Solution:  Put your child’s inheritance in a trust for his benefit.  Here’s the deal, if you die and leave everything you own to your child, there is nothing that you can do to stop him from leaving your assets to your ex (your children’s mother).  Of course, the possibility of your ex outliving your child is slim, but if your child die’s prematurely and does not leave a Will, the laws of intestate succession could give your ex your child’s estate.  Alternatively, if your child does have a will and names your ex as beneficiary, there is nothing you can do.  BUT if you leave your assets in trust for the benefit of your children, you can put limitations on the trust fund such as who your child can name as alternate beneficiary (known as a limited power of appointment) or you can designate the alternate beneficiary.

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Proviso Law Group provides attorney services in the areas of Business Law, Estate Planning, Wills, Trusts, Probate and Trust Administration.  We are located in Manhattan Beach, California near Hermosa Beach, Redondo Beach, El Segundo, Torrance, Hawthorne, Culver City, Los Angeles, Orange County, Gardena, Lawndale, South Bay.

If you have very large balances in your individual retirement accounts (IRA’s) and employer-sponsored retirement plans such as profit-sharing plans, 401(k) plans, 403(b) plans, 457(b) plans or defined benefit plans there could be huge tax consequences if your heirs decide to take a lump sum distribution of their inheritance.  If you leave your plan(s) to your spouse, he/she has the option of rolling the balance over into his/her own IRA.  This is not an option for non-spouse beneficiaries such as your children.

Generally, once you turn 70 1/2, you are required by law to take Required Minimum Distributions (RMD’s) from your retirement accounts each year.  Since the money you paid into your traditional retirement accounts was tax-exempt and enjoyed tax-deferred growth, all RMD pay-outs would now be taxed at your income tax rates.  Upon your death, a non-spouse beneficiary has the option to stretch out RMD’s using his/her own life expectancy or take a lump-sum distribution.  If your non-spouse beneficiary is significantly younger than you (such as your child), the RMD’s would be much lower because it would be based on their life expectancy rather than yours.  Since the RMD’s are lower, this would leave a higher balance in your IRAs resulting in longer tax-deferred compounding inside the IRA. (see attached table)

So What’s The Problem?

If your children and grandchildren keep the inherited IRA funds in the IRA over their lives and only take the required minimum distributions each year, the amount of money that can be earned, accumulated, and paid to the beneficiaries can be staggering.  But what if they don’t?  What if you have an IRA worth $400,000 and you leave it to your 25 year old son.  He decides to cash it out to buy a new car and drive to Las Vegas to “let it ride”.  Besides an immediate tax hit of 35% ($140,000), the future value of that account (hundreds of thousands of dollars) would also be lost.

If you have over $150,000 in all of your retirement plans, an IRA Beneficiary Trust (also known as a Standalone IRA trust, IRA Stretch Trust or IRA Protection Trust) can be a useful method to ensure the stretch-out of RMD’s.  The IRS would recognize it as a “designated beneficiary”, ensuring that RMD’s would be stretched-out over the beneficiary’s lifetime.  If a trust does not qualify for designated beneficiary status, tax laws require immediate distribution and taxation of the entire balance in the IRA account.  Simply naming your revocable living trust will not work because of many technical IRS rules.

The major advantage of an IRA Beneficiary Trust is the ability to minimize tax effects and allow maximum growth.  However, even if stretching out RMD’s is not a priority, besides preserving that option, there are several other benefits of setting up this type of trust for your heirs:

provides protection against divorce by keeping assets as separate property

provides protection against creditors and lawsuits

provides protection against undue influence to withdraw funds prematurely

provides protection against the beneficiary’s own poor spending habits

ensures that IRA funds will go to certain beneficiaries instead of leaving it all to your spouse who may pass it on to a future spouse or leave it to children from another marriage

may prevent disqualification from needs-based government benefits, such as disability income or Medicaid

Types of IRA Beneficiary Trusts

It is important to note that not all trusts which qualify for “designated beneficiary” status are created equal.  There a several types to choose from depending on how simple or complicated your needs are:

A “conduit trust” is the least complicated trust because it merely serves as a pass-through vehicle for the RMD’s.  The trustee must withdraw at least the RMD each year from the retirement plan and immediately distribute the funds to the beneficiary.  An advantage of this is the beneficiary does not have to remember to take out the RMD each year, the trustee does.  This avoids the potential risk of a 50% excise tax on any distributions not taken.

