Amy Kanyuk has been serving as an expert witness in a family dispute - one that is increasingly familiar.
A husband had died, leaving assets in a trust to his wife, says Kanyuk, founding member of McDonald & Kanyuk, a law firm in Concord, N.H. The main asset, a closely held business, wasn't producing any income for the widow. After 17 years, she had spent her own money and wanted help getting some assets from the trust.
Similar circumstances occur with some frequency. When assets for spouses are left in trusts, restrictions often apply, chafing the living spouse.
Susan John, president of Financial Focus, a planning firm in Wolfeboro, N.H., says widows' discontent with trusts is a common situation, "especially now that interest rates are so low. Bonds mature, and it's hard to find a replacement that can provide sufficient income for the trust to distribute to the surviving spouse."
Meg Green of Meg Green & Associates, a wealth management firm in Miami, agrees that surviving spouses may chafe at trust restrictions. "I see this all the time," she says, "especially in second marriages where there are children from a previous marriage."
TROUBLES WITH OLD TRUSTS
What kinds of trusts are likely to leave widows feeling shortchanged? "I often find this problem in older trusts," Kanyuk says. Such trusts may have been drafted with less flexibility than the ones now being created. Some trusts may be based on outdated tax laws, and others may reflect an era when wives had little experience with, or exposure to, financial matters.
John says that older "A-B" trusts, commonly used in estate-tax planning, may deliver unwelcome results for the surviving spouse. "They may have been drafted when the federal estate-tax exemption was $500,000 or $600,000," she says. In many estate plans, the B (credit shelter or bypass) trust is funded up to the amount of the exemption, with other assets going to the A (marital) trust for the surviving spouse. "Now that asset values are down and the tax exemption is over $5 million, the credit shelter trust may get funded but not the marital trust," John says. The surviving spouse frequently has less access to assets in the B trust, and might not be a beneficiary.
No matter what type of trust is involved, a beneficiary's unhappiness generally falls into three categories. A widow might want more current income from the trust assets or might want access to the assets themselves. Sometimes, it's both. Assets typically pass to other beneficiaries at the widow's death, creating a basic conflict between the surviving spouse and those other beneficiaries.
While trustees can find it difficult to balance the needs of today's and tomorrow's beneficiaries, planners might encounter challenges as they try to bolster widows' bank books. "If the trust mandates income to the surviving spouse, you might be able to get the trust's asset allocation changed so that the portfolio produces more income,'' Green says. An advisor, however, shouldn't exceed 60% in bonds. And you'll still need stocks for growth potential.
Although a planner might suggest a different asset allocation to increase income, not all trustees might cooperate. John says that income-producing investments such as REITs and MLPs may not be acceptable to a corporate trustee if the bank's investment committee hasn't blessed such vehicles.
Trusts drafted in recent years may make it easier to generate income for the surviving spouse as long as the trustee has the ability to convert the trust to a private unitrust, or to make equitable adjustments between principal and income. If such a trust requires that a trustee distribute income to a beneficiary, and the trust's actual income is low, Kanyuk says the trustee can convert the trust to a unitrust, invest for total return and distribute a percentage of the trust assets (3% to 5% in New Hampshire, where Kayyuk is based) to the income beneficiary each year, instead of distributing the actual income.
Suppose a $1 million trust is converted to a 4% unitrust. If the trust throws off $14,000 in interest and dividends this year, for example, the trustee might sell $26,000 worth of assets to make a $40,000 distribution: 4% of $1 million.
Similarly, a trustee with the ability to make equitable adjustments between principal and income can allocate some principal to income and distribute it to the surviving spouse, the income beneficiary. "Many states allow both conversions to private unitrusts and equitable adjustments," Kanyuk says.
Cracking the corpus
Gaining access to a trust's principal is a different story. Still, there are some tactics to try. If the trust was created under a deceased spouse's will and it is still within a certain number of months from the date of death, the surviving spouse can elect against the will and take a statutory share of the estate instead, says Marty Finn, managing partner at Lavelle & Finn, a law firm in Latham, N.Y. In New York, that would be one-third of the net estate.
Gaining access to the principal may depend on the cooperation of the trustee and the other beneficiaries. "Distributing money from the trust principal means less money to the ultimate heirs, who might be the children from a previous marriage,'' Green says. The kids usually won't agree to that. ... Why should they?"
Even if all the trust beneficiaries come to an understanding, the trustee may also have to be persuaded. For one client, Green managed to get the parties to agree on revising the trust terms. "The trustee is very reluctant to do anything besides what's in the trust," she says. "The trustee has brought in a lawyer to get written permission from the children and their mother to revise the trust."
Assuming the trustee and other beneficiaries are cooperative, Kanyuk suggests a nonjudicial settlement as a possibility. The trustee and the beneficiaries can agree to modify a trust or to give the trustee a desirable power that's not in the original trust agreement. This agreement can be for any purpose, except that it cannot modify a material purpose of the trust.
Decanting can be a solution. The trustee transfers assets to a new strust from an old trust, which is possible as long as the original trust gives the trustee discretion to make distributions, Kanyuk says. "This doesn't require the consent of the beneficiaries," she says. "The new trust can't add beneficiaries, but it can eliminate people who are beneficiaries of the old trust."
THE FINE PRINT
Of course, financial planners are not likely to be experts on nonjudicial agreements or trust decanting. Still, Kanyuk believes they can play a valuable role. "Planners can look at the trust's investment portfolio to see if changes can be made, and read the trust document to see what rights a widow might have," Kanyuk says. The widow who spent down her own money over 17 years, for example, did not realize she could get the trustee to invest in income-producing assets.
Planners also should contact the trustee to see if something can be worked out. "Ninety percent of the time, the trustee will be cooperative," Kanyuk says. If not, planners might suggest that the client retains a lawyer to see if there are grounds for more aggressive actions.
Donald Jay Korn is a contributing writer for Financial Planning and also writes regularly for On Wall Street.