Case Study: Protecting Grown Children

As a single parent, Leslie Hope knew she needed to provide for her three children if something happened to her.

Having enough money wasn't the issue; diligent saving and some good investments helped Hope, an English professor at Los Angeles Valley College, accumulate a net worth in excess of $600,000. The problem was figuring out whom to trust to handle the money.

Hope, 54, has little confidence that her children could manage the two four-unit apartment buildings, condo in Mammoth, home in Leimert Park and $250,000 retirement fund she has accumulated. Her daughter, at 14, is still a minor. Her two sons, 20 and 24, have yet to complete college or hold steady jobs.

"I just wouldn't want them to have a big chunk of money to blow," Hope said.

She made an attempt to resolve the issue 11 years ago by drawing up a will that would create trusts, after her death, to benefit the children. But the terms are now hopelessly out of date.

Then, earlier this year, Hope discovered she has a genetic condition that can lead to heart attacks and strokes. Although she's in good health now, she resolved to put her good intentions into action.

"This gives an urgency to setting up a trust and making sure it's updated," Hope said.

Charles Rettig, a Beverly Hills attorney, agreed with Hope's assessment that her will, and her estate plan in general, needed serious revision.

"Initially, Leslie viewed her estate plan as being prepared in the event something were to happen to her in five to 10 years," Rettig said. But "it is necessary to prepare an estate plan that could be effective immediately. We cross the street every day. We make left turns in traffic. Anything can happen."

Hope no longer has much contact with the family friends she initially wanted to manage her children's trusts. The trusts themselves are also flawed in her eyes, because they are designed to give the children their share of her estate at age 18. With two children already past that age, she now sees 18 as far too young to handle a substantial sum of money.

Rettig seconds that emotion.

"At age 18, most individuals feel they can manage their affairs," Rettig said. "It is only later in life that they realize the increased maturity and judgment one obtains over the years."

Even if her children were able to manage the money competently, the assets would be subject to the children's creditors. Keeping the money in trust longer would help shield it from lawsuits or bankruptcy proceedings if her children were to stumble financially.

Hope also has to consider estate taxes and probate, two potentially expensive consequences for her heirs.

Estate taxes are federal death taxes levied on assets worth more than a certain exemption limit. The limit is $675,000 in 2000 and 2001 and is expected to climb to $1 million by 2006. The levy starts at 37% and quickly climbs to 55%.

Probate, on the other hand, is a court procedure that oversees the reading of a will, the identification of heirs, the payment of creditors and the distribution of property. In California, any estate with total property worth more than $100,000--not including loans, mortgages or other debt--has to pass through formal probate unless specific probate-avoidance measures are taken. California probate typically takes 12 to 18 months to complete and can eat up 5% to 15% of an estate's assets in attorneys' fees and administrative costs, Rettig said.

He recommended that Hope avoid probate by creating a revocable living trust and changing title to her home, her rental property and her Mammoth condo to put them into the trust. Hope could also designate the trust as beneficiary for her 403(b) retirement account. A living trust would allow Hope to have control over her property while she is alive and direct how it is distributed after her death. As an added feature, Hope could name someone to take over the management of the trust and her affairs should she become incapacitated.

Rettig further recommended that the trust include provisions that would dole money out to the children over time. Each child, for example, could get his or her share in three equal chunks, distributed five years apart, starting when the child reached a certain age--say, 35 or 40. Income from the trusts could be given to the children at regular intervals after they reached an earlier milestone, such as age 25, Rettig said.

Rettig cautioned Hope that a living trust would not save her money on estate taxes--a common misconception among people who have such trusts created. All of Hope's property, including the apartment building she owns jointly with her eldest son, will be subject to estate taxes after subtracting the estate tax exemption limit. In Hope's case, her estate would not be subject to estate taxes if she were to die tomorrow. But if her estate grows at just 5% a year, more than $300,000 could be subject to estate taxes by the time she is 70.

Once estate taxes are paid, her ongoing trust would have to pay taxes on any income earned that was not distributed to the children, Rettig said.