FAMILY TRUST

THE FAMILY TRUST 
By Nathaniel E. Clement, J.D.
The Family Trust is a trust by which the spouse who dies first (lets say the husband) transfers his estate NOT to his wife, but, rather, to a specially designed trust for the benefit of his wife the Family Trust. By doing so, the husband still accomplishes his goal of providing for his wife, but adding extra protections to his wife's inheritance protections that she cannot give herself estate tax protection and asset protection. Marital Exception To understand how a Family Trust works, we must digress a moment to talk about the marital exception under the tax law. The traditional way that spouses leave property to each other is outright 
-&nbsp; &quot;here, honey, its all yours.&quot; When this is done, the husband's goal of taking care of his wife is met and there is NO estate tax on the money or property when it is left this way. (Caution: the marital exception is not available to you if your spouse is a non-citizen). One of the problems in leaving wealth this way to a spouse is that the husband's coupon is wasted. This means that when the wife dies, she will have tax protection only to the extent of her coupon (i.e., her husband's coupon was wasted). This will cost a $2.5 million estate $465,000 in unnecessary estate taxes, which the kids will have to pay. (They will blame their moms financial advisor, CPA, or attorney.) Another problem is well, maybe the wife is NOT taken care under the 
&quot;here, honey, its all yours plan.&quot;(!) Lets say the husband buys a $1 million life insurance policy to provide for his wife and even kids if they are still minors. If the husband dies, the insurance company sends a check to the wife. The IRS says the husband gave this money to his wife. There is no estate tax on the life insurance money because she was his wife 
-&nbsp; the marital exception protected the life insurance money. The marital exception also covers the residence, which was also passed directly to the wife. It also covers the husband's IRA, which passed directly to the wife. Is the husband's goal of providing for his wife and kids accomplished?
 Lets say the wife's name is Janie. She has invested the insurance money. All she wants is 5% a year from the investments, or $50,000 a year. The kids are still at home, so Janie has to take the kids to after-school events. One day Janie is ferrying them to a church event. Teenagers will be teenagers their friends are in the van and they are rowdy. Its raining and Janie is on the cell phone. She is very distracted. Unfortunately, she doesn't see the stopped school bus ahead and plows into it (she also ran the red light, right before that which doesn't help her case). Five school children are severely hurt (or so it is alleged). The school children's mothers raise a ruckus and hire a plaintiffs lawyer. The lawyer does his investigation and finds that Janie has $250,000 in auto liability insurance and he learns she has in the bank and in her brokerage account $1million! Jackpot! A lawsuit ensues for $2 million in damages. The insurance company pays out $250,000. Janie settles with the plaintiffs for $500,000 (she is afraid of going before a jury and losing all of her money). There goes one-half of her life support! So, the problem in relying on the marital exception is two-fold: (i) estate taxes when the surviving spouse dies, and (ii) no asset protection for the surviving spouse, when both could have been given to her. Credit-shelter Trust Many lawyers or CPAs or financial advisors will talk about the credit shelter trust or the bypass trust. This is a description of a trust driven solely by tax planning. Under our tax law, a married person may give or bequeath to non-spouses (for example, children) an amount equal or less than the coupon and have to pay no estate taxes or gift taxes on that transfer. The coupon in 2008 is $2.0 million. It is available to any person subject to the US estate tax, citizen or non-citizen. The credit shelter trust (bypass trust) is a term used to allow a husband to leave money to his wife (and vice versa) and NOT waste his coupon. Its a technique that separates use from ownership. The typical credit-shelter trust is set up so a husband, in his will, bequeaths an amount up to or equal to the coupon amount to a credit-shelter trust established under the terms of his will. The terms of the trust state that all income shall be paid to the wife for her life and she can take principal as needed for her support. The trustee of the trust is often not the spouse, but a bank. When the wife dies, the balance of the credit shelter trust is paid out to the children outright in shares of equal value. No attention is paid to whether the husband and wife own assets in a way such that there ARE assets which can, in fact, be paid to the credit shelter trust. The Family Trust The Family Trust goes beyond the credit-shelter trust. The Family Trust is as concerned about tax protection as it is about asset protection for the wife and the children. 
