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Trust Issues

“So-and-so can’t see the forest for the trees”, is a colorful way of describing a person who focuses on a particular detail of a situation to the extent that he/she totally misses the larger picture. Exactly the kind of person you do NOT want as a trustee for your special-needs (or indeed any other) trust.

In an ideal world, the trustee of a special needs trust should be someone, who is 1) familiar with the trust beneficiary and her or his lifestyle, 2) is well versed in the regulations surrounding certain Social Security and Medicaid benefits and 3) is an excellent and prudent investor. Often it is difficult to find one person who combines all of these qualities, and thus it is not unusual to have multiple trustees. There may be an individual trustee, often a family member or close friend, whose role it is to liaise with the beneficiary and understand which of the beneficiary’s needs that the trust can and should meet. There may be a professional trustee with a social work background, who helps to ensure Social Security and Medicaid compliance. Then, there may be a bank or other financial institution, charged with the job of investing the trust’s assets.

It is totally acceptable and often a very good idea to have, if not multiple trustees, advisors to the single trustee, who each have a particular expertise. However, it is crucial that all involved in managing the trust and its assets have the same objectives and approach. It is especially important for the grantors (those who create and usually fund the trust), and the primary trustee to be very, very clear about how the trust is to function and what it is designed to achieve. I ran into an example of what not to do recently. The case involves a simple revocable living trust, rather than a more complex special-needs trust, but it does illustrate the conflicts that arise when all trust parties are not on the same page.

An actual client came to me with funded revocable living trust. A regional bank’s trust department had managed the assets for years. The client was comfortable with the bank and wanted them to continue managing the assets. The assets had seen respectable, if not exceptional, growth for the 25 years that the bank had managed them. The client’s circumstances, however, were changing. Approaching her 80th birthday, this client is now primarily concerned not with asset growth and capital preservation, but with long-term care and her legacy. As a single person from a long-lived family, she wants to make sure that she has sufficient assets to provide for her own long-term care, even if she needs this care for an extended period of time. At the same time, this client wants to leave a lasting legacy through generous donations to charities working on behalf of migrants and underprivileged women and children around the globe.

We cannot predict how much of her trust money she will need to care for herself, and how much may be left over to fund her favorite causes, but we do want to maximize the resources that are available for both. If she self-insures for long-term care, she risks exhausting all her money if she comes to need many years of high-level care. If she purchases traditional long-term care insurance, the premiums will be very high, given her age, and the money will be lost if she does not need to use the insurance. We thus decided to take a portion of the assets to purchase a life insurance policy that can also be used for long-term care and also add a rider so that the long-term care benefits will continue as long as necessary, even if the policy funds are exhausted. What she does not use for long-term care remains as the life insurance death benefit and will go to the charities when she passes from this life. The remaining trust assets that she will donate to the charities over the next 10 years will allow her to see her money at work for her causes.

Donating appreciated assets to a charity provides a double benefit to the donor. First, no one has to pay tax on the capital gains if the donee is a registered 501(c)(3) or a similar charity. By contrast, if the donor were to sell the asset and donate the proceeds, the IRS would get its cut and the charity would get less. Second, the donor gets a charitable deduction on her/his tax return, further reducing tax liability. Most of the equity securities held by the trust carried unrealized capital gains. All of the fixed-income securities carried modest unrealized losses. Our plan, therefore, was to sell the fixed-income securities to pay the life/long-term care insurance premiums and reserve the equity securities to fulfill the client’s charitable giving plans.

So far so good here. But a glitch appeared when the bank that was managing the money did not understand the implications of these new goals. The bank has the assets in a managed portfolio that is 60% equity and 40% fixed income. Their primary objective, as they understood it, was to maintain that balance. As the market moved, they bought and sold equity and fixed-income securities taking into account the risk/return expectations of each asset but little else. They were about to sell a block of highly appreciated stock, a move which would not only leave the client on the hook for the capital gains tax, but might also raise the tax on her salary—she loves her work and is still at it—and would make her Social Security benefits taxable as well. A three-way conversation set them straight and now the client and I must pre-approve all trades. Disaster averted! If you know which trees to cut and which to keep, the forest will be the most productive.

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