

49

ATTITUDES AND APTITUDES

check (the paycheck stub should break out the details). It also includes copayments or deductibles that you pay out of pocket, money you spend on drugs—prescription or not, and expenses for seeing chiropractors, therapists or anyone else who tends to your well-being. 5—Education. This includes the costs of your education or your children’s. Student loan payments, tuition, school supplies (including uniforms, afterschool activities or day care expenses). 6—Taxes. This includes everything you pay directly to the federal, state or local governments. Include income taxes withheld from your paycheck (and itemize that, breaking out federal, state and other, if you like). Also include property taxes that are impounded (that is, included) in any mortgage payments. Leave out sales tax for this exercise. 7—Retirement planning and savings. This includes contributions to retirement plans—tax-advantaged or not; and money that you deposit each month into a savings account. Again, you may have some of these expenses deducted directly from your paycheck—so look at that stub. 8—Recreation. This will be the first of several broad categories. It should include things like health or country club memberships, athletic equip-

50

CHAPTER 2

ment, hobby supplies, collections, etc. Most people who use this system include travel and vacation expenses in this category. The ’66 Triumph and its attendant expenses probably goes here. 9—Entertainment. This includes eating in restaurants; drinks with friends; concerts, plays, sporting events or movies; videos you rent, books, magazines or newspapers you buy. It also includes gourmet coffee, lunches, online computer services or memberships, etc. 10—Clothes. Everything that you wear—whether functional or outrageous—goes here: work clothes, weekend clothes, funky thrift-shop coats, Armani tuxedoes, Nikes. Most jewelry. Dry cleaning and tailoring. 11—Communication. This includes your home phone bill and—importantly—any cell phone bills. Also, you probably should include things like home DSL lines and/or Internet service fees, answering services, if you use them, pagers, phone hardware, etc. 12—Religious and charitable donations. This may include cash contributions and pro-rated commitments (for example: one-twelfth of an annual gift that you’ve promised). The prorated commitment may be a little tough to calculate; keep it to actual pledges that you’ve made. Usually churches or

51

ATTITUDES AND APTITUDES

charities will send you some kind of paperwork describing the commitment. 13—Interest and finance charges. This includes interest on consumer debt—credit cards and the like. It should also include bank fees charged to your account and finance charges for things like cash advances and specialized transactions. It includes late fees for tardy payments. You don’t need to include interest on things like mortgages or margin loans...though some people do. You may feel that particular expenses deserve their own categories, or that these 13 categories don’t do justice to your complicated life. But the purpose of this exercise is to make basic conclusions about where your money goes. Most people spend roughly:

52

•

35 to 40 percent of their net income on shelter

•

10 to 15 percent on transportation

•

10 to 15 percent on food

•

10 to 15 percent on medicine and health

•

5 to 10 percent on savings

•

5 to 10 percent on recreation

•

5 to 10 percent on entertainment

•

5 to 10 percent on clothes

CHAPTER 2

•

5 to 10 percent on education and daycare

•

less than 5 percent on communication

•

less than 5 percent on charitable donations

•

less than 5 percent on finance charges

Use this list as an indication of trouble areas. If one item is way out of range, it may be a problem. Pay particular attention to the items near the bottom of the list. The expense categories that surprise more people are communications, entertainment and interest/finance charges. If any of these are more than 10 percent of your monthly spending, you probably need to cut back. This exercise isn’t intended for people with urgent money problems. Make gradual, lasting adjustments rather than radical change. CURING

BAD

SPENDING

HABITS

Most of us have at least a few bad spending habits—whether we are inclined to be spenders or savers. In many cases, a lack of experience with daily costs of living leads to a certain level of volatility, which makes steady savings difficult. What follows is a review of some of the worst, but most common, spending habits that screw up people’s financial lives. Check your own habits against these patterns. Pay close attention to the solutions discussed and take control.

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ATTITUDES AND APTITUDES

Buying on credit is probably the worst habit you can have. If you have it, you shouldn’t feel alone. American consumers have more short-term, unsecured debt than any other group on the face—or in the history—of the planet.

People who avoid using credit are sometimes seen as cranks or eccentrics—people who aren’t willing to play by the conventional financial rules. But there’s a lot to be said for avoiding revolving consumer debt.

Borrowing money to buy things that lose value over time means you lose twice—once in the interest costs of borrowing the money and twice in the lost value (depreciation is the accountant’s term) of the thing you’ve bought. Consumer lending is designed to lull the consumer—namely, you—into a false sense of financial security. That’s why Circuit City, Bloomingdales and Nordstrom are happy to issue store credit cards. But credit cards are the worst form of borrowing. Once they’ve encouraged you to spend beyond your current means, they charge you anywhere from 15 to more than 20 percent interest. Break this habit by not buying anything on credit except your education, your car or your house. Everything else should be paid in cash or paid off when you get the credit card bill. Keeping up with the Joneses is another bad habit. Thanks to a natural competitive instinct and bil-

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lions of dollars spent every year by advertising geniuses, we have been brainwashed into judging ourselves by whether we have the same material goods as our friends.

This is the familiar rat race of consumption—more money to support a fancier lifestyle which then requires even more money. And that word lifestyle doesn’t just mean buying fancy cars and beach houses. It applies to just about anything: the amount of time you spend on the Internet; the number of times you see your favorite band in concert; the food you eat, booze you drink or clothes you wear.

Keep your mind on the long-term goal: Building and maintaining wealth that will last for generations after your gone. Buying without goals is the bad spending habit that even careful people can suffer. For many people, making a good salary or inheriting some money means feeling that they have to spend it to show they’ve got it. This is the flip side of the debt problem—and a variation of the status issue. Rethink your personal and financial goals. In other words: Start saving more. In an economy that laughs at old notions of career stability, no one is doing well if the main source of income is a salary. Most people are fairly average financially—that is, they don’t make that much more or that much less money than other people their age. It’s just that

55

ATTITUDES AND APTITUDES

some people are better at using their money to reach their goals. What should your goal be? Go back to your monthly detail and look at how much money you put into savings. Is it 15 percent of your income? It should be. If it’s not...there’s your goal. HEIRS

ANXIOUS

TO

INHERIT

The November 2000 Wyoming Supreme Court decision in Estate of Constance Louise Fosler deals with some of the psychological and emotional issues that can shape family money disputes. It serves as a cautionary tale for what can happen if you generate a lot of money but instill the wrong attitudes about wealth in your family members. Constance Fosler died in December 1998, leaving an estate in excess of $19 million—and no will. Her only surviving relatives were first cousins and their descendants. The question was how to fairly distribute the assets among the heirs. The court construed state law to require distribution to the nearest living relatives (the first cousins) as the root generation per capita and to their descendants per stirpes.

In this context, per capita means all those who would receive an equal share of the family money; per stirpes refers to the children or dependents of each of the per capita people. The per stirpes beneficiaries get a subpart of a per capita share.

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Consider the chart below as an illustration of per capita and per stirpes shares:

Per capita distribution

Per stirpes distribution

Per capita distribution treats all living relatives equally; per stirpes tries to follow a family tree.

Any solution would rub some part of the family wrong. And this one, although plenty wise, did. Daniel Fosler, a first cousin, ran the numbers and realized that he could get more of Constance’s money by pushing for a different distribution. Daniel filed a lawsuit, proposing a distribution plan that would give him and his immediate family a bigger share than his cousins. Once the case got some publicity, people started crawling out of the woodwork. In all, 26 relatives came forward to be recognized as the objects of Constances’s far-ranging view—and funds.

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ATTITUDES AND APTITUDES

When the court didn’t adopt the distributing method that would have given Daniel the most money, he appealed. Although Daniel took the most visible position of Constance’s heirs, he wasn’t alone in taking aggressive measures to collect the most that he could. All of the heirs were aligning and positioning themselves with some and against others. It was a kind of Darwinian competitive ritual. Daniel’s appeal finally ended up in the hands of the Wyoming State Supreme Court, which had to apply some dusty law to the group of conniving heirs. The court had to scrutinize the laws referring to people who die intestate, and it had to determine the practical meaning of those laws’ language. The court noted that neither the word cousin nor cousins appeared in the statutory language. So, Constance’s cousins could only take by representation as descendants of the uncles and aunts. The court ultimately agreed with Daniel’s interpretation because “grandfather, grandmother, uncles, aunts” were specifically named in the state law. This changed hundreds of thousands of dollars in inheritance among Constance’s relatives. And it meant Daniel had prevailed in the Darwinian battle. The Wyoming Supreme Court admitted that its decision might seem harsh to some observers: ...we recognize that many state legislatures have adopted intestacy provisions which

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identify the root generation as the nearest generation with living members. However, our 131-year-old statute and case law do not support such an interpretation. ...Although some may perceive this result as being unfair, others may well conclude that the statute accurately reflects what the majority of people would intend. However, we cannot revise the statutes through interpretation to satisfy our individual views of contemporary family ties and equitable distribution. Keep this statement in mind when you think about building family wealth. In many ways, saving and maintaining the money is the easier part—raising family members who understand and agree with what you want to do is harder. If you count on the courts...or God...or fate to distribute money, there’s a good chance your heirs will end up battling each other for every additional dollar. And the courts may begrudgingly refer to ancient laws that reward the pushiest partisans. R E T I R E M E N T. . . A N D

F A M I LY

This book isn’t about retirement planning. But, if you are trying to build or maintain family wealth, you need to think about your own old age. The good news here is that the same perspective that you need for maintaining family money—making conservative money decisions, keeping your eye on long-term goals and having at least a working knowledge of legal/financial devices like wills, trusts and investment accounts—will also help you make sure you have enough to take care of yourself. 59

ATTITUDES AND APTITUDES

The main devices that most Americans use for retirement planning (other than Social Security, which we’ll talk more about later), are the tax-advantaged savings plans known by the following names: 401(k), IRA, Roth IRA and Keough. These plans are the best and easiest way for people to save money for their old age. The plans are designed to encourage the slow, steady asset growth that takes advantage of compounding value. There are limits to the amount of money you can put in these plans—through the 1980s and 1990s, it was $2,000 per year in most cases. Several reform plans proposed in the early 2000s raise the limits to approximately $5,000 per year. In some cases, your employer may match part or all of your contribution to these retirement plans. (This is usually offered as a benefit to attract and keep good workers.) Even if you don’t work at a traditional job—you’re self-employed, you’re staying home to raise kids or you can afford to follow your bliss on your own terms—you should still put money into one of these plans. Most banks and stock brokerages have the paperwork for setting up individual retirement accounts.

A big caveat: These tax-advantaged plans are not very good for building family wealth. Each plan varies slightly—but they all share the trait of taxing the transfer of assets to anyone other than a spouse.

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So, from a family money perspective, the best way to think of 401(k)s and the like is: The money you put in will be available on very good terms for you when you’re older. At that point, it will be money that you don’t need to take from family accounts. And it will give you a benchmark for making your own retirement budget. IS

YOUR

401(K)

ENOUGH?

As we noted before, most people try to save between 5 and 10 percent of their take-home pay for retirement (and other things—but retirement is usually the main concern). In many cases, saving 10 percent of your net income will put you past the maximum tax-advantaged contribution to a 401(k) or similar plan. Many people put this money into a basic bank savings account and then, periodically, move that money in larger chunks to another kind of investment (certificates of deposit, government treasury bills or bonds, investment accounts, etc.). A common rule of retirement planning is that you’ll need 70 percent of your annual pre-retirement income each year to live comfortably when you reach retirement. But most people can get by with less than 70 percent—especially if they’ve paid off their home mortgages before stepping back from the rat race. The problem with making general statements about retirement is that people head into it with all sorts of different assumptions about what they want.

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Some, having worked hard for many years in jobs they didn’t like or for companies they didn’t respect, feel entitled to a very high standard of living. They want to drive nice cars, live in plush surroundings and travel as they please. Others, having lived their lives keenly calibrated to the society around them, see little more than continuing to live in lockstep with the people they know. They want to live around their friends...or at least people like them. They want to belong to clubs. They want to follow traditional patterns of residence, activity and travel. Others want to be around their families. They want to help raise grandchildren, -nieces or -nephews. They want to offer support and advice when needed. They look forward to becoming the matriarchs or patriarchs of large clans. These are just three scenarios. There are hundreds of variations. All of them can be wonderful; all of them can be taken to extremes. And all of them can cost a lot. The specifics of how you live your retirement usually matter less than the attitude that you bring into it. Try to avoid the rat race while you work, piling a lifetime of expectation and deferred gratification into your later years. You may find that, when you get there, you end up living another rat race— to do all the things you didn’t do when you were younger.

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As with all things in life, building family wealth involves a long series of choices. In this case, you may need to make the decision that a decent condo in Miami or Phoenix allows you to play a lot of quality golf—and keep your money earning. Let someone else give in to the need to consume conspicuously in Boca Raton or Scottsdale. You have longer-term goals. In retirement, and in all of your life, the best way to build and maintain family wealth is to live beyond money. Earn it. Invest it. Respect it. But don’t fear it...or worship it. Or hate it. CHANGING

FACE

OF

RETIREMENT

Another important thing to remember is that retirement—at least the version of it that dominates commercial breaks during the evening news—is a relatively recent creation. Historically, people’s roles in family or other community changed as they got older; but they didn’t bolt for Leisure World and 20 years of golf cart races. The elders remained involved in the life of the village or clan. We, as a culture, may be heading back that direction. Through the 2000s and 2010s, American retirees will continue to retire to a higher quality of life than those who’ve retired before them. But, starting in the mid-2010s, financial pressures on the Social Security system in the U.S. will probably start reducing the benefits available to able-bodied elders. This will come as a shock to the more than half of all Americans who’ve never even sat down to run the numbers about how much money they’ll need to live.

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Since you’re reading this book, you’re already ahead of that half. But, it never hurts to reiterate: Plan for your retirement in tandem with your plans for managing family money. The better you do the one, the more you’ll have left of the other. Specifically:

•

Set savings goals;

•

Don’t agonize over specific investments;

•

Contribute the maximum to a taxadvantaged retirement plan;

•

Realize that your expenses will change; and

•

Accept working in retirement.1

In the end, retirement is a critical test of your attitudes about money because it’s usually your largest opportunity to plan carefully and act selflessly. You can teach your family members a lot—by lesson and by example—from the way you handle money and your own old age. ATTITUDES

ARE

SUBJECTIVE

The challenge to raising family members who share your attitudes about money is that attitudes are subjective things. What your family considers a healthy disdain for materialism, you may see as irresponsibility. Of course, if you’re in charge of the money, you can enforce your opinions...financially. But lording over family members is risky; you can make enemies of the people closest to you. 1

According to one AARP survey, more than 80 percent of Baby Boomers said they planned to work either full or part-time after they retire. 64

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Consider the August 2000 Texas appeals court decision in J. Howard Marshall III v. Don Cordes and Charles Koch. It’s hard to find a more colorful example of conflicting attitudes about money. Even Anna Nicole Smith had a starring role in this drama. In 1995, J. Howard Marshall III (Howard 3) filed suit against the estate of his father, J. Howard Marshall II (Howard 2), who had died a few months earlier and left virtually all of his considerable wealth to another son, E. Pierce Marshall. In December 1998, Howard 3 amended his lawsuit to include Charles Koch and Donald Cordes as defendants, alleging they used undue influence to cause Howard 2 to restructure his estate plan to suit their purposes. Charles Koch was the CEO of Koch Industries, Inc.; Donald Cordes was a corporate vice president and the chief legal officer. Why were two executives from a large petrochemical company based in Kansas involved in an inheritance case taking place in Texas? The answer went back almost 20 years. Howard 2 had amassed a fortune, based primarily on his large investment in Koch Industries. In 1980, a dispute arose among the Koch stockholders. Two sides emerged, one led by Charles Koch and the other led by his brother, William Koch. Howard 2 supported Charles Koch. Howard 3 owned a relatively small stake in the company— approximately four percent of the voting stock— but it was the swing vote in the dispute.

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ATTITUDES AND APTITUDES

Howard 2 asked his son to vote his shares in support of Charles Koch. But the son was inclined to go with the others for business reasons. Angered by his son’s dissent, Howard 2 played hardball immediately—threatening to disinherit Howard 3. In December 1980, the father and son met to discuss the matter. Howard 2 offered to buy Howard 3’s shares, which he did under interesting terms. Among them was the stipulation that Howard 3 would not be left out of any estate planning on the father’s part. His mother would also get an annual income of $100,000. Howard 3 could demand the additional terms because the $8 million sale price was far below fair market value (the others had offered him $16 million). The son was willing to accept the low price because he wanted to resolve a number of family issues with his father; the father seemed willing to put some bad times in the past and reach an amicable solution with his son. By 1982, things started taking an ugly turn. A series of events led to an allegation that Donald Cordes, an attorney and executive at Koch Industries, and other execs at Koch had persuaded Howard 2 to rewrite his estate plan and renege on the promises made in the stock sale. In Howard 3’s lawsuit, it was discovered that Howard 3 had been kept in the dark about a lot of things, and that his brother—Pierce—had been informed of everything along the way. Enough evidence surfaced to show that Cordes and Charles Koch had conspired for the benefit of themselves, Pierce and other Koch Industries execs.

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Although a trial court used the legal definition of “conspiracy” to dismiss Howard 3’s claims, the appeals court took a much more sympathetic view. That court concluded: Howard [3]’s sale of his Koch Industries stock to [his father] was a definitive contractual agreement between a father and a son who trusted him. Howard completely performed his side of the contract by delivering the agreed upon shares. However, after this contract the [father] breached his side of the deal. In other words, the promises and representations made to Howard [3] by his father were false and made with no intention of fulfilling the promises. So Howard 3 won that round and was reinstated as an heir of his father’s estate. Had he been a good son to his father? No one other than the two Howards could answer that question. And the courts didn’t even try. But the Marshall family was due for more trouble. Aside from having problems with one of his sons, Howard 2 did something else that often causes problems when it comes to family money. Late in life, he married a much younger woman. In 1994, Howard 2 wed Anna Nicole Smith, a voluptuous model and former Playboy magazine Playmate of the Year. He was 89 years old; she was 26. He lived less than a year after the marriage. A side effect of Howard 3’s challenge to his father’s 1982 will was that it gave Smith—who’d lost sev-

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ATTITUDES AND APTITUDES

eral court attempts to make a claim on Howard 2’s estate—a chance to get more of her husband’s money. After all, she was his wife when he died. This made Howard 3 and the former Playboy model unlikely allies in legal battles against Pierce. How much money was at stake? Some estimates valued Howard 2’s estate at $1.2 billion. Pierce claimed it was only $60 million—but many of his positions in the legal battle had been dubious. In December 2000, a federal bankruptcy court awarded Smith $475 million as her share of Howard 2’s estate. But that ruling conflicted with others that had gone against her. Pierce appealed, citing these conflicts. His lawyers looked forward to a long encampment...and millions of dollars in legal fees. According to people who knew him, Howard 2 was serious when he promised to Howard 3 that he’d treat his children equally in his will. But the mess that followed—undue influence of corporate wraths, left-handed disinheritance, a last-minute marriage—suggests that he was a person who wasn’t able to sort out his own values...let alone instill them in his family. DO

GOOD

GUYS

FINISH

LAST?

Few families have as much money or eccentricity as the Marshalls of Texas. But more than the money or the weird facts, what stands out about the Marshall’s case is the thought of Howard 3—apparently a decent guy trying to make peace with his father—on

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the outside, having to ally with the Playboy model to make his claim on his father’s estate. That doesn’t seem right. And it may make you wonder whether decent guys trying to do the right thing even end up on the winning side of money disputes. Do the aggressive jerks always win? Not always. Although there may be dark moments of greed or resentment in any human heart, a focus on building and maintaining family wealth...and some skepticism about wanting money for its own sake...position people to do well. The July 2000 Minnesota Appeals Court decision in Estate of Lawrence C. Dahlheimer dealt with one such case. Lawrence and Delvina Dahlheimer were first married to each other in 1936. They owned and operated a farm in Dayton, Minnesota and had 11 children, including a son named Adrian. Adrian lived on the farm since his birth in 1938, with the exception of four years when he served in the Air Force. After 1961, he worked on the farm with his father. In 1983, Adrian bought a portion of his parents’ land by contract for deed. The purchase price was $80,000, structured as $5,000 down and the balance payable in monthly installments of $650 at 9 percent interest until the contract was paid in full. Although Adrian did not make regular monthly payments on the contract, his parents—the sellers— accepted his unpaid labor on the farm and occasional cash payments as sufficient to keep the note current.

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In 1995, Lawrence and Delvina Dahlheimer began divorce proceedings. Adrian had to relinquish his contract for deed claim so the land could be divided simply between his parents. In July 1996, Adrian executed quitclaim deeds and reconveyed the land to his parents. Lawrence and Delvina remarried in 1997—but Lawrence died later that year. Adrian was left with nothing to show for nearly 30 years of unpaid labor and occasional cash payments to his parents. He filed a claim against his father’s estate for $334,907.50, seeking compensation for services rendered on his father’s farm from 1967 to 1997. The probate court found that there was no written contract between Adrian and his father to compensate for his labor or financial contributions to the farm. Thus, it dismissed his claim. Unwritten agreements like the one between Adrian and his father fall into the category of what Minnesota law calls “quasi-contracts.” The appeals court noted that, under quasi-contract principles, the right to recover is based in equity. The idea is to prevent unjust enrichment at the expense of someone like Adrian.

Samuel Goldwyn’s famous quote about verbal contracts not being worth the paper they’re written on aside, many family squabbles get down to these quasi-contracts. They are handshake arrangements,

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often loosely-defined, that stay in place for years— in ways that non-family arrangements never would.

The lawyer for the father’s estate argued that, even if Adrian hadn’t waive his right to bring a claim, his action was barred by the so-called “presumption of gratuity.” Courts often presume that services rendered by an adult child are gratuitous so long as the child remains in the parental home. But the appeals court pointed out that: ...the presumption may be overcome by facts and circumstances from which an implied promise to compensate may be inferred. Here, [Adrian] provided extensive and regular labor and financial contributions to his parents’ farm. In fact, during her divorce hearings, Adrian’s mother had testified that he had “kept the farm going since 1983. ...[Adrian] has more than paid for the deed in payment of kind.” The appeals court agreed that Adrian’s labor and other contributions to the farm fulfilled his contract for deed obligation for 13 years. At $650 a month, this meant he could claim at least $101,400 against his father’s estate. It sent the case back to the lower court to determine how to resolve Adrian’s legitimate claim. The irony of the Dahlheimer case is that Adrian had what many people would consider a healthy

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attitude about family money. He selflessly did what was required to help his parents keep their farm and make money from it. When his parents were having marital problems, he did what they asked to help expedite an amicable separation. Was Adrian Dahlheimer too casual about money? Wouldn’t he have been better served by being as aggressive as Daniel Fosler or Pierce Marshall? No. Those others either lost their legal battles or won—at best—measured victories. Adrian Dahlheimer’s claims were ultimately vindicated in stronger terms. The best attitude about money to convey to your family members combines a smaller part of the creativity and aggressiveness that Louisianan Ralph Brockman showed in using trusts to invest in a hunting club with a larger part of the goodwill and selflessness that Howard Marshall III or Adrian Dahlheimer tried to show in tough circumstances. That’s a tough combination to accomplish. But, if you can do it, your family should be positioned to do well, financially.

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CHAPTER 3

3 THE VEHICLES FOR TRANSFERRING FAMILY MONEY

Avoiding family conflict is the main reason people create wills and trusts. But these financial devices have little meaning in and of themselves. That’s why we spent so much time in the first two chapters discussing more personal matters that affect families and their dynamics. Now, you’re ready to dig into the details and mechanics of how best to structure your estate. There are two ways to move money effectively to family members:

•

inter vivos transfers, or

•

testamentary transfers.

Inter vivos transfers are made while the estate owner is still alive; testamentary transfers are made after the estate owner is dead. These transfers can be made in various ways—as wills, gifts, trusts or policy ownership under rights of survivorship...all of which we’ll discuss in turn. First, let’s consider the most common mechanism: wills.

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ELEMENTS

OF A WILL

People often lose sight of the fact that the actual word—will—means exactly what it says: a way to extend your will, your intent and decisions, about financial matters into the future of your family for their benefit.

A will is a decision-making device, forcing you to see that it becomes a precise legal tool that no one can argue with, dispute or change easily.

Still, many people avoid making wills. They fear death...or don’t want to “waste” time thinking about things that happen after they’re gone. If, however, you fail to make your decisions known and die without a will, legally you will have died intestate. That means probate—the state’s bureaucratic process of handling property—takes over. A will not only gives you decision-making control over who gets what but it also gives you control over how and when they receive it. It conserves and distributes your assets and money according to your wishes, names guardians for your minor children, etc., and generally minimizes the chances that things get screwed up. There are two basic ways to write a will: either with an attorney or by yourself. And, if you write the will yourself, there are several ways to proceed: you can use a will kit or software that includes stan-

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dard forms...or, you can scrawl your thoughts on a scrap of toilet paper (in legal terms, this is called a “holographic will”).

Courts sometimes recognize poorly scrawled wills, while tossing out carefully crafted lawyer’s work. But, the scrap of paper approach is easier for angry heirs to challenge, so it’s not a good idea if you’re leaving people anything more than a few bucks.

Some of the items in a will include: •

your full name and principal residence, stated clearly;

•

the date;

•

a declaration that the document is a will;

•

the names of your executor and substitute executor;

•

the names of guardians and successor guardians for children or disabled people in your care;

•

a list of your assets;

•

which funds should be used...or assets sold...to pay estate taxes, and how they should be managed;

•

bequests (general, specific and residuary);

•

where you want to have your funeral,

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burial, cremation, etc.—or whether you don’t want these ceremonies at all; •

a list of established trusts, including names of trustees and successor trustees; and

•

your signature, made in the presence of at least two witnesses with their names attached to the document.

THE

BACKGROUND

WORK

The mechanics of a will aren’t complicated. But writing a will require an inventory of the things that you own...and some basic decisions about who should get what. This background work makes many people shy away from the effort. If you thought compiling the guest list for your wedding was tough, try choosing the family member or friend that both you and your spouse agree will be able to finish raising your two-year-old twins. Start by using a basic personal inventory checklist. Not all of this information appears in a will, but it’s important to keep a list of your assets and liabilities so that your spouse, family, trustee or executor can manage your estate properly. The assets and liabilities listed in any will or trust that you sign should include the following items and approximate values:

76

•

Checking Account(s)

__________

•

Savings Account(s)

__________

CHAPTER 3

•

Certificate(s) of Deposit __________

•

Safety Deposit Boxes

__________

•

Retirement Accounts

__________

•

Brokerage Accounts

__________

•

Insurance Policies

__________

•

Real Estate

__________

•

Other Investments

__________

•

Cars

__________

•

Household items, jewelry and collectibles __________

Total assets •

__________

Mortgage and Home Equity Loans

__________

•

Credit Cards

__________

•

Auto Loans/Leases

__________

•

Tax obligations

__________

•

Other personal debt

__________

Total liabilities

__________

As you review these possessions and obligations, there are a number of more general questions you should consider. Does your will reflect everyone you wish to cover? Has it been updated to reflect births and deaths, changes in tax laws and changes in your state of residence?

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Does your will address any charitable bequests you want to make? Do you take into account items that will pass outside of your will, such as insurance policies and retirement plans? Do you take care of bequests involving personal property that may have significant sentimental or emotional value? Should you establish trusts or other means to look after your children’s financial assets, in addition to a guardian? Will your beneficiaries have enough money to live on while your will is in probate? These questions aren’t as simple to answer as the basic mechanical issues of drafting a will. And there aren’t any quick answers to them. Through the rest of this chapter (and the rest of this book), we will examine the various issues and how they can be handled. IF YOU DIE WITHOUT A WILL Some people, even those with considerable assets, remain cynical about what will happen with their money after they die. If you die intestate (without a will), the court will choose the person responsible for wrapping up your affairs. This person is called an Administrator, and might not be the person you would have wanted. Often, a neutral lawyer is appointed, and must be

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paid with estate funds. A neutral person may not be in any hurry to get things resolved.

A key point to remember: Probate is designed to prevent fraud or abuse. It’s not designed for efficiency or protection of wealth.

A quick way to consider probate is to look at what happens under different family circumstances. Here are the ground rules if the person who dies without a will is: •

Married with children. The law in most states awards only one-third to one-half of the dead person’s property to the surviving spouse and the remainder to the children, regardless of age.

•

Married with no children. Most states give only one-third to one-half of the estate to the survivor. The remainder generally goes to the dead person’s parent(s), if they’re alive. If both parents are dead, many states split the remainder among the dead person’s brothers and sisters.

•

Single with children. State laws uniformly provide that the entire estate goes to the children.

•

Single with no children. Most state laws favor the dead person’s parent(s) in the distribution of property. If both

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parents are deceased, many states divide the property among the brothers and sisters. There are some good reasons for these statutory distributions. If there is a will, the surviving spouse can usually renounce it and instead opt to take the share of the estate provided by state law. This is a legal device historically intended for the protection of the survivor.

If a husband holds the title to the property himself and writes a will directing it to his children by a previous marriage, the second wife can file a petition in probate court to take her share of the estate.

In most cases, though, probate proceedings and statutory distributions interfere with and diminish the transfer of family wealth. RECIPROCAL

WILLS

Most married couples (and, for that matter, unmarried ones) are smart enough to set up reciprocal wills. The concept is simple: Each partner writes a separate will that is a mirror image of the other’s. Depending on where you live, the wills may be part of a single legal document, may reference each other or may restrict changes made to one but not the other. Among other things, this device provides the simplest form of parity and assurance that basic financial plans can be achieved.

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For married couples, reciprocal wills also simplify some tax issues. If the combined estates of both spouses total under $675,000, the wills may be all the tax planning they need. (If your combined estate totals more, however, federal estate taxes become a factor. More on this later.) Updating wills is a challenge that requires twice as much effort. What happens if a beneficiary dies before the makers of the wills? The best solution: name contingent beneficiaries to bequests or specify that if a beneficiary dies, his bequest is included and distributed with the residue of the estate. Most simple wills prepared for parents have a clause to deal with a common disaster situation. Each will says some variation of: “All of my property to my spouse, if he/she survives me by at least 30 days. Otherwise, all to the children.” (There’s nothing special about using 30 days, but the period should always be less than six months. If it is longer, the tax-free status of the property transfer to the surviving spouse could be lost.) If either or both the wife and husband have children from a previous marriage, the reciprocal wills are usually not true mirror images. Each will has a parallel section that articulates the differences. This usually works—legally—but you need to have an estate lawyer review it before you sign it. Differences—even minor ones—can make a big difference when one spouse dies first (or is presumed to die first, in the case of a common disaster). What happens, for example, if a husband and wife with

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reciprocal wills die together in a car wreck? The executor of the husband’s will sees that the wife did not survive for 30 days after her husband’s death. She inherits nothing. The husband’s estate is divided among his children. They pay inheritance tax, but the logic of the transfer is clear. Now let’s look at another scenario. Assume the common disaster clause says something like: “If we die together, and the order of death cannot be determined, my wife is presumed to have survived me.” This might sound ludicrous...but in some tax situations it’s a good idea. Property must be left to the surviving spouse, in order to take the unlimited marital deduction for calculating federal estate taxes. If the spouses’ estates are different sizes but total over $675,000, this can mean a big tax break. Now, go back to the aftermath of the car wreck. The husband’s executor distributes property as if the wife were still alive. Never mind that she lived only a minute longer; she gets everything. The husband’s money is lumped in with the wife’s property. Her will doesn’t mention the husband’s children from a previous marriage (as his didn’t hers). All of her assets, including her husband’s, go to her kids, according to her will. His kids from the previous marriage get nothing.

Most states have adopted the Uniform Simultaneous Death Act to avoid these problems. The law dictates the order of death when parents die together. It is used only when the spouses’ wills say nothing about who survived whom—or if there are no wills at all.

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COMMUNITY

PROPERTY

The term community property often comes up in discussions about estate planning (and divorce). It is a form of property ownership derived from Spanish law—solely between husband and wife—recognized in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. (The other states are common law states, using a different set of laws regarding their marital property ownership system.) Specific community property laws differ greatly among these states, but the defining feature is this: Irrespective of the names on title documents, ownership of (almost) all property—including income from wages and self-employment—acquired during marriage by either spouse is automatically split, so that each spouse owns a separate, undivided onehalf interest.

