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 But the terms are now hopelessly out of date.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.

Hope could reduce the potential estate tax bill by giving away money to reduce the size of her estate, Rettig said. Hope can make gifts of $10,000 per person to as many people as she wants each year without having to file a gift tax return, or she can make charitable donations and reap a tax deduction. Although Hope is considering leaving $100,000 to her college’s writing center, she said she is not yet ready to start giving money away.

Once she decides to create a trust, Hope must choose who will replace her as trustee when she dies or if she becomes incapacitated.

Trustees are distinct from executors or personal representatives, who are charged with overseeing the distribution of a person’s property after death. An executor’s responsibilities end once the provisions of a will have been implemented and the estate has passed through probate court procedures, if required.

A trustee’s responsibilities, on the other hand, can continue for years. Trustees must manage any investments, make sure tax returns are properly prepared and distribute the money.

It’s important to choose a trustee who is not only competent with money but who can withstand pressure from impatient beneficiaries, Rettig said. Children may see the trustee as a barrier between them and “their” money; in the worst cases, trustees can be subjected to constant harassment, lawsuits and even death threats from unstable heirs. Trustees must be counted on not to cave in to pressure but still look out for the best interests of all the heirs, Rettig said.

For some troubled families, Rettig recommends a professional trustee, such as an attorney, CPA or a bank trust officer, although he usually prefers that clients use someone who is familiar with the family situation.

Hope said her younger sister Jane, 40, is more than up to the task. Hope described her sister as a no-nonsense woman with business sense who is unlikely to respond to any attempts by her children to circumvent the trust.

“I don’t see that with Jane they’d get very far,” Hope said, chuckling.

Jane and Hope’s other sister, Candice, would serve as guardians of Hope’s youngest child if Hope dies before her daughter turns 18.

Hope can reduce later conflicts between her children and their Aunt Jane by specifying clearly how she wants assets to be invested, managed and distributed, Rettig said. But Hope should also provide her sister with some flexibility. A typical provision allows the trustee to dip into the principal before the distribution time if the money is needed for medical care, education or other specified uses.

Creating such a trust, along with a will and other related documents, will cost Hope from $1,000 to $5,000, depending on how complicated the trust is and on the nature of Hope’s investments, Rettig said. She must also follow through by putting all her current and future assets into the trust, a process that is more time-consuming than expensive. In return, Hope can expect to save $25,000 or more in probate costs.

Hope should also be aware that the trust will have ongoing costs after her death. Institutional trustees typically charge 1% to 1.5% of assets annually to manage a trust; although Hope’s sister probably won’t charge a fee, she may have to hire experts to help her manage the money and property.

“Fees for accounting, financial planners and investment advisors could render the cost of an individual trustee substantially equivalent to that of an institutional trustee,” Rettig said.

After reviewing Rettig’s suggestions, Hope said she is determined to create the trust and make sure that her children get enough, but not too much, if she should die prematurely.

“Thinking about your own demise and thinking about money is always a little dicey,” Hope said. But, she added, “I’m glad I did it.”