Goldilocks Trusts Save the Day

Summary:

Economic volatility can be a boon and bust for
your estate plan, and in particular for the trust funded on your death (whether
under your will or a revocable trust). So if you’re not sure if your porridge,
or the markets, will be hot, cold or just right, try the Goldilocks approach.
Each bear gets its own trust (bulls too if you remember what they look like).
Your estate planner might call this the “double pecuniary”, but Goldilocks and
the bears seems more apropos.

Impact of Market Changes
on Trusts Under Your Will.

◙ What happens in a down market (cold porridge) when
values decline between the date of death and the date of funding the bequests
under the will? ◙ Assume you have a will with a
pre-residuary pecuniary marital bequest, and the residuary will be the bypass
trust. A “pecuniary” bequest is a fixed dollar amount, whether stated as a
dollar figure or by formula.  ◙ If the value of the estate declines between the
date of death and date of funding, the entire estate could inure to the marital
trust, and there will be no value/assets passing to the residuary to fund the
bypass. ◙ What will be the impact on bypass
trust heirs (e.g., what if bypass includes as beneficiaries children of several
prior marriages)? ◙ If the market recovered by
the time the second spouse dies, all would be includible in the surviving spouse’s
estate and none would have been sheltered in the bypass trust. ◙ How do you preserve some benefits of the bypass
amount of the predeceasing spouse in light of the uncertainty as to whether the
estate will increase or decrease in value post death and prior to funding the
testamentary trusts? ◙ The double pecuniary
approach can provide a possible solution. This approach requires your will to
include 3 trusts, kinda like the 3 bears.

The Three Trusts.

Just like Goldilocks, you
want your trusts not to hot, not to cold, but just right, no matter what the
stock market does. The Three (3) trusts would be drafted as follows: (1) A
pre-residuary pecuniary marital trust; (2) A pre-residuary pecuniary bypass
trust for somewhat less than the applicable exclusion amount ($3.5M in 2009);
and (3) The remainder to the residuary (what’s left) bypass trust. Here’s the
key: As the pre-residuary bequests are both pecuniary bequests, post death
changes in the asset values, will be shared pro-rata between the trusts. This
would preserve at least some of the bypass amount in a down market (cold
porridge).  In an up market
(remember that concept?), all of the increase will pass to the residuary bypass
trust, thereby sheltering more assets from tax on the second death.

Sample language for your
will could include the following for each of the 3 Goldilocks trusts:

◙ Pre-residuary pecuniary marital trust. “I
give, devise and bequeath to Pecuniary QTIP Trust the smallest amount necessary
to reduce my estate tax to zero.”

◙ Pre-residuary pecuniary bypass trust. “I
give, devise and bequeath to Pecuniary Bypass Trust the amount that equals the
applicable exclusion amount available to my estate, reduced by Two Hundred
Fifty Thousand Dollars ($250,000) [or some other amount]”.

◙ Residuary Bypass Trust (i.e. everything else).
“I give, devise and bequeath the residuary of my estate to the Residuary Bypass
Trust.” You could combine this bypass with the above bypass but it would ruin
our Goldilocks paradigm.

Using the sample language
above here’s how your “new and improved” will plays out. ◙ Up. In an up market, all the upside goes to
residuary share so if values of the estate assets increase above $250,000 after
the date of death, this increase will benefit the Residuary Bypass Trust. ◙ Down. In a down market, if estate assets
decline post-death, the estate will loose the residuary bypass trust. ◙ All Around. This is a funding formula that
might warrant consideration in light of volatility. ◙ There
is no rigid time as to when the executor must close the estate; so long as
there is some basis your executor can keep your estate open.  If the markets recover, your executor
can capture the upside in the Residuary Bypass Trust. ◙  The double pecuniary formula
attempts to maximize the benefit of the bypass amount in either type of market
conditions.

Example 1 – Typical
Estate Plan: Assume a $10M estate at death. No post death change in
value.  In a bypass/marital will: ◙ First part is a pecuniary marital. The absolute
minimum without incurring an estate tax. What is the smallest you can give
without estate tax? $6.5M. ◙ The residuary bypass
would be funded with $3.5M since that is the maximum federal bypass amount.
When actually drafting the document the dollar figure would not be used, rather
a reference to the amount that can pass with federal (or perhaps state) estate
tax.