In terms of community property, an undivided interest is one in which each spouse has half ownership of the whole pie, rather than full ownership of only half of the pie.

Property acquired by a spouse separately and brought into the marriage remains separate. Property acquired by gift or inheritance, or in exchange for separate property or money, also remains separate. The income, if any, the separate property produces is treated differently. In California, for example, separate property income remains separate property.

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In Texas, however, income produced by the separate property of one spouse becomes community property. Each spouse is free to dispose of his or her half of community property in a will. It does not automatically pass to the survivor, as it would if owned jointly, with right of survivorship. Of course, the deceased spouse’s federal taxable estate contains his or her half of the couple’s community property. In common law states, the 50/50 outcome that frequently occurs in divorce settlements is not automatic. The goal of the court in these states is simply to be fair. OF

SOUND

MIND

Under the law of most states, the person making a will must be of sound mind. He must understand, for example, that he has three children and four grandchildren, who would naturally be those to whom a person would leave his estate. (But that does not mean he must do so.) Additionally, he must be aware that, by signing the will, he is making a final disposition of his property.

The will maker is not required to be smart or wise or reasonable or fair. He must only know what he is doing and, if he does, the law will respect whatever disposition he cares to make, subject to lawful claims that must be paid first, and the rights, if any, of the surviving spouse.

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Most wills recite that the maker is of sound mind. The law tries hard to reject claims that the maker was mentally-impaired or under undue influence or duress. If a will is thrown out, the estate is handled as if there wasn’t one to begin with. CODICILS A codicil is an amendment to an earlier legal document. Written additions or changes are usually not made on an original document. Instead, a separate page is prepared, referring specifically to the original and executed with the same formalities required of a will or other document. Codicils are usually best used to address legal technicalities or things like typographical errors in the original document. Any substantive changes—like new beneficiaries added or others removed—should mean drafting a whole new document. At this point, one basic piece of common sense bears repeating: Read your will thoroughly before signing it. For one thing, this will help establish that you are, in fact, of sound mind. For another, it should help avoid the need for things like codicils. It’s no secret that most law offices use form documents, such as wills they’ve previously drafted for others, as models for subsequent clients. It would be inefficient to reinvent the wheel every day; you are paying the attorney for guidance in formulating and implementing a plan, not for typing the plan. However, editing mistakes can occur (these are sometimes the typographical errors that need to be fixed by a codicil). If something is not right, or if you have any concerns, don’t be afraid to speak up.

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HOLOGRAPHIC

VS.

WITNESSED

Contrary to popular belief, many states do not permit handwritten, “holographic,” wills. For one to be legal, at least three competent witnesses must testify that they believe the will was written entirely in the handwriting of the person whose will it purports to be and that the signature was written in the handwriting of that person. At least one witness must testify that the will was found after the person’s death among his valuable papers, in a safe-deposit box or other “safe place,” or that the person had left it with someone for safekeeping. An attested will, on the other hand, is written and signed by the person making the will, or someone else in his presence, and attested by at least two competent witnesses. State law says the witnesses must sign the will in the presence of the person making the will but need not sign in the presence of each other. It isn’t necessary for the will to be written in the presence of the witnesses. But the person making it must signify to the witnesses that this is his will and sign it in their presence or acknowledge to them that the signature is his if he has already signed it. When the person dies, the witnesses must appear before a court representative to testify that the witnessing signatures on the will are theirs. Most state laws do not require either holographic or attested wills to be notarized.

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A self-proved will is hardest to question or contest. This kind of will must be written substantially in the words specified by state law, signed by the person making the will in the presence of a notary public and two witnesses under oath, signed by the witnesses, and signed and sealed by the notary. The most famous fight over a holographic will involved the so-called “Mormon Will” of reclusive billionaire Howard Hughes. Hughes died in 1976, leaving an estate estimated between two and three billion dollars—and no apparent will. When a holographic will emerged on a desk in the office building of the Mormon Church, gossip and conjecture ran rampant. Among the provisions of this alleged will was one that gave one-sixteenth share of the estate—or $156 million—to Melvin Dummar of Gabbs, Nevada.

Years before, Dummar had owned a small gas station in southern Utah. During that time, he claimed, he’d picked up a ragged old hitchhiker who said he was Howard Hughes. Dummar had given the old man a ride into Las Vegas, dropped him off at the Sands Hotel and left him some spare change.

To make a long story (which was made into a funny movie called Melvin and Howard) short, a Nevada court found Dummar a kook and ruled the will a forgery. In the meantime, Hughes’s estate had to endure months of trial and spend millions of dollars defending itself from a bizarre fate.

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A more recent dispute over a holographic will is the Estate of Pearl McCormick. The case began when Mark Lukas and his wife bought a home across the street from an elderly lady named Mearl Stiller. The Lukases and Stiller became friends and, in 1988, Mark agreed to become Stiller’s legal guardian. She was getting forgetful and needed someone she trusted to help manage her affairs. Stiller’s main estate document was an inter vivos trust naming her sister, Pearl McCormick, beneficiary. Stiller died in January 1989, and McCormick became the owner of the trust’s assets, valued at approximately $300,000. McCormick failed to execute a will of her own, though; her attorney, Stephen Hodsdon, never drafted one because he questioned McCormick’s testamentary capacity. Frustrated by her lawyer’s delays, McCormick got Lukas to help her draft a holographic will in October of 1989. The will provided that $40,000 be given to an English relative of McCormick’s deceased husband, with the remainder going to the Lukases. McCormick died in January 1997, following a period when she was indisputably not of sound mind. By June, her distant cousin, Lorraine Bowdoin, unexpectedly emerged to take control. The court appointed her as personal representative of the estate. Lukas filed McCormick’s holographic will in October, and a month later, he filed an inventory and accounting of his conservatorship and a petition to probate the holographic will. Bowdoin quickly filed objections.

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In January 2000, a probate court ordered Lukas to pay Bowdoin $40,420 in attorneys’ fees and $10,263 in personal representative fees resulting from the will contest and litigation. Lukas appealed. The court later disallowed the holographic will, a decision no one appealed. So, the dispute focused on whether Lukas had to pay the fees to Bowdoin. On appeal, Bowdoin argued that, because Lukas had acted in bad faith toward the estate, she should be allowed to recover attorney and personal representative fees from him personally. Lukas argued that he should not be surcharged as a fiduciary because he was not a fiduciary when he offered the holographic will for probate. This was a tough claim. Lukas had the dual role of conservator and beneficiary of the estate. Lukas was not precluded from filing the holographic will because he was conservator; but, as beneficiary of that will, Lukas had a natural interest that might not be the same as the estate’s. The appeals court concluded that Lukas filed the will in his capacity as beneficiary, and that such filing did not violate any fiduciary obligations he owed as conservator. He didn’t have to pay Bowdoin. But Lukas had also hoped to recover his attorneys’ fees from the estate. The probate court had denied his motion on this matter. And the appeals court agreed, writing: Lukas was aware that when the holographic will was drafted McCormick’s testamentary capacity was highly questionable. Never-

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theless, he allowed McCormick to draft the will.... Because Lukas was aware that the validity of the will was speculative, the [probate] court did not abuse its discretion in denying Lukas’s request for fees. He’d pushed too hard about the holographic will. Implied in the court’s decision: If McCormick had been of sound mind, she could have drafted an attested will. Even if Lukas had helped her do so. The handwritten will suggested too much help. W H AT

A

WILL

DOESN’T CONTROL

Property that passes under the terms of your will is called probate property, referring to the probate process that executes the terms of your will. There are a number of assets that pass by the operation of law or contract, and are not controled by the terms of your will. The most common of these are below. Proceeds from your life insurance policy go directly to the beneficiary named on the policy, without passing through your will. The person who receives the proceeds does not have to pay taxes on them. But, if you own and control the life insurance policy (having the ability to borrow on the policy or change the beneficiary is considered control), the proceeds of the policy are part of your estate and may be subject to estate tax. Keep in mind that because of the unlimited marriage deduction (which we will discuss in more detail below), payments to your spouse incur no liabilities. However, for payments to your kids or others, you will want to:

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•

have someone other than you buy and own the policy on your life; or

•

irrevocably transfer the policy at least three years before you die.

Also, after that transfer, you can’t change the beneficiary or borrow money from your policy. Proceeds from retirement plans, such as SEPs, IRAs, 401(k) plans, pension and profit-sharing plans, etc. also pass directly to named beneficiaries. However, like insurance proceeds, these assets are subject to estate tax, and federal income tax—although you get a deduction for estate taxes paid. There’s also an additional 15 percent tax if you have a large amount of money (at press time, the amount was $750,000) in your plan. Items owned by you and someone else, such as houses, bank accounts and brokerage accounts, can be held in joint tenancy with right of survivorship or JTWROS accounts. This means that if one of you dies, the other person has legal rights to the assets. If your spouse is the surviving person, usually half of the value of the asset is taxed in your estate. If it’s someone else, such as your child, the IRS will look to who actually paid for the assets to decide who will pay.

Owning something in a JTWROS with your children is not typically a successful way to avoid taxes.

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A living trust—also called a revocable trust—is a trust that allows you to control your assets during your lifetime but pass them directly to your beneficiaries. TRUSTS A trust is a legal contract by which one party—the trustee—is given legal ownership of some property to be managed or invested for the benefit of someone else. Trusts are private contracts or agreements, but are recognized by the laws and courts as independent legal entities—like people or corporations. The property in the trust is known as the trust principal or corpus. The person for whom it’s being managed or invested is the beneficiary (there can be more than one beneficiary to a trust). Finally, the person making the trust is called the grantor (or settlor or trustor in different locations).

Generally, one person can play up to two of the three key roles in a trust. The grantor can also be the trustee; the grantor can also be the beneficiary. In most cases, though, one person can’t be all three.

Like any contract, a trust can be structured too rigidly and with unreasonable conditions—or it may be written too loosely. Both extremes can encourage unwise decisions among the people they’re intended to benefit.

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Trusts can dramatically reduce the estate tax that your family has to pay.

Most married people leave their property to their spouses when they die. But, for larger estates, it may be better to leave property in a credit shelter trust for the surviving (also called second) spouse’s benefit. This trust shelters the first spouse’s assets— and credit—up to $625,000. The income from it still goes to the second spouse for life; even the principal can be tapped for purposes of health, education and support. But the assets aren’t subject to estate tax when the second spouse dies. Without this type of trust, the tax hammer would fall on the children with the death of the second spouse. Single people have fewer options, but can also reduce estate taxes by setting up charitable trusts (in which a charity owns the principal but the beneficiaries collect interest as long as they live) or making annual gifts. Like an executor, a trustee has a legal responsibility—fiduciary duty—to manage the property and see that it is used in a manner established by the grantor in the trust contract. In many cases, a trust can remain empty (unfunded) for quite a while after its creation. In some states, however, nominal funding (e.g., $100 in a bank account) is required. This is a good idea anyway. It shows that the trust is more than a piece of paper.

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Although an empty trust can exist, in order to function, a trust must have assets formally transferred to the trustee, with this title used in the documents of ownership. Financial institutions will require authorization, in the form of the trust document, before they will accept instructions from a trustee. Trusts can be living (established during the grantor’s lifetime) or testamentary (established in a will). Separately, trusts can either be revocable or irrevocable. Living trusts are usually revocable, which means the grantor can change structure or terms. If a trust is irrevocable, the grantor can never change or terminate it—or withdraw assets, even in an emergency. An irrevocable trust is an independent entity under the law. It is important to note that testamentary trusts require that the will creating them be probated. Moreover, these trusts might then be accountable and have to report to the probate court, under state law—unlike living trusts. These are significant drawbacks, without offsetting advantages. Testamentary trusts remain more common than living trusts because most people are hesitant about transferring major assets while they’re still alive. Even though a trust created by a will has to go through probate, there’s no re-titling of assets into the trustee’s name until the grantor has actually died. This hesitation is understandable...but it runs against the best efforts of building family money. Lifetime property transfers into living trusts inevitably involve frank discussions about death...and lots of paper work. And many people are uncom-

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fortable talking about death, let alone executing a contract about it. But relying on testamentary trusts to transfer assets only delays the work until somebody else (usually a lawyer or accountant from outside the family) has to do it. The main problem with trusts is that they are sometimes badly drawn. If they leave important people or facts out—or if they include language that contradicts itself—trouble will follow. The existence and structure of trusts also may complicate family relationships. The June 2001 New York Appeals Court decision In Re: Trust Created by James F. Wible dealt with one such mess. Shortly before his death, James Wible created a living trust funded by his home, household furnishings, boat and the proceeds of a note and mortgage on an investment property. Following his death, the trust was to pay 40 percent of the monthly net proceeds of the investment property note to his children, including Sharon Bailey. The trustee—a friend of Wible’s named Stephen Palka—was also required to pay Wible’s wife, Ilean, the net income from, or provide her with exclusive possession and use of, the remainder of the trust corpus. This included the right to live in the Wible home for the rest of her life. Upon her death, the trust was to be terminated and all proceeds distributed to the children. After the note on the investment property was repaid in full, Palka distributed 40 percent of the proceeds to the children and 60 percent to Ilean. This was a mistake—since Ilean was only supposed

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to have access to the income from her husband’s estate. But the section of Wible’s trust dealing with the investment property seemed to suggest a split of the proceeds. In any event, it was confusing enough that the mistake was understandable. Palka soon realized that he’d make a mistake and reported it to the probate court. The court ordered that Ilean return the 60 percent payment and that Palka sell the Wible home and give Ilean an amount equal to the actuarial value of her life estate. Ilean returned the overpayment. But the error had opened floodgates of animosity between Ilean and her husband’s children. Sharon Bailey—who acted as a spokesperson for the children—agreed to the sale of her father’s home and the distribution of the resulting proceeds. So, Palka sold the house and filed a final accounting of the estate. Both Ilean and Bailey filed objections. Ilean wanted more than she was being offered as a liquidated payment; Bailey argued that Ilean was already being paid too much. Palka again went to court, asking for a judgment resolving the dispute. Following a hearing at which Ilean’s expert testified about the actuarial value of her life estate in the Wible home, the court issued a decree which settled the final account, awarded fees to Palka, distributed the remaining corpus of the trust and terminated it. Sharon Bailey appealed, again arguing that this resolution gave too much money to Ilean. Also, she argued that she’d been treated unfairly—in that the trial court had allowed Ilean’s expert to testify but

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not Bailey’s. And she claimed that Palka had taken excessive fees. The appeals court upheld the lower court’s ruling. After 40 percent of the proceeds from the note and mortgage had been distributed to Bailey and her siblings, the remaining purpose of the trust was to provide Ilean “with a residence and/or income for her lifetime.” Sale of the Wible home and distribution of its proceeds, to which Bailey consented, substantially depleted the trust corpus and eliminated the means of providing Ilean with a lifetime residence or its income equivalent. There wasn’t anything left for Wible’s adult children.

Bailey may not have liked the fact that Ilean—her stepmother—was getting so much money from the trust. But the court ruled that the early liquidation and termination of the trust was the best way to make the fairest resolution. This is a common ruling.

The appeals court also disagreed with Bailey’s other claims. In all, because James Wible’s trust was confusingly written, Palka had a hard time managing it effectively. And the people most hurt by this, in the end, were Wible’s children. LIVING

TRUST

MECHANICS

Generally, a living trust is used as an alternative to a will; it gets its name because you set it up when you’re alive, transfer all or most of your assets into it, then administer it yourself as trustee.

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Living trusts cost more at the front end to set up than wills, but wills cost more at the back end when you die because they go through probate. At your death, assets in the living trust are distributed according to your provisions, without supervision of a court. A properly designed living trust makes the hand-off of assets clean and private. Living trusts do not cut estate taxes. During your lifetime, you have to pay taxes on investment profits made by the trust and, after you die, your estate still owes estate taxes. So, the same kind of tax planning you do with a will should be done with a living trust.

Keep things up to date if you use a living trust. If you forget to transfer new property into the trust, your estate may have to be probated anyway.

Remember, the simple living trust is revocable. The grantor transfers ownership of assets to the trust; but the trust document reserves for the grantor complete control over everything, including the right to terminate the trust, during the grantor’s life. If there is only one grantor, the simple living trust becomes irrevocable at his or her death. If the grantor has been serving as his or her own trustee, it is imperative to have an alternate named to handle post-death affairs and property distribution. Instead of the court order which gives the executor of a will his authority, the trustee uses a copy of the

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grantor’s death certificate and a certified copy of the trust document as authorization to act. The will that accompanies a living trust is sometimes called a pour-over will, because it pours over into the trust any assets—often things like cars, active bank accounts, etc.—that have not been formally transferred to it or have been acquired after the living trust was created. In the common case of a married couple with children, upon the death of the first spouse, the trust can be set up to remain revocable. Usually, the survivor stays in control as sole trustee. But—again— it is critical to have an alternate trustee already in place when the second spouse dies. Otherwise, a court will appoint a trustee of its choosing. When the survivor dies, there are two broad options for the disposition of trust assets: a division into separate trust shares for each child; or continuation as a single fund for the benefit of all the children until specified ages, at which time total or partial distribution occurs. The single pot approach is usually best, since it allows more flexibility in dealing with emergencies or special needs. In the broad financial context, there are three main advantages to using a living trust: •

Avoiding probate. This can save you significant time and money on probate fees and attorneys’ fees.

•

Privacy. Probate is a public process; wishes in living trusts are kept private.

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•

Flexible management. You can turn over the management of your trust during your lifetime to your successor trustee. In most cases, you can scrap the whole trust and start a new one. Just make sure that the grantor retains the right to terminate the trust, regardless of who’s managing it.

If you live in a community property state, or own many of your assets in joint tenancy with right of survivorship, it may be difficult to split your assets into two separate living trusts. In this case, you may choose to form a joint living trust. This can accomplish the same goals as a living trust, but without the difficulties of splitting up your joint assets while you are both alive. T E S T E M E N TA R Y

TRUSTS

Having made the argument for the privacy and smooth operation of living trusts, we now turn to the mechanics of traditional trusts created by wills. In most families, an adult child or heir is best suited for the role of trustee or successor/alternate. It’s important to think of this succession from an early age; the best trustee is one who knows what you think about family money and how it should be managed. If you have no reliable family members, institutional trustees are available. Generally, these are banks or trust companies. And professional service providers—attorneys and accountants—often serve as trustees. But they are often a relatively expensive option...and they sometimes attract as much trouble as they avoid.

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LIFE

INSURANCE

TRUSTS

This is a widely used, but unfortunate name for an irrevocable trust used to buy insurance as an investment. The trust can also be authorized to hold a range of investments, and not just life insurance. Remember that proceeds from policies you own will be included in your estate, even though they are paid to a third party. If an irrevocable trust owns the policy, however, death proceeds can be received by the family income tax free (as usual), yet not be included in your taxable estate. A trust is not necessary to get this result. For example, if a child owns, pays for and is beneficiary of a policy on the life of a parent, he or she can receive the policy proceeds with no tax consequences to anyone. (So, one of the smartest money things a child can do is fund estate taxes and other costs by taking out a policy on his or her parent’s life.)

Trusts that hold insurance provide for the use and management of the policy proceeds according to your wishes. The beneficiaries might not be old enough to manage a sizeable lump sum of money.

Too often, an irrevocable life insurance trust is prepared by an attorney as part of a family estate plan, but little guidance is offered on avoiding taxes.

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An existing policy can move out of your estate if transferred to an irrevocable trust and if you, as the former owner, retain no incidents of ownership. But you have to plan ahead to take tax advantage of this transfer. Policies transferred to a life insurance trust within three years of death will be included—and taxed—in the estate, anyway. An unfunded irrevocable life insurance trust is an estate and income tax planning tool for use in solving a variety of problems. It can be used to:

•

protect and preserve assets;

•

manage assets professionally;

•

avoid probate;

•

provide a source of estate liquidity;

•

create tax exempt wealth; and

•

save taxes in general.

It accomplishes the last two points by:

•

lowering or freezing the value of an estate by the grantor divesting himself of ownership of the property; and

•

passing estate taxes by keeping the principal out of the estates of grantor and the grantor’s spouse.

TRUSTS

FOR

MINORS

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tax exclusion. The rules are plainly written in the federal statute books—not in a cloud of court opinions. These trusts are irrevocable, yet permit some control over the timing of wealth transfer to the next generation. In a trust for minors, annual income may be accumulated and not paid out, but the trust must provide that, if necessary, both income and the entire principal can be used for the minor’s benefit. When the beneficiary turns 21, things change. He or she may be allowed—by law—to receive all assets available to him or her in an outright distribution. In any event, the annual income of the trust can’t be accumulated after the beneficiary turns 21. And there are ways to work around the rules about making funds available. For one thing, the minor can name a beneficiary of the income from the trust but not the principal in it. That can go to somebody else. However, splitting the benefits like this creates some problems. If the minor beneficiary has no right to the trust principal, he or she only has an income interest—the right to receive annual income payments from trust investments. Therefore, the amount of each gift that qualifies as a gift (for tax purposes) is the present value of the series of income payments that the gift will produce over the years. Different assumptions about investment returns can change this number dramatically. This usually comes into question if the beneficiary with an income interest makes some sort of claim against the trust. Both life insurance trusts and trusts for minors can be receptacles for tax-advantaged gifts, includ103

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ing gifts used by the trustee to pay life insurance premiums. If the insured person (or spouse) is the grantor, trust income should not be used to pay premiums—because the grantor will incur income tax liability on the income so used. Worse still, the grantor might be considered the owner of the policy for estate tax purposes.

If you’re using these trusts, consider using trust principal or yearly gifts to pay insurance premiums. It keeps ownership clear.

Again, it bears repeating that imprecise or confusing language in trusts can create major problems for the people making them...and the beneficiaries who are supposed to receive money from the things. The June 2001 Tennessee Appeals Court decision in Guardianship of Courtney Warner Hodges shows how a hash of oral trusts and handwritten notes botched what should have been a relatively simply inheritance of some real estate. Oral trusts—or lengthy instructions left with trustees—are called parol trusts in most legal circles. Most often, when a close-knit family doesn’t feel the need to draw up a written document, they wrongly rely on intentions and assumptions. Ida Hodges was the grandmother of Warner Hodges III. Warner married Jo Whiteley Massey in 1978; and, in 1982, they had a daughter named Courtney Warner Hodges. Ida felt very close to Courtney and

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intended to leave her great-granddaughter enough money to pay for college and get started in life. Ida owned two fairly valuable pieces of real estate, and when she died, her will deeded to Courtney an undivided one-eighth interest in the net sale proceeds of one of the pieces of real estate. It also gave her a one-fourth interest in a life estate in the other property. After Courtney’s parents divorced in 1990, her mother, Jo, filed a petition for appointment of a guardian for Courtney. The petition also stated that the income interest to Courtney was outright and not encumbered by trust. In other words, that the rental income should go directly to Courtney’s guardian. Warner, Courtney’s father, didn’t like the sound of this. He argued that oral instructions from Ida had made it clear that all income and proceeds from the real estate should flow through trusts established for Courtney. In October 1999, a Tennessee trial court ruled that Courtney needed a guardian for purposes of representing her interests in Ida’s estate. However, the court refused to impose oral trusts upon the property. It ruled: The Court is impressed with the testimony about the close-knit Hodges family and the desire of all parties...to see that the children received a good education. However, it cannot be found that this is sufficient to impose an oral trust on the funds. Such a

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finding would require speculation as to the terms and conditions thereof and the testimony is not sufficiently clear and convincing under the law to find such a trust. This was a major victory for Jo; she was one step away from controling the assets Ida had left for Courtney. But Warner hadn’t given up. He appealed the decision. The appeals court had to decide whether either or both of the properties received through deed and devise were encumbered by oral express trusts. Tennessee law permits an express trust in real estate to rest upon a parol (another legalism for “verbal”) agreement. And, Warner claimed that Ida had engaged in discussions with him, his brother and his father about Courtney’s inheritance. His brother and father agreed—and testified—that Ida had told them she didn’t think it was necessary to make a formal trust document—since the family members all got along. Jo and her lawyers, however, argued that Ida’s intentions had been expressed in general terms, not specific enough to impose oral trusts upon the property. Jo also pointed to the language in her divorce papers, which stated: If the children’s Poplar Pike property sells, income attributable to Courtney’s share shall be invested and the tuition payable by the Husband shall be diminished by the amount of income generated by Courtney’s share each year.

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She argued that the document referred to the “children’s property” instead of the “children’s share in trust.” The appeals court concluded that all of this tallied up to enough doubt that it couldn’t create a trust from recollections of conversations. It concluded: Because both the trust and its terms must be established by clear, cogent and convincing evidence in order to establish oral trusts upon the property, we find that the trial court did not err in failing to find that the property was encumbered by oral trusts. Courtney’s cashflow from the rental property would go directly to her—via her guardian. C H A R I TA B L E

REMAINDER

TRUSTS

Charitable remainder trusts (CRTs) work best for people who have a lot of money tied up in capital investments that have appreciated over the years, such as stock, bonds, a home or a business. When you sell that asset, you are liable for a lot of taxes. But if the asset is not providing you with a lot of dividends, interest or other income, you may need to sell the asset and buy some other investment that provides you with income. Once you have placed assets in a CRT, the trust can sell the assets without paying taxes and put the proceeds into investments that provide a good source of current income. You (and your spouse) are entitled to that income for as long as you live, and when you die, what’s left goes to the charities you named when you started the CRT. 107

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In a variation, called a Charitable Remainder Unitrust (CRUT), the grantor receives a fixed percentage of the trust’s value each year, rather than an unchanging dollar amount. Many people prefer CRUTs because they can provide inflation protection. As the trust grows in value each year, so does the amount of the grantor’s annual draw. With either a CRT or CRUT, the remainder that will eventually go to charity has a value today, established with a financial calculation, using an assumed future interest rate. The IRS publishes the interest rate each month to be used in this calculation of the value—in today’s dollars—of the charity’s right to receive the remainder of trust assets at the specified future date. That is the amount the grantor is giving away. It is, therefore, the value of the current income tax deduction. (The IRS rate was 6.2 percent in July 2001.) A big additional benefit is that the donated property, and all future price appreciation, is removed from the grantor’s taxable estate.

When interest rates go up, the present value of the remainder (and therefore the tax deduction) goes down, and vice versa. The present value of the remainder also decreases as the length of the trust term increases, and vice versa.

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OTHER

VA R I AT I O N S

The grantor retained annuity trust (GRAT) is an irrevocable trust, good for shifting some of the value of an asset out of an estate. The grantor places assets in a trust for the ultimate benefit of heirs—they have a remainder interest—but retains the right to an annual pay out for a period of years. By accepting some gift tax liability at the time the GRAT is set up, the grantor has reduced his estate tax liability later; and the heirs end up with more. If the grantor dies during the term of the trust, all property is included in the estate, and there are no tax consequences—just as if nothing had been done. The key to GRATs (and CRTs) is the relative value given the two interests involved: the gift of the remainder interest in the trust principal and the value of what the grantor has retained—the present right to collect a certain cash payout from the trust each year for X years. (And that X has to be established at the beginning.) The greater the annual payout and the number of years of payments, the greater the value the grantor has retained for himself, and the smaller the value the IRS gives to what is left over—which is the taxable gift. (In the CRT, of course, what is left over goes to charity, so there is no taxable gift. This value will therefore be the amount of the donation and current income tax deduction.) A Qualified Personal Residence Trust (QPRT) is an irrevocable trust, similar in concept to a GRAT. It is a good method of shifting the value of the

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family home out of an estate, for the purpose of lowering the ultimate estate tax. The house is placed into trust for the future benefit of heirs. The value today of this remainder interest is a taxable gift. As with a GRAT, the grantor accepts some federal gift tax liability now to save more on federal estate tax later. What is retained here by the grantor is not income, but the right to live in the house for a set term of years. If the grantor outlives that term, the value of the house—plus any property appreciation since it was transferred to the trust—passes to the heirs with no additional federal estate tax. As with a GRAT, if the grantor does not survive the term of the trust, a QPRT has no tax effect. The QPRT has two major drawbacks: First, heirs will receive the house by lifetime gift, not inheritance, so there’s no step-up in tax basis. For a home purchased decades ago at a fraction of current value, this means that income tax (at the 20 percent capital gains rate) must be paid on the increase in value— if the property is ever sold. Second, a tax reform— applicable to QPRTs created after May 1996—eliminated a loophole permitting the grantor the right to buy back the residence for his continued occupancy at the end of the trust term. A Generation-Skipping Trust is an irrevocable arrangement that provides income only, not access to trust principal, to the grantor’s spouse and/or children. It terminates when all have reached a specified age or died—with trust principal then distributed to grandchildren.

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Under a loophole in prior law, by skipping over the children in the final distribution of principal, a grantor could save gift and estate tax. Now, such transfers are taxed at the maximum federal gift and estate tax rate of 55 percent. But there is a cumulative exemption of $1,030,000 (adjusted annually for inflation) per donor that can be used to avoid tax on generation-skipping transfers (by trust or gift) during the donor’s lifetime or at death. Any gift to a natural person that qualifies for the $10,000 annual exclusion from federal gift and estate tax automatically qualifies for an exemption from the generation skipping tax. This, again, means that a generation-skipping trust can make sense—if you start gifting money early enough. Medicaid trusts were designed to hold assets that were given away to impoverish the trust grantor, so that he or she would qualify for Medicaid benefits. The purpose was to preserve life savings should nursing home care become necessary. These trusts took many forms, which were all made obsolete by changes to the federal tax code that took effect in 1993. Today, an asset transfer to any irrevocable trust within a “look back” period of five years of applying for a Medicaid nursing home bed is presumed by law to have been made in order to qualify for Medicaid. MINIMIZE

P R O B AT E

As we’ve mentioned already, probate is the legal process that oversees the working of your will.

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It is the way to see that your will is valid, and then oversee the repayment of your debts and the distribution of your assets. Probate is usually a long and tedious process. And, just like anything that is long, tedious and requires attorneys, probate can be very expensive.

Expect to pay between 6 and 10 percent of your estate’s value in probate costs, attorneys’ fees and executor’s fees. If your estate is worth a modest $200,000, probate can cost your family $20,000.

Probate is initiated in the county of the dead person’s legal residence. Usually, the first step is taken by the executor or other interested person who’s in possession of the will. This person files (with or without the help of a lawyer) a Petition for Probate of Will and Appointment of Executor—or a similar standard form. If there is no will, somebody must come forward and ask the court to be appointed as administrator, instead of an executor. Most often, this is the surviving spouse or an adult child, although it might also be another interested party. The probate estate simply refers to any property subject to the authority of the probate court. Assets disposed of outside the probate process are part of the non-probate estate. There is a common misconception that a will can be drafted in a manner to avoid the probate process

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completely. This is not possible. Specific assets can avoid probate...but some form of the process must take place for every estate. There are usually streamlined—and in some places highly expedited—procedures set up by the local court system to handle the settlement of small estates, or even larger ones, if uncomplicated. The probate procedure involves three basic steps:

•

Collection, inventory and appraisal of all assets that are subject to probate;

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Payment of taxes and creditors; and

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Formal transfer of estate property.

The surviving spouse and/or children are generally allowed some inheritance under state law, whether or not there is a will. Generally, that comes off the top first. After that, the order of payment of claims against the estate is usually: 1) Costs/expenses of administration; 2) Funeral expenses; 3) Debts and taxes; and 4) All other claims. What remains of the estate after these payments are made is available for distribution to heirs and beneficiaries. Throughout this process, the executor—in some states, called a personal representative—plays a central role. He or she is responsible for seeing that the estate makes it through probate.

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Sometimes the executor is also a beneficiary. In these cases, he cannot give himself preferential treatment. The best way to assure family peace is to make a will that states clearly how assets should be handled.

One of the executor’s most important duties after appointment is to take an inventory of estate assets. An executor must also act to preserve and protect the assets, according to the Prudent Person Rule. Obeying this rule is part of a fiduciary duty imposed by law on executors (and trustees) to act cautiously, as though dealing with their own affairs. That said, the burden of getting things right rests with the person who’s died. An executor will only be liable for problems if he or she acts criminally or is grossly negligent. This is rare. The executor is also not liable for a poor return on estate investments (this is not so rare), as long as those chosen are prudent. An executor is entitled to reasonable compensation, often limited to a certain percentage (e.g., 5 percent) of the property in the probate estate. Extra compensation, related to handling some special matter, may be allowed by the court.

