Whenever I draft wills for a young couple expecting their first baby, or for a couple who already have at least one child, I always set up a children’s asset protection trust for them within the will documents. In case the parents pass away before their children have finished their education, or in case the parents become incapacitated so that they can no longer financially care for their kids, the parents always want to plan for a responsible adult family member or friend to manage their children’s assets for them as trustee of the children’s asset protection trust, in a way where the assets of the children’s trust will be protected against any possible future liability, creditor, or financial problems encountered by one of their children.
All of my client parents agree that such asset protection for their kids is a good thing! But while parents definitely want asset protection for their children, my younger client parents frequently are a lot more cavalier (“it won’t happen to me”) about asset protection for themselves.
Many of my client parents initially ask me for the following will planning:
- Sweetheart Will. If either one of the parents pass away leaving a surviving parent, all of the deceased parent’s assets benefit the surviving parent. The surviving parent can then use this money to take care of the children.
- Surviving Parent Wants Benefits in Cash. Except for the deceased parent’s share of the home, his or her personal property, or retirement account proceeds, the surviving parent receives the deceased parent’s assets “outright,” or in cash. Any life insurance (important in financially protecting young families) owned by the deceased parent benefits the surviving parent directly, in cash.
- The Parent’s Assets, Retirement Accounts, and Life Insurance Proceeds Flow Directly Into the Children’s Asset Protection Trust When Both Parents Pass Away. When both parents pass away, all of their assets, and any life insurance (and any retirement account proceeds in inherited retirement accounts) flow into the children’s trust, where a trusted adult family member can manage trust assets for the children as they grow and complete their educations. Once assets are held within the family trust, if one of the 17 year old children later has a car accident creating financial liability, all of the children’s family trust assets within the family trust are protected from the liability claims brought by an opposing attorney.
This is a pretty good strategy, but it can be greatly improved! The parents’ desire to receive their deceased spouse’s assets unhindered in cash (in Step 2 above), and life insurance benefits unhindered in cash, may leave the liability window open! This open liability window could seriously chill the financial outlook of both the surviving parent, and the surviving children.
DON’T LEAVE THE LIABILITY WINDOW OPEN!
Most parents would want to guard against the following tragic scenario: The dad is works late one night, falls asleep at the wheel driving home, and has a car accident killing both himself and the driver of the other car.
As is typical, both the mom and the dad are the co-owners of the car that dad was driving. The opposing plaintiff’s attorney receives a large financial judgement for the family of the other deceased accident victim, greatly in excess of mom and dad’s automobile liability policy limits.
If the unlucky mom and dad had set up a sweetheart will, where many of the deceased dad’s assets flowed directly to the mom in cash, and the dad’s $500,000 life insurance policy benefitted mom directly, both mom and the surviving children may be in trouble! The dad’s individual assets may have to pay vehicle liability claims in probate, where valid creditor claims have to be paid before the deceased person’s assets can flow through the will to beneficiaries. Thus there may be none of dad’s own assets left for mom, and the kids, to live on!
What about the $500,000 life insurance policy? Well, since mom was a co-owner of the car, the opposing plaintiff’s attorney could sue her individually, even though she was not even in the car with her husband during the accident. Since mom receives the $500,000 from the life insurance policy directly, and in cash, all of the $500,000 insurance proceeds may now be available to the opposing plaintiff’s attorney. And if mom never gets the $500,000, the children will now never get it either, because the liability window was left wide open!
THE SURVIVING PARENT’S ASSET PROTECTION TRUST
North Carolina law would have allowed, however, the dad to have set up a testamentary asset protection trust (testamentary irrevocable 3rd party trust) in his will benefitting mom, which is a type of “vault” which could have protected assets that dad left for mom from any of mom’s future creditors. Even though North Carolina probate rules would not have protected dad’s individual assets from his own probate creditors (for example the auto accident claim holders), dad could have set up his $500,000 life insurance policy where mom’s testamentary asset protection trust was the direct beneficiary of dad’s life insurance benefits, not mom individually. Planning this way, where dad’s $500,000 life insurance benefits would flow directly into mom’s asset protection trust, could have saved the $500,000 life insurance proceeds for both mom, and the children.
Some younger parents worry that leaving assets from a deceased spouse in trust for them may be too restrictive. But in North Carolina, the surviving parent can be the full manager, or “trustee” of his or own asset protection trust, writing checks to himself or herself as needed for his or her health, education, maintenance, or support, or for his or her children’s same needs. A “right of withdrawal” may also be written into the surviving parent’s asset protection trust, where, as beneficiary of the trust, the surviving parent can decide to withdraw any portion, or all, of the trust funds out the trust at any time, for any purpose.
A lawsuit called a will or trust “contest” occurs where a disinherited heir tries to get assets which were not willed to him or her, or not distributed to him or her through a trust by the deceased asset owner. Frequently, the deceased person had a very good reason for not leaving assets to an heir who had not treated the deceased person well during life.
