If you’re a parent, you probably have a will to make sure
your family is taken care of if something happens to you. What you might not
know is that a simple will won’t protect your children from some common
problems which can plague families when tragedy strikes.
Standby Guardianship Document
Many parents believe that naming a guardian in their will is
enough to make sure someone is available to take care of their children. However,
a guardian designation in a will has no effect if a parent is alive but unconscious
in the hospital.
Even in the case of death, a guardian named in a will has no
legal authority until a Petition for Guardianship is submitted and approved by
a court — a process that could take months. In the meantime, no one would have
the ability to authorize medical treatment for your child or to enroll your
child in school or health insurance.
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To make sure your child is always under the care of a
legally responsible adult, you must execute a Standby Guardianship Designation,
which triggers temporary legal guardianship until a permanent legal guardian
can be appointed by a court.
A Testamentary Trust
While many people think trusts are for only the very
wealthy, trusts should be a staple of every estate plan for families with young
children. There are several different kinds of trusts, but all of them serve to
hold and administer assets for a named beneficiary.
A trust is generally
created by a parent to hold and administer assets for their child until the
child reaches a certain age. The parent names a trustee, who is responsible for
administering the trust, and establishes conditions under which distributions
should be made to the child.
Trusts provide protection for your family in many ways.
Trusts prevent your child from having unfettered access to
his or her inheritance at a young age. In the absence of a trust, your child
could be given control of large sums of money at the age of 18 or 21 (depending
on the type of asset).
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Trusts relieve your your child’s guardian of costly and
burdensome legal obligations that would otherwise be imposed until the assets
are transferred to the child at the age of maturity.
If you have more than one child, a trust ensures that your
assets are fully available in the event that one child incurs unexpected
medical or therapeutic expenses. Otherwise, one sibling’s share of the
inheritance could not be used for another sibling, even in extraordinary
circumstances.
The most common type of trust is a testamentary trust. This
is a trust that is created pursuant to a Will and receives assets in the event
of a person’s death. For example, many parents have Wills directing that all of
their assets be transferred to a trust for their children in the event of the
parent’s death. The document specifies the conditions under which distributions
can be made from the trust and the age at which the children should be given
complete access to their inheritance.
Other trusts can be created during a person’s lifetime. Such
trusts can receive assets during the life of the trust maker.
A Separate Trust for Your Retirement Accounts
While a regular testamentary trust is sufficient to hold
most assets, funds that are held in a tax-deferred retirement account require
special planning. If funds in a retirement account are transferred to a trust
or estate pursuant to a beneficiary designation, income tax on the entire account
balance will be triggered upon transfer. When this happens, all tax-deferral
benefits are lost and the large amount of income pushes the taxpayer into the
highest tax bracket.
There are two ways to avoid this situation. The best way is
to name a special retirement trust as beneficiary of the accounts. Such a trust
has certain provisions that allow for continuation of the account’s
tax-deferral benefits.
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The other way is to name your children as the direct beneficiaries
of the accounts. In this case, the children would be given full access to the
funds at the age of 18 and the account would be subject to court supervision
and reporting requirements until that time. Moreover, funds left to one child
could not be used for the benefit of a sibling, if necessary.
Estate Tax Planning with an Irrevocable Trust
If your net worth plus your life insurance (your “taxable
estate”) exceeds, or is likely to exceed, $5.5 million in the next 10 years,
your family could end up with a tax bill for hundreds of thousands of dollars
in state and federal estate taxes at the very worst time.
Fortunately, this tax can often be completely
avoided by transferring your life insurance policies to an Irrevocable Life
Insurance Trust (ILIT). Unlike a testamentary trust, an ILIT is created during
your lifetime but survives after you’re gone. If your net worth plus your life
insurance exceeds or is likely to exceed $5 million within the next ten years,
you should talk to an estate planning lawyer about setting up an ILIT for your
family. Please note that certain information above applies specifically to
residents of New York State.
Shannon P. McNulty is an attorney at The Village Law Firm, Law Office of Shannon P. McNulty LLC specializing in estate planning for families.