The key point in choosing an executor is fairness. The executor of even a modest estate can be the lightning rod for all kinds of family disputes.

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CONCLUSION Wills and trusts are among the essential tools in most people’s lives, especially if you have a considerable estate and lots of (potential) heirs. In this chapter we gave you a general overview of typical vehicles for transferring money. The goal is to avoid costly mistakes, like extensive probate proceedings and bitter family squabbles. Sometimes, however, those incidentals are hard to avoid. In this next chapter, we’ll continue to discuss the vehicles of family money by talking about types of investments.

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4 TYPES OF INVESTMENTS

We’ve considered family, attitudes and the mechanics of wills and trusts. In this chapter, we’ll consider how the types of assets that most families own can best be transferred from one generation to another. F A M I LY - O W N E D

BUSINESSES

In a commercial society, a business that stays in a family’s control for several generations is the literal embodiment of a legacy. And family businesses can be efficient. In one much-quoted study, Cornell University economist R.J. Monsen found that family firms have a better-managed capital structure, more efficient allocation of resources and a better return on investment. Management gurus have taken to calling this conservative, long-term approach to running a business stewardship. They talk about professional managers creating a sense of stewardship toward their companies and their employees. Legacy and stewardship are different ways of describing the same thing. They describe a sense of the

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business as a means of perpetuating values and beliefs, as well as organization and cash flow. In this context, succession becomes less a matter of bright people battling in a corporate arena and more a matter of setting parameters and letting everyone who’s interested learn them.

Thanks to the downsizing of the late 1990s and early 2000s, a large number of experienced employees have been given ample severance packages—some of which are used to start a family business.

Many entrepreneurs share the dream of building a strong, profitable business that they eventually can pass along to their children. However, it’s important to remember the statistic that only 30 percent of all family businesses—less than one in three— actually are passed on to the second generation. And only 10 percent pass to the third generation. These are shockingly low percentages, but there are a number of reasons for them—most of which have no bearing on the type of relationship that the business owners have (or have had) with their children. Some businesses simply fail, leaving nothing to pass along to the next generation. Or the owner may sell or liquidate the business before it can be passed along. New technology may make the business obsolete between one generation and the next. Some family members may prefer careers of another sort and have no desire to run the business, while others may not have the ability to run a business.

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Still, a profitable business is a valuable thing. If you own one—and make sloppy plans for what will happen when you’re gone—trouble will follow. The May 2001 New York Appeals Court decision in Estate of Francis Penepent v. Richard Penepent shows just how difficult the transfer of a family business can be. And these guys had a plan in place! In 1937, Anthony Penepent and his four sons, Richard, Francis, Angelo and Philip, started a business. In 1952, they incorporated the business—and each took a 20 percent interest. They also entered into a shareholder agreement, which provided that upon the death of any shareholder Penepent Corporation would pay the dead person’s estate (either through a life insurance policy or directly) a set price for all of his stock. The agreement further provided: the stock so purchased shall be delivered and surrendered by the representative of the [dead person] to the Corporation, which shall thereupon retire such stock. This is known as a “mandatory buy-out” or “stock retirement” agreement. The agreement also described a method by which the corporation could increase the purchase price: The parties hereto agree that the value of the stock may be changed from time to time.... A revaluation must be signed by all Stockholders and the Corporation....

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Originally, the set price was $10 a share, then $15 a share and finally, in 1984, the set price was increased to $200 a share. In 1979, the four brothers bought out their father’s interest, each becoming a 25 percent shareholder. In the late 1980s, however, a rift had formed among the brothers over how to transfer the business to their children: Richard and Angelo were on one side; Francis and Philip on the other. In May 1990, Philip petitioned for the dissolution of the corporation under New York Business Corporation Law. In June, Francis also sought dissolution of the corporation.

New York Business Corporation Law allows a holder of 20 percent or more of a closely held corporation’s stock to file a petition for dissolution of the corporation on the grounds that those in control have either committed “illegal, fraudulent or oppressive actions toward the complaining shareholders” or have “looted, wasted or diverted for non-corporate purposes” the corporation’s assets.

Invoking another section of state business law, Richard and Angelo agreed to purchase Philip’s shares at “fair value.” While awaiting a court decision about what fair value would be, Angelo died. A state court permitted Angelo’s estate to revoke his agreement to purchase Philip’s shares; Richard thus stood to acquire

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all of Philip’s shares. Penepent Corporation paid Angelo’s estate the specified price for his own shares and retired them. In December 1991, after his decision to sell but prior to the fair value determination, Francis died. The court now had to determine whether the mandatory buy-out provision in the shareholder agreement trumped a “fair price” purchase that had been agreed upon before the provision became operative—that is, before Francis’s death. Richard argued that Francis was still a shareholder when he died and, pursuant to the shareholder agreement, the corporation had a right to acquire Francis’s shares at the set price and retire them. According to Richard, Francis remained subject to the mandatory buy-out provision until the court fixed fair value and the stock purchase transaction was actually completed. Francis’s estate argued that at the time of his death Francis was a shareholder in name only. Richard had already made an irrevocable agreement to purchase the shares at a fair value; thus, he was legally bound to purchase Francis’s shares at fair value. The court agreed. Once a party makes an election, that party is obligated to purchase (and petitioner is obligated to sell) the petitioner’s shares at their fair value. A mandatory buy-out agreement will not operate to frustrate a fair value purchase. The divestiture event under the shareholder agreement—namely, Francis’s death—did not occur un-

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til a year and a half after Richard made a valid decision to purchase Francis’s shares at fair value. The court held that, upon Richard’s agreement, Francis had a vested right to recover fair value for his corporate stock and that right survived his death. F A M I LY

BUSINESS

FINANCES

In a family business, you are not only watched by colleagues, you are watched by family members. Overcoming this pressure is one of the most difficult aspects of being in a family business. Aside from taking care of the daily activities of the business, the management group makes sure succession issues are planned properly—well in advance and in a logical way.

Creating a tax structure to sustain future generations is important. You’re not rewarded for building a business for the next and passing generations. In fact, it is just the opposite. You are taxed at a high level. The group that inherits the business could end up working for more than 20 years to pay off the tax liability of the business.

There are a number of ways in which a business can be organized. Each one has certain advantages and disadvantages for the owners. If it is not, the business or its owners may be paying more taxes than necessary. They may not be using tax advantages that the law provides. And they may be laying the groundwork for future problems regarding

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control of the business, legal accountability and how to generate cash effectively. However you start your business, one of the first major decisions you must make is how to structure it. There are six basic possibilities: •

sole proprietorship;

•

general partnership;

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limited partnership;

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closed (Subchapter S) corporation;

•

open corporation; and

•

limited liability company.

For many people, a significant advantage of operating a family business is the opportunity to obtain start up or growth capital from members of the family. Parents, grandparents, brothers and sisters, aunts and uncles, cousins and in-laws frequently have the means—and the willingness—to provide funding for your business. Family financing comes with its own costs—which can be emotional, as well as financial. Still, it’s the source of capital that most start-ups use. And it’s the reason there are so many family-owned businesses. There are situations in which relatives have mortgaged their homes to provide start-up capital for a promising entrepreneur. There are others in which siblings have advanced the entrepreneur his projected share of the family inheritance so he could start a business. And there are others in which a child has borrowed against parents’ insurance to raise some needed business capital.

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The form that financial support from family members takes will depend, in part, on the ownership structure the entrepreneur selects for the company. If it’s a sole proprietorship and the loan is small, a simple promissory note from the borrower may suffice. If the company is larger—and the borrowing is larger—the lenders may want some equity in the venture. Some families may want a partnership structure in order to invest. There’s no best way to proceed; every situation depends on the needs of the business and the wants of the family. TRICKY

VALUATIONS

One of the challenges of running a family business is that the things are hard to value. This was a bitter lesson learned by Selcuk Sahin, who sued her ex-husband in 1999 for fraud after he sold his computer software firm for more than a billion dollars. Mrs. Sahin claimed in Virginia court documents that Kenan E. Sahin committed a multimillion-dollar fraud by pricing his firm at just $4.9 million when he agreed to pay her 30 percent of the firm’s value following their 1996 divorce. She accepted a $1.5 million cash payment. Mrs. Sahin argued her former husband hid the true value of his company from her—allowing him to sell the firm in January 1999 to Lucent Technologies Inc. for $1.47 billion in Lucent stock.

By taking the cash, Mrs. Sahin passed on the option of being paid in company stock, which would have been worth about $441 million in Lucent shares.

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Although Mrs. Sahin claimed she helped get the firm off the ground during her marriage, Mr. Sahin—who’d started the software company in 1982 while teaching at MIT—disputed the fraud claim and the sob story. He pointed out that his ex-wife had access to scores of documents estimating the company’s value, as well as the opinion of her own expert. His arguments convinced the court, which tossed out Mrs. Sahin’s fraud claim. Still, Mrs. Sahin wasn’t destitute. In addition to the $1.5 million in cash, she got $100,000 a year in alimony from Mr. Sahin. But the lesson remains: If you get divorced, consider taking the stock in a family business instead of cash. Even if this means keeping in contact with someone you’d rather not see, the payoff can be well worth the inconvenience. As Selcuk Sahin knows only too well...now. REAL

E S TAT E

When you hear the term “American dream,” the first thing that comes to mind is probably home ownership. However, the dream can quickly turn into a nightmare if you don’t take the time to educate yourself on the details of financing and law. People buy homes for a variety of reasons. Some look at it purely from a tax savings and investment perspective. Others hate the thought of throwing away rent money. And still others simply want a place to call their own and raise a family. Whatever your reason for buying real estate, it will probably be one of your main vehicles for growing family wealth. 125

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Generally, as a homeowner, you are entitled to a mortgage interest deduction on your taxes. Both the interest and property taxes are deductible. In the first few years of any mortgage, the bulk of what you pay is interest.

Assume that on a payment of $1,300 per month, you could deduct $1,160 in interest. That would mean you could reduce your taxable income by $13,920 over a period of a year. Your tax bracket would determine how much per month that is to you. If you are in the 28 percent tax bracket, then it’s worth $324 per month.

There are various caveats to this calculation. Because the government allows for a standard deduction, some homeowners may not qualify for a mortgage interest deduction. With respect to local taxes, not all states allow for a mortgage deduction. What about the upside of a real estate investment? Of course, no one can know for sure what the future holds. At various points in time, a real estate market can see both appreciation and deflation; and, since most people borrow heavily even when they buy investment properties, the leverage increases the boom or bust. Generally speaking, though, most people have done pretty well in real estate since the end of World War II. Because of the tax breaks and borrowing, real estate investments are sometimes not liquid. Getting at the value—even if its large—can be difficult. The

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January 2001 California Appeals Court decision in Alicia Remsen et al. v. Carol E. Lavacot et al. shows how tough this can be. Alicia and Greg Remsen were brother and sister and beneficiaries of a trust set up by their greatgrandparents. Those great-grandparents, Willard and Ruth Cain, owned 3.7 acres of beachfront property in chic Laguna Beach, California—some extremely choice real estate. The Cains believed the property was worth over $10 million. In 1983, the Cains created a revocable inter vivos trust funded by the Laguna Beach property. Through the trust, they left $1 million to their daughter; $300,000 to a personal friend; $200,000 to a cousin; $100,000 to each of their seven greatgrandchildren; and the remainder to the principal beneficiaries, their four grandchildren. Distribution of the trust assets was not to be made until after all debts, taxes and administration expenses related to the Laguna Beach property had been paid. Willard and Ruth passed away in August 1987 and January 1988, respectively. After their deaths, Carol Lavacot—their granddaughter—and her husband, who served as trustees, gave the beneficiaries copies of the trust and said the money would be available when the property was sold and all taxes paid. Selling the property wasn’t easy, and by November 1990 Alicia Remsen filed a petition demanding that Carol and her husband distribute her $100,000 inheritance. It was approaching three years since

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Ruth’s death...and Alicia wasn’t the only family member getting exasperated with the delays. The probate court agreed to investigate the situation. Carol and her husband explained to the court their troubles. All offers to purchase had been contingent on the estate securing a city-approved tract map, which in and of itself would have been a feat. Like many ritzy coastal towns, Laguna Beach had quite a few land use regulations. The value of the Cains’ land was based on developing it into several residential tracts—exactly the kind of project the land-use regulations and various state agencies are designed to delay and restrict. The court believed Carol’s explanation and denied Alicia’s petition. Six years later, Alicia received a letter informing her that a deal was in place for her great-grandparents’ land. The letter went on to outline the specifics: The sale price is $5,200,000. At the close of escrow, there will be $3,200,000 paid with the remainder financed by us at a rate of 8 percent. Unfortunately, the IRS will take its cut which amounts to almost $2,000,000 and the State of California their cut, the amount not determined as yet. There are also administration costs that must be paid which also are, as yet, undetermined. As you can see, it will take some time to figure this all out. [When escrow closes, our] plan is to get everyone together for a meeting... and hopefully, distribute a percentage of your inheritance at that time.

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It certainly didn’t sound like Carol was going to be able to fund the trust fully. Alicia received another letter in January 1997 stating that escrow had closed on the property—but that the trust had received very little cash from the sale due to taxes and closing costs. The trustees said they had applied for “an overpayment reimbursement from the IRS” and expected to be able to make a distribution in a few months. Alicia wrote back, requesting documentation of the trust’s assets and liabilities and a complete accounting. In April 1997, Carol replied that she didn’t want to deplete trust resources by having the documents photocopied...but she invited Alicia to view the documents at the accountant’s office. Carol added that she planned to give Alicia her inheritance, minus expenses incurred to fight the 1990 lawsuit, “as soon as the money was available.” In November 1997, Alicia and her brother Greg filed a another lawsuit to direct Carol to give them $100,000 each plus interest from July 1, 1989, and attorneys’ fees. They also asked that Alicia’s distribution not be reduced by costs incurred by the trust in defending against her 1990 lawsuit. Even though Carol sent them a check for $85,000 and a letter stating the remainder would come later, this wasn’t enough in Alicia and Greg’s eyes to settle the issue. In June 1998, Carol asked the court for a ruling on whether Alicia’s 1990 petition and her more recent legal demands qualified as “contests.” The trial court

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agreed to consider all of the issues together, as a single process. After considering the various arguments, the court granted Alicia and Greg’s petition, stating: Court finds $100,000 cash bequests to be “general pecuniary devise[s]” entitled to earn interest after [one] year, if not yet distributed; payment of earned interest depends on estate ability. Court finds no authority for trustee to deduct atty. fees for cost of past trust litigation. After this ruling, Carol filed motions to reconsider and a petition for instructions. She argued that, if interest was due on the cash bequests, no money would be left for the remainder primary beneficiaries (the Cains’ grandchildren). In January 1999, the court took back its original decision on the interest issue and agreed with Carol that the trust didn’t have to pay interest on undistributed cash bequests. As expected, Alicia and Greg appealed. But in the end, they didn’t win the interest…because there was no provision in California law for the payment of interest on a cash gift from a revocable living trust established before July 1989. This was a small victory for Carol, who had had a hard time selling her family’s real estate. REAL

E S TAT E

TRANSFER

TIPS

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Pay close attention to how ownership is described on the title or deed to any real estate property. Common descriptions of real estate owners include:

•

a single person;

•

joint tenants (for married or, in some cases, unmarried couples);

•

a divorced person;

•

a married person as an individual; and

•

an investment partnership.

Depending on the state, there may be other descriptions. But any description should include the number of owners (specifically, one or more) and their marital status. The reason that the description of ownership is important is simple: When it comes time to divide or transfer the property, you have be clear on where the transfer starts. Marital status is always an issue with real estate. Community property laws, designed to make ownership easier to determine, can make this more complex. For example: Hank purchased a home 10 years ago with a $50,000 down payment; for the next nine years, he paid $10,000 a year for the mortgage and repairs/maintenance. Then he got married. In the 10th, the $10,000 mortgage and repairs/maintenance payments were paid from community funds. If Hank and his wife get a divorce, she has a sole and separate one-thirtieth interest in the home calculated as follows: total payments of $150,000 ($50,000 down payment and the 10 years of mortgage and repairs/ maintenance payments at $10,000

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per year) with $10,000 being payments from community funds. His wife’s half share of the community funds is $5,000—and $5,000 is one-thirtieth of $150,000. If Hank dies with a will, he can do just about anything with his interest in the house. If Hank dies without a will, his wife will get the entire interest in the home—unless Hank has legitimate children, either with his wife or from a prior marriage. In that event, his wife will have to split Hank’s interest in the home with the children. (Her one-thirtieth interest remains her sole and separate property.) This brings us to the next point: You need to be careful about how children—often adult children— are included on real estate deeds. During the summer of 2001 an inheritance law aimed at preventing older people from committing a serious real estate blunder took effect in Arizona. The blunder, a fairly common one, involved listing adult children as current co-owners on the deed of a parent’s home in order to transfer the property—probate free—when the parent passed away. The problem was that such titling, especially when done as joint tenants with right of survivorship, could lead to problems while the parents are still alive. These problems include:

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If the child got into financial problems, the parent’s property could be included in a judgment or tax lien.

•

The parent’s house could be dragged into divorce proceedings if the child’s

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marriage fell part. A spouse could claim the house was community property.

•

If the parent changed his or her mind about joint tenancy, an adult child had to agree in writing to relinquish his or her stake in the property.

•

A child’s co-ownership could disqualify a parent from tax advantages and discounts available to people 65 and older.

•

Gift taxes could apply.

And parents...or grandparents...who added minor children as co-owners could face another hurdle if they wanted to sell their house. They’d likely have to go to court and have a conservator appointed to oversee the transfer of the minor’s interest. The Arizona law solved these problems by extending a so-called “beneficiary deed designation” to real estate assets. (The mechanism had been used for years in Arizona on investment and bank accounts.) It provided for a probate-free “payable on death” transfer, expressly stating that the deed isn’t effective until the owner dies.

Real estate is one of the most common assets that families have to manage from relatives’ estates. But the tax impact of inheriting real estate can be difficult. Very often, heirs decide to sell, pay the resulting taxes and divvy up whatever is left.

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STOCKS,

BONDS

&

OIL

RIGHTS

Every investment requires a decision-maker to consider a virtually endless series of factors, including personal ones (that the gnomes at the FED contemptuously call “non-economic” factors). No two people ever reach the same conclusion about what to do with money. That’s why Warren Buffett buys convertible preferred stock in Coca-Cola while your Uncle Everett buys Azerbaijani treasury notes. Every investment you will ever consider is either equity, debt or cash, although some investments have aspects of each. In an equity investment, you are an owner or part owner of a business or property. Stocks, partnerships and real estate are the most common examples of equity investments. If the business prospers or the property increases in value, your investment increases in value. However, your investment can decrease in value. Theoretically, your potential loss is your entire investment, and your potential profit is unlimited. In a debt investment, you are loaning your money to a person or company. In exchange for that loan, the borrower agrees to pay you back with interest. Examples of debt investments are corporate bonds and municipal bonds. Debt investments are also called fixed income investments. That’s because the borrower pays you a pre-arranged amount of interest. Unless the borrower goes bankrupt, you will receive exactly what you expected—your money back with interest.

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In all but the most extreme cases, the longer you invest, the more money you make. That’s because your savings will earn money, and then that money earns you even more money. This is the magic of compound growth.

As with real estate, the form of ownership of an investment can be important. Each of the two or more joint owners of an asset has an equal, undivided interest in the whole account or asset. Most married couples own their homes and checking accounts in this way. By operation of law, a dead person’s share automatically shifts to any surviving joint owners or tenants at the moment of death. The transfer of ownership is complete at that point. In most situations, no federal tax is saved by using joint accounts. For tax purposes, 50 percent of property held jointly with a spouse is included in a dead person’s estate. If the surviving joint owner is not the spouse, 100 percent of the jointly held property is included in the dead person’s taxable estate, unless the surviving joint tenant can prove his or her contribution to the account or property. An alternative to joint ownership is tenancy in common. In this arrangement, each tenant takes a separate, equal interest and can sell or bequeath it independently of other owners. Tenancy in common is frequently an appropriate form of ownership in situations such as when siblings inherit real estate from their parents. But tenancy in common can be applied to non-real estate assets.

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Tenancy in common can be dicey. If there’s discord between the tenants, any one can sell his or her shares to an outsider.

Another common investment issue: How should a family handle retirement money in company pension plans for IRAs when a breadwinner dies? In most situations, the owner has to select a beneficiary when enrolling in the plan or opening the account. If the owner dies, the retirement account acts like a living trust or life insurance—bypassing probate and going straight to the beneficiary. At one time, these funds enjoyed special tax treatment; but now they are usually included in a dead person’s estate for tax purposes. A 1997 IRS rule change permits revocable trusts— not just individuals—to be IRA and retirement plan beneficiaries, without a sacrifice of continued tax deferral. If you already have a good trust program for your heirs, this is probably something you should consider. One point to keep in mind: The receiving trust has to become irrevocable upon the grantor’s (that is, the IRA owner’s) death. The May 2001 Wyoming Supreme Court decision in Oedekoven Family Trust v. Douglas C. Greenough et al. dealt with unusual—but highly lucrative—family investments. When Frank and Doris Greenough discovered oil on their ranch property, they decided to give the resulting royalty interests to their children. Between November 1967 and January 1969, the

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Greenoughs executed a series of Assignments of Royalty. Each assignment specified that it “is intended as a gift” for a named child. Each further stated that the Greenoughs: do hereby SELL, ASSIGN, SET OVER, TRANSFER and CONVEY...all right, title and interest in, of and to __ Percent (%) of all the oil, gas and other hydrocarbon substances produced and saved from the following described lands.... Each assignment stated that it was for either 0.5 or 1 percent of the oil, gas and other hydrocarbons produced from one of 11 tracts of land on the Greenough ranch. The 77 separate documents gave each child a shared 7 percent interest in the oil produced from some of the 11 tracts and a 3.5 percent interest in the others. In 1974, the Greenoughs sold their ranch to the TR Ranch Limited Liability Company, reserving the mineral rights. In 1995 and 1996, TR Ranch sold portions of the ranch to Edwin and Elizabeth Rogers and Gabrielle Manigault Boley who, in turn, sold a portion of the land to the Oedekoven Trust. All of the transactions involved lands burdened by the Greenough assignments. In early 1998, the Boley No. 31-36 Well was drilled on land subject to the Greenough children’s assignments. The well operator obtained a Drilling Title Opinion and a Division Order Title Opinion, but neither could determine whether the assignments to the Greenough children were perpetual royalty interests or were limited to any oil and gas leases in effect at the time of the assignments. 137

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The Oedekoven Trust, which had drilled the well, was advised to hold royalties in suspense pending resolution of the assignment questions. This was the first time in 30 years that the Greenoughs’ royalty payments had been interrupted. They sought a court order enforcing their interest in oil production on their family’s former land. The Greenoughs claimed that they had perpetual nonparticipating royalty interests. The Oedekoven Trust countered that, because the assignments used the term “overriding royalty” and the Greenoughs had leased some land to others for oil drilling at the time, the assignments were either limited or void from the start. The trial court sided with the Greenoughs; it found that the assignments were intended to transfer perpetual royalty interests in the described lands which were not limited to the duration of any particular lease—but were applicable to existing and subsequent leases of the underlying mineral interests. The Oedekoven Trust appealed. After some procedural moves, the Wyoming state Supreme Court agreed to hear the case. It noted that, when the Greenough family made the disputed assignments, it owned approximately 64,000 acres of land...and all mineral rights. The assignments were made immediately after the discovery of oil and gas on the land—and had the stated purpose of providing the grantors’ children with cash flow. According to the high court, the fact the Greenoughs had already leased some parcels to third parties at

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the time of the assignments didn’t prevent an interpretation of the assignments as conveying perpetual nonparticipating royalties. The court wrote: It is clear from the “heirs, successors and assigns” language...that the Greenoughs were creating perpetual nonparticipating royalties as opposed to a life estate or a term of years. This all supported the Greenoughs’ claims. The only question that remained: Did use of the term “overriding royalty” in one clause contradict the balance of the assignment...and render the assignment void? The court said the “overriding royalty” did not preclude the creation of nonparticipating royalty interests in perpetuity. So, the Greenoughs could keep collecting their checks. I N T R A - FA M I LY

LOANS

Federal tax regulations can make lending money to your relatives complicated. Although most people reduce the interest rate charged on loans to family members, the IRS establishes limits. When you lend more than $10,000, the IRS sets a minimum interest rate that it expects you to charge. This minimum is known as the applicable federal rate (AFR) and varies monthly. (You can look the rate up on the IRS’s Web site at www.irs.gov.) Even if you charge less than the AFR, you must pay income taxes on the interest you would have received if you had charged the AFR.

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Regardless of the rate you charge, it is important that you have a formal written promissory note signed. If the borrowers default, you will have difficulty deducting the loss on your income taxes without a note. You may also want to prepare a simple mortgage if you want to be sure that you have security in the event of default. Aside from the tax issues, loaning money to family members can be tricky on the personal level, too. The June 2001 Nebraska state Supreme Court decision in Estate of Thomas J. Reading dealt with the fallout of one such situation. After he died, Thomas Reading left a sizable estate that was meant to be distributed among quite a few extended family members. In the course of sorting through the details, the state probate court ordered Reading’s executor to transfer five promissory notes from the estate to a revocable trust that was in existence at the time of Reading’s death. Reading’s wife Katherine and daughter Paula— who’d borrowed the money and made the promissory notes—appealed. They argued that the notes were not assets of the estate because the notes were so old that they should have been canceled.

If they prevailed, the mother and daughter would effectively create a new mechanism for transferring money: loan it to your child and then instruct your estate to forgive the loans after your death.

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In October 1995, Connie Distransky—Reading’s other surviving child—filed a petition for determination of heirs and appointment of a personal representative. She wasn’t excited about her sister’s loan forgiveness plan. According to Connie’s lawsuit, a will her father drafted in October 1984 should have been offered for probate. In October 1995, the court declared the 1984 will to be valid and admitted it to probate. Norwest Bank of Nebraska was appointed as personal representative of the estate. So, Norwest had to figure out what to do with the promissory notes Paula had given her father in exchange for loans. At one point, Katherine and her daughters agreed to resolve their disputes by forming a new trust to handle the family’s money. Under the terms of the new trust, Katherine and her daughters were to receive all trust income and as much of the principal as necessary to provide for their support, in the sole discretion of the trustee—which was Norwest. In January 1998, Norwest asked the court for instructions about a proposed distribution, which included transfer of the promissory notes to the trust at their face value, with no further interest accrual. be applied to Paula’s share of the trust. This approach made sense, from a lay person’s perspective. In short, it would debit the money Paula had borrowed—plus interest—from her inheritance. But Paula and her mother didn’t agree to this proposal. They kept arguing that Paula’s promissory

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notes were not assets of the estate and should have been canceled. The trial court ruled for Norwest and ordered Paula’s promissory notes to be applied against her rights in the trust. Paula and her mother appealed, insisting that any attempt to enforce Paula’s liability on the promissory notes was barred by the statute of limitations under Nebraska law. But the state’s probate law allowed for debiting unpaid loans against inheritance. Specifically, the court noted: Unless a different intention is indicated by the will, the amount of a noncontingent indebtedness of a successor to the estate if due, or its present value if not due, shall be offset against the successor’s interest; but the successor has the benefit of any defense which would be available to him in a direct proceeding for recovery of the debt. Paula and Connie were each to receive one-half of Reading’s personal effects and household furnishings, with all other assets to be distributed to the trust. Paula’s loans would be repaid from her share. The appeals court agreed with the trial court’s order authorizing the transfer of the notes to the trust.

This case suggests unbalanced favor on the mother’s part, who was determined to erase $50,000 in loans to another daughter.

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LIFE

INSURANCE

Life insurance is a critical asset for most estates. It’s a guaranteed, quick source of funds to pay the various costs that come up. Even if you plan well, substantial federal estate tax may be due. This can present a serious problem when the estate has big non-liquid assets, like real estate or a business. Insurance can prevent a distressed sale of assets to raise cash for taxes under time pressure. Family business owners often underestimate what their companies are worth (at least for estate tax purposes). As we’ve seen, another way to protect a familyowned business is to execute a shareholders’ agreement whereby the surviving owners have the right to purchase the dead partner’s shares. There are different details to these deals, but a common point is that funds must be available to honor the agreement; there are life insurance policies designed specifically to generate them. A major advantage of life insurance is the income tax-free transfer of proceeds to the beneficiary. This is widely known to the public. What the public doesn’t always appreciate is that the insurance proceeds can be included in a dead person’s estate, if that dead person owned the policy—and even though someone else got the money! For example: Mom owns a life policy on Dad, with the children as beneficiaries. She is careful to pay premiums with her own separate funds, so that Dad won’t somehow be deemed by the IRS to have

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strings attached, and the proceeds, therefore, will not be included in his taxable estate. At Dad’s death, the insurance money goes directly to the children, exactly as planned. No estate tax is due. But Mom has made a taxable gift to the kids, for federal purposes, because she gave them the policy proceeds! And if the kids put up part of that money to help Mom with the gift tax—if any is actually due and payable—then they will be deemed to have made a taxable gift to Mom. Life insurance proceeds pass to a spouse income and estate tax free (as can all other assets). If the insured person owns the policy upon death, the death benefit is included in the taxable estate (just like all other assets). If children or a trust own the policy, then neither the policy, cash value nor death benefit is included in the taxable estate. The proceeds are likewise included if the policy owner names his “estate” as beneficiary. That beneficiary designation is also a bad idea because it exposes the policy proceeds to creditors of the estate, which would not otherwise happen.

Wills and trusts created within wills are always under jurisdiction of the local probate court. If you leave life insurance proceeds to a trust for your children, the probate court will probably become involved with the proceeds.

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Unlike term life insurance—which has no value after a set period of time (its term)—there are some forms of life insurance that build a cash equity value over time. These include:

•

whole life;

•

universal life;

•

blended whole/universal life;

•

interest sensitive whole life;

•

variable life;

•

variable universal life; and

•

variable blended whole/universal life.

In most cases, premiums start higher than term insurance—but they stay level...and the policy accumulates a redeemable cash value as time goes on. This kind of insurance makes sense if you:

•

are accumulating cash for the future;

•

need coverage for more than 15 years;

•

are in a high tax bracket; or

•

are over 35 when you buy your first policy.

The most common of these kinds of insurance is whole life. Whole life insurance is a permanent form of insurance protection that combines a death benefit with cash value accumulations. In a whole life policy, the face amount is constant—and this amount will be paid if the insured person dies at any time while the policy is in effect.

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Whole life insurance is usually used as a form of level protection during income-producing years. At retirement, many people then use the accumulated cash value to supplement retirement income. This gradually reduces the death benefit. Whole life plays an important role in financial planning for many families. In addition to the death benefit or eventual return of cash value, the policy has some other significant features. During a financial emergency, policy loans may be available. Some whole life policies also pay dividends. The policy owner has options as to how dividends will be received. They can be taken in cash or applied toward premium payments. They can also be held by the insurance company and earn interest— then be transferred later. Finally, they may also be used to buy additional amounts of whole life insurance or one year term insurance additions. After a whole life policy has a cash value, certain values are guaranteed upon the lapse or surrender of the policy. Any of these options (which are known as nonforfeiture options) may be elected by the owner if a premium is in default. The net surrender value is the cash value, plus the present value of dividend accumulations and additions, minus any outstanding policy loans. Outstanding loans that are subtracted from the surrender value will include any interest or other amounts charged against the policy.

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Whole life is preferred to other kinds of life insurance by most people because it combines protection and savings—two major factors in the financial plans of most families.

ANNUITIES Annuities combine elements of insurance and fixed-income investment—and offer some tax advantages. Essentially, you agree to pay a certain amount of money to an insurance company, either in a lump sum or several payments. After a period of time, the company agrees to make a series of payments to you. The earnings on the annuity are not taxed until you actually receive your distributions... and you arrange to receive these when you’re older. With a fixed annuity, you have no choice of investments but you are guaranteed a certain return on your investment. Also, the fixed rate is usually only fixed for the initial period of the annuity and may be reset thereafter. In a variable annuity, you typically have certain limited investment choices. CONCLUSION Face it: It’s hard to take control of family money issues when there’s more than one person involved. It only takes one dead relative and one distant— but very alive and combative—one to pose a problem. As we’ve seen in this chapter, investing in the family is critical to your family’s continued health and longevity. And there are lots of ways to do it.