Although this trust allows the beneficiary to “stretch-out” the benefits over their own lifetime, it does not allow accumulation of the funds in the trust.  Because this feature is not allowed, many benefits such as creditor protection and spendthrift protection are lost.  This type of trust is useful for beneficiaries who do not need asset protection and clients who wish to name both individual and charitable beneficiaries.  If a revocable living trust is named as beneficiary of the retirement plan and the trust has both individual and charitable beneficiaries, it would not qualify as a “designated beneficiary” without conduit trust provisions (because a charity is not an individual and does not have a “life expectancy”).  This trust allows the primary beneficiary’s life expectancy to be used to calculate RMD’s and any successor beneficiaries (in this case, charities) to exist without detriment to the “designated beneficiary” status.

An “accumulation trust” allows a trustee to accumulate income in the trust after receiving it from the IRA instead of distributing it immediately.  Because of this discretionary power, the beneficiary is shielded from creditors, lawsuit judgments or just poor spending habits.  This type of trust makes qualifying for “designated beneficiary” status much more difficult because all beneficiaries, both primary and residuary, must be taken into account when calculating RMD’s.  If there’s a chance that non-individual beneficiaries or older beneficiaries  may take, the trust risks disqualification or loss of income tax benefits of the stretch-out.  Usually, an accumulation trust has an income beneficiary for life and if all trust assets are not distributed, successor beneficiaries step in to receive benefits.  Under the RMD rules, the age of the oldest beneficiary must be taken into account in order to calculate the RMD.  If you name your child as primary beneficiary and have any residuary beneficiaries who are much older, much of the “stretch-out” benefits are lost because the lower life expectancy will make the RMD’s much higher.

Also, if the beneficiary is given too great of a “power of appointment” over the trust or there is a remote chance that the trust contains a charitable or un-identifiable beneficiary, the trust will not qualify as a “see-through” trust and the entire balance of the trust will have to be withdrawn within 5 years.
A “toggle trust”, which is a hybrid of a conduit trust and accumulation trust, is a more flexible solution because it allows the choice of which trust to use to be made at the last minute.  This trust allows a “Trust Protector” to make that decision based on the needs of the beneficiaries at the time of the IRA owner’s death.  So if the beneficiaries are responsible adults with no creditor problems, the Trust Protector will choose the conduit trust for that beneficiary.  If not, the Trust Protector may choose the accumulation trust option for maximum creditor protection.  The beauty of this type of trust is that it can be drafted to create a sub-trust for each child and the decision to use either a conduit trust or accumulation trust can be individually executed for each trust.  However, the decision can only be made once, and it must be made within 9 months of the IRA beneficiaries death.

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Proviso Law Group provides attorney services in the areas of Business Law, Estate Planning, Wills, Trusts, Probate and Trust Administration.  We are located in Manhattan Beach, California near Hermosa Beach, Redondo Beach, El Segundo, Torrance, Hawthorne, Culver City, Los Angeles, Orange County, Gardena, Lawndale, South Bay.

Once your child’s name is on the deed, your home becomes an attachable asset to your child’s creditors.  If he/she gets sued or files for bankruptcy, it is an asset that creditors can go after to satisfy outstanding obligations.  Once “the deed is done” it is almost impossible to undo once a lawsuit or bankruptcy is filed.  There are laws which protect creditors, and if you attempt to deed the property back in your name, it can be considered a “fraudulent transfer”.

A much safer way to avoid probating a property is to set up a living trust.  It may cost more than preparing a deed, but your living trust can be drafted to give the home to your child after your death.  This would avoid exposure to your child’s creditors while you are still alive because you will retain full ownership of the home.  In addition, if you are worried that your child may mismanage his/her inheritance, you can create a “spendthrift trust” in your revocable living trust in order to protect against potential creditors.

