My wife and I are expecting our third child any day now, so when I saw Erik Canter’s post over at Forbes.com on financial and estate planning for new parents it caught my attention.  It is generally a good article, with solid advice.  He suggests that new parents update their estate plans, which includes their Wills and/or their Revocable Trust documents, powers of attorney and living wills, and any beneficiary designations for retirement accounts and life insurance.  He also suggests that parents re-evaluate life insurance coverage, review the family budget, and begin planning for college expenses.  These are all important steps for new parents.

However, there is one critical error in Erik’s advice.  He appears to suggest that parents should name their child (or children) as a beneficiary of life insurance and retirement benefits directly, which is almost always a terrible idea.  This is because minors are not allowed to manage their own property, and if on the parent’s death a minor child is designated to receive insurance proceeds or retirement benefits directly, a Court will have to appoint a Guardian of the Estate to hold the property for the child until adulthood.  

Having a Guardian of the Estate appointed requires formal legal proceedings which will produce additional legal fees (usually well in excess of the cost of planning to prevent the situation).  Also, the time it takes to obtain an appointment of a Guardian of the Estate may cause delay in the distribution of funds which are often needed for the child’s immediate care.  In addition, in Pennsylvania, a surviving parent may not be appointed as sole Guardian of the Estate (i.e. a co-guardian is required).

Just as troubling, when a child turns eighteen the Guardian is legally required to distribute all of the property to the child directly.  I think that generally speaking, teenagers do not have the life or financial skills required to manage significant wealth.  Also, if life insurance was intended to provide for the child’s higher education, distributing the proceeds (perhaps hundreds of thousands of dollars or more) at age eighteen may have the exact opposite effect.

It is far more advisable to name a trust for the child as the beneficiary.  The trust can be established in the parent’s Will, as part of a Revocable Trust, or even as a stand-alone document.  Using a trust reduces the chance that a Guardian of the Estate will need to be appointed and allows parents to ensure a trusted adult will have control of a child’s inheritance until the child is old enough and mature enough to handle the responsibility.  

It is very important for parents to update their estate plans when they have a child, and beneficiary designations are critical components of a comprehensive estate plan.  That is why parents should make sure their designations name trusts for their minor children as the beneficiaries, and never as the beneficiaries directly.

A recent post by Deborah Jacobsat Forbes.com discussed Facebook’s founder, Mark Zuckerberg’s possible use of tax planning techniques to make large tax free gifts. Ms. Jacobs’ post points to footnotes, contained in the offering statement, which indicate Zuckerberg and several other Facebook executives are each a trustee of their own annuity trust. Jacobs believes these footnotes suggest each of them have established a grantor retained annuity trust (GRAT), and I think that is a reasonable inference. GRATs can be a very effective wealth transfer tool, particularly where rapidly appreciating assets are used. I think stock in a company which has changed the way a large portion of the population interacts with each other qualifies as such an asset, even more so when the stock will soon be offered in the largest tech IPO in history.

A GRAT, for which there is expressed authority in the tax code, involves the transfer of assets to a trust in exchange for an annuity payment for a set number of years. The value of the annuity interest is calculated based on the size and term of the annuity, along with an imputed interest rate prescribed by the IRS (the section 7520 rate). The difference in value between the assets transferred and the annuity interest retained by the Settlor is a gift, but if the values are the same there is no gift.

This is where the magic comes in. If the assets transferred appreciate at a rate higher than the section 7520 rate, which is currently 1.4%, the trustee can make all of the required annuity payments and all the excess appreciation is effectively transferred with no gift tax liability. Between 1965 and 2005 the average rate of return in the first 21 days following an IPO was 22%.

Jacobs suggests that Zuckerberg transferred a little over 3.6 million shares at a value of $0.83/share for a total value just above $3 Million. She assumes that the Facebook stock appreciates 3.6% for 4 years, and in year five the company goes public at $40/share. At the end of a five year GRAT term, Zuckerberg’s trust could hold more than $37 Million worth of stock, without incurring gift tax, a potential $17 Million in tax savings for his heirs.