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But, as always, there are things in life that seem to thwart one’s ability to protect the family and generate wealth. Taxes probably first come to mind, which we’ll get to in Chapter 7. For now, we’ll dive into the arena of legal and administrative fees.

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5 LEGAL AND ADMINISTRATIVE FEES

We’ve discussed elsewhere in this book how legal and administrative fees can eat into the value of family resources. This is particularly true when an estate goes through the probate process—but it can be true in other situations, too. Anyone involved in managing family money—either as the grantor putting together an estate plan or as the beneficiary receiving the proceeds—must pay close attention to the lawyers, accountants and trustees charged with assisting in the transfer. We’re not going to rant, as some writers on this subject do, about these professionals being “sharks” or “crooks.” But, when it comes to managing family money, there are some troubling statistics:

•

Trust and estate lawyers sustain malpractice claims twice as frequently as do criminal defense lawyers, according to a survey published by the American Bar Association in April 2001.

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•

State funds that compensate victims of crooked lawyers paid 37 percent of their outlays in claims involving estate attorneys, says an ABA study covering 1993 through 1995.

•

According to Dominic Campisi, a San Francisco litigator who heads a committee on estate malpractice for the American Bar Association, “there are lots of attorneys that steal from estates.”

But it doesn’t take outright theft to make trouble. Most professionals will do as much work as you’ll allow...to generate the highest fees you’ll pay without a fight. This is, simply, human nature. And it’s something families need to watch carefully. In this chapter, we’ll expand on some topics we’ve considered before...and add some new topics...that have to do with the mechanics and strategies of managing the people that your family hires to manage its money. AVOIDING

LAWYERS

C O M P L E T E LY

It’s no secret that some people have such a low opinion of attorneys that they don’t want to use them at all. What drives many people’s fears of lawyers as trustees? The all-too-frequent tales of abuse. For example: In July 2001, a Washington D.C. court ruled that a local lawyer had violated her ethical duty when she sold a house owned by a schizophrenic client to her own parents at a below-market price, allowing them to make a big profit when they renovated and resold the property.

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The court recommended that Deborah Boddie repay $53,000 to Benjamin Land, the mentally-impaired man it had appointed her to represent. The money would make up for the below-market sale, some fees Boddie charged Land for her services and the cost of the investigation into her actions. Boddie had resigned as Land’s conservator and trustee a few weeks earlier. She had also repaid Land some money she billed him inappropriately. At one point, she had claimed—wrongly—to have worked 23 hours in a single day on his case. Land’s childhood home was the most valuable item he had inherited when his mother died in 1991. Boddie never hired a real estate broker to market the property and did not alert the court, as the law required, that she was selling the property to her own family. Even more incriminating: She allowed her stepfather, a contractor, to begin renovating the house months before he actually bought it. Boddie sold the four-bedroom house in northeast Washington to her mother and stepfather for $36,000 in May 2000. Boddie had claimed that the $36,000 price was the fair market value of the house and that there was nothing wrong with selling the property to her family at a fair price. But the court investigation found that the property was worth at least $50,000 to $66,000 when Boddie sold it to her parents. In July 2000, they sold the property for $137,000. The court concluded that Boddie had negligently “breached her duty;” but it found no proof that she acted with malice toward Land. It wrote:

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Although there is no evidence that the sale was construed for Ms. Boddie’s personal benefit, the familial relationship causes a conflict in the actions of Ms. Boddie that borderlines on misconduct. The main tool for do-it-yourself family money management is the so-called “will kit.” Numerous publishers and software companies offer these products, which all include the same basic parts. The kits usually include:

•

a blank will form that includes the standard language (“boilerplate language” in legal terms) required to make a will effective;

•

an inventory form for listing assets;

•

a form for witnesses to sign; and

•

blank forms for personal messages or special gifts or instructions.

Some kits also include the basic paperwork required to set up several kinds of trusts; however, trusts are usually best set up by a professional. Even though these will kits can save you hundreds or even thousands of dollars in legal fees, if you’re dealing with a lot of money, you may be putting more money at risk than whatever fees you’ve saved. Therefore, you should only use will kits or software to prepare your will if it’s relatively simple. If any of the following describe you, you should use the books and software for education, but you should hire a good attorney to prepare the documents and give you advice:

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•

your assets are over $500,000;

•

you intend to set up a living trust, a charitable trust or any other kind of trust;

•

you own your own business;

•

you own assets jointly with your spouse, or someone else, that have appreciated in value by over $50,000, and you have not yet paid taxes on that appreciation;

•

you expect any contests or other issues with family members; or

•

you live in a state that has significant estate or death taxes.

Even if your family is perfect and won’t have any fights, the IRS is waiting over your shoulder, like some hideous bird of prey, for you to make a mistake that will cost you thousands in additional taxes.

PLANNING

SCAMS

One area of rampant abuse in estate planning fees is the aggressive selling of cookie-cutter living trusts to senior citizens who may not need them. A recent study form the American Association of Retired People (AARP) found that 18 percent of people over the age of 50 and with incomes of $25,000 or less had a living trust. That’s a 125 percent growth in the number of people in that category who had living trusts in 1991. The AARP is concerned about

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this because sales materials often twist general commentary from the AARP into what seems to be an endorsement of specific living trust packages.

The problem with generic trusts is that they usually don’t conform to specific state laws.

If you’re thinking of using an estate planning or will kit, you need to understand what the kit is. For one thing, it’s not the same as legal advice. If you make a technical mistake because you used a kit, you (or your heirs) will have a hard time holding the publisher liable for the resulting problems. Also, some “estate planning kits” are actually marketing tools designed to sell you services of questionable value. Be wary of cheap or free estate planning or will kits. For example: In early 2001, Pennsylvania Attorney General Mike Fisher announced that a Texas-based company would pay $5,000 in civil penalties and investigation costs to resolve accusations that it had provided legal advice and estate planning services to Pennsylvania consumers for a fee—without a license to practice law. According to Fisher, Nationwide Estate Planning used direct mail solicitations to advertise and promote the sale of its estate planning services to Pennsylvania consumers between 1999 and 2001. A “New Information Update” encouraged consumers to request a free guide offering money saving

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tips and information that “gives you hard facts and straight answers on living trusts to protect your estate and privacy, plus information on how to avoid probate and estate taxes.” People who requested the free guide were contacted by Nationwide to set up an in-home appointment to discuss the purchase of estate planning services that focused on setting up prefabricated revocable living trusts. Fisher claimed that Nationwide falsely led people to believe that licensed attorneys provided the advice on estate planning and living trusts. In reality, he said, Nationwide’s employees were not licensed lawyers. Fisher went on to say: Estate planning is a specialized field that in many cases requires expert legal advice and legal services to ensure that consumers are aware of their options, responsibilities and rights under the law. In this instance, we allege that consumers believed they were paying for legal advice and services from a licensed lawyer, which was not the case. Although Nationwide admitted no wrongdoing, it agreed to comply with Pennsylvania’s Consumer Protection Law. As part of the settlement, it canceled any contracts with consumers who requested refunds, and it paid fines to the court.

Be careful: Lots of companies will try to sell you “services” that are nothing more than one-size-fitsall tools—no matter what your actual needs may be.

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TOO

MUCH

LEGAL

ADVICE

Because lawyers play such a critical role in estate planning and the drawing of wills and trusts, many people come to rely on them heavily for family money advice of all sorts. This is not always a good idea. The June 2000 Illinois Appeals Court decision in Leslee Peterson v. Stanley Wallach dealt with a case of one family’s excessive reliance on the advice of one lawyer. Anger, recrimination, charges of malpractice and other ugliness followed. Leslee Peterson was the daughter of Ardele and Sidney Peterson and the sole beneficiary of Ardele’s estate. Leslee received the bulk of her mother’s estate pursuant to an inter vivos trust. Leslee filed a complaint in November 1998, alleging that Stanley Wallach had committed malpractice by negligently rendering estate planning advice to her mother. Specifically, Leslee alleged that, in 1989, Ardele had hired Wallach to handle the administration of Sidney’s estate. Ardele also asked Wallach to recommend estate planning procedures that would minimize death taxes on her estate when she passed away. According to Leslee, Wallach recommended that Ardele make substantial taxable cash gifts to Leslee; on this advice, Ardele made gifts to Leslee totaling approximately $580,000 in 1990 and 1991. This should have raised some red flags for either Ardele or Leslee; large cash gifts are almost never a good family money management tactic.

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Upon Ardele’s death in November 1996, the gifts were “added back” into her estate for purposes of determining death taxes. As a result, the death taxes due on Ardele’s estate were increased by approximately $238,000. Wallach’s response to Leslee’s charges was a technical one: That, by 1998, the statute of limitations had passed for malpractice claims based on advice given in 1989. In Illinois, claims of legal malpractice have to be made within two years of “the time the person bringing the action knew or reasonably should have known of the injury.” The court had to determine when the two years started ticking: When Wallach allegedly gave Ardele the bum advice...or when Leslee figured out what had happened? A specific part of Illinois law helped in answering this question. It read: When the injury caused by the act or omission does not occur until the death of the person for whom the professional services were rendered, the action may be commenced within 2 years after the date of the person’s death.... By that standard, Leslee had sued Wallach in time. But the trial court first hearing the case ruled for Wallach, making a complicated ruling that essentially said the extension only applied to estates going through probate disputes. Leslee appealed. The Illinois appeals court noted that the primary issue in determining whether the extension was applicable was whether the injury caused by the

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act or omission occurred upon the death of the person for whom services were rendered, not the manner in which assets were distributed. So: where any injury caused by an act or omission does not occur until the death of the person for whom services were rendered, [the extension] is applicable regardless of whether the assets are subject to distribution through probate proceedings, an inter vivos trust or some other mechanism. To support this decision, the court went back to the legislative history of the extension. It quoted a state representative who’d sponsored the bill saying that there were: some exceptions, of course, as in the case where you don’t learn about the malpractice in the case of say a will or testamentary trust because the error could not be discovered until after the client has died. Wallach argued that this supported his theory that the extension applied only to estates involving wills and testamentary trusts—not living trusts. The court didn’t buy this argument. In fact, the court didn’t buy many of his arguments. The appeals court concluded that: The clear and unambiguous language of [Illinois law] states that where the injury caused by the act or omission does not occur until the death of the person for whom professional services were rendered, the complainant has two years from the date of that person’s death in which to commence

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an action. There is no language limiting [that] section to assets subject to distribution through probate proceedings or excluding assets that are transferred via an inter vivos trust. Ardele Peterson had relied too heavily on Stanley Wallach for advice on managing her family money. He’d failed her...to the tune of a quarter-million dollars in taxes. And then he fought hard to avoid being held responsible for the mistake. The diligence of Ardele’s daughter finally prevailed. But things would have been much better if Ardele had shopped around a bit for estate planning advice in the first place. USING

LAWYERS

E F F E C T I V E LY

Because the standard terms and conditions of trusts are different from those of wills, you should use a lawyer to prepare any trust. Property (real estate and personal) that you want transferred must be handled by a lawyer. This includes deeds prepared for real estate, financial accounts modified to show joint owners, insurance policies amended for either owner or beneficiary, etc. This makes the up-front cost of setting up trusts higher than a simple will. You need to weigh this cost against the cost—and terms—of allowing your family money to grind through probate. Most states automatically provide a fee schedule for your executors; in some states these are as high as 10 percent of your assets. Most executors will

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agree to waive the fee, or take a fixed fee. Your next biggest cost is usually your estate attorney. If not having to pay a probate attorney’s percentbased fee is the only reason you want a living trust, you (or your executor) can find somebody willing to handle probate on an hourly fee basis. Don’t gripe about lawyers; just shop around. Wills, trusts and estate work make up one of the most complex areas of the law, so attorneys who work in the field often charge more than others. But, even with a high hourly rate, the final cost may be less than a fixed percentage—if the estate is simple to settle.

One of the real services that an attorney can provide to you and your family is knowledge of and experience with the local probate courts.

Like any legal process, probate can be easier or harder depending on the judges and other players involved. A good attorney will know the politics of the local system...and navigate for family money accordingly. In many situations, this is what you’re paying for...not the filing of paperwork. Make sure your lawyer is spending most of his or her time concentrating on the activities that save your family the greatest amount of time and money. TRUSTEES

FEES

The best trustee for overseeing the transfer of money from one generation to the next is a family member who knows the details of how money management

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should work...and who will treat each beneficiary equitably and appropriately. People who’ve survived battles over family money may cynically say that such a person doesn’t exist. That self-interest and human frailty will inevitably mean that one group or individuals will be treated differently than others. When family members won’t work, institutional trustees (banks, trust companies or professionals) can serve the purpose effectively. The fees these institutions charge to serve as trustee are usually a percentage of the amount of the estate (often 1 percent per year...or less). But these fees can increase, depending on the amount of effort involved in the trusteeship. A complex estate that involves multiple trusts and intricate wills may require anywhere from a few thousand dollars a year to tens of thousands—just to keep up with all of the paperwork. Some estates require active, day-to-day management. These accounts usually involve a familyowned business or personal services to heirs who can’t manage their own affairs. Because this level of service calls for several hundred thousand dollars a year in trustee fees alone, it’s not something any reasonable person should want.

The schedule of fees and services offers the first clue about whether an institution caters to trusts like yours. A lot of fixed fees for specific services will

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drive the annual amount up quickly...and probably means the firm wants to focus on very large estates.

An institutional trustee typically charges about 2 percent of an estate’s value each year. A trust account of at least $250,000 is required for these fees to make sense for everyone involved (though some institutions are happy to manage smaller accounts). If you hire an institution to serve as trustee, it’s a good idea to name someone close to the family as co-trustee. This person can be a family member distant enough to be impartial or a family friend whose judgment is sound. The purpose of this arrangement is to support the institutional trustee with personal input and advice. EXECUTOR

AND

BENEFICIARY

From the beneficiary’s standpoint, inheritance money is free from federal income tax. The fee paid to an executor, however, is ordinary, taxable income to him. When an executor is also a beneficiary, these facts weigh in favor of the beneficiary/ executor not taking his fee, and obtaining a slightly larger (income tax-free) inheritance. So if the only beneficiaries are you and your spouse, for example, then it makes sense to skip the fee. If there are other beneficiaries, then not taking an executor’s fee means this money is left in the estate to be shared with the others. Depending on how many other beneficiaries there are, and on the distributions provided by the will, 162

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the executor might end up with more money after all, by taking an appropriate executor’s fee and paying income tax. Two other factors should be considered in the decision to take or not take an executor’s fee: 1) Executor’s fees are a deductible expense when it applies to estates over $675,000. But the tax rates are so high that the executor might be duty-bound (to the other beneficiaries, if any) to reduce federal estate tax by taking his fee, in larger estates where the tax is applicable; and 2) Some states have an estate or inheritance tax of their own. Executors who are also beneficiaries must perform their fiduciary duties honestly and in good faith. The main problem posed by an executor who is also a beneficiary is the perception of conflict...and resulting legal fees...that follow any misstep. How bad can these legal fees get? The March 2000 Tennessee appeals court decision in Estate of Lillie Mae Porter looked at the details of one such problem. In this case, the court considered whether the former executor of an estate had forged documents and breached his fiduciary duty to act in good faith and—as a result—ran up legal fees defending himself, which he tried to pass on to the estate. The attorneys were Mary Katherine Longworth and Peggy Monger; their problematic client was Thomas Harvey, the former executor of the Estate of Lillie Mae Porter.

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Harvey didn’t start out as the executor. In September 1990, Lillie Mae Porter executed her last will and testament. When probated, it was accompanied by an affidavit of attestation prepared contemporaneously with the will. Under the provisions of the 1990 will, Harvey was to receive certain real property and the remainder of the estate was to be divided as follows: 20 percent to Harvey; 20 percent to Ted L. Porter; 25 percent to Shirley Porter Wheeler; 25 percent to John Kerley; and 2.5 percent each to Lillie’s four step-grandchildren. In September 1993, Lillie allegedly executed a codicil to the will, thereby amending it. The 1993 codicil did not change the disposition of the real property to Harvey but did name him executor. And, it modified the division of the remainder of the estate. Harvey’s share increased from 20 to 50 percent. The share of Shirley Porter Wheeler decreased from 25 to 20 percent; and John Kerley’s share was eliminated. The codicil did not change the bequests to Ted L. Porter and the step-grandchildren. The codicil was also accompanied by an affidavit of attestation. When Lillie died in November 1993, Harvey offered the will and the codicil for probate. For more than 12 months, the various heirs debated the merits of the will and codicil. They couldn’t reach any settlement; so, in the spring of 1995, the probate court sent the dispute to circuit court. The contestants (basically, everyone named in the will except Harvey) raised three issues:

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1) whether the will was invalid due to undue influence and whether Lillie’s signature was forged to the codicil; 2) whether a prior will executed in 1975 and codicils executed in 1980 and 1984 were lost or spoliated testamentary documents; and 3) whether the wills and codicils executed in the 1970s by Lillie and her late husband were mutual and contractual, rendering Lillie’s 1990 will and 1993 codicil invalid. In addition to suing the estate, the contestants sued Harvey personally, alleging—among other things— that he’d caused Lillie to change the designation on certain certificates of deposit shortly before her death, thereby diminishing the assets of the estate. Once the matter headed to trial, Harvey started churning through lawyers. Longworth and Monger were the third set of lawyers he’d used in a few months. In the course of representing Harvey, the attorneys prepared documents, deposed numerous individuals and retained the services of a forensic document examiner. Then, in December 1997, Harvey terminated the services of the attorneys and proceeded without counsel. The jury eventually found that the 1990 will was valid, but held that the 1993 codicil was invalid. The court then entered a judgment declaring the 1993 codicil invalid—“null and void ab initio”— and declaring the 1990 will valid. Accordingly, Harvey was removed as executor of the estate.

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The dispute didn’t end here. When Harvey’s earlier attorneys went after the estate for fees and expenses owed to them, the family filed objections. The question that had to be decided was whether executor Harvey had acted in good faith when he attempted to probate the 1990 will and codicil. The appeals court found itself unable to make this determination with any certainty. So, it sent the case back to probate court to figure out whether Harvey had acted in bad faith. If he did, the appeals court said, the probate court would “have to apportion, in some equitable fashion, services performed by the attorneys....” (At press, this case was still undecided.) HOW

FEES

WORK

What exactly constitutes excessive legal or administrative fees? The term is more limited than angry clients think. The March 2001 District of Columbia Court of Appeals decision in Estate of Hazel M. King, et al. took a broad view of what’s a fair fee. The case was one in which the key players had multiple roles— in this case, as trustees and personal representatives, relating to the same assets. It was also the second time the court had considered the “contentious administration of the estate of Hazel M. King.” King had died, with a will in place, in July 1991 at the age of 91. The Estate of Hazel M. King was the distributee of the remaining principal and the accumulated and undistributed income of an inter vivos revocable trust that had been created by King, which by its terms terminated at her death. The estate consisted of approximately $1.5 million

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in assets comprised of cash, stocks and bonds. Riggs National Bank and Sanford Goldstein were trustees; Riggs and Goldstein were also named co-personal representatives of the estate, along with Lillian Malins. All the specific legacies were paid. The trust provided that: upon termination of this trust, the remaining principal and the accumulated and undistributed income, if any, shall be paid over to the Personal Representatives of the Grantor’s estate and said trust assets shall be distributed in accordance with the Grantor’s will, dated August 27, 1982. This made yet another situation in which the trustees were also personal representatives and—most likely—beneficiaries. King’s trust also provided that: The [t]rustees shall be entitled to receive the compensation that is customary for trustees in the District of Columbia; provided, however, that the compensation of any institutional [t]rustee shall be in accordance with such institution’s standard trust fee schedule as in effect from time to time. From a few weeks after King died in 1991 until early 1998, King’s heirs, the trustees and the personal representatives battled over every scrap of detail related to the estate. The trustees failed to make several required reports on the estate’s assets. And no one could agree on what constituted a “standard trust fee.”

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On these counts, the probate court: 1) approved unpaid trustee commissions payable to Riggs but denied further trustee commissions requested by Goldstein; 2) approved in full the compensation sought by the law firms representing Riggs and Goldstein; and 3) approved half of the compensation sought by Riggs as personal representative, but 4) denied entirely the compensation sought by co-personal representatives Goldstein and Malins. The probate court ruled that the personal representatives were responsible for the failure to disclose the final account of the estate to the beneficiaries and sanctioned Riggs by reducing its requested compensation by half. Because Goldstein had been overpaid from the estate in his role as trustee, the trial court refused to approve further compensation for him (though he was not required to reimburse the estate). Several parties appealed these decisions; the appeals court combined the separate appeals into a single case that would consider both the administrative and legal fees being charged to King’s estate. The appeals court heard expert testimony from both the trustees and the beneficiaries regarding general practices in the payment of trustee commissions in the District of Columbia. That figure, according

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to the court, was a 1 percent trust termination fee of $14,820.69 taken by both Riggs and Goldstein (a total of $29,641.38), as well as a $1,251.95 termination fee for principal reductions taken by Riggs and $2,502.93 in other commissions taken by Goldstein. Thus, the contested trustee compensation on appeal was $33,396.26. The appeals court considered Riggs’s fees first. It noted that institutional trustees are often paid commissions based on their standard schedules of fees, but that institutional trustees in the District of Columbia typically do not charge a percentage termination fee where they serve as trustee for a trust that pours over into an estate for which they also serve as personal representative—even if a published fee schedule literally permits a termination fee. But the probate court had noted (correctly, according to the trial court): [T]he payment of termination commissions was contractual, in the sense that the Trust instrument provided that institutional commissions would be based upon the fee schedule of Riggs...which in turn does provide for termination fees.... Riggs was within its contractual rights, pursuant to the trust instrument and the fee schedule in place at the termination of the trust, to receive the termination fees. However, noting the “natural conflict of interest” that arises when the same entity occupies the roles of both trustee and personal representative,

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and citing Riggs’s failure—as personal representative—to provide a final account of the King trust to the heirs until compelled to do so by court order, the appeals court awarded Riggs one-half of its requested personal representative compensation based on the “totality of the circumstances.”

Non-institutional trustees customarily bill their time at an hourly rate; otherwise, non-institutional cotrustees are typically paid 50 percent of what the institutional co-trustee is paid.

Rather than presenting an hourly statement of services, Goldstein, a certified public accountant, charged the trust the same commissions charged by Riggs at its institutional rate. The probate court found that Goldstein’s request for commissions was “entirely arbitrary” and approved Goldstein’s trustee commissions at 50 percent of the commissions charged by Riggs. The appeals court stressed that the standard for determining fair administrative fees was based on what was reasonable. It quoted D.C. law: A request for compensation for work performed with respect to the administration of an estate [by each personal representative or any attorney employed by them] must be accompanied by documentation showing a reasonable relationship between the requested fees and the nature of the ser-

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vices performed, the reasonableness of the time spent, the number of hours expended, the applicant’s usual hourly compensation, and the results achieved. Because Goldstein had overcharged the trust by almost $15,000 while King had been alive, the probate court had denied Goldstein any further compensation. Rather than have Goldstein reimburse the estate for the prior overpayment, however, the court offset the amount Goldstein had been overpaid as a trustee against the amount he was requesting in personal representative compensation. The appeals court found that the overpayment received by Goldstein as trustee “should be deducted from his claimed compensation as a Personal Representative.” But the court went further—concluding that, “in conjunction with a further reduction for all of the same reasons that this court will reduce the fees of Riggs,” Goldstein was entitled to no more than $10,000 of his requested $20,000 personal representative compensation. This meant that Goldstein owed the estate between $4,000 and $5,000. These decisions resolved the administrative fees; so, the court moved on to consider the legal fees. King’s heirs asked that the legal fees they had incurred bringing litigation against Riggs and Goldstein be assessed as a sanction against Riggs and Goldstein. Riggs and Goldstein, on the other hand, filed for payment from the estate, pursuant to D.C. law, of the fees expended by the attorneys representing them as personal representatives.

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The appeals court noted, ruefully: Although both requests were for work performed in connection with the [same] litigation and raise similar issues, they are considered under different standards. The legatees’ fee request is an exception to the “American Rule,” under which litigants, win or lose, bear their own fees. The appeals court noted that it had previously recognized a narrow exception to this rule in cases “where a party...withholds action to which the opposing party is patently entitled...because of a fiduciary relationship, and does so in bad faith, vexatiously, wantonly or for oppressive reasons....” Did this bad faith exception apply to Riggs and Goldstein? In short: No. The court ruled that, in their capacity as trustees, Riggs and Goldstein didn’t owe a fiduciary obligation to the heirs. And the court did “not regard the defense of the civil action to have been maintained in ‘bad faith’” because there was “nothing vexatious about defending an allegation or demand that was deemed to be meritless.” On the other hand, Riggs and Goldstein’s request for legal fees was governed by D.C. law, which provided that a personal representative who prosecutes or defends a proceeding “in good faith and with just cause” is entitled to “necessary expenses and disbursements relating to such proceeding.”

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This was like a logic problem from a college philosophy class. A determination that Riggs and Goldstein’s litigation posture was not in bad faith for purposes of an equitable exception to the American Rule did not necessarily mean that Riggs and Goldstein were entitled to reimbursement of their own legal fees, which must be supported by a showing of “good faith and just cause.”

A lack of bad faith does not establish good faith.

The probate court had found that “all attorneys’ fees were necessary and reasonable,” having been “convinced that the Personal Representatives had a duty to monitor and protect the interests of the estate in the lawsuit that was technically filed against the Trustees.” According to that court, “[s]uch fees are a basic bill that must be paid by the estate.” But the appeals court noted that: In the context of the requests for attorneys’ fees, which must be based on an evaluation of [Riggs and Goldstein’s] conduct..., however, the court cannot blind itself to the fact that throughout that litigation [their] responsibilities as trustees had been superseded, as of Ms. King’s death, by their duties as personal representatives. So, the question was not simply whether the trustees had a good legal defense to the lawsuit. It was: Should they have continued to defend the lawsuit,

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with its drain on the assets of the estate, when they easily could have met their reporting obligations? Riggs and Goldstein didn’t owe the heirs any fiduciary duty when they were wearing their “trustee hat;” but they did when they were wearing their “personal representative hat.” The appeals court noted that these dual responsibilities were “inextricably connected in the controversy.” The dual responsibilities shouldered by Riggs and Goldstein resulted in them simultaneously defending—as trustees—a lawsuit from the heirs but monitoring it—as personal representatives—on behalf of the estate. They were not free to act as if they were solely trustees when they also were getting paid in their capacity as personal representatives. The appeals court suggested that an independent personal representative would have demanded the final trust account from the trustees, so as not to dissipate the assets of the trust/estate with unnecessary legal expenses. And that was the standard that needed to be applied: Having taken on dual conflicting roles, [Riggs and Goldstein] are not relieved of their responsibility to act independently in the fiduciary roles which they occupy. [They] had a duty to demand a formal account from the [t]rust and take appropriate actions concerning the Trust accounting if it was not forthcoming. The lower court had determined that the attorneys’ fees were “well earned” and “not unreasonable” and

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that the fiduciaries—not the lawyers—were responsible for the failure of reporting. The issue, therefore, was not whether the lawyers should be compensated but whether they should be compensated by the fiduciaries or the estate. On this note, the lower court had determined that the bulk of the Riggs and Goldstein’s legal fees (totaling approximately $125,000) were incurred in the exercise of their duty, as personal representatives, to monitor the litigation on behalf of the estate. That suggested the estate should have to pay the fees. But the lower court had not explained what “bulk” meant in detail. Why the need for the extensive monitoring represented by a fee of that magnitude? The appeals court sent the case back to the lower court to resolve the details of how much the estate would have to pay...and how much Riggs and Goldstein would have to pay. When all was concluded, administering King’s estate was probably not a money-maker for the trustees. And it was a money-loser for her heirs. CONCLUSION As this chapter has shown, living and dying gets expensive. We haven’t even gotten to the heart of family expenses—taxes, which make family money matters even more problematic. But first, the question must be asked: What happens when somebody dies? The answer is in the next chapter.

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CHAPTER 6

6 WHAT HAPPENS WHEN SOMEBODY DIES

Through the first half of this book, we have assumed that the “you” reading each chapter is the person who is creating family money...or at least planning what to do with family money that’s in his or her control. Starting in this chapter and continuing for the rest of the book, we’re going to adjust the focus slightly. Assume—for the most part— that the “you” reading the book is the person who’s been given the responsibility of managing family money. The “you” might be an executor...or an heir who’s also in charge of making estate decisions. This different focus doesn’t change the mechanics of how to use wills, trusts and insurance. And it shouldn’t change the attitudes that you have about money—it’s still best to try to live beyond money and to plan for retirement in a way that preserves as much wealth as possible for your heirs. But the different focus does reflect the specific challenges that an executor or heir faces. What happens immediately after a death in the family? How do

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you deal with problem siblings or cousins? How do you deal with taxes...even if the older generation anticipated them? Of course, matriarchs and patriarchs will want to consider these issues, too. Hours of advice from some commission-based life insurance agent isn’t worth as much as a few minutes of thinking in concrete terms about what your eldest child will face after you’re gone. The first point to make as we head into this topic is that advance planning can make a big difference in ensuring that things go smoothly after someone has died. If someone asks you to be his or her executor, make sure that you have a working knowledge of the estate and the maker’s wishes. Things like special burial or organ donation arrangements should be discussed in advance; make sure that you know where financial and other important documents are kept so that you can get them quickly, when you need to. FOLLOWING

THE

WILL

No matter how contentious relations may have been in life, most family members want to honor the general spirit of what parents, grandparents or other elders wanted to do with their resources. And there’s more to this process than familial honor. Usually, the fastest and least expensive way to distribute family money is to follow the guidelines set up by existing wills and trusts. You can change them...but it’s time-consuming and expensive.

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So, the first thing to do when an asset-controling family member dies is take a look at the paperwork he or she has left. Hopefully, you will have had some communication with the person before, so this look will be a review of plans. Usually, this is done with the assistance of a lawyer (often the dead person’s); but you may also need the help of a financial advisor, CPA or other professional. In most cases, these professionals will be paid from estate funds.

Don’t confuse advice for decision-making. Tragedy often follows families who let hired guns make decisions. If you’ve been named executor of or heir to family resources, your family wants you to make the decisions. You don’t need a law degree, MBA or other license to know what’s best for your family.

No matter how intimidating it may be to make decisions about wealth that belonged to a spouse, parent or in-law, it’s usually better to have a family member make an imperfect decision than an outsider make a “perfect” one. Your memory of what your father said during a Thanksgiving dinner 10 years ago is worth as much—or more—than the details of some subparagraph of the tax code. If a lawyer or financial advisor is pressing too hard about what you should do and when you should do it, take a step back from the process. Estate planning and inheritance laws don’t usually require immediate actions. In fact, they’re more likely to re-

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quire some time to lapse in order to maximize the chance of good judgment. One good tactic for managing professionals is to ask for a memorandum or letter outlining at least three options to any trust structure, tax strategy or investment. Insist that the pro’s and con’s of each option be simple; this shouldn’t take more than a page or two. As the person dealing with the fallout of death in the family, you may have to navigate come confusion that came at the end of the dead person’s life. In dramatic fashion, this can mean things like deathbed wills or codicils; in less dramatic fashion, it can mean bad decisions on things like power of attorney agreements. A power of attorney is normally given to allow someone (sometimes called a recipient or assign) to act for another person. Common examples are giving a power of attorney to sign checks or buy or sell stocks. A power of attorney normally becomes void when the person granting it dies or loses mental capacity. A durable power of attorney remains valid when the person granting it becomes incapacitated. A common example is to allow the donee recipient to make medical care decisions even after the donor becomes incapacitated. A properly obtained and properly given power of attorney is often an indication of whom the person trusts. Sadly, when a person is sick or quite old, matters of trust can become...unpredictable.

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Powers of attorney are normally good until the person relying on the power of attorney knows that the giver of the power is dead or incapacitated. By the time an executor or personal representative comes into the picture, the power of attorney—durable or not—will have expired. But the results can still be fresh. The potential for financial abuse is obvious. A dishonest person holding a power of attorney could use the giver’s banks, stocks and assets for their own use after the giver was legally incapacitated and no one would know the money was being taken.

If you’re named executor, you become responsible for your friend’s estate from the moment of death. The law requires you to fulfill your duties with the utmost integrity and restricts your investment of assets unless you are explicitly given more discretion in the will.

