The world in which we operate — from technology to family circumstances to the enactment of state and federal laws — is constantly evolving. Congress enacted the American Taxpayer Relief Act of 2012, which forced us to rethink how estate plans are structured, particularly for married clients with assets under $11 million. Currently, you can pass assets of $5.49 million upon death or during life without triggering the estate or gift tax. For married couples, that amount doubles. For many, estate and gift tax issues once drove the design of the plan and this shift in exemption rates has allowed clients to focus more on what is right for their families and less about the tax consequences of their decisions. We are often able to simplify the estate plan and save the family money from ongoing trust administration.
An update to your estate plan to focus more directly on family considerations and less on tax considerations is relatively straight-forward. The complications arise when one spouse has already passed away or the estate plan contained irrevocable trusts primarily for the purpose of avoiding, minimizing or paying estate taxes. Often these trusts are irrevocable life insurance trusts designed to hold life insurance policies that would pass to the family free of estate tax. Often clients understand “irrevocable” to mean permanent. The good news is that tools are available to terminate or restructure these trusts. This planning might be appropriate for clients who no longer are concerned about estate taxes or asset protection.
So how do you do it? It all depends on the terms of the trust. The terms of the trust agreement are very important in determining how to close down a trust.
Often the trust agreement grants an independent third party the power to direct the trust assets to one or more of the beneficiaries. If the spouse was an initial beneficiary, the trustee can distribute the insurance policy and any other assets in the trust to the spouse. The distribution of all trust assets under such a power allows the trustee to simply close the trust. If the trust agreement doesn’t contain this power, then the principal distribution standard under the agreement may give the trustee enough flexibility to distribute the policy and any other assets to one or more beneficiaries. If no power exists and the trustee does not have broad enough authority, the trustee may terminate the trust under state law without court authority assuming the trust assets are worth less than $75,000. This amount is indexed for inflation and goes up slightly each year. If the life insurance policy is a term or other policy with a cash value of less than $75,000, or generally if the assets of the trust are less than $75,000, the trustee has the authority to terminate the trust under the theory that the assets are insufficient to justify the cost of administration. Under this state statute, the trustee must give notice of the proposed termination to certain beneficiaries within 63 days. If the size or terms of the trust do not allow for termination, decanting may also be available, allowing the trustee to move the assets to a more flexible trust that ultimately will allow for termination. If all else fails, the trustee always has the ability to petition the probate court to seek court termination. With any of these approaches, it is important that the trust beneficiaries are aware of the termination. Oftentimes we ask that they give their consent.
When creating an estate plan, it is difficult to foresee all of the factors that will impact the plan in the future. The good news is that there are always ways to adapt the plan to the current situation and make sure it is still in your and your family’s best interests.