Because a will becomes a public document once its author passes away and probate begins, anyone can view the probate file and see what assets were left to whom. A disgruntled or disinherited will heir can use the long, open probate process to his or her advantage, using a court process to tie up estate assets so that probate cannot effectively proceed. Thus, the will challenger can potentially hold the executor and listed will beneficiaries “hostage” by blocking distribution of their inherited assets, which can give the challenger a lot of power to force a settlement with the will executor (and beneficiaries.)
Several features may make a trust harder to challenge in North Carolina. Assets held in valid trust do not go through the probate process. In addition, North Carolina law protects trust privacy. Only trustees or beneficiaries actually named in the trust are legally entitled to receive a copy of a trust, or an accounting from the trust, without a judge’s order. So, a challenger disinherited from the trust (and his attorney) may not be easily able to get a copy of the trust from the trustee–it may thus be much harder to challenge distribution of the assets with no road map to follow. And, unlike the probate of a will, the trustee is not legally required to give notice to all of the heirs of the deceased trust grantor.
A will challenger can challenge will beneficiaries more efficiently, as a group, by hijacking public probate proceedings. When challenging a trust, however, a challenger may be forced to file a lawsuit against each beneficiary individually, making the challenger’s job much more difficult, and increasing the challenger’s legal costs.
The following two methods are commonly used by attorneys to challenge wills:
capacity challenge–the challenger tries to prove that the testator (will author) was mentally incompetent when the testator signed the will, thus the testator did not know what he was doing when he left the challenger out, and the entire will is invalid. The challenger may try to prove that the testator did not intend to sign a will at all, and that some other heir made the will instead of the testator.
duress or undue influence challenge–the challenger attempts to prove that the testator was pressured by someone else (such as another heir) to leave the challenger out of the will.
Capacity, duress, or undue influence may also be argued in a revocable trust contest case, but these arguments can be harder to win. The following example demonstrates why.
EXAMPLE: When widowed Dad turns 70, he has a lawyer draft a revocable trust for him, where he leaves all of his assets at his death to Good Son, who has good manners, is always around, and always helps out. Dad disinherits Bad Son in that document, who joined a motorcycle gang 25 years before, rode out to Las Vegas, and never looked back.
The revocable trust that Dad signed at age 70 is a “living” trust, meaning that dad “funds” the trust with all of his assets right away, and in this case manages these assets himself as trustee of his own trust for 15 years, until Dad turns 85. A dementia diagnosis at age 85 causes Dad to resign as trustee, and turn over the management of his trust assets to his successor trustee Good Son.
When Bad Son learns in Las Vegas that Dad has passed away at age 87, Bad Son hops on his Harley, and rides back to North Carolina to find an attorney to help him get Dad’s assets (Bad Son assumes that Dad would not knowingly leave Bad Son any assets.) Good Son confirms (as trustee of Dad’s trust) that Dad did not leave Bad Son anything.
Bad Son finds a North Carolina lawyer to consult. The lawyer Bad Son visits has some bad news, and recommends against attempting a lawsuit. Because Dad set up the revocable living trust at age 70, and picked Good Son as the sole beneficiary at that time, Dad has a 15 year history of successfully managing Dad’s own assets after selecting Good Son as sole beneficiary. With Dad’s successful 15 year history of competently managing his own assets, it would be extremely hard to prove that Dad was not previously competent to set up the trust at age 70 (when he left Bad Son out.)
Plus, because Dad could have chosen to add Bad Son as a beneficiary during the 15 year period when Dad was managing his own trust assets, but continued to leave Bad Son out, it would be very hard to prove that Good Son continually unduly influenced Dad to leave Bad Son out during Dad’s entire 15 year period of successful trust management.
The extra difficulty in challenging Dad’s revocable living trust could cause Bad Son to ride back to Vegas, and look for some other trouble to get into.
Categories: Estate planning, trusts, elder law, Winston Salem, North Carolina, NC.
The basis in your home is its value for tax purposes. It can be increased by changes such as home improvements.
When your home is sold, the capital gain on the sale is calculated as the difference between the sale price and the home’s basis. If you have been in the home for many years and the home has appreciated, the capital gain could be large, and subject to a large capital gains tax.
Fortunately, where the primary residence is sold and it was the principal residence for two of the last five years before the sale, individuals may typically exempt up to $250,000 in federal capital gains taxes. Couples may typically exempt up to $500,000 in capital gains taxes under these conditions.
If you want to give your home to another, it is typically much better to leave the home to an heir in a will bequest than to gift the home to the recipient during life.
When your home is passed down to a beneficiary in a will, the beneficiary frequently benefits from a “step up in basis,” where your basis in the asset is updated to the current market value of the home. If the home has appreciated since its original purchase, this “step up in basis” may save the beneficiary thousands of dollars in capital gains taxes.
This rule may be more complicated in cases where the bequest is made to a spouse, and where the home is held jointly with right of survivorship.
Avoid Taxes on Your Home Sale Legally, THE HUFFINGTON POST (October 20, 2015), http://www.huffingtonpost.com/moneytips/avoid-taxes-on-your-home-_b_8307234.html.