As executor, your duties may include:

•

arranging for funeral services and burial (at least paying for these things, if not planning them);

•

preparing an inventory of assets, investments and debts; the list should include pension assets, bank accounts and insurance policies naming the estate as the beneficiary;

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•

collecting legal documents; including wills, trusts, power of attorney documents, bank account information, social security information, birth certificate, marriage license(s), citizenship papers, employee benefits and recent tax returns;

•

determining the status of titles or deeds to property in the estate (in other words, did the dead person really own everything he or she seemed to own?);

•

making sure that all insurance policies are assembled and complied with; this will mean notifying life insurance companies and providing death certificates, etc.; it may also mean keeping payments to home and car insurers current, at least for an interim period;

•

informing the benefits departments of dead person’s place of employment and the Social Security Administration...and providing them with any necessary documentation;

•

contacting any creditors;

•

scheduling a reading of the will;

•

filing for probate...that is, certification that the will and related documents are valid.

Remember: The term “executor” can mean different things in different situations. Some wills give the executor broad discretion to make decisions that resolve conflicts or allocate assets; other wills make those decisions and only want the executor to fill

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out required documents. Make sure you know the role you’re supposed to play. W H AT

EXECUTORS

DON’T

DO

As we’ve noted before, trusts are usually designed to operate outside of the will and probate process. So, strictly speaking, an executor will usually not have to get involved with trusts. However, an executor may also be called upon to manage trust funds established by the will for minors, mentally disabled or financially irresponsible beneficiaries and other family members who need help.

A good executor needs to know the complete picture of what resources are flowing through which channels. If you’re an heir and an executor, you’ll probably be involved in both the probate work and the trusts.

When probate has been concluded by a court (and, as we’ve seen, this process can take years), the executor is responsible for transferring and distributing assets. If these assets are piles of cash in bank accounts, the executor will have a relatively easy time. But assets aren’t usually so liquid. Personal assets belonging to the deceased are usually transferred into the name of the executor or personal representative of the estate and then distributed to family members or other beneficiaries. This process is intended primarily to be a single method for calculating tax val-

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ues. But it can create family squabbles. Family members who haven’t been in contact in years have been known to go to court over grandpa’s collection of blown glass. When it comes to personal assets, the executor has to handle various difficult issues, including:

•

confirming payment of debts and obligations, which may include mortgages or liens on assets or complex matters created by things like divorces or legal settlements;

•

distributing personal possessions, such as family mementos or heirlooms, to named recipients...or those best situated to receive them;

•

collecting and depositing any income from rents, licenses, partnerships or other activities of the deceased; and

•

determining the value of personal assets and selling them, when necessary or in the best interest of the estate.

That last item can be a killer. Family members have been known to pounce on what they think are below-market valuations of family assets. And they’re not always wrong to be worried about this issue— as we’ve already seen, executors will sometimes concoct sweetheart deals whereby they acquire valuable assets on the cheap. Generally, an executor’s actions are judged according to the “prudent person rule.” Obeying this rule is part of a fiduciary duty imposed by law on

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executors (and trustees) to act cautiously, as though dealing with their own affairs. If this duty is violated and a loss of assets results, the executor might be ordered to pay compensation personally to the beneficiaries; but this is a rare occurrence. The prudent person rule may seem like a burden—but it’s actually a protection for an executor. Still, any executor—family member or not—has to be aware that any decision or action he or she makes may be scrutinized later by family members who think they haven’t gotten enough money. The best ways to minimize these problems are really just common sense housekeeping matters:

•

keep complete accounting records (deposits and receipts for all transactions involving the estate and its assets); these accounts should be organized chronologically and kept current;

•

ensure the estate funds are earning an income and are not wasting (the investments an executor can make may be limited and should always be supported by a written legal review);

•

defend or prosecute actions on behalf of the estate—this usually includes legal actions for the collection of debts owing to or by the estate;

•

distribute the estate according to the terms of the will—contesting or challenging the will is rarely...very rarely...the executor’s job;

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•

arrange the transfer of titles of cars, home, or other properties; and

•

file a terminal tax return and ensure that all required taxes are paid.

An executor is entitled to reasonable compensation, often limited to a certain percentage (5 percent is common in many states) of the property in the probate estate. (Extra compensation, related to handling some special matter, may be allowed by a probate or other civil court.) In many cases, though, an executor will agree to take less—especially if he or she is a family member and also an heir. SURVIVORSHIP When it has fallen to you to make sense of an estate and the interests of its various heirs, a key issue you’ll need to consider is survivorship. If you don’t keep this in mind, someone may challenge the estate and a court may force you to think about it. In short, different rights of survivorship may apply to different assets in the same estate. And this may mean that the dead person didn’t actually own everything that he or she seemed to own.

A common example: The dead person had named a spouse or children as “joint tenants with rights of survivorship” in the title of a home. At death, the house passes to the co-owners easily, without going through the probate process.

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Some state laws recognize joint ownership of a home with rights of survivorship. By taking title under a survivorship deed, each owner holds an interest in the property. When one party dies, that person’s interest automatically transfers to the survivor(s). The most common alternatives are to own property in one name, in a trust, or between co-owners holding title as tenants-in-common. With tenants-in-common ownership, each owner may pass on his interest to the other through a will...but that transfer goes through probate. In most first marriages, joint and survivor ownership with a spouse is fine. But people who’ve been married more than once, people who are unmarried and parents considering adding children to their deeds should think twice before taking title by survivorship deed. How can holding title by survivorship deed cause legal problems? One problem arises from the automatic transfer of ownership from one party to the other upon a death. For example: A man is in a second marriage when he dies. He had intended to provide something for children from his first marriage out of the value he had accumulated in his home—but he had a survivorship deed with his second wife. So, the entire interest in the home passes to his second wife at his death. Unless she knows his intent...and is kind enough to honor it...his children are left out of the picture.

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Also, many people don’t realize that a survivorship deed takes precedence over a will. The will may leave everything to all children equally but the one child named on the deed will get the house. In our discussion of real estate investments, we mentioned that—in some states—joint survivorship may expose the property to the survivor’s creditors or ex-spouses. These parties are prone to nasty lawsuits, especially if they think an asset is being sold or transferred. This is another reason that an executor or personal representative needs to make sure that title to personal property in an estate is clear. SEEKING

A

COURT’S

ADVICE

State law allows heirs and executors to ask questions in advance of making any legal or investment move. This can make for a tedious process...and some people use it to excess. But it’s a good idea to use the probate court as a sounding board—especially if you’re dealing with a complex estate. The April 1998 California Appeals Court decision in Janis Pittman et al. v. Susan Lee et al. dealt with a complex estate made even more troubled by some ill-advised moves on the part of one group of heirs. Val and Donna Pittman, a married couple who each had children from previous marriages, created a trust in 1993. The trust estate was comprised of their personal property, which was described in Schedule A to their trust agreement. Schedule A was further divided into three separate parts— Schedules B, C and D. The property described in

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schedule B was their community property; the property in schedule C was Val’s separate property; and the property in schedule D was Donna’s separate property. Upon Val or Donna’s death, the estate was to be divided into three separate trusts:

•

a survivor’s trust;

•

an exemption trust; and

•

a marital trust.

This structure was intended to answer the needs of each spouse’s children. The survivor’s trust included all of the surviving spouse’s separate property and the surviving spouse’s interest in the deceased’s community property. The exemption trust consisted of the “maximum pecuniary amount that can be allocated to a trust that does not, to any extent, qualify for the federal estate tax marital deduction, without producing any...federal estate tax.” The marital trust consisted of the balance of the estate.

Upon the death of one spouse, the exemption trust and martial trust could not be amended, revoked or terminated. However, the surviving spouse was allowed to amend, revoke or terminate the survivor’s trust—and could do whatever he or she wanted with the income from the martial trust.

During the surviving spouse’s lifetime, the trustee could pay to the surviving spouse the income from

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the exemption trust and utilize assets from the marital and exemption trusts as necessary for the surviving spouse’s health, education, support and maintenance. The trust assets were to be distributed following the death of the surviving spouse. To make matters even more complicated, Val had disowned one of his children. In fact, the trust agreement contained the following no contest clause: Settlors have intentionally and with full knowledge failed to provide for BARRY VALDEAN PITTMAN, the son of VAL PITTMAN, or his issue. If any beneficiary under this trust, singularly or in conjunction with any other person or persons, contests in any court the validity of this trust or the settlors’ Last Will and Testament...that person’s right to take any interest given to him or her by this trust shall be determined as it would have been determined as if the person had predeceased the execution of this Declaration of Trust without surviving issue. Donna died in February 1995 and Val died in March 1995. Donna’s distribution consisted of the balance of the marital trust and exemption trust and provided for a $20,000 gift to her niece, Carrie Ann Lee. The remainder of Donna’s trust was to be distributed 40 percent to her son, Bradford Lee, and 60 percent to her daughter, Susan Lee. Val’s trust provided that $20,000 was to be distributed to his nephew, Ronald Koftinow. The remain190

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der of the survivor’s trust was to be divided equally between his children, Janis Pittman and Mark Pittman. After Val died, Susan and Bradford Lee—Donna’s children—asked to be appointed successor trustees and requested an accounting of the estate. They claimed that the designation of certain property in the trust as either separate or community property was done without their mother’s knowledge— and that some assets listed as Val’s separate property were actually community property.

The Lees asked the court to modify the trust agreement to move some of Val’s property into the community category.

When Val’s children—at least the ones he hadn’t disowned—found out about what Donna’s children were doing, they filed their own papers with the court. They argued that the Lees’ petition constituted a contest of the Pittman trust and that the no contest clause should be activated. This made Donna’s children nervous. They quickly responded that they hadn’t sought to void or invalidate the Pittman trust but merely sought “clarification” of its provisions. This argument didn’t hold up very well. In October 1995, a trial court found that the Lees’ efforts amounted to a contest. The court granted Val’s children’s request to activate the no-contest clause. 191

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Donna’s children made a weak request that the court reconsider because their original filing had been mistakenly prepared using an incomplete copy of the Pittman trust. The trial court denied their petition; they appealed. The appeals court looked at the quadratic equation of a will from the start. It pointed out that: a no contest clause is enforceable against a beneficiary who brings a contest within the terms of the no contest clause…. Whether there has been a “contest” within the meaning of a particular no-contest clause depends upon the circumstances of the particular case and the language used. …[T]he answer cannot be sought in a vacuum, but must be gleaned from a consideration of the purposes that the [will maker] sought to attain by the provisions of [the] will. According to Donna’s children, their petition was filed to clarify ambiguous provisions of the trust and to determine whether assets in the survivor’s trust were property characterized as Val’s separate property. But the appeals court didn’t buy this argument: Val and Donna Pittman meticulously set forth pieces of property to be included in the trust estate and characterized each piece of property.... It is clear from the terms of the trust that Val and Donna intended their property to be distributed according to their precise identification of the property as community or separate property and according

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to their distribution scheme; they did not set forth their property in general terms. So, according to the court, Donna’s children sought to thwart this clear intent by recharacterizing property expressly placed in the trust and specifically characterized. The court pointed out that state law allowed beneficiaries of a will to ask the court in advance whether a particular action would count as a contest. Had Donna’s children followed this statutorily authorized procedure, they could have avoided any forfeiture of benefits. They didn’t; so they lost. CONTESTS

AND

OTHER

DISPUTES

As we’ve seen throughout this book, contests and other legal challenges to wills and estate plans are a big concern for the people trying to maintain the value of an estate. Unfortunately, there’s not always much an executor or personal representative can do about the fundamental matters that determine a will’s validity—they’re not necessarily around for or involved with the drafting of the document. What can actually make a will invalid? Any disgruntled relative that can argue that the will failed in some basic requirement—it has internal contradictions...it’s witnessed only by beneficiaries...and, the old chestnut, the will maker was not of sound mind. Something we’ve noted before may warrant repeating. It’s tough to show someone was not of sound mind when making a will. For example: California’s

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Due Process in Competency Determination Act starts from a rebuttable presumption that people do have the capacity to make decisions and to be responsible for their acts and decisions. The person who wishes to challenge the acts or decisions of a will maker or trust maker has to prove mental deficits— and prove a connection between the deficits and the decisions in question. That’s a heavy legal burden. Most people who contest a will, trust or an estate believe they are entitled to something or that they have received unfair treatment. A son or daughter may feel that all the children should be treated equally. On the other hand, a child might feel that he or she should receive more because of specific things he or she did for their parents. People with conflicting claims in estate disputes often carry the emotional baggage of many things that were said and done over a period of many years. There may be a history of hurt feelings and broken promises that affect how deep the feelings run.

Mediation and arbitration sometimes allow all the people involved to have their say and agree among themselves what they consider to be a fair and reasonable argument. Mediation and arbitration can be used as part of litigation or in some cases instead of litigation.

What does the executor or personal representative do if the contest works? A court will usually look to

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see if there is a former will. If the will maker had a will that was written before the invalid one, and he or she did not revoke the will upon the creation of the second, the court will treat that former will as valid. If there is no former will or the former will was revoked, the court will treat the property in the estate as if the testator had died without a will. And we’ve already discussed how tough that can be...though it gives the executor a lot to do. Contests can also be based on things that trustees or executors do in the wake of a will maker’s death. The August 1999 Texas Appeals Court decision in Richard K. and John G. Sorrel v. Frank Sorrel Jr. dealt with the sloppy aftermath of some lazy postmortem actions. Frank Sorrel died on February 6, 1981. He left a will that established two trusts: a wife’s trust and a family trust. Sorrel appointed his wife, Katherine, and their three sons—Frank Jr., John and Richard—to serve as co-trustees of the Family Trust. Katherine removed Frank Jr. as a co-trustee in 1991. She died in 1994. According to its express terms, the family trust terminated upon Katherine’s death and the trust property was to be distributed per stirpes to her then living descendants. But John and Richard kept it going for almost three years...until October 1997. Compounding this problem: They failed to keep clear financial records and didn’t make timely reports about the condition of the estate.

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Frank Jr. eventually sued his brothers, complaining that they had failed to wind up the trust and divide the property in accordance with its terms. He also alleged impropriety in their capacities as trustees and sought their removal—plus damages from the estate. The trial court largely agreed with him, ruling that:

•

the family trust terminated upon Katherine’s death and the only duties of John and Richard were to wind up the affairs of the trust;

•

John and Richard continued operating the trust three years longer than they should have;

•

John and Richard had not filed either an annual accounting or the final accounting of the trust; and

•

the real estate belonging to the trust vested in the beneficiaries, Frank Jr., John and Richard, as tenants in common upon termination of the trust and couldn’t be partitioned in any other manner.

All three brothers appealed, though for different reasons. John and Richard wanted to be able to partition the real estate. Ironically, Frank Jr. also wanted to divvy up the real estate—but in a different manner. The appeals court, however, affirmed that the brothers didn’t have the power to partition the trust property. Texas law on this matter stated:

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A trust terminates if by its terms the trust is to continue only until the...happening of a certain event and the...event has occurred. If an event of termination occurs, the trustee may continue to exercise the powers of the trustee for the reasonable period of time required to wind up the affairs of the trust and to make distribution of its assets to the appropriate beneficiaries. So, when the trust terminated, John and Richard could only continue as trustees for a reasonable period of time. They argued that, because their powers as trustees expressly included the power to partition assets of the trust, they were endowed with that right beyond the termination of the trust. The appeals court disagreed. The express terms of the family trust stated that upon Katherine’s death “the trust...shall terminate, and the trust property shall be distributed per stripes to [her] then living descendants.” The trust provided for how the property should be disposed of upon termination. After that point, the trustees retained only the powers necessary to wind up the affairs of the trust or to distribute the property in accordance with the terms of the trust. This was because title, in effect, had already passed to the beneficiaries. The appeals court noted: On the termination of a trust, the estate of the trustee ceases, and the legal, as well as 197

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the equitable, title vests in the beneficial owner without the necessity of any act or intervention on the part of the trustee, unless the intention of the creator appears that the legal title should continue in the trustee. The termination of a trust leaves the trustee with a mere administrative title to the fund.... Upon Katherine’s death, the trust terminated and the trust property passed according to the trust instrument to her living descendants. On termination of the trust, legal and equitable interests merged and the beneficiaries acquired full ownership interest in the property. The court held that trustees could not partition trust property prior to distributing it in accordance with a trust agreement. They could only convey it to beneficiaries in the manner instructed by the trust. The court went on the rule: The settlor may bestow upon the trustees powers to distribute realty of the trust by partition upon termination, but such power is not present here. Hence, these trustees were acting outside their authority in attempting to convey trust property in 1997, and the trial court was correct in holding that conveyance void. John and Richard could not partition realty after the trust had terminated. The appeals court affirmed the lower court’s ruling—and the brothers remained linked as tenants in common in their inherited property.

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S TAT E

INTENTIONS

C L E A R LY

Careless wording of beneficiary designations—in wills or in life insurance policies—can result in family disasters. Each year in courtroom litigation thousands of hours are spent trying to sort out beneficiaries and heirs, all because of poorly worded beneficiary designations. For example, if you just designate your “wife” (without specifically naming her) as the beneficiary, a problem may arise. If you have been married several times, does “wife” mean your current wife or the woman you were married to at the time the beneficiary was designated? Or does it apply to, perhaps, a different wife who is now caring for your minor children? Who was the intended beneficiary? Be sure to designate your beneficiaries by their full name to avoid misunderstanding. Likewise if your “children” are designated as a class to receive your life insurance proceeds, it may be unclear whether you intend to include an adopted child in the disposition. The insurer will make every effort to comply with your wishes, as long as they are clear. When the intention is not clear, the insurer must distribute the funds according to the apparent intent of the policyholder, or pay the funds into court and seek a judicial determination of the proper distribution. In naming children as beneficiaries, a class designation is the best idea. Class designations should be used when individuals of a specific group (such as your children) are to share equally in your life insurance proceeds.

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If you designate your children as beneficiaries by naming each child specifically, other children might be accidentally excluded, especially if you failed to update your beneficiary provision to include children who joined the family since the original designation was made.

The wording of the class designation must carefully specify your intentions. “My children” will include children of other marriages or other unions, when in fact you might prefer to exclude both. In addition, this classification would exclude a posthumous child (born after the father’s death) from receiving a portion of the proceeds. If you wish to restrict your designation to the children of your present marriage, you might designate your present spouse “Anne Marie Salvage” as primary beneficiary and use the term “our children” or “children born of this marriage” as contingent beneficiaries. By using your spouse’s name, followed by the designation “my wife,” no question can arise as to your intent to have her as the primary beneficiary. Likewise, your intent to restrict the contingent beneficiaries to children of this marriage is clear. As we’ve seen before, per capita and per stirpes designations are also used to benefit children. The per capita designation means “by heads,” (individual) and per stirpes means “by stock” (family line or branch). Under a per capita designation each surviving child shares equally in the death benefit. Under a per stirpes designation each child, grandchild, or great

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grandchild, etc., moves up in a representative place of a deceased beneficiary. A per stirpes designation can become quite involved and it is important to know how the line of representation works because of the way courts interpret this designation. S I M U LTA N E O U S

D E AT H

Although life insurance isn’t usually something executors or personal representatives deal with directly, its terms and conditions can influence the size and shape of an estate. A problem can arise when the policyholder and the primary beneficiary—often a married couple—die simultaneously with no evidence as to who died first. Many states have adopted the Uniform Simultaneous Death Law. Under it, if there is no evidence as to who died first, the policy will be settled as though the policyholder survived the beneficiary. Accordingly, the life insurance proceeds would be paid to the estate of the policyholder, not the estate of the beneficiary. In this case, the money flows into the estate...and the executor’s oversight.

An exception: If contingent beneficiaries are designated in the policy, the proceeds would be payable to them.

For example, policyholder Paul has designated his wife, Joanne, as primary beneficiary on a $100,000 life insurance policy. Paul’s children from a previ-

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ous marriage are named as contingent beneficiaries. Paul and Joanne are killed in an auto accident. If it’s determined that Joanne survived Paul by 15 minutes, the insurance proceeds would be payable to Joanne’s estate and may not benefit Paul’s children. However, if—in accordance with the Uniform Simultaneous Death Act—it can’t be determined whether Joanne survived Paul, the proceeds are payable to Paul’s children as contingent beneficiaries. If the children were not designated as contingent beneficiaries, then the proceeds are payable to Paul’s estate. To avoid the problem of the primary beneficiary living for a very short time following the death of the policyholder and thus receiving the insurance proceeds, some life insurance policies include a common disaster provision. This provision places a time element on the survival period of the primary beneficiary; if the beneficiary doesn’t survive the policyholder by at least 30 days (the specific number of days may vary) both will be assumed to have died at the same time. And, in that case, benefits would be paid to contingent beneficiaries or the estate. INSURANCE

AND

CREDITORS

One of the unique features of life insurance is that the life insurance proceeds are exempt from the claims of the policyholder’s creditors as long as there

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is a named beneficiary other than the policyholder’s estate. Even the cash value of a life insurance policy is generally protected from creditors. Although the life insurance contract is between the policyholder and the insurer, once that person has died, a contractual arrangement exists between the insurer and the beneficiary. The beneficiary may even sue the insurer if payment is not received upon proper proof of death.

The spendthrift clause is designed to protect the beneficiary from losing the life insurance proceeds to creditors, assigning the proceeds to others, or spending large sums recklessly.

The spendthrift clause is not applicable to lump sum settlements but is operative with settlement options. It only protects the portion of proceeds not yet paid (due, but still held by the insurer) from the claims of creditors to the extent permitted by law. You would normally elect to include this provision at the time you apply for life insurance. As long as your proceeds are paid according to a settlement option where the insurer keeps the proceeds and sends a monthly payment to the beneficiary, then the amounts received by your beneficiary are exempt from the claims of the beneficiary’s creditors. This provision allows the insurer to select a beneficiary if the named beneficiaries cannot be found after a reasonable amount of time. To facilitate the payment of the death proceeds, the insurer may

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select a beneficiary if this provision is in the policy. This provision is found most often in policies with small death benefits, such as industrial life insurance. The insurer would usually select someone who is in your family’s immediate blood line (a brother, sister, aunt, etc.). WHEN IS THE PROCESS OVER? In most cases, a closed probate estate cannot be reopened after a final decree. It is usually the public policy of the courts and the state to administer and close estates as rapidly as possible. In some rare situations—where exceptional fraud has been perpetrated on the court—a closed probate estate can be reopened. But this is extremely rare. Most estates count on the quiet whimper of a closed probate file as the sign that the process is finished. That’s the cheapest way to go. Of course, some estates have to suffer the bang of a contentious court decision to resolve the matters. The May 2001 Arkansas Supreme Court case Juanita Jackson v. Jerry Kelly was one such bang. And it raised a new legal issue in Arkansas: Is there such a thing as a tort of “intentional interference with inheritance?” With the exception of a few minor details, the story is a familiar one. Mother has a will that splits everything equally to her son and daughter. Daughter leaves her brother and his wife to assist mother in personal matters, including execution of a new will. Son and wife spin details involving a loan mother

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co-signed for daughter’s son so that daughter is eventually written out of will. Some say it’s the perfect crime. The brother has nothing to lose. Even if he’s found liable for tortious interference, the original will is reinstated and he’s only out the half of the estate he tried to pilfer from his sister. Alta Austin died in 1997. Following her death, her son, Tommy Austin, petitioned to have her will admitted to probate. The will named Tommy as the sole beneficiary and specifically excluded his sister, Juanita Jackson. The point on which the whole story turned was a financial one. In August 1993, Juanita’s son Andrew borrowed $30,000 on a short-term basis from a local bank. Alta co-signed the note and placed two certificates of deposit in the amount of $37,600 as collateral for the loan to her grandson. He failed to repay the loan by its due date. According to Juanita, Andrew had contacted the bank about an extension on the loan and Alta had agreed to continue her security through the extension. In January 1994, Andrew’s wife Betty—who assisted Alta in personal matters—set a date for Alta to meet with attorney Jerry Kelly. At the meeting, Alta prepared a new will and disinherited Juanita. Kelly also prepared a complaint for Alta, alleging that her grandson had breached his loan agreement with the bank and that the bank “presently or will in the immediate future execute upon the certifi-

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cates of deposit to the extent of the loan balance[.]” The complaint, which alleged that both Juanita and Andrew had persuaded Alta to pledge her certificates of deposit as security for the loan, sought $30,553.32 to compensate her for losses, costs and attorneys’ fees. The lawsuit was eventually dismissed after Andrew repaid the loan in full. According to Juanita, all of this occurred because Tommy and his wife had misleadingly convinced Alta that she would lose her certificates of deposit because of Andrew’s delayed repayment of the loan. Juanita believed that attorney Kelly and her brother’s wife had jointly and severally conspired to have Alta leave all of her estate to Tommy, interfering with Juanita’s expected inheritance. As a result, Juanita contested the will in the probate court on the following grounds:

•

her mother did not have the requisite testamentary intent to execute the document as required by Arkansas law; and

•

her mother was subject to undue influence in preparing and executing the document.

The probate court found that Juanita had failed to meet her burden of proof to invalidate the will; it admitted the will that Kelly had drafted for Alta into probate. Juanita appealed.

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The Arkansas Court of Appeals affirmed the court’s decision. Juanita then filed a separate lawsuit in state court, claiming civil conspiracy and tortious interference with an expected inheritance. Kelly disputed Juanita’s allegations and pointed to several legal theories that nullified her claims. Most importantly, he pointed out that the tort of intentional interference with expected inheritance had not been recognized in Arkansas. The circuit court dismissed Juanita’s claims against Kelly and Betty. Juanita appealed again, arguing that although there was no Arkansas case directly on point an Arkansas appeals court had impliedly recognized interference with an expected inheritance as a tort in a 1990 decision. The appeals court disagreed: In that case, we affirmed the trial court’s summary judgment dismissal of a claim for tortious interference with expected inheritance. In doing so, however, this court did not decide whether such a cause of action actually existed under Arkansas law because the issue was never raised by the parties. Juanita then changed her argument, pointing to an obscure section of the Restatement (Second) of Torts entitled “Intentional Interference with Inheritance or Gift.” This section read: One who by fraud, duress or other tortious means intentionally prevents another from receiving from a third person an inherit-

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ance or gift that he would otherwise have received is subject to liability to the other for loss of the inheritance or gift. But the Restatement (Second) of Torts is a kind of handbook for states to use. It’s not law. And the Arkansas Appeals Court wasn’t inclined to make it so, simply “to provide Juanita with a remedy in this case.” The appeals court went on to write: [Juanita] had access to an adequate remedy in probate court. Her claim for interference with inheritance in this case was based on her own assertion that her mother “had many times represented to [her] that she would inherit one-half of [the] property....” Thus, in her complaint, Juanita sought compensatory damages equal to one-half of the property. Had Juanita prevailed in her will contest, she would have inherited one-half of Alta’s estate. A successful will contest would have provided Juanita with the same remedy that she sought in her tort action in circuit court. If either action would provide an adequate remedy, a plaintiff is usually limited to the probate action because that is the preferred method for resolving issues related to wills. The appeals court ruled: Most states that have considered the issue have held that a claim for tortious interference with expectancy of inheritance may only be brought where conventional probate relief would be inadequate.... If a will

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contest is available to the plaintiffs, and a successful contest would provide complete relief, no tort action is warranted. In a last-ditch gambit, Juanita tried a public good argument. She claimed that the appeals court should recognize intentional interference with inheritance because, if it didn’t, other plaintiffs would be left without an adequate remedy in probate court. She hypothesized that “there would be no adequate probate court remedy where the plaintiff is not an heir of the testator or where the property purportedly to be left to the plaintiff was in a trust.” But this argument was simply too wacky for the court. It concluded: the undisputed facts of this case are that Juanita was an heir of the testator, and the property was not in a trust. In this case, the relief available in probate court would have been adequate had she prevailed; she would have inherited one-half of the decedent’s estate. So, the appeals court decisively rejected making new law because the probate court offered a sufficient remedy. If the claim had been sustainable....which it was not. CONCLUSION Among the most daunting things for survivors to deal with when someone dies, besides what we discussed in this chapter, is taxes. We’ve dedicated an entire chapter to this subject, and it’s coming up next.

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7 TAXES

President George W. Bush’s campaign promises to abolish the death tax—an estate tax levied on estates worth more than $675,000—has focused further attention on what was already a heated debate. Conservatives have spearheaded the effort to have the tax repealed, claiming that it is nothing more than an unfair tax on death. Opponents of the tax point out further that it falls particularly hard on family-owned small businesses and farms. But supporters of the estate tax contend that, while no one wants to see families lose their farms, abolishment of the death tax is unnecessary. They argue that the tax only applies to 2 percent of the population. Within this 2 percent, only 6.5 percent of those who pay the estate tax are farmers or small businessmen. The majority of the $18 billion raised annually by the estate tax is drawn only from the pockets of the very wealthy. Repealing the tax would also be subtracting 1.2 percent of the federal tax revenue, which would have to be made up elsewhere.

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And, while the current amount of the exemption is $675,000, it is $675,000 after subtracting unlimited transfers to spouses and charities. In February 2001, wealthy Americans like Bill Gates, Sr., Paul Newman, George Soros and Warren Buffett came out publicly against a repeal of the estate tax. TAXES

STILL

LOOM

LARGE

Despite President Bush’s best efforts, taxes dominate most people’s thoughts about managing family money. Issues among family members may be emotional...familial loyalty can be a blessing and a curse...greed and materialism can warp good intentions. But, above all of these matters, the taxman wants to be paid everytime anyone inherits anything of substantial value.

If someone gives someone else money or property, the giver (though not the receiver) may be subject to federal gift tax. The money and property someone leaves in an estate when he or she dies is usually subject to federal estate tax. The proceeds of a life insurance policy can avoid the tax bite...unless they’re paid into an estate, in which they are taxed at the estate’s rate.

And these are all just federal taxes; there may also be state and local taxes on gifts and inheritance.

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Many families avoid gift and estate taxes altogether because the amounts of money they have are small enough to qualify for various exemptions. There is usually no tax if you make a gift to your spouse or if your estate goes to your spouse at your death. If you make a gift to someone else, the gift tax does not apply to the first $10,000 you give that person each year. You don’t even have to file a gift tax return in these situations.

Even if tax applies to your gifts or your estate, it may be eliminated by the so-called unified credit. The unified credit applies to both the gift tax and the estate tax—you simply subtract the unified credit from any gift tax that you owe. But the unified credit is a one-time thing; any part that you use against gift tax in one year reduces the amount of credit that you can use against gift or estate taxes later.

Through the 1980s and 1990s, the unified credit was $192,800, which eliminated taxes on a total of $600,000 of taxable gifts and estate value. Beginning in 1997, this exempt amount was increased gradually each year—to $675,000 in 2001. And the amount will continue to increase during the 2000s, to a maximum of $1 million in 2002 and then completely repeal in 2011 when—according to the estate tax reform advocated by President George W. Bush—there will be no estate tax at all.

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For now, most families avoid the estate taxes either by having estates worth less than $675,000 or by being smart enough to use gifts and trusts in a way that lowers their estate value beneath that number. In these cases, they don’t have to pay estate taxes. That leaves three types of families facing the biggest tax bite:

•

families with very large amounts of money;

•

families who owns businesses or other assets that are tough to break apart and move out of an estate; and

•

families who don’t start moving assets out of the estate early enough to make it seem small.

At its top level, the federal estate tax is 50 percent of an estate’s value, so the tax bite can really hurt. IT’S BETTER TO GIVE The term “gifting” has the irritating ring of bureaucratic double-speak. The term comes up frequently in financial planning—and with good reason. It’s a useful tool. Gifting refers to working around the federal gift tax, which applies to the transfer—for no compensation—of any property. You make a gift if you give property (including money)—or the use of or income from property—without expecting to receive something of at least equal value in return. If you

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sell something at less than its full value or if you make an interest-free or reduced interest loan, you may be gifting. The general rule is that any gift is taxable; however, there are many exceptions to this rule. Generally, the following gifts are not taxable:

•

the first $10,000 you give someone during a calendar year (this is called the annual exclusion);

•

tuition or medical expenses you pay for anyone (these are called the educational and medical exclusions);

•

gifts to your spouse;

•

gifts to a political organization for its use; and

•

gifts to charities.

Most tax plans stem from these five exclusions. A separate $10,000 annual exclusion applies to each person to whom you make a gift. Therefore, you can give up to $10,000 each year to each of any number of people or entities—and none of the gifts will be taxable. If you are married, both you and your spouse can separately give up to $10,000 to the same person each year without making a taxable gift. And, since you can give your spouse a limitless amount of money without paying tax, married couples have double gifting capacity.