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Proviso Law Group Attorneys provide guidance on Estate Planning, Probate, Wills, Living Trusts, Trust Administration, Estate Administration, Powers of Attorney, Advanced Health Care Directives and related matters.

*Courtesy of Utah Bar Journal

“Two years ago I started a company with a partner.  I brought in 250k in inventory and he brought in about 250k in manufacturing machines.  I was in charge of design and distribution and he was in charge of the manufacturing.

There was no agreement signed by either of us.

Now we want to dissolve the company and go back to what we were doing before.  We have made over 200k in lease payments on the company’s manufacturing machines.  They are not in my name but I don’t want the machines, my partner does. He seems to think that even though the company paid the lease payments for that equipment, I do not get a credit when we separate.  Another issue is that he owned the machines and was making payments before our company was formed.

Am I entitled to any of the payments that our company has paid?”

More often than not, businesses are started with friends and acquaintances without any written agreements.  It’s so easy to become excited about a great idea and the possibility of building something grand together, that nothing else matters.  When you are riding on the high of big dreams and possibly big profits, to actually sit down and think about everything that could go wrong and sign a written agreement, well that would just put a damper on things.

Entrepreneurs are dreamers, and dreams are a necessary element when starting your own business, but the reality is most partnerships fail.  They fail for all kinds of reasons, different managing views, different financial views, personality conflicts, moral/ethical dilemmas, family emergencies, etc.  These risks should be acknowledged before starting a business together.

In the example above, the partners could have prevented this dilemma by discussed things ahead of time and putting everything into a Partnership Agreement.  The agreement could have outlined their contributions to the company and determine how to account for property and liabilities in the event of a dissolution.  Now, if they cannot agree on how to resolve their disagreement, they each will have to get an attorney and settle things in court– a much more expensive solution compared to putting everything in writing in the first place.

So if you are headed down the partnership road, sit down and have a conversation with your potential business partner and talk about:

How much capital should each of us contribute?
What should the ownership percentages be?
Who will be responsible for what duties?
What if one of us wants to leave, what should the buy-out terms be?
What if neither of us has the money to buy the other one out?
What if something happens and one of us dies or becomes incapacitated?
Who will own the company name and/or trademarks if we part ways?
Should there be restrictions on the sale of of our interests?
What about community property interests?  Are our marital partners automatically managing owners?

This list could go on forever depending on the size and complexity of your business and the number of partners you have.  It is by no means exhaustive but should serve as a starting point for a good conversation.  There’s no doubt that these questions will lead into more issues that are specific to your situation.

In the end, the answers to those questions (and more) should be memorialized into a written agreement or several, depending on the type of entity you choose to form.  You may need an operating agreement, bylaws, shareholder’s agreements, partnership agreement and/or other type of agreement.

An experienced business attorney will be able to walk you through the risks involved and draft documents that can prevent a financial disaster in the event the business goes belly-up.

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Proviso Law Group attorneys and lawyers advise small businesses and entrepreneurs regarding legal matters.  Our experienced attorneys can form your business entity (LLC, C Corporation, S Corporation, LLP, Partnership, etc), dissolve your entity legally, represent you in a purchase/sale of a business, draft contracts/agreements and represent you in business disputes.

With a bit of pre-planning and preventive law, you can avoid the expensive and time-consuming court options that are available after the fact, like conservatorships and guardianships.  These proceedings are court-supervised proceedings which names an individual or entity to manage the affairs of an incapacitated person.  It is an expensive process requiring attorney-expertise and hearings with the court.  A properly drafted living trust can avoid this proceeding for a fraction of the cost.

Recently, I received a phone call from a young man who was worried that his father, a very intelligent, retired architect, was starting to show signs of dementia.  While his father was not completely incapacitated, he would have moments of forgetfulness and irrationality that impeded the handling of his own affairs.  His son was worried that a woman friend was taking advantage of his father by having his father withdraw cash from his accounts and credit cards to give to her.  Sometimes, this would happen several times a day and sometimes the father would forget that he did it.  The son wanted to know what he could do to stop this from happening.