Example 2 – Double
Pecuniary Format: Assume a $10M estate at death, no post death change in
value. ◙ First part is the pecuniary marital
which would be the same as above: $6.5 million. ◙ Bequeath
to a pecuniary pre-residuary bypass trust, something less then $3.5M. For
example, bequeath $250,000 less than the maximum amount permissible to give to
bypass trust. Therefore, $3.25 million will pass to the pecuniary pre-residuary
bypass trust. ◙ The balance is your residuary
estate, which is bequeathed to the residuary bypass trust ($250,000).

Example 3 – Double
Pecuniary in an Up Market: Estate on death was $10M, and at time of funding
was $12M. ◙ $6.5M pecuniary pre-residuary
marital trust. ◙ $3.25M to pecuniary
pre-residuary bypass trust. ◙ Residuary bypass
trust is $12M-$6.5 M-$3.25M = $2.25M. In an up cycle your estate would fund the
excess into a residuary bypass trust and all the growth will be outside the
surviving spouse’s taxable estate.

Example 4 – Double
Pecuniary in a Down Market: ◙ Estate at
death $10M and at time of funding was $6.5M. ◙ In
a traditional will. $6.5M would pass to the marital trust and there would be
nothing for the bypass trust. ◙ In a double
pecuniary will the following would occur: ◙  Residuary Bypass Trust is zero
since there are insufficient assets. ◙ Since
there is less than the $9.75M required by the two pecuniary formulas to fund
both the Pecuniary QTIP Trust and the Pecuniary Bypass Trust it must be
determined how the $3.5M decline in the estate’s value from $10M to $6.5M is
shared (i.e., allocated between the two trusts).  ◙ The two pecuniary trusts
have to share ratably in the $6.5M estate assets since insufficient value
remains to fund both. They share the decline in estate value proportionately. ◙ Pecuniary QTIP Trust: $6.5M/($6.5M+$3.25M) x $6.5M
estate value at funding = $4,333,333, is allocated to the Pecuniary Marital
Trust. ◙ Pecuniary Bypass Trust:
$3.25M/($6.5M+$3.25M) x $6.5M estate value at funding, or $2,166,667, is
allocated to the Pecuniary Bypass Trust. ◙ $4,333,333
+ $2,166,667 = $6,500,000.

Impact of State Estate
Tax.

If you have a pecuniary
marital and the estate declines post-death so that there is no bypass trust
funded, the state estate tax might have to be paid out of the marital portion,
as there is no other portion. If the state estate tax has to be allocated
against the marital portion will it reduce the marital? If the estate tax is
allocated against the marital share, this might decrease the marital deduction.
Estate of Stevenson v. Director, Div. of Taxation, 23 N.J. Tax 583.
Consider using $675,000 in New Jersey, $1M in New York (and other amounts
perhaps depending on the state where you live) instead of the exclusion amount
reduced by $250,000 in the above example.

Income Tax Consideration.

There is a risk of greater
income tax on funding the trusts used in the double pecuniary approach in an “up”
economic environment since you will be using appreciated securities to fund the
pecuniary amounts. The Residuary Bypass Trust would be the only portion of your
estate that is not pecuniary so your executor may endeavor to allocate the
appreciated assets to that share to avoid trigging income tax on funding.

Personal Considerations.

◙ Who are the intended beneficiaries of each of the
trusts? ◙ If they are different, what are the
priorities of protecting the economic benefits for each? ◙ What are the priorities? ◙
What are the distribution standards for each of the trusts? ◙ Who are the trustees (or distribution committees if
used)? ◙ Based on your actual goals and
objectives, the beneficiaries, priorities, persons making the distribution
decisions, weighing the potential income tax problems, types of assets
involved, and other considerations, does the double pecuniary really accomplish
your objectives?

Conclusion.

Yep, it could be a better
mousetrap. Yep, you’d empress your golf buddies on the 7^th green dropping
your new plan…… But, does it really accomplish your goals?