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In fact, you don’t have to play gifting games if you’re married. If you or your spouse make a gift to a third party, the gift can be automatically considered made half by you and half by your spouse. This is known as gift splitting.

If you split a gift, you do have to file a gift tax return to show that both spouses agree to the gift; and you have to file a return even if half of the split gift is less than $10,000.

Generally, you must file a gift tax return on IRS Form 709 if:

•

you gave more than $10,000 (annual exclusion) during the year to someone other than your spouse;

•

you and your spouse are splitting a gift;

•

you gave someone other than your spouse a gift that he or she cannot actually possess, enjoy or receive income from until sometime in the future (this would cover some trusts); or

•

you gave your spouse an interest in property that will be ended by some future event.

If the only reason you must file a gift tax return is because you and your spouse are splitting a gift, you may use IRS Form 709-A, which is a shorter and simpler version of Form 709. See the form instructions for details on who qualifies.

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It’s best to keep your gifts during any calendar year under the tax-free limit. If you go over, you either have to pay some money to the Feds or use up some of your unified credit. That’s why gifting takes discipline and an early start; it works best when you move money gradually to family members over an extended period of time. The following is an example of how the unified credit might apply to your gifting strategy. In 2001, you give your niece Ginger a cash gift of $8,000. You also pay the $11,000 college tuition of your friend Sporty, who’s gone back to school after a bad divorce. You give your 25-year-old daughter Baby $25,000; you also give your 27year-old daughter Posh $25,000. You’ve never given taxable gifts before, so you’re doing a lot of paperwork for the first time. You apply the exceptions to the gift tax and the unified credit as follows:

•

under the educational exclusion, the gift of tuition to Sporty is not taxable at all;

•

under the annual exclusion, the first $10,000 you give someone during a year is not a taxable gift; therefore, your entire $8,000 gift to Ginger, the first $10,000 of your gift to Baby and the first $10,000 of your gift to Posh are not taxable;

•

you’re left with taxable gifts of $30,000 ($15,000 over the annual limit on your

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gift to Baby plus $15,000 over the annual limit to Posh); at the standard gift tax of 20 percent, you owe the Feds $6,000;

•

after all those gifts, you don’t have another $6,000 to pay the IRS, so you subtract the $6,000 from your unified credit for 2001. The amount of unified credit that you can use against the gift or estate taxes in later years is reduced by $6,000.

CALCULATING

E S TAT E

TAX

A taxable estate is determined by calculating the gross value of a dead person’s estate minus various allowable deductions. Once this calculation is made, the IRS uses this number to assess estate taxes. As we’ve seen before, a gross estate includes the total value of all owned assets or property in which a person had an interest at the time of his or her death. The estate also includes:

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•

life insurance proceeds payable to the estate or, if the dead person owned the policy, to his or her heirs;

•

the value of certain annuities payable to the estate or its heirs; and

•

the value of certain kinds of property transferred out of the estate within three years before the person died.

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The allowable deductions used in calculating the taxable estate include:

•

funeral expenses paid out of the estate;

•

debts the person owed at the time of his or her death; and

•

the marital deduction (generally, the value of the property that passes from the estate to a surviving spouse).

For more information on deductions that you might be able to make from a family estate, check with IRS form 706—the detailed list of allowed deductions.

Once you’ve calculated the taxable estate value, you can apply the unused portion of your unified credit against the taxes to be paid. For example, Jon gave his daughter Angelina $100,000 in 1998. This was Jon’s first taxable gift; he filed a gift tax return, subtracting the $10,000 annual exclusion and figuring the gift tax on his taxable gift of $90,000. The gift tax turned out to be $21,000. Jon didn’t want to pay this tax, so he used $21,000 of the unified credit to eliminate the tax on the gift. Jon made no other taxable gifts and died in 1999. The available unified credit that could be used against his estate tax was $190,300. This was the unified credit for 1999 ($211,300) less the unified credit used against the tax on the gift to Angelina

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($21,000). Jon would be able to avoid taxes on about $550,000 in taxable estate value.

An estate tax return must be filed if the gross estate, plus any adjusted taxable gifts and specific gift tax exemption, is more than the filing requirement for the year of death.

The adjusted taxable gifts is the total of the taxable gifts you made after 1976 that are not included in your gross estate. Prior to President George W. Bush’s estate tax law changes—scheduled to take effect in 2002—all transfers of money or property (outright, or by will or trust) were subject to a single, federal unified gift and estate tax system. President Bush’s changes have set the estate tax (though not the gift tax) for repeal after 2011. The new law still allows some significant transfers to be excluded from the estate tax, while it lasts, and the gift tax, which is likely to remain. I N C O M E T A X O F A N E S TAT E The estate’s income, like an individual’s income, must be reported annually on either a calendar or fiscal year basis. An estate’s fiscal tax year can be any period that ends on the last day of a month and does not exceed 12 months. Normally, the personal representative selects the estate’s accounting period when he or she files its first income tax return (IRS Form 1041). 220

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Income that a dead person had a right to receive is included in his or her gross estate and is subject to estate tax. This income is also taxed when received by the recipient (estate or beneficiary). However, an income tax deduction is allowed to the recipient for the estate tax paid on the income.

Once you choose the tax year, you generally cannot change it without IRS approval. Also, on the first income tax return, you must choose the accounting method (cash, accrual or other) you will use to report the estate’s income. Once you have used a method, you ordinarily cannot change it without IRS approval. Every domestic estate with gross income of $600 or more during a tax year must file a tax return. If one or more of the beneficiaries of the estate are nonresident aliens, the personal representative must file IRS Form 1041—even if the gross income of the estate is less than $600. That nonresident alien will also have to file U.S. tax forms...though that’s not usually an executor’s concern. The estate’s taxable income generally is figured the same way as an individual’s income, with a few exceptions. Gross income of an estate consists of all items of income received or accrued during the tax year. It includes dividends, interest, rents, royalties, gain from the sale of property—and income from businesses, partnerships, trusts and any other sources.

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During the administration of the estate, you may find it necessary or desirable to sell all or part of the estate’s assets to pay debts and expenses of administration, or to make proper distributions of the assets to the beneficiaries.

While an executor may have the legal authority to dispose of the property, title to it may be vested (given a legal interest in the property) or partly vested in one or more of the beneficiaries. This is often true of real estate. So, again, the executor needs to confirm clear title before closing any deal involving estate property. BENEFICIARIES The personal representative has a fiduciary responsibility to the ultimate recipients of the income and the property of the estate. Although the courts use various names to designate specific types of beneficiaries or recipients of various types of property, the IRS calls all of them “beneficiaries.” A personal representative or executor of an estate must file a separate Schedule K-1 (to IRS Form 1041) for each beneficiary receiving money from the estate in a given year. The filing must show each beneficiary’s taxpayer identification number. So, when you assume your duties as the personal representative, you should ask each beneficiary to give you their taxpayer identification number.

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The personal representative or executor doesn’t have to provide any taxpayer ID information about himself or herself—unless, of course, he or she is also a beneficiary.

The income tax liability of an estate attaches to the assets of the estate. If estate income must be distributed during the current tax year, it’s reportable by each beneficiary on his or her individual income tax return. If the income does not have to be distributed and is retained by the estate, the income tax on the income is payable by the estate. In other words, income of the estate is taxed to either the estate or the beneficiary—but not to both. If the income is distributed later without the payment of the taxes due, the beneficiary can be liable for tax due and unpaid, to the extent of the value of the estate assets received. A note for executors who are also family members and may be managing the personal finances of other beneficiaries: Even if you don’t take money out of an estate in a given year, you may have to file IRS Form 1099-DIV, Form 1099-INT, or Form 1099-MISC if you receive the income as a nominee or middleman for another person. Any beneficiary (including a spouse that is not the designated beneficiary) must include in gross income the fair market value of the assets in the account on the dead person’s date of death. This

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amount must be reported for the beneficiary’s tax year that includes the dead person’s date of death. The amount included in gross income is reduced by the qualified medical expenses for the dead person that are paid by the beneficiary within one year after the death. TWO

PERSONAL

REPS

If some estate property is located outside the state in which the dead person’s home was located—or if family politics require it—more than one personal representative may be designated by a will or appointed by a court. The person designated or appointed to administer the estate in the state of the decedent’s permanent home is called the domiciliary representative; the other is called an ancillary representative. Two personal representatives can create paperwork problems. Each must file a separate tax returns following IRS Form 1041. The domiciliary representative includes the estate’s entire income in his return; the ancillary representative should provide the following information on his or her return:

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•

the name and address of the domiciliary representative;

•

the amount of gross income received by the ancillary representative; and

•

the deductions claimed against that income (including any income properly paid or credited by the ancillary representative to a beneficiary).

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TAX

BENEFITS

FOR

SURVIVORS

The U.S. tax code gives some major breaks to married couples and so-called “traditional families.”

Survivors can qualify for certain benefits when filing their own income tax returns. A surviving spouse can usually file a joint return for the year of death and may qualify for special tax rates for the next two years.

If the deceased qualified as your dependent for the part of the year before death, you can claim the exemption for the dependent on your tax return, regardless of when death occurred during the year. (This is the same treatment the tax code gives to a child born during a tax year.) If the deceased was your qualifying child, you may be able to claim the child tax credit. If your spouse died within the two tax years preceding the year for which your return is being filed, you may be eligible to claim the filing status of qualifying widow(er) with dependent child and qualify to use the married filing jointly tax rates. These are better than unmarried person rates. Generally, you qualify for this benefit if you meet all of the following requirements:

•

you were entitled to file a joint return with your spouse for the year of death— whether or not you actually filed jointly;

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•

you did not remarry before the end of the current tax year;

•

you have a child, stepchild or foster child who qualifies as your dependent for the tax year; and

•

you provide more than half the cost of maintaining your home, which is the principal residence of that child.

For example: Robert Browning’s wife Elizabeth died in 1998. Browning did not remarry and continued throughout 1999 and 2000 to maintain a home for himself and his dependent child from the marriage to Elizabeth. For 1998 he was entitled to file a joint return for himself and his deceased wife. For 1999 and 2000, he qualifies to file as a “qualifying widow(er) with dependent child.” In later years, he may qualify to file as a head of household. All of these classifications mean lower tax rates than filing as an unmarried person. INHERITED

IRAS

We’ve talked before about the importance of naming a beneficiary to pension accounts or IRAs. If a beneficiary receives a lump-sum distribution from a traditional IRA or a Roth IRA that he or she has inherited, some or all of it may be taxable. The rule here is that these monies are taxed once. If the dead person had put pre-tax money into the IRA, the beneficiary will have to declare the inheritance as taxable income; if the dead person contributed net dollars, the beneficiary is free from taxes later.

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Either way, the distribution is taxable in the year received as income.

If the beneficiary of a traditional IRA is the deceased’s surviving spouse and that spouse properly rolls over the distribution into another traditional IRA or to a Roth IRA, the distribution is not currently taxed.

Generally, Roth IRAs are complicated when it comes to taxes. So-called “qualified distributions” from a Roth IRA are not subject to tax. A distribution made from a Roth IRA is “qualified” if it is made after the five-taxable-year period beginning with the first tax year in which a contribution was made to any Roth IRA of the owner. In most cases, the entire interest in the Roth IRA must be distributed by the end of the fifth calendar year after the year of the owner’s death—unless interest is payable to a designated beneficiary over his or her life or life expectancy. Any portion of a distribution to a beneficiary that is not a qualified distribution may be included in the beneficiary’s gross income. This is an outcome that most estates try to avoid. GIFTS

AND

I N H E R I TA N C E S

Property received as a gift, bequest or inheritance is not included in your income.

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If property you receive in this manner later produces income—such as fees, interest, dividends or rentals—that income is taxable to you. The income from property donated to a trust that is paid, credited or distributed to you is taxable income to you. If the gift, bequest or inheritance is the income from property, that income is taxable to you. If you receive property from a deceased’s estate in satisfaction of your right to the income of the estate, it is treated as a bequest or inheritance of income from property. INSURANCE,

ANNUITIES,

ETC.

The proceeds from a dead person’s life insurance policy paid by reason of his or her death generally are excluded from income. The exclusion applies to any beneficiary—whether a family member or other individual, a corporation or a partnership. Veterans’ insurance proceeds and dividends are not taxable either to the veteran or to the beneficiaries. Interest on dividends left on deposit with the Department of Veterans Affairs is not taxable.

Life insurance proceeds paid to you because of the death of the insured policy-holder are not taxable unless the policy is turned over to you for a price.

You can exclude from income accelerated death benefits you receive on the life of an insured individual if certain requirements are met. Accelerated

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death benefits are amounts received under a life insurance contract before the death of the insured. These benefits also include amounts received on the sale or assignment of the contract to a viatical settlement provider. If you receive life insurance proceeds in installments (as sometimes happens to beneficiaries of annuities), you can exclude details of each installment from your income. For example: As beneficiary, you choose to receive $40,000 of life insurance proceeds in 10 annual installments of $6,000. Each year, you can exclude from your gross income $4,000 ($40,000 ÷ 10) as a return of principal. The balance of the installment, $2,000, is taxable as interest income. If each installment you receive under the insurance contract is a specific amount based on a guaranteed rate of interest, but the number of installments you will receive is uncertain, the part of each installment that you can exclude from income is the amount held by the insurance company divided by the number of installments necessary to use up the principal and guaranteed interest in the contract.

Example: The face amount of a policy is $200,000; as beneficiary, you choose to receive annual installments of $12,000. The insurer’s settlement option guarantees you this amount for 20 years based on a guaranteed rate of interest. You accept. You’re left paying income tax on everything you get over $2,000 each month.

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If, as the beneficiary of an insurance policy, you are entitled to receive the proceeds in installments for the rest of your life without a refund or periodcertain guarantee, you figure the excluded part of each installment by dividing the amount held by the insurance company by your life expectancy. Example: As beneficiary, you choose to receive the $50,000 proceeds from a life insurance contract under a “life-income-with-cash-refund option.” You are guaranteed $2,700 a year for the rest of your life (which is estimated by use of mortality tables to be 25 years from the insured’s death). The amount held by the insurance company, reduced by the value of the guarantee, is $41,000 ($50,000 - $9,000) and the excludable part of each installment representing a return of principal is $1,640 ($41,000 ÷ 25). The remaining $1,060 ($2,700 - $1,640) is interest income to you. If you should die before receiving the entire $50,000, the refund payable to the refund beneficiary is not taxable. SPECIALIZED

TRUSTS

We considered how various types of trusts work previously. It’s no secret that people use trusts to avoid taxes and pass more wealth to survivors—while retaining the maximum control permitted by law. On the next few pages we’ll take a quick look at the tax issues addressed by various types of trust.

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M A R I TA L

AND

BYPASS

TRUSTS

This is the tax planning cornerstone for many combined marital estates (all property owned by the husband, the wife and jointly) worth over $675,000 in 2001 (increasing to $1 million in 2002). Usually, husband and wife serve as their own trustees. Most people specify the broad outline of their intentions at the time the trust is prepared but leave themselves great discretion as to all kinds of details.

While both spouses are alive, there can be a single initial trust, that is revocable and completely in their control. It is similar to, and serves all the purposes of, a simple living trust. The initial trust ends at the first spouse’s death, by splitting into two new trusts (“A” and “B”).

The B trust (some planners joke that B refers to the “Below-the-ground” spouse) is irrevocable, and makes use of the deceased spouse’s estate tax shelter. The B trust is designed for the ultimate benefit of heirs; it’s designed to conform to the federal estate tax “shelter limit.” The B trust is also called the “bypass trust,” because property in it bypasses taxation. The tax goal of the B trust is to get this money out of the couple’s combined estate, so that it escapes estate taxation after the second spouse’s death.

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The A trust is also called the “marital deduction trust.” Property in this trust is absolutely and completely under the control of the surviving spouse, who can even revoke the trust at any time. With proper planning, both spouses add a disclaimer clause in their wills giving the surviving spouse the right to disclaim as much of her inheritance from the other as she wants. Anything she disclaims goes into the tax shelter trust, which pays her income and—at her death—goes to the kids. The trust, also set up in a will, is just a shell unless the surviving spouse disclaims money to fund it. Then if the surviving spouse inherits $1.5 million and the estate tax exclusion is only $1 million, she can opt to disclaim $500,000 to the trust. Her estate won’t be taxable; her heirs inherit $1 million from her and $500,000 from the credit shelter trust—both amounts untaxed because neither is above the $1 million exclusion. When it comes to using A/B trusts, you need to be careful about the beneficiaries you select. The March 2001 Massachusetts state Supreme Court decision in Estate of Stuart D. Mackey dealt with some inadvertent tax problems. Stuart Mackey died in February 1997. According to his will, the residue of his estate poured over into the Stuart D. Mackey Trust, which was made up of two subtrusts: trust A, the marital deduction, and trust B, the “non marital deduction.” Stuart’s wife Gloria was the sole beneficiary of trust A. Under the terms of Stuart’s will, Gloria was to

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receive either one-third of the entire trust estate or $500,000, whichever was less. Trust A stated that, upon Stuart’s death, if Gloria survived him (and she did), the property targeted for trust A was to be distributed by the trustee to Gloria “free of trust.” Trust B, which was to receive the balance of the trust estate, was for the benefit of the Stuart’s son, Richard, during Richard’s lifetime. Richard had a limited power of appointment that enabled him to designate the person or persons to whom the rest of trust B would be distributed on his death. In default of appointment, the rest of trust B would be distributed evenly to Richard’s three sons. Simple enough, right? Wrong. Because trust B’s assets went to Stuart’s grandsons, the trust was subject to the federal generation skipping transfer (GST) tax. Unless Stuart’s family could divide trust B into several smaller parts, it was going to be over the standard $1,000,000 personal exemption from the GST tax. At the time of Stuart’s death, trust B was valued at $1,730,770.59; so, his family was going to pay a lot to the IRS—on the entire amount. Stuart’s son and grandsons asked the state court to divide trust B in two, and administer it as two separate trusts with identical provisions. One of the two newly created subtrusts would be subject to the GST tax, and the other (through allocation of the $1,000,000 exemption to it) would effectively be exempt from the GST tax.

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The family pointed to earlier Massachusetts case law that allowed this kind of “administrative change.”

The court was remarkably supportive of the family’s argument. It concluded: Mackey’s trust referenced trust A as a “marital deduction” trust, reflecting an awareness of, and an intent to minimize, the federal estate tax consequences, regardless of whether the instrument actually accomplished that goal. We are satisfied that [Mackey] did not intend his will and trust to operate in a manner that would enrich only the taxing authorities. We also note that many other states, including New York and New Jersey, have statutes that expressly authorize the division of trusts without court approval. The New York statute expressly permits division for purposes of GST planning. So, it authorized the division of trust B as the family had proposed. The decision was a win for Stuart Mackey’s heirs...but it’s an extra step that is still best avoided. Make sure any trusts that result from an estate comply with tax guidelines. TRUSTS

FOR

MINORS

Gifts to trusts established for minors qualify—by law—in whole or part for the annual gift tax exclusion. These trusts are irrevocable, yet permit some control over the timing of wealth transfer to the next generation. 234

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In the so-called Section 2503(c) Trust (the section refers to U.S. tax code), annual income may be accumulated and not paid out—but the trust must provide that, if necessary, both income and principal can be used for the minor’s benefit. When the beneficiary turns 21, he or she must be given the right to receive all 2503(c) trust assets in an outright distribution. The beneficiary can, however, elect to allow the trust to continue. In the related 2503(b) Trust, annual income cannot be accumulated; it must be paid to the beneficiary each year. However, in this case, the principal need not be made available for distribution upon the beneficiary’s 21st birthday. Unlike the 2503(c) Trust, the 2503(b) Trust principal is not required to ever be distributed to the income beneficiary; it can go to somebody else. Since the beneficiary has no immediate (if any) right to the trust principal, the beneficiary’s only present interest in the 2503(b) Trust is an income interest, the right to receive annual income payments from trust investments. So, the amount of each gift that qualifies is the present value of the series of income payments that the gift will produce over the years. A financial calculation is necessary. Both types of 2503 Trust can receive annual gifts, including gifts used by the trustee to pay life insurance premiums. If the insured (or spouse) is the grantor, trust income should not be used to pay premiums—or the grantor may be considered the owner of the policy for estate tax purposes.

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This is an often overlooked point; so, consider using trust principal or yearly gifts to pay premiums. C H A R I TA B L E

REMAINDER

TRUSTS

Charitable remainder trusts (CRTs) are best for people that have a lot of money tied up in investments that have appreciated over the years, such as stock, bonds, a home or a business. When you sell that asset, you will be liable for a lot of taxes. But if the asset is not providing you with a lot of dividends, interest or other income you may need to sell the asset and buy some other investment that will provide you with income. If you intend to give a large gift to charity, you may want to consider a charitable remainder trust. Once you have placed your assets in this type of trust, the trust can sell the assets without paying taxes, and then invest the assets into investments that will provide a good source of current income. You (and your spouse) are entitled to that income for as long as you live, and when you die what’s left goes to the charities of your choice. In another variation, called a charitable remainder unitrust (CRUT), the grantor receives a fixed percentage of the trust’s value each year, rather than an unchanging dollar amount. The CRUT is often preferred because it can provide inflation protection: As the trust (presumably) grows in value each year, so, too, will the dollar amount of the grantor’s annual draw.

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With either a CRT or CRUT, the remainder interest that will eventually go to charity has a value today, established with a financial calculation, using an “assumed” future interest rate.

IRS publishes the interest rate each month to be used in this calculation of the value—in today’s dollars—of the charity’s right to receive the remainder of trust assets at the specified future date. That is the amount the grantor is giving away. It is, therefore, the value of the current income tax deduction. A big additional benefit is that the donated property, and all future price appreciation, is removed from the grantor’s taxable estate. GRATS The grantor retained annuity trust is an irrevocable trust, good for shifting some of the value of an asset out of the estate. The grantor places assets in trust for the ultimate benefit of the children (i.e., they have a remainder interest), but retains the right to an annual payout for a period of years. By accepting some gift tax liability at the time the GRAT was set up, the grantor has reduced his estate tax liability later and the heirs end up with more. If the grantor dies within the term of the trust, all property is included in the estate, and there are no tax consequences—just as if nothing had been done. The key to the GRAT technique (and the CRUT) is the relative values given the two interests involved:

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The gift of the remainder interest in the trust principal, and the value of what the grantor has retained—the present right to collect a certain cash payout from the trust each year for X years. There is a financial calculation that depends on the current interest rate published by the IRS, the number of years during which the grantor will take the trust payout, and the amount of the payout. The greater the annual payout, and the number of years of payments, the greater will be the value the grantor has retained for himself—and the smaller will be the value the IRS gives to what is left over. QPRTS The qualified personal residence trust is an irrevocable trust, similar in concept to a GRAT, but with a confusing name. It is a good method of shifting the value of the family home out of your estate, for the purpose of lowering the ultimate estate tax. In this scenario, the house is placed into a trust for the future benefit of the children. The value today of this remainder interest is a taxable gift. As with a GRAT, the grantor accepts some federal gift tax liability now, to save more on federal estate tax later. What is retained here by the grantor is not income, but the right to live in the house for a term of years. If the grantor outlives that term, the value of the house—plus any property appreciation since it was transferred to the trust—passes to the children with no additional federal estate tax. As with a GRAT, if the grantor does not survive the term of the trust, it has no tax effect.

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The QPRT does, however, have two significant drawbacks: First, the children will have received the house by lifetime gift, not inheritance, so there is no step-up in the tax basis of the property. For homes purchased decades ago at a fraction of today’s price, this means that income tax (at the 20 percent capital gains rate) must be paid on the increase in value—if the property is ever sold by the children. Note that a new tax regulation—applicable to QPRTs created after May 1996—has eliminated the common technique of permitting the grantor the right to buy back the residence for his continued occupancy at the end of the trust term. MEDICAID

TRUSTS

These trusts were designed to hold assets that were “given away” to impoverish the grantor, in order to qualify for Medicaid benefits. The purpose was to preserve one’s life savings for heirs, should end-oflife nursing home care become necessary. These trusts are seen in many variations, which all should be considered obsolete—and unsuitable for almost every purpose or situation. This was a tricky game, even before 1993 changes to the U.S. tax law. Under prior law, the grantor was allowed to derive significant benefits from a trust he himself created. Now, if a grantor sets up a trust—and there are any strings attached or possible benefits to the grantor—the assets are not protected from Medicaid. Also today, any transfer to an irrevocable trust within a period of five years of applying for a Medicaid

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nursing home bed is presumed by law to have been made in order to qualify for Medicaid. G E N E R AT I O N

SKIPPING

TRUSTS

A generation skipping transfer (GST) trust is an irrevocable arrangement that provides income only, not access to trust principal, to the grantor or the grantor’s spouse and/or children. It terminates when all have reached a specified age or died, with trust principal then distributed to grandchildren or grandnieces and nephews.

Some people shy away from these trusts because they aren’t confident that any financial plan can remain valid through three generations of family; but these trusts are extremely popular with old money mandarins—precisely because they look so far into the future.

Under a loophole in traditional estate tax law, by skipping over the children in the final distribution of principal, a grantor could save gift and estate tax. In the late 1990s, this advantage was largely eliminated. In 2001, such transfers were taxed at the maximum federal gift and estate tax rate of 55 percent. But...there is a high cumulative exemption of $1,030,000 (adjusted annually for inflation) per donor that can be used to avoid tax on generation skipping transfers (by trust or gift). So, the GSTs are still useful. But they are tricky business.

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The 1998 Indiana Appeals Court decision in Estate of Harold G. Meyer considered the tax payment provisions of a complicated estate. More specifically, it considered how death taxes should be allocated between an estate and subsequently created generation skipping trust. In April 1985, Harold Meyer executed a will which provided, that after the “payment of all taxes and expenses,” the remaining assets were to be placed in a residuary pour-over trust with beneficiaries being Janet Cleland, his only daughter, and Janet’s children after her death. This was a common...and simple enough...structure. But there was more to the story. About five years later, Meyer also created a living trust in which he retained rights to the income for life and named his grandniece, Kathy Burke, and her husband—who was also Meyer’s lawyer at the time—sole beneficiaries upon his death. Meyer funded this trust with his most valuable possession, Bank Calumet stock valued at over $8 million. Meyer died in March 1997. His daughter challenged the validity of the grandniece’s trust; both the Clelands and the Burkes argued over whether Meyer’s estate or the Burke trust should pay the federal and state taxes. In June 1997, the Clelands filed a lawsuit asking a state court to determine how the death taxes should be allocated. A few months later, the Burkes filed a claim against Meyer’s estate to pay all of the death taxes.

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Bank One, the institutional executor Meyer had chosen to handle his estate, filed legal papers that supported the Clelands’ arguments. The trial court determined that both entities—the estate and the Burke trust—had to pay death taxes. It ordered each party to “pay the death taxes, federal estate and generation skipping transfer and state inheritance tax and estate tax...proportionately to the amounts each received.” This meant that Kathy Burke was going to have to pay more in inheritance tax than she had expected; because she was Meyer’s grandniece, the generationskipping transfer tax only applied to her trust. Instead, she clung hard to the language in Meyer’s will that said the estate would pay all taxes. She appealed. The Indiana Appeals Court looked straightaway to the documents. According to the Payment of Taxes section of Meyer’s will: I direct my Executor to pay out of my estate all estate, inheritance, transfer, succession or other taxes or governmental charges that shall become payable upon or by reason of my death with respect to property passing under my Will, by operation of law or otherwise, including any interest and penalties thereupon without apportionment.... On the other hand, the Burke trust provided, in part:

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Only to the extent that the residue of my probate estate is insufficient or upon request of my Personal Representative, the Trustee shall expend such amounts as are necessary to pay...all federal and state death taxes payable because of my death. Kathy Burke and, presumably, her attorney husband argued that the tax provision in the will prevailed because a “trust may not direct or empower the personal representative to act in a manner inconsistent with the will.” More specifically, the Burkes argued that the language in their trust altered the testamentary intent and conflicted with the clear language of the will. And, according to them, when a conflict exists, the will controls. They also pointed out that the language in Meyer’s will was even clearer in directing payment of all taxes without apportionment to various beneficiaries. (And they made other arguments based on legal technicalities that ended up not being relevant.) The Clelands argued for the pro rata apportionment of the federal estate tax because neither the estate nor the Burke trust provision waived the presumption by referring to specific law. They also argued that the ruling on the generation skipping transfer tax and state inheritance tax should be reversed because federal and state law did not support pro rata apportionment of these taxes. Instead, they argued, the Burke trust should pay all of the generation skipping transfer tax and any state inheritance tax generated by the trust. The Burke trust would be taxed at a higher rate under

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Indiana inheritance law because the Burkes were more remotely related to Meyer. The Clelands downplayed the “accidental effect of the boilerplate tax language placed in the will.” They argued that Meyer didn’t mean his probate estate to be exhausted by the payment of inheritance taxes on non-probate assets (namely, the Burke trust). They also cited an earlier U.S. Tax Court decision that held that a clause in a will directing that “all federal estate taxes, state and city inheritance or estate transfer taxes, or other death taxes attributable to the bequests...shall be paid from the residuum of my estate” was not sufficient to cover trusts made later. Instead, that decision had held, the will must contain “an explicit reference to generation skipping transfer taxes” in order to pay the trusts’s taxes. The appeals court agreed with the Clelands on several points. It noted that living trusts had become so common that Indiana case law had allowed the term “will” to include trusts in certain situations. With regard to the Meyer estate, the court wrote: [W]e hold that the last instrument in time controls when there is a conflict between unambiguous tax provisions in a will and an inter vivos trust. Thus, ...the trust provision controls because it is the final expression of Meyer’s testamentary intent. The appeals court then decided that the language from the Burke trust—which had sounded optional and secondary to Kathy Burke—was, in fact, controling. The appeals court decision was beginning to look very bad for the Burke trust. 244

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The appeals court ruled: ...Meyer’s last expression of intent is found in the Burke Trust. The language in the trust is clear. It specifically provides that the personal representative may request payment from the trustee and to what extent. Specifically, Bank One may request payment of the estate’s federal and state death taxes...from [the Burke] Trust. The decision was a complete loss for the Burke trust. The trust was responsible for all of the Indiana inheritance and federal estate taxes because the presumption of apportionment was sufficiently rebutted by its own language and timing; and the Burke trust was required to pay the generation skipping transfer tax because only it involved a generation skipping transfer. This was an even more complete loss for the Burke trust than the trial court’s decision had been. Kathy Burke shouldn’t have appealed. TOO

SLICK

BY

HALF

One reason to set up a tax strategy as early as possible is that, if a family waits until after assetcontroling elders die, they may act too hastily to avoid or minimize taxes. This may not seem like a big problem...but it is. Even when lots of money is at stake—or especially when lots of money is at stake—people can make nervous decisions. And nervous decisions are often bad decisions.

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The November 2000 South Carolina Supreme Court decision in Estate of William D. Holden, Sr. considered the affairs of a family that was a little too slick about avoiding estate taxes. Holden died in January 1992. He was survived by his wife Julia, two sons—William Jr. and Robert— and one grandchild. A second grandchild was born within 10 months of his death. After Holden’s death, William Jr. and Robert were advised that their father had died without a valid will and, following state law, they would be heirs to his estate. If they disclaimed their rights as heirs, the property in the estate could go to their mother tax-free. So, the sons filed disclaimers of their interests in their father’s estate. The disclaimers stated, in part: I hereby disclaim and renounce any interest in the estate and relinquish any claim I may have to it. Subsequently, the personal representative distributed the proceeds of the estate to Holden’s wife, Julia. A short time later, though, the probate court informed the personal representative that, as a result of his sons’ disclaimers, Holden’s grandchildren were eligible to inherit a portion of the estate. According to South Carolina law, half of Holden’s estate would pass to the surviving spouse and half to his grandchildren. It turned out that this advice the sons had gotten wasn’t so good for them.

