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When a financial plan is no plan at all

May 5, 2024

When is an estate plan not a plan? When is an estate plan worse than no plan at all?

I wish this was the opening to a fun riddle, but sadly, when estate plans (wills, trusts, powers of attorney, health care directives) are unclear or out of date, it’s never funny, and can often be disastrous.

Said vs. meant to say

More often than I’d like to see, someone has gone to the trouble of having their estate plan created, but they sign the documents without understanding its terms. Sometimes, misunderstandings result because assets or circumstances changed, but the plan was not updated. Sometimes what’s in the documents does not match what mom or dad have told the kids, resulting in hurt feelings and often litigation.

A typical “plan” and sentiment is that a trust is to take care of the surviving spouse if there is one, and then “to my children equally” (often in fancy legal terms like “descendants” and “per stirpes,” both of which sounds like things you’d find in a pharmacy). But what if one child has been living in mom’s house taking care of mom in her final years, and mom has promised to leave that child the house? What if one child has worked in dad’s business and dad has always said to the hard-working child, “One day, this will all be yours”?

If a trust states, “to my children equally,” and says nothing about specific assets to specific children, the trustee’s hands are tied. Thus, in the above house example, the only way the house could be distributed to the caretaking child is if there are enough other assets to give the other children an equally valuable share. Even then, the trustee may need the consent of the other children. If the caregiving child was expecting the house and 1/3 of the other assets, they’re going to be out of luck. This is true even if that child was paying the mortgage on the house, unless the child can prove they were purchasing the house from their parent and thus entitled to some portion of the house as a purchaser rather than an heir.

The bigger problem

Even when a trust says “house to child A,” problems can arise. It should be clear whether child A gets the house “off the top” before all other assets are split among the children, or if child A gets the house as part of their share.

For example, assume dad dies with a trust holding a house worth $600,000, and other assets of $900,000, for a total of $1.5 million in assets.

If child A is getting the house, and the “remainder” (also referred to as “residual”) is going to all three kids equally, then child A gets $900,000 of assets (the house plus one-third of the $900,000 of other assets), and the other children each get $300,000. If, on the other hand, child A has the right to the house as a part of their one-third share, they are only entitled to $500,000 (one-third of $1.5 million) and will need to buy out their siblings’ share of the house.

Without specific terms, whichever way the trustee goes, this trust is likely to be contested by one child or another, and the legal fees will eat up a significant portion of the estate. Probate might have been cheaper.

Timing

When a gift is to be distributed is another important and overlooked issue that can nullify a plan.

If dad is leaving the family business to the child who works in the business, the trust again should make clear if that’s “off the top” or part of that child’s share. But what if dad’s spouse is still alive? Is the surviving spouse meant to continue receiving income from the business? Is the gift only made once both spouses are deceased (particularly a concern with children from different marriages)?

What if the child is no longer working in the business at the time of dad’s death? At the time of surviving spouse’s death? The trust should cover these conditions — e.g., the child only received the business as part of their share of the trust assets, after the surviving spouse has died, and only if the child is still working in the business.

Formula trust

Estate planning attorneys often draft trusts with complicated formulas for how a trust is divided. We do that not because we’re showoffs or charge by the word (that only seems true) but because tax laws change, asset values change, and we don’t know when you’re going to die. But sometimes, if the law changes drastically, or your assets significantly change, these formulas can up-end a plan.

When a trust is drafted, the formula could benefit the surviving spouse (i.e., the largest share under the formula is set aside for the spouse), but as laws and assets change over the years, that could reverse, and the formula may benefit the children more, or perhaps unintentionally reduce a spouse or child’s share to zero.

Make sure you consult with counsel every few years and confirm the formula still works.

Old trusts

If you have a trust that was put in place before 2012 and hasn’t been updated yet, you should have it reviewed. Tax laws have changed significantly, and where pre-2012, it was commonplace that a trust would split into two at the death of the first spouse to save on estate taxes, this is no longer the case. And in fact, splitting the trust into the “old school” two trusts may cause higher income taxes.

An estate plan is a living document for so long as you are a living person. Just as you buy new clothes, move homes, and change your diet and exercise habits, your trust is going to need an update as well. Just like those jeans you wore in high school, a plan is not a plan if it no longer fits you.

Teresa J. Rhyne is an attorney practicing in estate planning and trust administration in Riverside and Paso Robles, CA. She is also the #1 New York Times bestselling author of “The Dog Lived (and So Will I)” and “Poppy in The Wild.” You can reach her at [email protected]

Orange County Register

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When a financial plan is no plan at all

Said vs. meant to say

The bigger problem

Timing

Formula trust

Old trusts

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