But you do not need to be worth $17.5 Billion (Zuckerberg’s estimated wealth) to make a GRAT work for you, and you don’t have to own the next Facebook. At AMM we have helped clients who own companies whose stock is expected to appreciate in the near to mid-term use GRATs with great effectiveness.

As a general illustration, let us take a corporate executive (unmarried with a net worth of $8 Million), who over the course of several years has received stock grants as part of his compensation for a privately held company. The stock, valued at the IPO offer price, is worth $1,000,000. If that executive transferred his stock into a GRAT this month and took back approximately $150,000 for 7 years, there would be no gift on the transfer. If the Trustee then cashed out the stock interest in the first three weeks following the IPO, invested the proceeds and earned 5% a year, at the end of the GRAT term the trust would own assets worth $470,000, a potential $211,000 in tax savings.

In addition, the estimated tax savings do not include the possibility of a lower valuation if the transfer is done several years before the IPO is planned, and if the Trustee thinks the originally held stock will out-perform the market (maybe it is Facebook stock) there is no requirement to liquidate and diversify. Also, the estimated tax savings do not take into account possible valuation discounts which may be available on transfers of minority interests in private companies (which can easily be 30% or more). With respect to the above example, $211,000 is probably a conservative estimate of the savings produced by a well designed GRAT.

Moreover, you don’t need to be looking at an impending IPO to use a GRAT. Any asset which is expected to appreciate at a rate above 1.4%, or an asset which currently has a depressed value, but is expected to rebound, may also be good. Closely-held stock, real estate, and even a portfolio of publically traded securities are assets which can be used to fund a GRAT.

The GRAT is one of many tax planning techniques that can be used by wealthy taxpayers to reduce their tax burden. By Ms. Jacobs’ estimates, Mark Zuckerberg and his colleagues may have used GRATs to transfer almost $205 Million dollars without tax; potentially saving them nearly $92 Million in taxes. All wealthy taxpayers have this same opportunity, now that is something to “Like”.

My colleague, Alan Wandalowski, has some additional commentary on opportunities with GRATs, here.

The IRS has released the new applicable federal rate tables for March 2012, and they remain the same as they were in February.  The Short Term (0-3 years) rate is .19%, the Mid-Term (3-9 years) rate is 1.08% and the Long Term (9+ years) rate is 2.65%, with annual compounding. The I.R.C. § 7520 Rate, used to calculate the value of annuities, life interests, and remainders, remains at 1.4%See Rev. Rul. 2012-9.

It continues to be a favorable environment for Federal Estate, Gift, and Generation-Skipping Transfer tax planning, as the use of many common estate freeze techniques including grantor retained annuity trusts (GRATs) and installment sales to grantor trusts (IGTs) work best when interest rates are low.

It is not a happy topic, but divorce happens. And, January apparently has the greatest number of divorce filings. When going through a divorce a person’s entire life is rearranged, and there is often a complete reorganization of personal and financial affairs.

One important, but sometimes overlooked, part of that reorganization is updating the estate plan in light of changed circumstances. A new Will, Power of Attorney, and Living Will are essential, but just as essential are updates to any beneficiary designations on life insurance and retirement accounts.

While not a reason to delay updating an estate plan, the good news is that both Pennsylvania and New Jersey have laws providing that an ex-spouse’s interest in a decedent’s estate is nullified. The bad news is that these laws do not apply to plans and benefits governed by the Employee Retirement Income Security Act, commonly known as “ERISA”. This means if your 401(k) or 403(b), or your employer provided life insurance names an ex-spouse as beneficiary, the plan administrator is required to pay the money or benefits to the ex-spouse. This has, and will continue to, cause disputes among family members. Particularly, where there are children from different relationships involved.

The United States Supreme Court ruled on this issue in Egelhoff v. Egelhoff, 532 U.S. 141 (2001), and held that ERISA preempted a Washington State statute, which automatically revoked a spouse’s (or domestic partner’s) interest the in life insurance or retirement benefits of the other on dissolution or invalidation of the relationship. The Egelhoff case has been followed numerous times, including other Supreme Court cases, as well as cases in the United States Court of Appeals for the Third Circuit (which includes both PA and NJ), and the Pennsylvania Supreme Court.

