CREATING YOUR FAMILY DYNASTY
By Melvin J. Howard
Wealth creation and Estate planning go hand and hand. In today’s climate you have to take matters into you’re own hands. I was recently talking to an asset manager friend of mine who said he has a high net worth client that does not know where to deposit his money. With some recent bank failures and US banks only insuring up to $100,000 dollars per deposit some people our opening 10 to 20 different bank accounts. There are better ways first you should start by laying a foundation of Estate planning for the long haul past 20 years or more. It’s never too early to start. I start my investigation of individual trusts in Liechtenstein, which has no laws against perpetuities. But trust accounts have a minimum fee of US$4,500. Individual trusts could be pooled for the minimum fee, but cannot be pooled for the US$750 annual tax on individual trusts by the Liechtenstein government.
Over the last several years some American States have up the ante and are now competing with offshore jurisdictions. As of late 2005 there were nearly 20 American states that had abolished the law against perpetual trusts ("perpetuities") [KIPLINGER'S RETIREMENT REPORT; 12(5) (May 2005)] and other states have greatly increased the duration of trusts (Florida 360 years, Nevada 365 years and Wyoming 1,000 years). The nearly 20 states reported by Kiplinger as no longer having a law against perpetuities were: Alaska, Arizona, Colorado, Delaware, Idaho, Illinois, Maine, Maryland, Missouri, Nebraska, New Hampshire, New Jersey, Ohio, Rhode Island, South Dakota, Virginia, Wisconsin and the District of Columbia. A CARDOZO LAW REVIEW study (Volume 27, 2006) found that abolition of the Generation-skipping transfer tax of 1986 created a salient tax advantage on long-term trusts and that states abolishing the law against perpetuities significantly increased their trust business. This explains the recent surge of states to allow perpetual trusts and implies that more states may allow long-term trusts in the near future. Only two of the states with no law against perpetual trusts have no state income tax: Alaska and South Dakota. Alaska, however, has corporate income tax, and Alaska trusts are generally more expensive. The absence of state income tax not only avoids tax on income, it reduces trustee administrative costs in preparing tax returns.
The June 16, 1997 issue of FORBES magazine contained a very good overview comparing trust law features between states in the US. At the end of the article there is a color-coded map of the United States which summarizes the features. As should be clear from the map, about all that Wisconsin has going for it is Unlimited trust duration (ie, no law against perpetuities). The Uniform Probate Code is a negative -- a requirement that trusts be registered in a state court. Delaware has no such requirement, but the trusts that are of must interest to us (irrevocable trusts and post-mortem trusts) aren't probatable and needn't be registered.
Aside from having state income tax, Wisconsin is one of the states that have a state gift tax. I could not get straight answers from people in Wisconsin, especially about taxes, and I suspect that the complexity of the matter there plus a higher regulatory burden is at the root of the problem. Since part of annual trust costs is preparation of tax returns, total annual fees would be expected to be higher in Wisconsin. Wisconsin is at the bottom of my list of preferred perpetual trust states, just below Idaho.
From the trust map it would appear that South Dakota affords less protection from creditors than Delaware or Alaska. But the main vulnerability of irrevocable or post-mortem trusts for Settlors would probably be attacks by relatives. Delaware law, it turns out, is very soft- hearted about breaking trusts for the sake of a spouse or child-support. I heard a similar story in Alaska. An Alaska trust officer told me that the best protection is to have the spouse sign a document declaring that he or she has no beneficial interest in the trust.
The Uniform Prudent Investor Act gives statutory support for trust administrators to be relieved of money management responsibilities. Since you want the option of doing your own money management, this would seem to make Alaska look less favorable. But Alaska House Bill 197 brought the Uniform Prudent Investor Act to Alaska. Even without this statute, however, the Alaska Trust Company Fee Schedule lists fees for delegated money management while stressing that "The trust document must specifically exonerate and hold harmless Alaska Trust Company from any investment responsibility, liability or duty."
For people willing to pay for the luxury of having a mechanism for keeping assets out of probate, the expense of an annual fee for a revocable living trust is justified. By being revocable, assets can be moved in & out of the trust at will, and the assets & earnings of the trust are still part of the person's assets & income for tax purposes. Creation of an irrevocable trust, however, is a means of removing trust assets from one's taxable estate and trust income from taxable income. Although irrevocable trusts are usually created to reduce taxes, they could conceivably be of use for Settlors purposes if the named beneficiaries were Settlors service providers (for immediate care) and a Settlors trust for perpetual maintenance (or funds could simply remain in the trust and be designated for that use).
