Per Stirpes

An essential part of drafting a will or a living trust involves collecting information about personal and financial objectives of a client. Most clients are very clear as to whom they wish to leave their personal and financial property - a surviving spouse, children, and grandchildren are the most common beneficiaries.

It is also our job to make sure that those intended beneficiaries receive their inheritance. What happens if the intended beneficiary of a specific or residuary bequest under a will or trust dies before the client? Who will inherit?

There are three designations commonly seen in estate planning documents such as wills and trusts - Per Stirpes, Per Capita and By Representation. Each will be discussed over the next few weeks. We will also be discussing the importance of these designations in 'will substitute' instruments such as IRA and 401K plans, life insurance, etc.

The most common phrase used in estate planning documents is "per stirpes". Essentially, "per stirpes" means that a distribution will be made to the surviving family members in the family tree when an individual dies before the testator or settlor of a trust. This means that surviving "issue" will inherit equal portions of the share their deceased ancestor would have taken if living. "Issue" are persons descended from a common ancestor.

For example, assume that Mr. Client leaves his estate to three Children, A, B, and C, each of whom has three children. At the time of Mr. Client's death, one of his children, A, has predeceased. Mr. Client's Will says, "I leave all of my property, real and personal, to my three children, per stirpes." Who will inherit and in what proportions? The answer is that Mr. Client's two living children (B & C) will each inherit a 1/3 share of his estate. The remaining 1/3 share which would have been inherited by the predeceased child, A, will now be divided equally between the three surviving children, or issue, of A.

Sometimes, instead of using the phrase, per stirpes, estate planners will use another format. For example, Mr. Client's trust says, "The Settlor directs that the trustee shall distribute all of the then remaining property, both real and personal, of this trust to Settlor's Children A, B, and C, except that, should any of them not be living at such time, but leave issue surviving, the issue of such predeceased child shall take the share, per stirpes, which their parent would have taken, had he or she survived." The result is the same if A should predecease Mr. Client and leave three surviving children.

What happens if there is no per stirpes designation in a will or trust? The answer will be discussed next week.

What Happens When "Per Stirpes" is not used?

We began our discussion last week on the importance of proper designation of beneficiaries in estate planning documents, such as Wills and Living Trusts, and on beneficiary designation forms for life insurance, IRA's, 401K's and certain bank accounts.

The most common planning phrase used is per stirpes. Here, the issue (children or grandchildren) of a predeceased child will take their ancestor's share. What happens if no designation is made? That is, what happens if the phrase per stirpes is not used?

Under wills executed before September 1, 1992, if per stirpes is not specified, the distribution will be per capita if all beneficiaries are equally related to the testator, and per stirpes if not equally related.

A per capita distribution means that each person who is entitled to inherit receives an equal share. Assume Mr. Client has four children - A has two children, B has 1 child, C has 1 child and D has three children. A and C die before Mr. Client. Mr. Client's will does not specify per stirpes. All 5 beneficiaries - A's two children, B, C's child and D - will divide the estate equally.

Under wills executed after September 1, 1992, if a disposition of property is made to "issue" without the phrase per stirpes or per capita, then the issue take by representation. Again, assume Mr. Client has four children - A has two children, B has 1 child, C has 1 child and D has three children. A and C die before Mr. Client. Now, B and D will each receive their 25% share of Mr. Client's estate; A's two children and C's one child (three in total) will share the balance of the estate (about 16.5% each).

In calculating a share by representation, the intital division of shares is made at the first generation level (here, the children of Mr. Client) in which a member is living. Members of the nearest generation to the testator will each receive one share and the remaining shares are combined and equally divided among the heirs in the next generation.

The Use of a GRAT (Grantor Retained Annuity Trust)

A GRAT (grantor retained annuity trust) is a technique for transferring property to members of the grantor's family at a reduced transfer tax cost. A grantor creates a GRAT by transferring property to a trust and retaining a "qualified annuity interest" in the property. The trust lasts for a specified period of time that the grantor is expected to outlive(the trust "term"). At the end of the specified term, the trust property passes to the trust's remainder beneficiaries (members of the grantor's family).

GRATs take advantage of special IRS valuation rules which make tax savings possible. The grantor is treated as having made a gift of a remainder interest in the property, the value of which is determined under these special IRS valuation tables. For tax purposes the value of the interest passing to the grantor's family (the gift) is less than the total value of the property at the time the trust is created because the value of the gift is deemed to be (1) the value of the property (2) as reduced by the value of the interest retained by the grantor. The grantor's Applicable Credit against gift and estate taxes (currently $675,000, and increasing in phases to $1,000,000 in the year 2006) can be applied to the reduced gift to avoid or minimize the payment of gift tax on the transfer to the trust. If the trust does not qualify as a GRAT, the special valuation rules would not apply and,as a result, the value of the retained interest would be deemed to be zero, meaning that the grantor would have to pay gift tax (or apply his Applicable Credit) the entire value of the trust property at the time he created the trust.

When the grantor's retained interest terminates, the property remaining in the trust passes to the grantor's beneficiaries free of a gift tax, even if it has appreciated in value since the trust was created. If the grantor survives the trust term, the trust property won't be includable in his estate for estate tax purposes when he dies because he will no longer have any interest in the property. If the grantor dies during the term, part or all of the trust property will be includable in his gross estate. But, he won't be any worse off than he would have been if he hadn't created the trust in the first place.

