When Chicago attorney Mike Whitty recently helped a client plot how to dispose of his considerable estate, the client imagined a big send-off for his prized vintage wines. He planned to write into his will that his friends and family would hold a casino night: Guests would each get a kitty of play money for gambling and end the evening bidding in a wine auction.
This is estate planning far from the drafting of endless documents detailing which friends get which bequests and minimizing taxes. Estate planning is usually not considered a particularly glamorous or intriguing part of financial planning, but it has its entertaining moments. Planners report that they occasionally have to walk a fine line between talking clients out of distasteful or even illegal estate planning techniques and facilitating eccentric requests.
While one can imagine guests enjoying a casino night, many quirky requirements in estates are harder to stomach. When planning what will happen to their money after they die, people may become controlling, trying to force beneficiaries, especially children, to act in line with their own values. Although estate plans must not violate "public policy," or be "capricious," the law is surprisingly permissive on what is allowed.
Trusts can, for example, go a long way to discourage marriages. American courts have upheld estates stipulating that an income or interest terminates if a surviving spouse remarries or if a beneficiary marries a Roman Catholic, Scotsman, domestic servant or someone who is not Protestant or Quaker. Just last fall, the Illinois State Supreme Court ruled that an estate may disinherit a child or grandchild for marrying someone outside the family faith, in this case Judaism, although inheritance can't be pinned to a requirement to divorce.
Trusts have required beneficiaries to attend college or graduate school or lay flowers on the deceased's grave-or even change their name. A requirement more common in the United Kingdom than in the United States is that the beneficiary add the deceased's surname onto their own. The idea is to prevent the family name from dying out, but sometimes it is simple vanity. Those hyphenated names in the British upper-classes so dear to comedy-writers arose from this custom, says estate attorney Matthew Erskine in Worcester, Mass.
If a client has an especially odd stipulation, estate lawyers may point to demands courts have struck down as "capricious:" bricking up the doors and windows of a house for 20 years, throwing the income from the trust into the sea, spending the trust assets on monthly funeral services for the deceased, firing artillery salvos on the deceased's birthday or keeping a clock or portrait in repair.
As Erskine notes, it was once legal to leave a park to a city forbidding African Americans to use it. No more, of course. It is illegal to require beneficiaries to adhere to a faith, engage in specific sexual behavior, neglect public duties or perform illegal acts. "Within this broad scope, the client and planner can let their imaginations run wild," Erskine says.
Estate law does make it difficult, if not impossible, to keep beneficiaries secret from other beneficiaries. For a client who wanted to provide for a paramour as well as his wife, Whitty advised a life insurance policy naming the other woman as beneficiary and accepted instructions to provide her with a death certificate that would enable her to collect on a claim. "That way, there's no probate dispute, no challenge to the will and in fact, if the paramour knew she was named as a beneficiary under the life insurance policy and filed the claim as soon as the guy died, she could have her benefit as soon as the insurance company processed it," Whitty says.
Although this strategy avoids a challenge to the will and makes it easy for the other woman to collect, it doesn't assure secrecy. If the client's wife dies first, she may never know. Otherwise, she's likely to notice taxes on the policy payout. Life insurance is subject to estate tax, and the policy will show up on the estate-tax returns. The beneficiary of the life insurance policy is not his spouse, so there is no marital deduction that shields it from estate tax.
If the client's wife is still alive at that time, Whitty thinks it will be nearly impossible for her not to find out. "Even if she's not a trustee, she'll probably want to go through the schedule of assets on the estate-tax returns," he says. Adding insult to injury, she'll almost certainly end up owing the tax.
Residents of community property states do have a little recourse in this situation. The deceived spouse could challenge the insurance premiums as a misuse of their funds, also known as "fraud on the community."
If, after bequests to the spouse and other friends and family, the remainder of the estate, known as the "residue," is not going to the spouse-for example, to charity-she might succeed in winning back some money. The claim would be that the funds used fraudulently should go to her rather than the charity. But if the residue of the estate was going to the spouse anyhow, she's out of luck.
Did Whitty's client succeed in taking his secret affair to his grave? He's still alive, so the trust arrangement hasn't been tested yet.
Secrecy wasn't the issue when Joshua Hatfield Smith, an independent financial planner with Raymond James in Rockville, Md., designed a solution for a threesome. His clients were three men in a committed relationship. Two of the three were quite wealthy, while the third made much less as a social worker. The threesome wanted to equalize their income, both during their lifetimes and in their estates.
The solution: the two wealthy partners each donated the equivalent of $13,000 per year (the cap on the amount that can be gifted before tax kicks in) to the third, who then bought life insurance in their names, with himself as the beneficiary. The strategy allowed the less wealthy partner to receive tax-free payouts if either of the other two died, avoiding probate. At the same time, the premiums did not add into their gross estates and therefore did not add to the estate-tax bill.
An interesting wrinkle comes up when donating collections to charity. Success means snaring the estate a full tax deduction of the fair market value; failure means the giver simply writes off the original purchase price.
The key here is that the collection must be in sync with the beneficiary's charitable purpose. As Erskine says, that means a client's collection of rare 19th-century pornography cannot go to the Roman Catholic church, but it could perhaps find a home at, say, Yale University, which has an extensive art gallery. Another approach is to put a collection up for sale and donate the actual sale price to the charity. The client will pay the capital gains tax, but will get to write off the full cash amount of the donation.
One clever way to give money away tax-free is through a Health, Education Expense Trust, known as a HEET. In this case, the restrictions on the bequests from the HEET take advantage of the fact that money paid directly to an institution for the benefit of another for either health or education-related costs is not considered a gift for gift-tax purposes. Erskine points out if this were the case, parents would have to pay taxes on college tuition and family health insurance plans.
Sometimes clients just need to talk about their wilder ideas, rather than put them in action. In the end, Whitty's client decided against the casino night. "He said, 'If I'm going to do it, I'll do it while I'm alive. That sounds like too much fun to miss,'" Whitty recalls.
Elizabeth Wine is a freelance writer living in New York.