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To avoid the unintended result of estate property going directly to the grandchildren, the sons each executed a document entitled “Revocation and Withdrawal of Disclaimer.” This revocation stated, in part: It was my intent in entering into this said Disclaimer and Renunciation of Interest to disclaim and renounce my intestate interest in favor of [Mother]...the spouse of [Father], so that she would become the sole heir of the Estate.... The revocations were filed almost 13 months after the disclaimers were filed. The probate court didn’t like these revocations; it ruled that the sons’ disclaimers were valid for federal tax law purposes but that the revocations were not. Thus, the court ordered 50 percent of the estate’s assets to be distributed to Holden’s grandchildren. The family appealed to trial court. There, its attorney pointed to a filing letter that had accompanied the disclaimers; the letter expressly stated that the sons meant to direct their interest in the estate to their mother. However, the circuit court also found that this intention was contrary to applicable provisions of the Internal Revenue Code. It agreed with the probate court. So, the family pressed the appeal to the state Supreme Court. The high court agreed to consider the case, focusing on the following questions:

•

Did the Court of Appeals err by determining sons filed valid disclaimers of their interest in their Father’s estate? 247

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•

Did the Court of Appeals err by failing to rule on sons’ claims that they had effectively revoked their disclaimers?

•

Did the Court of Appeals err by refusing to apply equity principles to set aside the disclaimers?

The high court started by reading the section of South Carolina inheritance law dealing with disclaimers. The law said, once an heir had filed a valid disclaimer, his or her interest in an estate is considered “never to have been transferred to the disclaimant.” The court also considered federal law on this matter. The Internal Revenue Code defined a “qualified disclaimer” for purposes of federal estate and gift tax laws: ...the term “qualified disclaimer” means an irrevocable and unqualified refusal by a person to accept an interest in property but only if—such refusal is in writing..., [the disclaimant] has not accepted the interest or any of its benefits, and as a result of such refusal, the interest passes without any direction on the part of the person making the disclaimer and passes either to the spouse of the decedent, or to a person other than the person making the disclaimer. The sons focused on the “without any direction” language in the law. They argued that, because they had intended the estate assets to go to their mother, they had attempted to direct the estate. This, they argued, made their disclaimers invalid.

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But they made a big mistake—in legal terms—by going on to argue that their revocations were further proof of their intent to direct the estate to their mother. The court interpreted this as contradictory logic. The sons were claiming both that the disclaimers were void from the start...and that the court should give credence to their revocations of the disclaimers. According to the courts, this meant that the revocations were filed to correct a mistake of law. And “since equity will not correct a mistake of law, it would have been improper to consider the revocations as evidence of sons’ intent in filing the disclaimers in the first instance.” The high court concluded: A mistake of law occurs where a person is well acquainted with the existence or nonexistence of facts, but is ignorant of, or comes to an erroneous conclusion as to, their legal effect. [The sons’] execution of the disclaimers was not the result of a mistake of fact. [They] were fully aware of all facts, but they did not realize the legal consequences of their disclaimers. [Their] error was a mistake of law and is not subject to equitable relief. The high court affirmed the appeals court decision— the estate would be split between Julia and her two grandchildren. And the tax advantage of transferring everything to the spouse was lost.

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CONCLUSION As you can see, taxes are a big issue when it comes to family money. And, despite the current effort to change estate taxes—as well as other types of taxes— they still loom large in our lives today and will continue to do so in the future. Putting taxes behind us, however, we now turn to other issues that can have a major impact on your family’s money: disabled children, family violence, terrible in-laws, suicide, etc. All of these things cloud the family photo album and complicate family money issues. In Chapter 8, we’ll take a look at some of these problems and provide some tools—both practical and mechanical—that you can use to best manage the most unique and odd of situations.

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8 PROBLEMS AND PROBLEM PEOPLE

We mentioned before that some rich people—Bill Gates and Warren Buffet are two—have said publicly that they won’t leave their great wealth to their families. In most of these cases, these billionaires don’t like the idea of creating generations of dissolute heirs dependent on scheming advisors...people like Barbara Hutton, certain Kennedys and various other movie-of-the-week cases. Money doesn’t solve all problems...in fact, it can cause quite a few. A whole book could be written about how family money, badly used, can screw up the very people it’s supposed to help. But we’ve only got one chapter to deal with money and people problems that go far beyond trust fund brats. These problems affect a lot of families. If you have a mentally disabled daughter, how do you make sure any money you leave her isn’t swindled by shady trustees? If your drug-addled brother kills your father and you’re left in charge of everything, should your brother inherit any money from your father’s estate? If your wealthy uncle writes what seems like a coherent will changing all of his bequests...and

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then kills himself the next day, should you challenge the will? These are the kinds of issues we’ll consider in this chapter. They range from the financially practical to the psychologically bizarre. They detail odd situations and relationships. And they don’t offer easy solutions for the courts or the families involved. LEGAL

C A PA C I T Y

One of the most common people problems that complicates the smooth transfer of family money is capacity. This word is sometimes confused with competence. They aren’t exactly the same...but they are similar enough that they’re often used interchangeably.

Competence is the mental or intellectual fitness (or lack of disqualifying disabilities) to enter into contracts or give testimony in a court of law. Capacity is the qualification—including competence but also things like age—to enter into agreements. Capacity is a more broad term; competence, a more narrow one. Strictly speaking, the terms mental capacity and competence are closer to the same.

Legal competence is generally required in most transactions. For example, to sign a lease you must be legally competent. However, legal competence becomes especially significant where wills are concerned. Because wills are so often made by the elderly or by persons in their last illnesses, disputes over mental capacity come up a lot.

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As we noted before, the concept of capacity is used in a number of legal contexts. Interestingly, the standard of capacity to make a will is often not as strict as to enter other contracts. In most states, the will maker must have a sound mind at the time the will is signed; it’s not enough that he or she had a sound mind when the will was planned. But what, in terms of a will or trust, constitutes a sound mind? Most courts agree that there are four requirements for testamentary capacity. They are: 1) Understanding the Nature and Extent of Property. The first test is the will maker’s understanding of the nature and extent of his property. To satisfy this requirement he must have a general knowledge of his property. For example, there is no need for him to know the names of individual stocks in his portfolio; it is only necessary that he knows that he owns some stock or investments. However, there may be problems if the will maker has little idea of how large his estate is. 2) Recognizing the “Natural Objects of His Bounty.” Second, the will maker must know the members of his family—even if they’re not all included in the will. Some older will makers may have excellent memories of their childhood, but may be unable to recall which of their children are currently alive. In such a case, the requirement would not be satisfied and the individual would not be legally competent to sign a will.

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3) Understanding the Testamentary Act. The third requirement for legal competence is that the will maker has a basic understanding of testamentary law. In other words, she must understand that the will operates to dispose of her property at death. 4) Understanding the Relationship Between the First Three Elements. The fourth criterion of legal competence is the will maker’s understanding of the relationship of the first three criteria to one another. In other words, she must be able to understand the relationship between her family, her property and the operation of her will. PROOF Determining a person’s competency can be troublesome. It is often hard to distinguish simple confusion from incompetence. This is especially so if the person is ill and under medication. If he can recall both his family and property but is confused about how the will is supposed to work, it’s probably too late to make a will. Even if the will is signed and witnessed, it may be found invalid if challenged.

People who challenge a will on grounds of competence must demonstrate to the court that the will maker lacked one or more of the four elements of testamentary capacity—at the time the will was made. It’s not enough to show that the person lacked capacity at some later date.

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This is why witnesses are required for most wills. In a contest, the court will call on the witnesses to describe the condition of the will maker when the document was signed. Of course, there may be other witnesses. A doctor, nurse or caregiver can be called on to describe the will maker. Because these people have experience in dealing with sick people—and usually have no interest in the outcome of the case—their testimony may also carry weight. Also, mental capacity isn’t only an issue for the person making a will or trust. The person administering it—an executor, personal representative or trustee—must have capacity to fulfill his or her role. In contentious fights over family money, it’s fairly common that an executor or personal rep will have his or her capacity challenged. Sometimes these challenges cause even more trouble than challenging the will maker’s capacity. The requirements for capacity are the largely the same for will makers and administrators. In Maryland, for example, an administrator can’t be:

•

a person under 18;

•

a mentally incompetent person;

•

a person convicted of a serious crime;

•

a person who is not a citizen of the U.S. (unless that person was the spouse of the will maker and a permanent resident of the U.S.); and

•

a nonresident of the state.1

1

Unless there is an “irrevocable designation of a person who resides in the state on whom service could be made.” 255

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However, courts may not give administrators the leeway they give will makers. S L AY E R

S TAT U T E S

Family members kill each other more often than most people would like to think. When this happens, all kinds of problems surface. For one thing, there are laws in most states known as slayer statutes—premised on the notion that killers shouldn’t profit from their wrongful acts. In Georgia, for example, the slayer statute provides that property which would have gone to the slayer (or slayers) will go, instead, to the nearest heirs “under the rules of descent and distribution.” In the Georgia decision Bradley v. Bradley, a man left a well-thought-out will. In it, he left his son James only $100 because James had previously received an advance on his inheritance in a certain land deal. The balance of the estate was left to his other son Benjamin, with the provision that, if Benjamin was not alive when his father died, his share would go to four alternative beneficiaries. Despite its specific language, the will did not predict what actually transpired: Benjamin had killed his father. It was obvious to the court that Benjamin didn’t deserve to take anything under the will. James, however, wanted more than what the slayer statute provided; he wanted Benjamin’s share of the estate to pass through the laws of intestacy to him. The court of appeals didn’t agree, and barred Benjamin and his heirs from taking anything. James could not take any of Benjamin’s previous share because the will limited his claim to the $100

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legacy. Thus, the balance of the estate passed to the four alternative beneficiaries.

The mechanics of slayer statues are also seen in insurance codes. A person who kills an insured in the hopes of reaping the reward of a policy is barred from taking anything as a beneficiary. If you kill your sister, for example, thinking her $5 million life insurance policy will go to you, you’re wrong. You won’t be entitled to any part of the proceeds.

DISABLED

CHILDREN

Roughly 14.7 million people have a “severe” disability, as defined by the Americans with Disabilities Act, according to the U.S. Census Bureau. Virtually all of these people face financial planning challenges, largely because their medical expenses tend to be far higher—and their incomes far lower— than the average American, according to government statistics. But the financial planning challenges are usually even greater for the parents of more than half of those individuals—roughly 7.5 million—who are mentally retarded. Many of these children are likely to require physical and financial help for their whole lives. While this assistance is often provided by parents while they are alive, few parents outlive their children. An adult with severe mental retardation or physical disabilities will usually qualify for a host of gov-

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ernment-paid services, ranging from health care to custodial care. If the disabled individual has no income or assets of his or her own, the state (which administers the federal Medicaid programs) will pay for special schooling, physical therapy, doctors, medicines and—when necessary—convalescent home care. Through Supplemental Security Income (SSI), a welfare program for people who cannot work, disabled people also get a monthly allowance that can help pay for incidentals. However, in most states, the SSI stipends must be used to repay the state for the cost of other services. This is where family usually steps in, providing the disabled person with money and the things he or she needs for daily living. The challenge comes when the disabled person has financial resources. In this scenario, the medical care provided by the state is means-tested—that is, government case workers will apply various financial formulas to determine whether a disabled person qualifies. If he has too much money, the child may be disqualified from state programs.

Some disability rights advocates complain that means testing doesn’t affect the very poor and very rich but does hurt middle-class people who have some financial resources to leave disabled family members. So, if traditional estate planning leaves assets to the disabled child, it can leave the child just enough money to disqualify him or her from state programs.

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In most cases, a disabled person’s inheritance is treated in the same way as assets of older people in nursing homes. The government seizes the inheritance to pay for current—and, sometimes, past— food, board and medical expenses. It will “run through” the resources until the child is again dependent on the state’s small, monthly allowance. This is where supplemental needs trusts come in to play.

People receiving government benefits cannot have more than a minimal amount of assets in their name to remain eligible. In these cases, family members should establish special-needs trusts, or discretionary trusts; in these cases, assets belong to the trust but the trustee can use the money for nonbasic care items such as transportation, education or recreation. A similar trust can be set up for a nursinghome patient to pay for supplemental needs.

SUPPLEMENTAL

NEEDS

TRUSTS

These trusts are allowed by state and federal law for disabled people. The trusts insulate personal assets, making the disabled person eligible for public aid and other government benefits. In some places, these are called “payback” trusts. That name gets to an important element of the trusts: They must pay back the government for assistance received to the extent of trust’s value remaining at the disabled person’s death.

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Generally, there are two types of supplemental trust for disabled persons:

•

Third-Party Trust. This trust is established for a disabled person with the funds of someone other than the disabled person, the disabled person’s spouse, or someone legally responsible for the expenses and care for the disabled person. The trust is funded with the monies obtained by the disabled person by a court or through settlement of a medical malpractice or personal injury case.

•

Pooled Trust. Pooled trusts are created by a non-profit association. They are available to disabled persons over the age of 65. Also, a pooled trust may be established not only by a parent, grandparent, guardian or court, but also by the disabled individual him or herself.

The most cost-effective way for middle-class families to set up a trust is as part of a will. After expenses and taxes are paid, the money is sheltered— only one administrative step away from the person who needs it but isn’t capable of managing it. SPENDTHRIFT

TRUSTS

A family member may have problems other than a mental or physical disability. In some cases, the challenge posed by a family member has to do with chronic or irresponsible behavior: problems with alcohol or drugs...or simply bad judgment that is constantly getting the person into financial or legal trouble. 260

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In these situations, many families choose to work around the problem person—excluding him or her from the ordinary distribution of family money by moving focus to children or siblings, etc.

Another useful tool for assisting a troubled person is to leave him or her life estate in a home, which will ultimately be passed on to other family members, charitable institutions or other beneficiaries. A life estate (the mechanics of which we’ve already considered) gives a person a place to live—but not the ability to sell or mortgage the actual property. Important questions to ask when you’re considering granting a life estate:

•

Should there be any limits or restrictions on how the person can use the property during his or her life?

•

Will the life estate create any problems for benefit eligibility (most often, related to Medicare or Medicaid) for either the grantor or beneficiary?

•

Does the life estate create any capital gains, gift or estate tax consequences? (It usually will, in at least one category.) How will they be paid?

Otherwise, the best solution may involve a spendthrift trust, which is—simply said—a testamentary trust that comes with particularly strict terms. It will usually rely on an institutional trustee or attorney to administer; and it will usually include

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detailed instructions for how money can be distributed and how long the trust will remain in place. A caveat: Spendthrift trusts (and the wills that establish them) are often contested by beneficiaries frustrated with what they perceive as overly restrictive terms. As long as the trust has been clearly defined and explained, most courts will defer to the person or persons who established them. But that clarity—which is always important—is particularly critical in these situations. POWERS

OF

ATTORNEY

If your family has some problems or problem family members that you think might make the smooth transfer of financial resources difficult, you may need to rely on tools like living wills and powers of attorney to avoid disputes. A living will is a directive to health care providers as to your wishes with regard to specific treatments or procedures to use in the event of your incapacity. Often the document describes the nature of life sustaining medical treatments desired. In some cases instructions include a directive that any and all medical treatment available should be used. A health care power of attorney authorizes another person to make decisions for you, your minor child or disabled family member in the event of incapacity. This authority generally includes the right to authorize use or withdrawal of life support, admission to hospitals or nursing homes, consent to operations and access to medical records. Like a

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living will, the health care power of attorney can set parameters on the authority of the trusted person. Some states have surrogate health care laws that allow a spouse, relative or friend to make health care decisions on your behalf in the event of your incapacity if there is no power of attorney. However, a guardianship proceeding have to be commenced in the absence of a health care power of attorney. PROPERTY

POWER

OF

ATTORNEY

A property power of attorney allows another person to make financial decisions and execute documents on your behalf. Most people specify that it is to take effect in the event of their disability or incapacity. You can have a property power take effect in whatever circumstances you desire.

You can specify how a determination of incapacity (or other specified condition) is to be made. You can also specify the powers and responsibilities of the agent. These may include paying family expenses, managing real estate and engaging in real estate transactions; collecting government or other benefits, making investments, executing financial transactions, filing and paying taxes; operating a business, claiming property you inherit or are otherwise entitled to, representing you in court or hiring someone to represent you; and managing your retirement accounts, carrying out a gifting program and creating and funding trusts on your behalf.

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Remember: If you become incapacitated and you don’t have a power of attorney, a family member may have to seek court authority to obtain guardianship over your affairs. The disadvantages of guardianship are that the guardian often has to post a bond, prepare and file financial reports (or hire a lawyer or accountant to do so) and get court approval for certain transactions, such as selling real estate. Someone with power of attorney doesn’t have to. A living trust can substitute for a power of attorney because your successor trustee can carry out the functions of a property agent—but only with respect to property held by the trust. A separate power of attorney is advisable. The power of attorney ends at your death unless your agent has power to dispose of your remains. OLD AND SANE Aging can be a nuisance, especially when people begin to question your mental capacity and challenge your ability to make decisions. Such was the case with Carl Hone. Hone died in the spring of 1998, but the problems that his wealth caused within his family had started years earlier. At the age of 82, Hone suffered a disabling stroke in late October of 1996. He had been a bachelor his whole life and had amassed a considerable estate. He owned over 500 acres of property that included residences, outbuildings, farm land and land suitable for logging in Oregon. It was no wonder everyone in his family—siblings, nieces and nephews—wanted a piece of Hone’s estate when he died.

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After his stroke, Hone was hospitalized for several days and then spent several months in a nursing home. During that time, Hone’s niece, Judith Doyle, began taking care of his personal finances. The family hired Ledadeane Hagedorn to help care for him when he returned home. In early February of 1997, three days after Hone returned home, he was readmitted to the hospital suffering from internal bleeding. Things looked grim, but his life wasn’t over yet. While in the hospital, Hone executed a will and trust with Doyle as trustee. Miraculously, Hone recovered and returned to his residence by the end of the month. Almost immediately upon Hone’s return home, his relationship with his family began to deteriorate. He complained of his inability to get access to his bank accounts or take care of his finances and expressed his displeasure with Doyle’s handling of his finances. His family members, on the other hand, complained of “restricted access” to their rich uncle and brother. And they soon pinned all of their issues onto Hone’s hired caretaker, Ledadeane Hagedorn. This called for a family meeting in late March 1997. As a result of that meeting, Doyle and another niece resigned their positions as trustee and successor trustee of Hone’s estate. The situation got worse, however, as Hone became distressed by his siblings’ assertions that he belonged in a nursing home and by his inability to regain control of his assets. By early May, Hone took action and he met with an attorney to change his estate plan.

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Hone’s siblings were still in hot pursuit. In early June, they initiated a protective proceeding in circuit court seeking to appoint a guardian and conservator for their brother. The siblings were appointed temporary guardians and conservators, and two hearings were scheduled. It didn’t take long for the court to conclude that Hone did not need a guardian, but that he was in need of assistance with his financial affairs. Hone wasn’t incompetent. In fact, he had executed a new will in August of 1997 that revoked the previous will and trust and effectively cut out most of his family. In this new will, he gave nominal sums to his family and he gave Hagedorn a life estate on his farm and surrounding land. He also established a trust in the remaining lands for the benefit of Hagedorn and named a hospice facility as trustee. He also gave some sums outright to the hospice; and, in the event of Hagedorn’s death, the entire estate would pass to the hospice. Hone died shortly afterward, leaving an angry family behind. In their attack on the new estate plan, Hone’s family claimed undue influence. The trial court only needed four days to determine that his wills were, in fact, valid. On appeal, the court referred to the framework established by the Reddaway Estate case of 1958, which required the court to determine whether a “confidential relationship” existed between the testator and the challenged beneficiary and, if one did exist, to evaluate whether “suspicious circumstances” were present as defined by seven enumerated factors.

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The seven factors for determining undue influence are: 1) whether the beneficiary participated in the preparation of the challenged will; 2) whether the will maker had the “benefit of the independent advice of his own attorney in drawing up” the will; 3) whether there was secrecy and haste in the making of the will; 4) whether there was an unexplained change in the will maker’s “attitude toward those for whom he had previously expressed affection”; 5) whether there was a discrepancy between the testator’s new and previous will and whether there was a continuity of purpose running through his former wills indicating a settled intent in the disposition of his estate; 6) whether the provision for the beneficiary amounts to an unnatural or unjust gift; and 7) whether the physical and mental condition of the donor made him susceptible to influence. To make a long case short, the appeals court didn’t find that any of these factors were met. Despite Hone’s health problems, he was a competent man who was neither dependent upon his caregiver nor dominated by her. People testified on his behalf that debunked his family members; and the appeals court concluded that, although Hone and Hagedorn shared a confidential relationship, any suspicious

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circumstances that might have pointed to undue influence were overcome by testimony and evidence. The appeals court was compelled to uphold Hone’s new wills. It reproduced a letter of opinion from the trial court because it concisely and accurately summarized the events and family attitudes that followed Hone’s stroke: The court wishes to stress that some of the plaintiffs created problems as early as March 1997 and the problems had nothing to do with Hagedorn or any other defendant. The problems were exacerbated by the attempt to have the decedent declared incompetent when it was clear he was not incompetent…. [T]he guardianship hearing the decedent was basically abandoned, not because of a locked gate but because some plaintiffs were mad and upset with the decedent.… Pride seemed to govern the actions of some plaintiffs. The recovery from the stroke and subsequent hospitalization was, in effect, an inconvenience to them and when it was pointed out to them that the decedent needed rest and should not be upset, they resented receiving that information. Then again, as the court suggested, maybe the family members were just jerks. SUICIDE There are lots of reasons for declaring someone not of sound mind or not capacitated. Medications, 268

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health conditions and senility can all contribute to such a declaration. But what happens when someone makes a holographic will and then commits suicide? In the event of a will contest, can the court find that feelings of suicide mean that a person is not “of sound mind” enough to compose a valid will? That’s what the court had to determine in the case of Estate of W.O. McIntyre. This case that not only involved the tragic ending to an individual, but it had tragic consequences for the family left behind. On April 28, 1996, W.O. McIntyre committed suicide at the age of 56. He was survived by his wife of 18 years, Jane McIntyre, and his two grown children from a previous marriage, Teresa Burns and Keith McIntyre. It was no secret that McIntyre was in a state of extreme depression prior to his death, stemming from a recent diagnosis of diabetes and the resulting fear that his health would worsen and leave him a burden to his family. Before taking his own life, McIntyre had written three suicides notes by hand. In each, he expressed his wish that everything he owned go to his widow—with the exception of bequests to his son and daughter of $25,000 each. After his wife admitted the notes to probate as a holographic will, his children filed a lawsuit, contesting the will. They asserted that their father was incompetent to make a valid will at the time he wrote the suicide notes. His wife, however, asserted that her late husband was not incapacitated when he drafted the notes and took his own life.

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A jury trial was held in March 1998. Mrs. McIntyre testified that a document, tendered to the probate court as her husband’s last will and testament, consisted of three notes written on three separate dates. Her husband had shown her the first note shortly after he wrote it on March 3, 1996; she found the second note on the morning of March 14, 1996. At her husband’s request, she had kept the first two notes. The last note was left by her husband on the dining room table of their home on the day that he committed suicide. She testified that she was positive that the three notes were entirely in McIntyre’s handwriting. On March 1, 1996, McIntyre had come home early from his job as a river boat captain because he was so depressed that he felt incapable of captaining the boat. At his employer’s insistence, McIntyre talked to a counselor, Linda Laney, about his depression. He met with Laney twice, on March 7, 1996, and again on March 8. On March 13, Mrs. McIntyre met with Laney and told her that she was afraid to leave her husband alone, for fear that he would commit suicide. McIntyre was hospitalized briefly for depression in mid-March. Things didn’t get much better, though. On a Sunday afternoon in early April, McIntyre succeeded in killing himself while his wife was away from the home. She found him—as well as the last note—when she returned. Most telling to the jury was the evidence of the notes. They showed that McIntyre knew what he

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owned and what needed to be divvied up prior to his death. The relevant parts of the notes read: To All that I Leave Behind Dying is part of living and it comes to us one and all. To me it is not such a big deal. and to me in my present state of mind it would be a relief. I have talked and told Jane all about it and it is a heavy Burden almost more than I can bear. To those that I leave behind do not grieve for me because if I am no more I am relieved of my pain and mental anguish + turmoil. As all of you know I am a diabetic and there is no cure for that only control. Also I have seen other people get old and become invalids + not be able to take care of themselves—and be dependant on family, hospitals, nursing homes—and I do not want that for myself. and Also the expenses of a serious sickness. can completely wipe out a family’s money + savings. Teresa and Family, Keith and Family: I have been having suicidal thoughts and if I do this (take my own life) I want Jane to have everything that I leave behind. Because she is the one that will be affected and hurt the most. And has been a dear + understanding partner in life. Also she will need it all— to continue her life and if there is any left at her time of passing. I want you all to have your share. Please be good to Jane + help her any way that you can.

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...It seems like that I am deeper in this black hole, and no hope of ever coming out. And I just can’t take it. If there was a way that I change things + make them better I would, believe me. Jane: Please give or see that Teresa + Keith get $25,000 a piece of my savings + investments I have always wanted them to have something when my life was over. Jane, I love you so much + really am sorry I know of no other way. You and all remember my better years. I know that no one can understand this I don’t myself. but it is bigger than me. Bye Bye To All And Please Forgive me In addition to the explanation of his thoughts, McIntyre’s notes meticulously outlined all of his assets, down to the estimated dollar. This included investments, 401(k) plans, savings bonds, bank accounts and various other assets. He even had the correct account numbers recorded with contact names of people in banks and financial institutions. Witnesses testified that McIntyre’s personality had changed in the last six months of his life; he was less active and spent less time with his grandson, but it was clear that he was mentally cognizant.

The hard part, for the court, was deciding upon how to consider suicide with regard to mental capacity. The children and the step-mother took different viewpoints. The children wanted to invalidate the will; the wife wanted the will upheld.

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The trial court ruled that Mrs. McIntyre had met her burden of proving legal execution of the will; the burden then shifted to the children to show that their father lacked testamentary capacity at the time he executed it. They relied on his change in personality and his deep depression; they argued that he had “faked his way out” of the hospital after his short stay there. The trial court heard testimony from several witnesses, including a doctor who had diagnosed McIntyre as suffering from “major depression without psychotic features.” Another psychiatrist, however, felt that McIntyre was having “irrational thoughts and feelings” when he wrote the suicide notes. This doctor said that McIntyre’s feelings of hopelessness about his rather mild case of diabetes demonstrated that he was, to a degree, “out of touch with reality.” But only to a very slight degree. The jury found that McIntyre had been of sound and disposing mind and had sufficient mental capacity to make the will. Consequently, on March 30, 1998, the trial court entered an order finding that the holographic will “was valid in all respects,” and confirmed its previous probate. The children’s appeal soon followed…and another long round of arguments ensued.

The burden to prove the existence of suspicious circumstances is always on the person contesting a will. Deeply enmeshed in family battles, these people often believe this suspiciousness will be easy to prove. It’s usually not.

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On appeal, the children argued that McIntyre’s delusional belief about the severity of his diabetes, the resulting suicide, and the fact that his will consisted of suicide notes, amounted to suspicious circumstances that placed the burden upon the wife to produce evidence of McIntyre’s capacity. The appeals court didn’t agree. It said: “Under these circumstances, we find no error in the trial court’s refusal to shift the burden of showing testamentary capacity from the [children] to the [wife].” The appeals court then turned to the question of mental condition. It wrote: A strong presumption exists that the testator possessed the requisite capacity to know and understand his actions at the time he executed his will…. In this case, ...McIntyre always knew his family. In the notes, McIntyre listed his various accounts in detail, by name, account number and latest account balance. He gave Mrs. McIntyre detailed instructions on the location of his savings bonds and the office of a person with whom he had placed some investments. Virtually every close family member and friend was mentioned by name. Moreover, he explained the reason for leaving the bulk of his estate to his wife. Despite McIntyre’s ultimate ending, he had met the court’s requirement for being of sound mind when contemplating his suicide and figuring out how to go about leaving his estate. If he hadn’t penned such a meticulous and specific will, and if the doctors hadn’t testified as to his mental problems

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lacking signs of psychosis, the courts may have ruled otherwise. But here, in this story, his final wishes were upheld and the children were billed for the court costs. CONCLUSION To review some basic things discussed in this chapter on problem situations:

•

Competence and mental capacity are the bases of many disputes over family money in problem situations. Prepare for this by making sure will makers and administrators are competent;

•

If your children are minors, they should not be designated as beneficiaries of your will. Appoint a trustee for any minors and name the trust as beneficiary;

•

Be careful when leaving money to family members who are receiving government benefits. The gift may compromise their benefits. It’s usually best to leave them money in a supplemental needs trust;

•

It’s an unfortunate fact of life that family members are sometimes foolish about money—even if they aren’t, legally, incompetent. In these cases, spendthrift trusts will usually limit the bad things a reckless person can do;

•

Occasionally, even a good family faces a member who carries bad behavior to a criminal level. In these cases, slayer

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statutes and other laws will usually limit the inheritance a criminal can receive. And, finally, one point warrants repeating: Stating your plans for your estate in clear and cogent terms prior to your death is key. You can’t bulletproof your wishes from problem individuals, contests and family squabbles; but you can do your best to ensure that your wishes are upheld in the end.

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9 INHERITING MONEY

Some 115 million families will start inheriting $10 trillion this year. But inheriting money isn’t easy. Some inheritors have grown up in modest families, only to receive a substantial inheritance from parents or relatives who became wealthy in older age or had a lot of life insurance. Even some who grew up with wealth find that managing an inheritance isn’t as easy as they thought it would be. Part of the challenge is financial. What do you do with $100,000 or $1 million or $10 million? A survey by Oppenheimer Funds found that 40 percent of Baby Boomers who have received at least a $50,000 inheritance made a financial decision in less than a week. Many of these go on to rue their first decisions. Part of the challenge is psychological. Inheriting a family business or the family farm requires immediate attention. You’re more likely to have known about such an inheritance, though an unexpectedly early death may have put it into your hands sooner than you planned. But the same advice applies. Try not to make any rash decisions. Take your

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time, think about what you really want to do with it, educate yourself on what it can and cannot reasonably do for you. Remember: clear objectives help you manage the money better. IT’S

AN

EMOTIONAL

THING

While the financial side requires patience, attention to detail and professional consultation, the psychological side of inheriting is often the more deeply rooted challenge. It’s not emotionally easy for many people to inherit money. Various feelings collide: gratitude, joy, guilt, fear, relief, inspiration, etc. And inheritance usually comes upon someone’s death— often a loved one’s. So, add grief to the mix. And that’s not all there is to it. Another common feeling is isolation. This is particularly so among people who did not grow up with wealth, and whose friends and family may not be wealthy. Like lottery winners, inheritors often worry—sometimes with good reason—about friends or family badgering them for loans or gifts. The emotional stress tied to inheritance has caused some inheritors to get rid of the money as quickly as possible, either by disclaiming the inheritance, giving it away or spending it. Others have been known to sit on their wealth and continue living their current, more modest lifestyle, sometimes for decades. And some people just don’t like talking about money—even when they have a lot of it. Only one in three millionaires share their estate plans with their children.1 As we’ve seen throughout this book, that’s not a smart thing. 1

The U.S. Trust Co. polled millionaires for this result.

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Conflicts are notoriously disruptive in even tightlyknit families. Inheritance combines death and money—two things that alone can wreak havoc on one’s emotions and personal serenity. According to advice columnist Ann Landers, “Inheriting money is not nearly as much fun as making it yourself.” Sans becoming a street entertainer, making money gives people something to do, and there’s something to be said for that.

SUDDEN

W E A LT H

The mixed emotions that come together when someone inherits a decent amount of cash or assets has been called “sudden-wealth syndrome” or “affluenza.” (The term sudden-wealth syndrome was coined by California psychologists Stephen Goldbart and Joan Di Furia.)

Getting a handle on emotions often takes the help of a professional—besides the tax attorney or estate planner. Sometimes a psychologist can help. Many leading private banks encourage clients to seek advice from psychoanalysts. It’s not just about money relationships among family members; it’s about people’s relationships to money.