Four parties to a Perpetual Trust
Unlike classical trusts, a perpetual trust allows for the existence of a 4th party to the trust: the Trust Protector. The Trust Protector has the power to change Trustees and to change Beneficiaries. Changing the beneficiary might be useful if laws change affecting the nature of the entity allowed to be Beneficiary. But can you trust the Protector?
A perpetual trust provides the means for a Trust administrator to allocate money to administration costs as well as provide for wealth upon generation through generation. There are potential problems in having the Settlor and Beneficiary being the same person, with the Beneficiary being a legally dead person when the trust comes into effect. You could use a lawyer, asset manager, or banker or even a friend as a Trust Protector.
Trusts must name an alternative Beneficiary, and if poorly chosen the alternative Beneficiary could sue the trust on grounds that trust assets were mismanaged. An alternate Beneficiary must be chosen who is guaranteed not to sue. The Trustee must be in the same state as the trust, eg, a South Dakota Trustee. How trustworthy is the Trustee? An untrustworthy Trustee could deplete assets by poor investments or active stock trading intended to generate commissions. The answer to that question is to establish a co-Trustee.
DEATH TAXES IN THE UNITED STATES
The question of taxes invariably arises when discussing American domestic trusts. Canada does not have estate taxes, but the United States has estate taxes which have a noticeable "soak the rich" orientation. Trust companies (in the US and offshore) mainly expect to be dealing with wealthy folks seeking to reduce taxes. (And they charge accordingly.) The basic exemption from US Estate taxes is $1,000,000. To prevent the wealthy from evading estate taxes through pre-mortem gifts, gift taxes were created. Thus, an individual has a lifetime exemption to a Unified Estate & Gift Tax (in 2007) of $1,000,000. However, gifts less than $10,000 to any one individual in any single year are not included, although any excess over $10,000 will be included. Gifts to trusts are completely excluded from the $10,000 yearly exemption (but are included in the lifetime exemption).
Case law, however, has established an exception to the taxability of gifts to trusts (the case of the California Crummey family in Crummey vs. Comm, 1968). If a beneficiary of a trust is given 30 days notice and the right to withdraw funds deposited in the trust, then the money placed in the trust qualifies for the $10,000 annual gift tax exemption. (This will work so long as the beneficiary does not withdraw the money!) Trust companies often charge extra for making yearly mailings of Crummey notices for the irrevocable living trusts they maintain. Settlors who are wealthy enough to have problems like this to worry about should be wealthy enough to pay for their solution.
Another form of trust which might be of interest for Settlors purposes is the Life Insurance Trust. Such trusts typically have a life insurance policy as the primary asset. Although life insurance proceeds are not taxable, they are included in the $1,000,000 basic exemption of the deceased. An irrevocable living trust, however, is a separate legal entity. With an irrevocable life insurance trust the proceeds of the contained insurance policy are not included in the estate, in calculating the exemption. However, the payment of the premiums on the included insurance policies are taxable if Crummey provisions are not claimed, since premium payment would be a "gift" to the trust (not a problem for someone with an estate far less than $1,000,000).
LETS LOOK AT CANADIAN ESTATE TAXES
Unlike the United States, Canada has no Estate Taxes. These were abolished in Canada in the 1970s. But Canadian tax laws are structured in such a way as to take a far larger bite out of the assets of the deceased than American Estate Taxes do. Before any assets can be distributed to the estate, they must be deemed liquidated with all accumulated capital gain assigned to the final income tax return of the deceased. For example, imagine that the deceased purchased stocks at $10,000 thirty years ago and a cottage at $16,000 twenty years ago. If the stocks are now worth $110,000 and the cottage is worth $216,000, there will be $100,000 capital gain on the stocks and $200,000 capital gain on the cottage. Capital gains are taxed by adding 75% of the gain to taxable personal income. Therefore, the personal taxable income of the deceased will be increased 0.75 X$300,000 = $225,000 of which about 50% will go to Federal and Provincial taxes.