At this point, a Conservatorship was the only solution available.  This could have been avoided if the father had a properly funded living trust in place that named the son as successor trustee in the event of the father’s incapacity.  Then, all of his father’s assets would be held in trust and only accessible and controllable by the son.  His father’s friend could not get to the money through the father because the son would be trustee.  However, this option was no longer available because his father no longer had capacity to have these documents drafted and to understand what they meant.

Today’s preventive law tip: Don’t wait until it’s too late to get your estate planning done.  Capacity is a  very necessary requirement.  For more advantages of having a living trust, click here.

Many small business owners use readily available form contracts to enter into all types of business deals, from sales and purchases, to financing and leasing contracts.  While these forms offer a low-cost convenience, they are not customized and may leave out important contingencies unique to your deal.  Or worse yet, they may have clauses which are irrelevant or specifically wrong for your transaction.

For instance, two business men from California and Texas enter into a purchase and sale contract for goods using a form contract.  The deal goes wrong and one man wants to enforce the contract against the other.  In the contract, the choice of law and jurisdiction is Wyoming.  Do you see how this could get ugly and expensive?

What happens if you try to modify the contract and end up including contradictory clauses in the contract?  For example, what if you enter into an asset purchase agreement and you modify the contract to include a financing contingency, but another clause in the contract specifically states “this purchase agreement is effective upon execution and not subject to inspection or financing contingencies.”

As you can see with these real life examples, many things can go wrong if your contract does not cover situations specific to your deal.  The result can be expensive litigation to interpret and enforce a defective contract.  This can cost thousands of dollars more than the cost of prevention from the beginning.

A well-drafted contract can prevent a lawsuit or at least minimize the costs of litigation.

If you are dealing with a reasonable person, the fact that they have signed a written document which outlines the problem and a way to solve it is enough to end the disagreement.

If you are dealing with an unreasonable person who decides to hire a reasonable lawyer to sue you (even though the contract is clear), the lawyer will take a look at the contract and see that they have no case.

If you are dealing with an unreasonable person who hires an unreasonable lawyer who sues you anyway, the judge and/or jury will enforce the contract as written.

When in doubt, hire an attorney to draft a contract specific to your needs.

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Proviso Law Group provides attorney services in the areas of Business Law, Estate Planning, Wills, Trusts, Probate and Trust Administration.  We are located in Manhattan Beach, California near Hermosa Beach, Redondo Beach, El Segundo, Torrance, Hawthorne, Culver City, Los Angeles, Orange County, Gardena, Lawndale, South Bay.

This post is directly related to a recent inquiry I had by a son who wanted me to update his parents’ powers of attorney, advanced health care directives and set up a living trust for them.  To make a long story short, I could not help him because his parents no longer had the legal capacity to execute these documents.  He was taking care of both of his parents and I have no doubt these documents could have helped him immensely to manage their assets and make their health care decisions.  Because they waited too long, his parents’ health deteriorated and they could no longer make those decisions.  His only legal recourse is to petition the court for legal conservatorship… a very expensive and time consuming process.

This estate planning mistake could have been prevented by just simply drafting the documents sooner.

Q: I named my friend as Trustee of my living trust and now she thinks she’s a beneficiary, is this true?

Q: My parents had a living trust and named my brother as trustee. All of the assets were supposed to be divided between us but it has been 2 years and I haven’t received anything. He won’t return my phone calls and has ignored all requests for documentation. What can I do?

These kinds of situations can be prevented by planning ahead and choosing a Trustee who understands the duties and responsibilities of the position. In the situations listed above, it is clear that the Trustees do not understand their duties. A Trustee is not automatically a beneficiary unless named as one. Additionally, Trustees must read the trust instrument and follow all distribution instructions, legal notice requirements and all other fiduciary duties required by law. Sometimes it may be appropriate to name a professional fiduciary or trust company if you don’t have someone who meets these requirements. Also, a living trust may keep your assets out of probate but since it is unsupervised by the court, mismanagement may go unnoticed until it is too late. In these types of situations, avoiding probate may not be the best move. To determine whether avoiding probate by setting up a living trust is the best decision for you, talk to an experienced attorney who can analyze your personal situation.