Interestingly, what troubles rich people the most is the effect that their wealth will have on their children. Will their children work? In the face of so

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much money, will they be unmotivated and feel purposeless? Will they squander it all? This harkens back to the case we considered at the beginning of this book, where the dispute over a Johnson & Johnson heir’s legitimacy shined a light on numerous strange relationships. Material advantage will sometimes have the effect of taking away a person’s initiative and independence. A U.S. Trust survey concluded that wealthy parents reckon that an heir’s motivation begins to tank once they pass on more than about $3.4 million. While heirs can feel the burden of money, they can also feel the pressure of matching the achievements of those who created the wealth and security. And that’s not such a bad thing. Toward this end, incentive trusts have become popular within the last decade or so. A more hopeful variation on the spendthrift trusts we considered earlier, these make inheritance conditional on behavior. An heir’s ability to take control of the inheritance relies on his life choices—from education and career to a spouse and habits in general. Smoking? Less money. Drinking? Less money. Philandering? Less money. Some critics decry these incentive trusts as little more than egocentric parents trying to control their children from beyond the grave. In some cases, that may be what’s going on; in others, the trusts may be a tool for encouraging behavior that will maximize wealth and wisdom for future generations.

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TIME-TESTED

STEPS

Some things to consider when it comes to managing an inheritance:

•

Take time to focus on what you want to do with inherited money—before using it.

•

List all the things you’d like to accomplish. Put them in order and ask whether having money helps.

•

Create a budget, reflecting how much of your windfall, if any, will go toward current expenses.

•

Think about specific goals: a new home, charitable donations, paying off certain debts, etc.

•

Don’t touch an inherited IRA or other such account until you’ve seen an accountant or tax planner.

•

Contribute more to tax-advantaged retirement plans like an IRA or 401(k) and use your inheritance to cover the gap in your take-home pay.

•

Avoid blowing more than 5 percent in the initial rush on Versace clothes or high-limit craps at the Bellagio. If you need to, pretend for a little while that you have nothing. Let the first rush of emotions move through you…before your money does.

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WHEN

YOUR

SIBLINGS

GET

MORE

As you’ll see in this next case, the experience of the Posner family is one for a Lifetime Original. It demonstrates how important it is to treat family members equitably, if not equally; otherwise, they’ll spend time, energy and family money in courtrooms battling out issues that would overwhelm Sigmund Freud. Rose Posner died a rich woman. Having been the widow of a wealthy developer, she left a $20 million estate to two daughters and a son. To her daughters’ dismay, however, she left them a mere $100 each—leaving everything else to her son, David.

Rose’s children weren’t delinquents. Her son was chief of gastroenterology at Mercy Medical in Baltimore; one of her daughters, Carol Jean Posner Gordon, was a neuropsychiatrist—also in Maryland. From the court proceedings, though, it was clear these people didn’t get along. The other daughter, Judith Geduldig visited Rose only once in 19 years. Rose had even sued Carol Jean at one point after the daughter took a photograph from the family home. David was accused by his sisters of fraudulently turning their mother against them with various lies and misstatements.

At the heart of the matter was the will, which was written by Rose—for a 12th and final time—before she died in 1996. The daughters filed lawsuits to invalidate the last will and declare an earlier 1994

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will as valid, which would have divided the money equally among the children. In court, the nasty accusations began to fly between the brother and the two sisters. In the threeweek trial, they never looked one another in the eyes and stood in distant corners during breaks. Among the more interesting accusations:

•

The children with MDs tried to overmedicate their mother in order to gain control of her and her estate;

•

David actively persuaded his mother to reduce the daughters’ inheritance; and

•

The man who wrote the will wasn’t allowed to do so because he also represented David.

In all, the children filed three sets of lawsuits. They fought over who’d cared for their mother most...or best. They fought over taxes. They fought over trust structures. Some of these arguments were still being made when a Baltimore jury found that David was entitled to the largest share of Rose’s estate; it agreed that he didn’t lie to persuade Rose to leave her two daughters so little money. By the time this ruling came, however, the value of Rose’s estate had begun to dwindle. About $7.5 million had gone to pay taxes. In an earlier decision, a jury had ruled that a $7 million trust created by the estate was beyond David’s control and had to be split three ways. This gave each child $2.33 million. So, the remainder in question was about $3.5 million.

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INHERITING MONEY

The key ingredients to David’s case were videotapes. Rose had died at age 87, but she didn’t die senile. Jurors viewed four videotapes of Rose dictating her various wills. The tapes showed a spirited, intelligent woman who was sick of her children’s bickering. In a 1994 videotape, for example, Rose said, “It distresses me when my children dicker with me like this and they think they know what I want.” This telling testimony rewarded David in the end, as he walked away with the majority of the money. THE

COST

OF

FA M I LY

B AT T L E S

Warring siblings in a family’s time of need is a bad idea; but it happens a lot when inheritance comes. One awful Virginia case (Bruce v. Bruce) saw two very different brothers wage a war against each other, and the losers became everyone involved—including their incapacitated father. When the court finally was forced to referee and oust the “flamboyant” son as co-trustee, his mother must have turned over in her grave. Sylvia and Martin Bruce had two children, Paul and Steven. During their early years, Sylvia and Martin had amassed a sizeable estate and left their estate to their sons. Martin was incapacitated by a stroke in 1992. Sylvia managed her husband’s estate after 1992 but she herself died of a stroke in 1994. In 1988 the Bruces had executed revocable trusts into which most of their wealth was eventually transferred; most of their wealth meant real estate in various locations. They owned residences in Florida and Virginia and held

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other property in North Carolina, Ohio, New York and Virginia Beach. The incapacity of their father and the death of their mother prompted the Bruce brothers to engage in some quick estate planning; the brothers were both named guardians of their father’s person and property. In the beginning, things between the brothers looked okay as they jointly relied upon the efforts of an attorney to carry out plans. Through the guardianship, Martin disclaimed his deceased wife’s estate and made a sizeable gift to his sons. Paul asked for and received the cooperation of Steven in allowing a portion of Martin’s gift to Paul to pass through him to his two daughters. In return, Paul agreed to cooperate in setting up a charitable remainder trust from their father’s assets to be used to benefit abused children. Soon, however, animosity between the brothers broke out. Both brothers attempted to get control of the trust and oust the other as a co-trustee. Steven tried to file a suit in 1997 in California (where he lived); it was dismissed for lack of jurisdiction. Virginia— where the elder Bruces and Paul lived—had the jurisdiction to enforce the Bruce trusts, which it did in a second suit. According to the court: To say that a court can remove a trustee does not mean it can be done easily. Mere unfriendly feelings between trustees are not enough. The antagonism must affect the management of the trust. There must be a clear showing of abuse or mismanagement. The antagonism must militate against the profitable management of the estate. 285

INHERITING MONEY

Hence, the court had to consider the “unfriendly feelings” between the brothers and decide if those feelings were strong enough to call for the removal of one of them from the trust. In doing so, the court relied on Florida law, stating “When it is necessary to repeatedly resort to court action to resolve conflicts...the interests of the estate may best be solved by removing one or both of the representatives.” First, the court turned to each of the brothers’ personalities. It noted: The brothers each display ample intelligence. However, Paul is methodical in his explanations, somewhat stoic and measured in his response to questions. Steven, on the other hand, is impulsive, impatient, mercurial and flamboyant in his testimony. …[T]hey present very different personalities. Clearly, the brothers weren’t one in the same when it came to their demeanor. Second, the court turned to the logistics of the brothers’ residences. Paul lived in Virginia close to his dad, Martin Bruce. Steve, on the other hand, lived in California and could not interact with his father nearly as much as Paul. Third, the court considered each of the brothers’ jobs. Paul was a real estate broker and had been in the business since 1982. He was knowledgeable of real estate, particularly of those holdings in the Bruce family. Steven, on the other hand, was a lawyer. Although he was completely capable of understanding real estate transactions, he did not have the same

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experience as Paul with regard to the family holdings, nor was he in close proximity to the properties themselves. This unfortunate position made for more frustration when Steven tried to gain control. It was easy for the brothers to argue over everything, from surgery procedures for their father to real estate matters. When one made decisions without getting the other’s clear permission, fury followed from either coast. The issues related to the Bruces’ real estate holdings took center stage in most of the arguments. Steven frequently accused Paul of breaching his fiduciary duties. More out of spite, he demanded that he receive every piece of paper in connection to the Bruce real estate holdings, even when Paul was doing all the work on the other side of the country. After one such squabble, Paul explained his predicament very clearly in a letter to Steven dated November 1993: “There is no personal reason why you have not received the copies of all of the documents. It’s just one of the many things I have not gotten to.” Paul further described the volume of materials involved (“a full foot of documents,” etc.) and what was happening with regard to several of the properties. Paul’s attempts to comply with Steven’s incessant requests for copies culminated in his mailing three file storage boxes full of materials in March 1995.

Although Steven complained frequently and bitterly about Paul’s failure to provide him with informa-

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INHERITING MONEY

tion or copies of material, the court found no evidence “of Steven ever attempting to take the bull by the horn, so to speak, and arranging himself to have the documents copied.”

The constant bickering over real estate matters resulted in delays in getting business done. Paul was reduced to sending copies of his phone and fax records to pinpoint various times during which he spoke to or faxed someone something in order to show Steven that his complaints were groundless. The court found this paranoia and endless paperwork to be the antithesis of good management. Steven’s allegations continued. The court found no evidence that Paul had breached his fiduciary duties; but Steven didn’t give up. He wrote threatening letters to Paul over his fiduciary duties at least 13 times (that the court could count). The administrative bickering compelled the court to sound like some comic exaggeration of a radio psychiatrist. For example, it wrote, Paul, “had a tendency to tune his brother out.” According to the court, “This only infuriated Steven more and brought about attacks that became more intense.” The court was unable to determine which came first—Paul’s reserve or Steven’s tendency to distrust. The family history that came out at trial led one to speculate that the differences did not begin at the death of Sylvia Bruce. At any rate, the situation could not continue and the court determined that the level of discord be288

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tween the brothers was a detriment to the management of the estate. In other words, it reached the level of dysfunction that had been recognized by the Florida courts as sufficient to justify the removal of a trustee. The court retained Paul Bruce as the trustee for a few reasons. First, he had experience in the real estate field and in particular with the properties in the Bruce estate. Second, his calm demeanor would serve him well as a trustee. And third, the court believed that his conservative approach benefited the estate. “He cannot act alone,” however, the court said. The court noted that Steven’s interests had to be protected, so it appointed an attorney to act in Steven’s stead. The fact that the estate had to pay for his services was the price both Paul and Steven had to pay for their inability to get along.

Both brothers continued as co-guardians over their father’s person. “This responsibility is too intimate to the family for one brother to displace the other,” the court said.

The court acknowledged that this was a difficult decision. It doesn’t like to referee in family squabbles at the expense of one person’s ego. Here, Steven Bruce clearly lost the war, and lost more as a result of his personality rather than his actions.

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INHERITING MONEY

AN

INDIVISIBLE

ESTATE

As the Bruce decision shows, courts often force family members who don’t get along to deal with each other, regardless. And this is probably a good thing; probate court isn’t family counseling. But some estates require cooperation among heirs, because the most valuable assets can’t be broken up and sold off. This usually applies to family-owned business, but it can also apply to real estate. What happens when an estate is indivisible, and the heirs all want an equal amount? The Steinbrecher case proves how tough these situations can get, and how cumbersome they can be in a legal system that wants to settle things as quickly as possible. Like most cases of inheritance and sibling rivalry, this one started with the death of the last parent. Francis Steinbrecher died in January 1991, leaving three noncontiguous parcels of property—totaling 409 acres—in Illinois worth well over $4 million. Of course, all of his three children—John, Jerome and Rosemary—wanted a piece of the pie. They held title to the property as tenants in common. John Steinbrecher was the first to take action, wanting to partition the land among the heirs. In April 1996, he filed a motion to appoint a commissioner; later that summer the trial court appointed Michael Crowley as “substitute commissioner.” After estimating that the land was worth close to $5 million when appraised as three separate parcels, Crowley testified at a partition hearing that the property was incapable of being equitably partitioned among the three heirs.

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On October 28, 1997, the trial court approved Crowley’s report and found that “the whole or any of the premises sought to be partitioned cannot be divided without manifest prejudice to the owners thereof” and that “the entire property at issue be...sold at public sale.” This is when the real trouble began. The court agreed to the listing of the property by an agency, and by January 1998 a company by the name of Moser Enterprises, Inc. had offered $3,550,000 to purchase it. And, on August 19, 1998, the trial court entered an order “approving the offer/bid tendered by Moser Enterprises, Inc.” Rosemary and Jerome Steinbrecher didn’t like any of this—particularly the ordered sale of the property. Rosemary raised hell over and over again in a flurry of appeals and motions. Jerome never filed an appellate brief in the matter, so despite his anger the court dealt only with Rosemary. She argued several points, among which were:

•

The trial court didn’t have jurisdiction over the partition suit;

•

The court should not have ordered a public sale and that the conduct of the sale was wrong; and

•

The judges should have recused themselves.

Rosemary didn’t give up her fight...but did manage to waste a lot of the court’s time. It denied many of her motions, most of which were filed at the last minute and had little to do with the core of her arguments. She tried to get a change of venue; she

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INHERITING MONEY

tried to get extensions for her appeals; and she tried to dismiss judges because they had “some personal or venal motivation.” At one point, the court threatened to impose sanctions on her, stating, “We’re not going to be disrupting everybody’s life simply because you want to file a motion, especially when I’ve given you a date in the future.” Rosemary didn’t have the court on her side; nevertheless, the appeals court still listened to her issues. Finding that her appeal was not moot, the court addressed the sale of the property. Most of her claims were worthless. But the court had the hardest time dismissing her claim that the land was, in fact, divisible and could be divvied up. Crowley had stated that the property was divided into three noncontiguous parcels; the land on these parcels ranged from farmland to heavily wooded acreage on a flood plain. The trial court had found that the land was not capable of being fairly divided among the three heirs: It would be a momentous job to try to equitably divide the…parcels among the three heirs to the point where each one felt that they were getting an equal one-third value of the property regardless of whether it was sold or not. That being the case, and the heirs being unable to agree among themselves, it is the Order of this Court that the premises shall be sold at a public sale pursuant to the Statute. But this wasn’t necessarily so. Commissioner Crowley had told the court that he’d formulated a division

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of the property in which the one-third shares of the property would have estimated values of $1,595,000, $1,608,000, and $1,656,000. The appeals court hopped on this opportunity to settle things, stating: “Commissioner Crowley could have arranged a fair and equitable division of the property.” It then cited previous case law that dealt with this issue: The law favors a division of land in kind, rather than a division of proceeds from a sale of the land and, therefore, an unequal division with owelty is preferred over a sale of the premises. The appeals court concluded that the trial court’s finding that the property could not be equitably divided was against the weight of the evidence. The appeals court declined to comment on Rosemary’s other claims, remanding the case to the trial court for further determination of a possible division. It acknowledged, however, that the trial court could again determine that the property was indivisible without manifest prejudice to the parties. In that case, the property would have to be sold. The appeals court also admitted that Rosemary had a point when she argued that the proposed Moser sale was not a public one that involved “competitive bidding in a public place upon proper notice.” But this didn’t really matter anymore because the court had already reversed the order of the sale and sent the case back for reconsideration. Rosemary Steinbrecher would have to sit through another round of hearings to determine whether the land could be partitioned and, if not, she’d have to ensure that a legal public sale took place. 293

INHERITING MONEY

This case makes the standard advice all the more valuable: Get your affairs in order before you die— especially if you’ve got lots of children who don’t necessarily see eye to eye—or you will not leave behind a family in harmony.

STEP-DAUGHTER/STEP-MOTHER Money matters get sticky when it comes to steprelatives and in-laws. The issues around the estate of Maurice A. Gervais landed in Rhode Island’s Supreme Court, and it’s worth talking about it if only for the sake of the court’s final say. Gervais died in 1998, leaving two women who didn’t get along. One was his daughter, and the other was his second wife. After his will was duly filed for probate, his daughter, Jeanette, was named executrix to the will. His widow, Lillian Gervais, elected to waive and renounce the bequests made to her in her late husband’s will and instead, she claimed her right to a life estate interest in the house. Note, however, that she didn’t possess any ownership interest in the house at the time of Gervais’s death. Her claiming of rights to it probably didn’t sit well with Maurice’s daughter. To make matters worse, once her claim was granted, Lillian left the property and leased the house out for a period of two years, terminable immediately upon her death or by court order. Meanwhile, Jeanette filed a motion in the probate court to “Enjoin and Restrain Widow from Leasing Premises.” She asserted that Lillian had “abandoned”

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the premises when she vacated it and that she had failed to pay her proportionate share of the real estate taxes assessed against the property. On April 5, 1999, the probate court granted Jeanette’s motion and ordered that “[t]he interest of Lillian Gervais in the real estate...shall be valued and paid over to her in lieu of her interest in said property.” Lillian appealed. When the case reached the state’s Superior Court, it turned to what the state Legislature had written in 1978: Whenever any person shall die leaving a husband or wife surviving, the real estate owned by the decedent in fee simple at his or her death shall descend and pass to the husband or wife for his or her natural life subject, however, to any encumbrances existing at death.... If any estate, real or personal, be devised or bequeathed to a surviving spouse, the devise or bequest shall bar the life estate unless the surviving spouse shall, within six (6) months after the date of the first publication of the qualifications of the fiduciary of the estate of the deceased spouse, file in the probate court granting probate a written statement waiving and renouncing the devise and bequest and claiming his or her life estate in the real estate of the decedent. Thus, it was clear that the law provided for Lillian to claim a life estate in her late husband’s real estate. And if Maurice had owned more property than that one house, she could have claimed a life estate in all of his real estate—residential and nonresidential alike. This made it easy for the court to also 295

INHERITING MONEY

find that having a residency requirement would be absurd. It said, “Lillian did not ‘abandon’ her life estate in the former marital domicile when she attempted to lease the property to a third party.” In his decision, the Superior Court judge found that because the property had been neither sold nor taken and, because Lillian hadn’t asked the court for the payment of the value of her life estate in lieu of it, the probate court had made a mistake. The Rhode Island Supreme Court later affirmed the Superior Court’s ruling, leaving Jeanette with nothing pursuant to her claims. She couldn’t kick her stepmother out. A

DISPUTE

WITH

EVERYTHING

Time and time again, we see that large assets can sever family ties upon the death of someone important in the family. We’ve also seen how in a great majority of these cases, those assets come in the form of real estate—homes and land. The case involving the estate of Samuel C. Mumby, however, casts a long shadow over this area of family money. Mumby liked his neighbors well; but his plan to leave them a piece of his property didn’t sit well with his daughter. For the daughter, the friends were a big thorn in her side. Could she nix the neighbors’ share simply because they weren’t heirs by blood? That’s what a Washington court had to decide. Mumby died in January 1997 at the ripe old age of 94. He was survived by his only daughter, Darlene Wood, and four grandchildren. Mumby had done well for himself, and his estate was comprised of 44 acres of property on an island near Seattle, Wash-

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ington, as well as liquid assets worth half a million dollars. In 1992, he had executed a will, a quit claim deed and a durable power of attorney. Through the deed, he conveyed approximately 38 acres of wooded property to James and Erma Caldwell, his long-time friends and neighbors. The will left the balance of the estate to Wood. Then, in 1995 Mumby had executed a pour-over will and a living trust. The trust again provided that the Caldwells would receive the 38 acres, in addition to a $20,000 cash bequest. He left his residence, a six-acre waterfront parcel, and the residue of the estate to his daughter. The pour-over will and trust named James Caldwell as executor and trustee. The daughter was also the direct remainder beneficiary of a family trust fund valued at approximately $175,000. This didn’t make Darlene happy, however, and in May 1997 she filed a petition to invalidate the trust on the grounds that James Caldwell exercised undue influence over Mumby. The Caldwells counterclaimed that the no-contest provision in the trust barred Wood from taking as a beneficiary. This started the battle for control of Mumby’s estate, as both sides had bones to pick with regard to their relationship with Mumby. For starters, the father-daughter thing between Darlene Wood and Mumby wasn’t so clear. She had limited contact with her father during her youth, and only during the later years of his life did she resurface. Although she visited her father about once a week to help around the house since 1992, there was evidence of

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some tension. At one point, she asked her father to co-sign a $250,000 promissory note needed to refinance a loan, which he refused. The attorney who prepared his trust documents testified that Mumby did not feel his daughter supported, visited or cared for him as much as he would like. The reason he didn’t leave the wooded part of the land to her was that he feared she’d clear-cut the timber. In between the lines, it’s not so hard to see why she showed up in the later part of his life. The Caldwells, however, shared a very different relationship with Mumby. In 1976, Mumby sold his neighboring property to them, and thereafter, the Caldwells regularly helped Mumby with chores such as splitting wood, mowing grass, assembling paperwork, cutting his hair, driving him into town, cooking for him, providing him with desserts and mending his clothes. It was through the Caldwells’ help that Mumby was able to live on his own and in his own home until his death. In the summer of 1995, the Caldwells referred Mumby to Earnest Dill for “asset management” services. According to Dill, Mumby wanted to “tighten up his estate plan” against a challenge by Wood. From Dill’s perspective, Mumby had reasons to suspect his daughter would contest the wishes set forth in his will. This was why the trust contained a no contest clause virtually identical to the clause in the 1992 will. And, any questions about Mumby’s competency were quickly dispelled. It didn’t take long for Wood to learn about the trust and her father’s gift to the Caldwells. Wood did everything she could to disinherit the Caldwells;

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she hired investigators, attorneys, and consulted with other family members about her options. She initiated a will contest and a guardianship proceeding against her father. Nothing worked in her favor. Mumby remained firm, albeit at an advanced age. He remained as lucid and clear as could be to convince the courts that Darlene wasn’t a nice person by trying to do away with a dying man’s final wishes. The trial court ruled that there was no undue influence and that Mumby was competent to execute the living trust and pour-over will. Finding no valid basis for Wood’s challenge, the court applied the no contest clause and ruled that Wood should take nothing under the trust document. Consequently, the property that would have gone to Wood under the trust was distributed to her children. She really lost big time in this contest. When she raised the issue of fraudulent inducement on a motion to reconsider, the court denied that motion because “[t]he testimony did not begin to establish that theory.” On appeal, Wood argued that the trial court erred when it failed to find that Caldwell fraudulently induced Mumby into leaving him the 38-acre parcel of property. The appeals court disagreed: The right of testamentary disposition of one’s property as an incident of ownership, is by law made absolute.” Thus, to estab-

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lish fraud and set aside a will, the contestant must present “clear, cogent and convincing” evidence of all of the elements of fraud. “To sustain an order premised upon clear, cogent and convincing evidence, the ultimate fact in issue must be shown by evidence to be ‘highly probable.’

The court said: “[W]here a will is attacked because allegedly induced by fraud, it may be avoided, not because the testator’s mind was coerced, but because his mind was deceived.”

In the context of a testamentary disposition, the elements of fraudulent inducement are: 1) representation of an existing fact; 2) materiality of the representation; 3) falsity of the representation; 4) knowledge of the falsity or reckless disregard as to its truth; 5) intent to induce reliance on the representation; 6) ignorance of the falsity; 7) reliance on the truth of the representation; 8) justifiable reliance; and 9) damages.

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Wood failed to establish any of these things, which further made it easy for the appeals court to affirm the trial court’s ruling against her. The appeals court also determined, as did the trial court, that Wood had acted in bad faith. Remember: Bad faith is defined as “actual or constructive fraud” or a “neglect or refusal to fulfill some duty...not prompted by an honest mistake as to one’s rights or duties, but by some interested or sinister motive.” All of the independent witnesses testified that Mumby was competent and exercised his own judgment until his death. Moreover, Mumby’s expressed intent was consistent from his 1992 will through the 1995 trust to his death—he wanted the Caldwells to have the 38 acres. The trial court did not err in enforcing the no contest clause. In all, the trust was upheld. Mumby could rest in peace. The same probably couldn’t be said for his daughter, however, who would have to share land on a small island with her enemies. She didn’t necessarily lose because of the no contest clause, as having such a clause doesn’t make any will bulletproof. The lesson here: If you think there’s a high probability of problems surfacing over your dead body and over your prized possessions, worry most about the language of your will. Make it bulletproof with clear and cogent language that does not contain conflicting material between the pages...or the lines.

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CONCLUSION In the end, this is the best advice anyone can make about building and transferring family money. Clarity is key. Keep clear about your financial goals— which may be longer term than early retirement or golf every day after 65. Keep clear about your plans for leaving money to family members. This is especially true if you have a non-traditional or blended family. The law may not give your family the breaks it gives others...so, spell everything out, no matter how awkward or painful. Leaving money to heirs is one of the most profound things a person can do. It’s tough—but possible— to do it well. We hope we’ve given you a few tools.

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INDEX accelerated death benefits 228 administration expenses 127 administrator 24, 27, 78, 112, 255-256, 275 administratrix 32 ancillary representative 224 annual capital contribution 42 annuities 109, 147, 218, 228-229 asset inventories 38 bad faith 89, 166, 172-173, 301 beneficiaries 14, 16-17, 19-20, 39-40, 56, 78, 81, 85, 88-93, 101, 103-104, 113-114, 127, 130, 133, 136, 143-144, 149, 156, 159, 161-163, 167-168, 181, 183, 185, 190, 192, 196-203, 205, 221-224, 226-230, 232, 235, 241, 243, 256-257, 261-262, 266-267, 275, 297 contingent beneficiaries 81 sole beneficiary 156, 205, 232, 241 beneficiary designation 144, 199 bequest 75, 78, 81, 130, 164, 227-228, 244, 251, 269, 294-295, 297 bonds 24, 61, 107, 134, 167, 236, 272, 274 charitable bequest 78 charity 22, 93, 108-109, 236-237 child care costs 23 codicils 85, 165, 180 community property 83-84, 100, 131, 133, 189, 191 conservator 88-89, 133, 151, 266 creditors 113, 144, 182, 188, 202-203 debt 46, 52, 54-55, 77, 112-113, 134, 142, 181, 184185, 219, 222, 281

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INDEX

deed obligation 71 disabled children 250, 257 disinherit 66, 205, 298 dissolute heirs 251 divorce 38, 70-71, 83-84, 105-106, 124, 131-132, 184, 217 domiciliary representative 224 educational exclusion 217 equity 46, 70, 77, 124, 134, 145, 248-249 estate planning kits 154 executor 75-76, 82, 93, 99, 112, 114-115, 140, 159160, 162-166, 177-179, 181-186, 188, 193-195, 201, 221-223, 242, 255, 297 exemption 111, 189-190, 212-213, 220, 225, 233, 240 family-owned business 117, 123, 143, 161, 290 fees 89-90, 96-97, 100, 112, 149-153, 160-163, 166, 168-175, 206, 228 attorneys’ fees 89, 100, 112, 129, 173-174, 206 excessive fees 97 executor’s fee 112, 162-163 legal fees 5, 68, 152, 163, 168, 171-173, 175 trustee’s fees 160 fiduciary duty 93, 114, 163, 174, 184 final decree 32, 204 financial assets 2, 5-6, 78 financial hardship 30 fixed annuity 147 fundamental fairness 19 generation skipping transfer (GST) 233-234, 240, 242245 gift splitting 216 grantor 92-94, 98-100, 102, 104, 108-111, 149, 167, 235-240, 261 guardian 24, 74-75, 78, 88, 104-105, 107, 260, 263264, 266, 268

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INDEX

guardianship 24, 104, 263-264, 268 heir at law 26 holographic will 75, 87-90, 269, 273 income 11-12, 15, 83-84, 91, 93, 95-97, 101-108, 110111, 126, 134, 139-141, 143-144, 146-147, 153, 162-163, 166-167, 184-185, 189, 214, 216, 220230, 232, 235-241, 257-258 income interest 103-105, 235 income of the estate 221, 223, 228 income tax-free transfer 143 individual investment plans 7 inherited IRAs 226 insurance 8-9, 24, 77-78, 90-91, 101-102, 104, 119, 123, 136, 143-147, 159, 177-178, 181-182, 199, 201-204, 212, 218, 228-230, 235, 257 life insurance 90, 101-102, 104, 119, 136, 143147, 178, 182, 199, 201-204, 212, 218, 228230, 235, 257 whole life insurance 145-146 Veteran’s insurance 228 intentional interference with inheritance 204, 207, 209 inter vivos transfers 73 interest rate 108, 139, 237-238 intestate 74, 78, 247 intra-family loans 139 investment properties 126 investment return 11-12, 103 investments 11-12, 77, 101, 103, 107-108, 114-115, 117, 126, 134, 136, 147, 181, 185, 188, 235-236, 253, 263, 272, 274 capital investment 107 fixed income investments 134 joint tenancy 91, 100, 133 legal capacity 252 legal competence 252, 254 legitimacy 17-20, 22-23

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INDEX

liability 7, 10, 104, 109-110, 122-123, 137, 142, 208, 223, 237-238 life estate 96, 105, 139, 261, 266 marital deduction 40, 82, 189, 219, 232, 234 Medicaid 111-112, 239-240, 258, 261 Medicare 8-9, 261 mentally-impaired 85, 151 mortgage interest deduction 126 no contest clause 190-192 paternity 14, 18, 20, 23, 25-26 pension accounts 226 per capita 56-57, 200 per stirpes 56-57, 195, 200-201 person interested 28 personal inventory checklist 76 personal representative 27, 88-89, 114, 141, 166-175, 181, 183, 188, 193-194, 201, 220-224, 243, 245246, 255 power of attorney 2, 180-182, 262-264 probate 2, 6, 24-29, 32, 70, 74, 78-80, 89-90, 94, 96, 98, 100, 102, 112-115, 128, 132-133, 136, 140142, 144, 149, 155, 157-160, 164, 166, 168-171, 173, 182-183, 186-188, 204-206, 208-209, 243244, 246-247, 269-270, 273 Probate Act 208 probate estate 113-114, 186, 204, 243-244 non-probate estate 113 probate property 90 property settlement agreement 32 property transfer 81, 95, 218 qualified disclaimer 248 real estate 77, 104-106, 125-127, 130-135, 143, 151, 159, 188, 196, 222, 263-264 real estate deeds 132 real estate investments 126, 188 real estate transfer 130

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INDEX

retirement 77-78, 91, 119, 136, 146, 177, 263 royalty interests 136-139 settlor 92, 190, 198 shareholder’s agreement 119, 121, 143 slayer statutes 256, 275 Social Security 182 sound mind 84-85, 88, 90, 193, 253, 268-269, 274 spendthrift clause 203 statutory distributions 80 stewardship 117 succession 100, 118, 122, 242 suicide 250, 268-270, 272-274 survivorship 73, 84, 91, 100, 132, 186-188 taxes tax advantages 122, 133, 147 estate taxes 75, 81-82, 91, 93, 98, 101-102, 143144, 155, 213-214, 218, 244-246, 250 federal gift tax 110, 212, 214, 238 federal unified gift and estate tax system 220 generation skipping transfer tax 243-245 gift tax 40, 103, 109-110, 133, 144, 212-214, 216-220, 234, 237-238, 248 income tax 39, 50, 91, 101-102, 104, 108, 110, 139-140, 143, 162-163, 220-221, 223, 225, 229, 237, 239 inheritance tax 82, 163, 242-243 benefits for survivors 225 savings 125 structure 122 tax-advantaged savings plans 60 tenants in common 196, 198, 290 testamentary capacity 88-90, 253-254, 273-274 testamentary transfers 73 trusts A trust (marital deduction trust) 232 B trust (bypass trust) 231-232 charitable remainder trust 2, 107, 236, 285

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INDEX

charitable remainder unitrust (CRUT) 108, 236237 exemption trust 189-190 generation skipping trust 240-241 grantor retained annuity trust (GRAT) 109, 237238 irrevocable trust 40, 94, 101-102, 109-111, 237239 life insurance trust 101-102, 104 living trust 92, 94-95, 97-100, 130, 136, 153155, 158, 160, 231, 241, 244, 264, 297, 299 Medicaid trust 111, 239 parol trust 104 pooled trust 260 qualified personal residence trust (QPRT) 110, 238-239 revocable trust 92, 94, 101-102, 109-111, 136, 140, 166, 237-239 supplemental needs trust 259, 275 testamentary trust 94-95, 158, 261 third-party trust 260 unfunded irrevocable life insurance trust 102 trusts for minors 103-104, 234 undue influence 65, 68, 85, 165, 206, 266-268, 297, 299 unified credit 213, 217-219 wills 2, 26, 38, 59, 73-75, 80-82, 85-87, 98, 100, 115, 117, 144, 156, 158-161, 165, 177-178, 180, 182, 193, 199, 208, 232, 252, 255, 262, 266-268, 284 attested will 86, 90 holographic will 75, 87-90, 269, 273 pour-over will 99, 297, 299 reciprocal will 80-82 self-proved will 87 will kit 74, 152, 154

308