Registered Retirement Pension Plans (RRSPs) are worse. All assets from an RRSP must be liquidated and 100% of the proceeds added to the taxable income of the deceased before distribution to the estate. An RRSP can, however, bypass the estate and probate by having a person as the named beneficiary. If a man named his daughter as the beneficiary of his RRSP, the liquidated RRSP would go directly to the daughter, reducing his own final tax statement and reducing probate costs. But the daughter would have to pay tax on 100% of the RRSP proceeds as an addition to her taxable income. The only way to avoid probate and all RRSP taxes is to name one's spouse as the beneficiary. Only a person can be named as an RRSP beneficiary (not an organization). A Canadian wishing to use RRSP proceeds to augment Settlors funding will have to allow the RRSP to be liquidated, taxed in the final tax return, added to the probated estate and then distributed to the Settlors organization (or a Settlors trust). [An RRSP is, nonetheless, a good way to accumulate tax-sheltered money for income in the later years of life. But it is taxed very heavily if death occurs before it can be used for that purpose.]
A life insurance policy, however, can name a Settlors organization as beneficiary. Life insurance proceeds are paid fairly quickly, and they bypass the estate as well as probate. Naming your estate as the beneficiary of a life insurance policy and then attempting to direct payment of estate proceeds to a Settlors organization is not a good idea. Besides increasing the vulnerability of the assets and the costs of probate, the money would be subject to delays on the order of 6 months (a typical duration of the probate process).
TRUSTS IN CANADA
Settlors have often thought of creating trusts which could hold assets during long periods. Most jurisdictions have "laws against perpetuities" which prohibit the creation of trusts that do no end after a certain period of time (after the death of the youngest Beneficiary, for example). Canada has one province that has no law against perpetuities: Manitoba. But Canada would be a very bad choice of a country for creation of a Dynasty trust.
In Canada, a trust is taxed as if it is a separate taxpayer not entitled to any personal exemptions. A living trust (trust existing while the Settlor is still alive) is taxed at the top combined Federal and Provincial rate -- amounting to about 50% of annual income. A testamentary trust (a trust created by a will) can avoid the highest tax rate by deferring capital gains if the beneficiary is a spouse. But at the start of 1999, however, all Canadian trusts are required to pay taxes on all deferred capital gains every 21 years as if all capital assets had been liquidated.
CONCLUDING REMARKS
Individual trusts have the greatest potential for flexible provision of funding generations to come. Terms of the trust can be written to suit the means & desires of the Settlor.
"Nothing can be said to be certain, except death and taxes"
-- Benjamin Franklin
Benjamin Franklin was a can-do, jack-of-all-trades kind of fellow, who may have made the above statement only after failing to circumvent those "certainties". After reading Thomas Tryon's WAY TO HEALTH, Franklin adopted a vegetarian diet. Franklin was healthy, wealthy and wise enough to live to the age of 84 at a time when average life expectancy was less than 40 (he died in 1790). Franklin had the words "food for worms" placed on his tombstone.
Approximately 60% of the adult population have done no estate planning. In fact, an estimated 60% of people die without having made a will. I suspect that the reasons for this are that (1) death is unpleasant to think about, (2) death seems remote and less pressing to plan-for than events in the near future and (3) most people probably don't believe their estate is of much consequence. This is wrong thinking Wealth creation dictates that you have a plan. Estate Planning can be as complicated as Foundations, Partnerships, LLC’S,Corporations and Multiple Trusts:
· Closed-End Funds
· Blind Trust
· Deed of Trust
· Q-Tip Trust
· Testamentary Trust
· Statutory Trust
· Protective Trust
· Board of Trustees
· Derivative Trust
· Public Trustee
· A-B Trust
· Active Trust
· Charitable Trust
· Constructive Trust
· Contingent Trust
· Controlled Trust
· Express Trust
· Fixed Income Trust
· Grantor Trust
· Illusory Trust
· Implied Trust
· Irrevocable Trust
· Layered Trust
· Passive Trust
· Purposeful Trust
· Q-Dot Trust
· Revocable Trust
· Simple Trust
· Sprinkling Trust
· Tentative Trust
· Unitrust
Voting Trust
They can also be as simple as writing a Will. Seek legal and financial advice before embarking on an Estate plan.
