For those who made much of musician Prince’s lack of a will after his unexpected death in April, estate planning attorney Ilene McCauley sounds a harsh wake-up call.
There’s no such thing as a person without an estate plan, says McCauley, principal at Goldinov & McCauley in Scottsdale, Ariz., and a speaker at the 2016 NAPFA conference in Phoenix. “If you don’t have an estate plan, the state you live in will give you one,” she says.
QuoteThere’s no such thing as a person without an estate plan.
That’s exactly what happened to Prince Rogers Nelson, who died on April 21. “He died with hundreds of millions of dollars in assets,” McCauley says. “He was a brilliant singer, a brilliant man, a brilliant businessman, but for whatever reason he did no estate planning.”
The Prince estate has been estimated at $250 million. The performer had one full sister, five half siblings and may have an adult child, pending a DNA test. “The estate will pay $100 million to the federal government, due nine months from the day he died,” McCauley says. “The planning he could have done would have eliminated estate tax at his death.”
Prince’s estate will also be distributed to siblings he cared for as well as to those he may have disliked (Minnesota law treats full and half siblings identically), and possibly to a son he never knew. Estate planning, McCauley says, allows people to control their property while they are alive, take care of themselves and their loved ones if and when they are disabled, and give what they want, to whom they want, how they want, with the least possible cost and hassle.
NO PLAN, NO CONTROL
“Estate planning is about control, full stop,” McCauley says. “If you don’t plan, you have no control. Property passes to unintended heirs in unintended ways. You lose planning opportunities, create excellent opportunities for creditors and predators, and spend way too much in tax dollars.”
QuoteEstate planning is about control. If you don’t plan, you have no control.
McCauley says that a variety of trusts could have provided Prince the control he otherwise demanded in his creative endeavors. “Prince could have had his money go wherever he wanted after his death, tax-free,” she says.
A foundation trust would have combined well with a charitable remainder and/or a charitable lead trust, she says. A charitable remainder trust is designed primarily to save on income taxes. The person creating the trust funds it with appreciated assets, can take an income tax deduction over five years, receives an income stream for life and can assign the stream to a second person as well. At the founder’s death, the trust’s assets go to a selected charity.
Alongside a charitable remainder trust, Prince could have used an irrevocable life insurance trust, or ILIT, which puts money into a trust and uses the principle and increase to buy life insurance on the founder. The death benefit is a tax-free way to replace the money going to charity. “I’ve rarely done a charitable remainder trust without a life insurance trust,” McCauley says.
A charitable lead trust, on the other hand, pays income first to a designated charity organization. The remainder passes to heirs, free of estate and income tax. There is no income tax deduction for the founder, who also pays tax on the trust’s investment income during his or her lifetime. This trust is a good tool for passing assets tax-free to the next generation.
GROWTH WITHIN THE TRUST
“Usually there is great growth within the trust, so families end up with a lot more,” McCauley says. Charitable trusts are irrevocable, though the founder can change the trustee and/or the charitable beneficiary.
An intentionally defective grantor trust, or IDGT, is another vehicle for moving assets on to the next generation. In an IDGT, the founder loans the trust assets, receiving an interest rate below the rate at which the assets are expected to appreciate. The grantor pays income taxes on trust income, allowing the assets to appreciate unencumbered by that expense, and beneficiaries receive the assets tax-free.
“You can also design an IDGT that invests in annuities that don’t pay out immediately, so you pay no income tax,” McCauley says.
QuoteCash goes out, real estate goes in, as long as the values are the same.
IDGTs are irrevocable and not changeable, McCauley says. Grantors and beneficiaries pay neither gift tax nor estate tax. “These are for people who have tons of money and really want to reduce their assets and pass everything to the next generation,” she says. “You can do your charitable giving through an IDGT, and you can also move equally valued assets into and out of the IDGT. Cash goes out, real estate goes in, as long as the values are the same.”
GETTING CLIENTS ON BOARD
With any trust, it’s important to ensure that the client’s cash flow will be adequate to meet future needs. “Clients will be really ticked at you when they go to the lawyer to unravel this when it’s 10 years later and they can’t pay their bills,” McCauley says.
QuoteThe hardest part of creating trusts is persuading clients to take action and regularly review their plans.
The hardest part of creating trusts, McCauley says, is persuading clients to take action and regularly review their plans, making whatever changes are necessary. “I have clients come in for yearly updates at discounted rates,” she says. “I have yet to have a client who hasn’t made a material change.”
It’s too late for a planner to persuade Prince to work on his estate — but it’s not too late for your living clients.