The Family Trust in our office is built into (usually) a revocable living trust 
for the married clients who, together, have or will have, an estate greater than 
the current coupon amount (in 2008: $2.0 million). Since it is also driven by asset protection, the Family Trust may, and often is, appropriate for any transfer of wealth from one spouse to the other. We structure the Family Trust so that the coupon amount is transferred to the Family Trust when either spouse dies. The Family Trust must be funded when the first spouse dies, or it is a wasted planning tool. Therefore it is most important to look at all assets that either spouse owns or assets they own jointly and ask: If this person dies, will it be possible to, in fact, fund the Family Trust? If not, we counsel our clients on how to own their assets. We think that is usually a mistake to not have the spouse as trustee or co-trustee of the Family Trust. When this is done, there are some, but minor, restrictions on how the money in the Family Trust can be used. Without these instructions, the asset protection of the Family Trust is blown as is estate tax protection. We think it is usually a mistake to require that income must be paid out of the trust to the spouse. We think it is a mistake not to counsel clients that the Family Trust should be, not the primary source of funds for the wife, but a back-up source of funds for the spouse. Primary sources of funds for support can be her own assets, her husband's retirement plan, or life insurance proceeds residing in a life insurance trust. If the husband has obligations to his children or even grandchildren, we think it is wise to structure the Family Trust so all such family members can be beneficiaries of the trust, subject to the wife being the 
primary beneficiary. In determining how the Family Trust will be funded when the husband dies, we think clients should be explained the opportunity to use BOTH the husband's assets and the wife's assets to fund the Family Trust. Here is an example: Jake has an IRA of $500,000. He has other assets, not including the residence, of $1,500,000 (this might include life insurance death proceeds). His total estate is, thus $2.0 million. Janie, his wife, has an investment portfolio of $500,000 and an IRA of $200,000. Jake would like to fund the Family Trust with up to $2.0 million when he dies. But he would like for his IRA to be a stretch IRA, and he has learned that having it outside of the Family Trust is the only way to accomplish that. So, he has only $1.5 million to fund the Family Trust. Remember that the Family Trust could receive up to $2.0 million. Jake and Janie know that the Family Trust will take care of Janie for life, providing whatever financial resources she needs, but with asset protection. Janie, as trustee, will essentially be able to look at herself in the mirror and request money from the trust. No creditor can break into the Family Trust and take her money. If Janie, the grieving widow, remarries 6 months later, her new husband, the tennis pro, cant get his hands on the money either. If Janie is sued or goes through an unsuccessful marriage, her creditors and ex-husband can certainly take her $500,000 investment portfolio, but, if structured and administered right, the Family Trust is protected. But, wait! Is there a way to protect Janie's other $500,000? Often there is! We believe that these clients should be counseled in how it is possible for Janie's $500,000 to be owned in a way that it, too, can be allocated to the Family Trust too. A Family Trust, if used properly, and structured with proper counseling so the clients make the right choices for them, as well as being administered properly, will protect the property of the trust from the claims of creditors, remarriage, divorce, extraordinary health care expenses incurred by the spouse or kids, and from further estate taxation. This is why we call it the Family Trust. Protective Trusts The next step in the use of the Family Trust is protecting the money in the Family Trust after the surviving spouse dies. Can it be done? The spouse had protection during her lifetime. Do we have a way to continue that when the children inherit money from the Family Trust? Happily, and fortunately, the answer is yes. The Family Trust can continue as one or more Protective Trusts for the children, and be protected from further estate taxation, divorce claims, claims of creditors, claims of health providers for catastrophic health care expenses, and be used to promote your values.
 ============================ Copyright, Nathaniel E. Clement, Attorney and Counsellor 
at Law, 2008
1709 Legion Rd., Ste 214, Chapel 
Hill, NC 27517
Tele: 919-929-9298
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