The Elder Suite

The vast majority of caregiving for the senior population is not provided in nursing homes or assisted living facilities. Most seniors are able to receive care at home with the help of their family. In some cases, this is an alternative. However, in many cases this is simply not an option. Location issues, careers, money and raising families of their own prevent many adult children from caring for elderly parents. However, children do not want their senior parent's safety or comfort to be at risk and many want to participate in caring for their elderly parent. This is a common issue for many families with elderly relatives today.

Balancing the needs of the elderly parent and caregiver child can be difficult. However, one solution can be the addition of an "elder suite" to the caregiver's residence. Basically, an elder suite is approximately 300 square feet of living space that is custom tailored to the special needs of senios and is installed on the caregiver's residence. The elder suite has an open layout for easy accessibility and also has the safety features such as shower seating, oversized doors, non-slip flooring, grab bars and panic buttons.

Paying for the elder suite is often less expensive and more time efficient than the costs and time involved in building an addition to the caregiver's residence. The elder suite provides both the senior and the caregiver's family with the privacy and independence each needs. In addition, the elder suite can be removed and the caregiver's residence can be returned to its original condition when the circumstances of the family change.

There is a cost to install the elder suite and you can either rent or buy the elder suite, depending on your situation. Compared to the rising costs of assisted living facilities and nursing homes, this is an ideal option for many families. It allows the parent to remain at "home" and maintain a sense of independence while allowing the caregiver child to have peace of mind that his or her parent is comfortable and safe.

Divorce and Beneficiary Designations

Generally, we look to state inheritance law (i.e., NYS Estates Powers and Trust Law) to know who are the "distributees" of an estate. Distributees are those individuals who are entitled to inherit estate assets which do not contain beneficiary designations or are not disposed by will.

A recent case* addressed the issue of whether state law controls where a decedent died before changing his beneficiary designation on his 401(k) plan and life insurance policy (Both named his ex-wife.) The U.S. Supreme Court held that federal law controlled this situation. According to federal law, qualified retirement plans are required to pay the benefits to the designated beneficiaries.

The outcome of this case teaches us the importance of reminding our clients who are going through a divorce to change beneficiary designations on all assets, including retirement plans, IRAs, bank accounts and life insurance policies. Accordingly, these clients should also revise their estate planning documents, such as the Last Will and Testament, Health Care Proxy and Power of Attorney.

*Egelhoff S. Ct., March 21, 2001.

Gift Splitting

It is a common practice for financial advisors, accountants and attorneys to recommend that their clients gift the "annual exemption" each year as part of the clients' estate, gift and income tax planning. The following is a summary of the rules regarding "gift-splitting" which is an important part of utilizing the annual exemptions.

Generally, each individual is permitted to gift $10,000.00 to any number of donees during a tax year without the requirement of filing a gift tax return and, at the same time, without utilizing the applicable exclusion amount. If a gift from a married individual exceeds $10,000.00 to any one donee, you may consider gift-splitting with their spouse. That is, if the nondonor spouse agrees, the gift can be deemed to have been made from both husband and wife; thereby utilizing the $10,000.00 exemption per spouse, for a combined $20,000.00 gift per donee.

The following are the requirements for gift splitting: Gift-splitting can only be elected between spouses. Gift-splitting is not permitted if the couple is divorced and either of them remarries during the year; the spouses must both be U.S. citizens or residents; and the nondonor spouse must consent to the gift-splitting.

A split gift is recorded on the donor's gift tax return. If only one of the spouses makes gifts during the calendar year, then the nondonor spouse simply consents by signing the donor spouse's gift tax return and will not need to file their own gift tax return (unless the total gifts to the donee exceeds $20,000.00 for the year or any gift constitutes a future interest).

Note that a nondonor spouse may revoke the splitting of gifts on or before the April 15th following the year of the gift. In addition, the gift-splitting election applies to all of the gifts made during the year. As a result, the nondonor spouse cannot elect to split some gifts but not other gifts.

As the end of the year approaches, it is important to advise clients on the basic rules of gift-splitting and the gift tax return requirements so that the gift tax exemptions are not jeopardized.

Proper Beneficiary Designations

We have been discussing the importance of proper beneficiary designations in wills and living trusts. Generally, the most frequent type of designation seen is, assuming no surviving spouse, "to my children, in equal shares, per stirpes." This means that a distribution will be made to the surviving family members when a beneficiary dies before the testator or settlor of a trust. But what about beneficiary designations for non-probate assets such as life insurance, annuities, 401K's and IRA's? The answer is that equal attention must be paid to the beneficiary selection for these types of assets as with wills and trusts. The per stirpes designation on a financial institution's or insurance company's beneficiary designation form is acceptable. Some issues to be aware of include: per stirpes (for example, "to my son, A, per stirpes") may not avoid the appointment of a guardian by a court if a minor does inherit as a contingent or designated beneficiary of a non-probate asset. A simple solution: "To my son, A, per stirpes, but in the event such issue who inherit shall be minor (s) then said minor's beneficiary share shall be paid to a custodian under the Uniform Transfers to Minors Act until the maximum age permitted by law and thereafter directly to the beneficiary. The custodian, if none, shall be designated by the executor or administrator of my estate." If there is no per stirpes or per capita designation on a beneficiary designation form, the proceeds of the policy or retirement account will be payable to the testator's estate, and be distributed according to the terms of his or her will, or by intestacy, if no will exists. This may create unintended results and unintended beneficiaries. If a trust is named the beneficiary of a IRA, and the testator later revokes the trust, care must be taken to change the beneficiary designation form, as well. It is also recommended that a beneficiary designation form be completed in duplicate, with one copy returned to the owner of the account or policy. This avoids the potential problem of a misplaced or lost designation form by a financial institution.