In 2009, the Supreme Court decided Kennedy v. Plan Administrator, 555 U.S. 285 (2009), where both a decedent’s ex-wife and the executor of the decedent’s estate (his daughter from a prior marriage) claimed the decedent’s benefits under a company administrated savings and investment plan (SIP). While the ex-wife had waived her interest in the SIP in the divorce, the decedent never changed the beneficiary designation form with his employer; the plan administrator followed the designation on file and paid the benefits to the ex-wife. The Supreme Court held that the ex-wife’s waiver to the benefits was not invalid, but that because the wavier was not part of a Qualified Domestic Relations Order (QDRO), the plan administrator was obligated to follow the plan documents and pay the benefits to the ex-wife. In a footnote, the Court stated that it was not opining on whether, and left open the possibility that, the Estate could bring an action directly against the ex-wife for the benefits received.

And, just this past November the Pennsylvania Supreme Court, in In re Estate of Sauers, held that a Pennsylvania statute, 20 Pa. C.S.A. § 6111.2, which in effect, revokes an ex-spouse’s interest in the life insurance or retirement accounts of a decedent (similar to the Washington statute addressed in Egelhoff), is preempted by ERISA with respect to the plans ERISA governs. Going further, the Pennsylvania Supreme Court found that the right of private action against an ex-spouse for benefits paid by the plan administrator provided by the Pennsylvania statute was also preempted by ERISA and was invalid.

The bottom line, if you or a client has been through, or is currently going through, a divorce estate planning should be at or near the top of the list of priorities. And, when updating an estate plan, beneficiary designations are as important as your Will and other documents.

Making a Will is easy.  Doing it right takes planning.

In Pennsylvania making a Will is not complicated. There are only a few techincal requirements. But, having a valid Will and having a Will that works for you and your family are not the same thing.  Many valid Wills (particularly the do-it-yourself kind) create more problems then they solve.  Working with an estate planning attorney is the best way for you to make sure your Will is valid, it actually does what you want it to, and that it works with the rest of your estate plan.

Here are the basic requirements of a Will in Pennsylvania:

1) A Will must be in writing.

You can’t make a video or audio Will. Also, it is generally considered a bad idea to record the signing or reading of a Will. While people think it will make their intentions clear it often has the opposite effect, and in some instances may lead to a disgruntled beneficiary raising questions about capacity or undue influence.

2) A Will must be Testamentary in nature.

Obviously not every written document is a Will. A Will must dispose of your property, and should generally be titled Will or Last Will and Testament.

3) A Will must be signed at the end by the Testator (person making the Will).

All of the terms above the signature are part of the Will. But, if terms are written below the signature those terms are not part of the Will and will not be enforced.

4) Witnessed by two people (well not really, but it is highly recommended).

Technically, there is no requirement in Pennsylvania that a Will be witnessed. However, without witnesses probating the Will becomes more difficult, because the Register of Wills must then hold a hearing where people familiar with the Testator’s signature will have to appear and testify. Therefore, it is highly recommended that people have at least two uninterested persons witness the signing of their Wills.  It is also advisable to have the witnesses execute (sign) what is known as a self-proving affidavit, so that the witnesses don't have to appear before the Register of Wills in order to probate the Will.

Also, if a person lacks the physical ability to sign for him or herself, a Will can be signed by the Testator’s mark, or at the Testator’s direction another person. But, both of these alternative signature methods require two witnesses in order to be valid.

Even if you have a valid Will there are no assurances that it does what you want it to.  Many valid Wills create problems because:

- they fail to dispose all of the Testator's property,

- they do not account for the possiblity that a beneficiary may die prematurely,

- they lack trust mechanisms for minor or incapacitated beneficiaries,

- they give away property the Testator no longer owns,

- or they do not give suffcient authority and discretion to the Executor requiring the Executor to obtain court approval for certain decisions.   

This is just a few of the many ways that a valid Will can create problems during the admininstration of an estate.  Working with an estate planning attorney to make sure your Will contains the right terms and provisions, that it works with the rest of your estate plan to meet your goals, and allows the Executor to admininstrate your estate in the most efficient way possible is a wise investment for you and your family.  

The third week of October has been declared National Estate Planning Awareness Week. 

http://www.ammlaw.com/faq/estates-trusts.html