Jan Copley: Thank you and thank you for joining me today. Brenda and I did a little bit of brainstorming about what’s due for this year’s presentation, and we decided that asset protection for weird assets would be the overall theme of the day.
I volunteered to talk about asset protection for retirement benefits for two reasons. First of all, it’s important. For many, many people, it’s a major part of their retirement. The second reason is it’s really, really complicated and this gave me a reason to bone up on all the legal technical stuff.
The other thing is, what you may or may not know is that, yes, I’ve been doing estate planning for a long time. But before that, I started my life as a bankruptcy attorney. I think I have some kind of sense of what asset protection really involves. I’m hoping that this discussion will be helpful to you for that.
We care about asset protection for our clients, both for the retirement benefits, and just in the general broad spectrum, because we want to help them. Most people work hard for what they have, and they want to be able to protect it in case some kind of misfortune happens.
It doesn’t necessarily have to mean a lawsuit. Brad Dorsey is here to talk today about asset protection in case you have a catastrophic illness, with all of the expenses that come with that, and then it can help ourselves. If we are able to help our clients keep their stuff, the financial advisors in the room have more assets under management.
That’s a certain amount of self interest, but that’s OK. If we can help our clients, we can help get ourselves out of trouble by avoiding advising people incorrectly, or seeing a possibility and knowing when to tell our clients to go see somebody to help them. Then hopefully this might be useful to you too, if you have some concerns about preserving your wealth.
I thought I would start today by giving you a primer on what asset protection is, and then a primer on retirement benefits, and then weave them together. I am hoping that I don’t insult anybody if it gets a little bit too basic. I got a smile or two. If I am insulting you, let me know and I will move on. No, back. I want the why slide, I’m sorry.
Why do we do asset protection? The first and most obvious is that not everyone manages their life well. How many of you know a 19‑year‑old that manages their money well? Yeah. How many of you know a 19‑year‑old who doesn’t manage their money well? Especially, in my life as a Bankruptcy Lawyer, what I have learned is that there are some people that never manage their lives well. For whatever reason, it just doesn’t work for them.
We want to put structures in place, so that even that they can’t do it, many parents want to make sure that their kids have a safety net. That’s one reason for doing Asset Protection.
Another reason is creditors and predators. We can get in trouble for whatever reason. We’re sort of pulling ourselves out of the great recession, and we’ve seen a number of people get in trouble. They’ve gotten in trouble a) because maybe they weren’t quite as rigorous about managing their finances as they might have been, or they lost their jobs. It really had nothing to do with them, and then suddenly finding themselves with some bills that it’s very, very hard for them to pay.
Then there are the “Predators,” as we call them in the estate planning world. The people that take advantage of people who don’t necessarily have the appropriate knowledge that they need to manage their affairs.
We have CPA’s in the room, so you’re aware of the IRS’s dirty dozen for tax scams. We all know people that have fallen for investment advice that is just too good to be true. The predators might also be that child in law, who you just don’t really like, but who your kid insisted on marrying anyway. There are people who take advantage of people for whatever reason.
Then things happen. You can get an automobile accident. You can get sick. Stuff happens that doesn’t have anything to do with managing your life, not managing your life. It just happens. That can produce flames against you, and maybe a threat to your nest egg. It’s litigious out there. Our legal system is such that anybody can sue anybody for anything. They may not win, but it is a pain, and it’s expensive to defend a lawsuit.
Asset Protection is a way of protecting your nest egg, but it’s also a way of making it really hard for the creditors out there. That’s kind of the point of my primer, as far as what Asset Protection is that even if there’s a claim against you, you make it tough for people, so that they give up. They settle with you, rather than going full‑board against you, because they know it’s just going to be so hard to get at your stuff.
Next slide, “When?” When do you do Asset Protection? Hopefully, you do it when things are copacetic. When the client comes to you, and they say, “Life is good. We’re making some money.” You say, “Great.” “Now tell me a little bit about what you own.” And they say, “Well, I have a five unit apartment building down the street.” And you go, “Oh dear, Oh my goodness.” And they say, “Yeah and I inherited the gas station from my dad and we’ve raised it and we’ve put a dry cleaner on top of that,” and you are thinking, “Oh my God, environmental liability.”
They say, “I’ve got a 16‑year‑old and they just got their driver’s license” and you are thinking, “Oh my God, he is a nice kid but he is 16.” You want to do the asset protection then when there aren’t any claims on the horizon, before you discover that your tenant is running a crystal meth lab in the kitchen of your rental unit, before the EPA swoops down on your gas station, and before your kid gets in an automobile accident. So that is the time to do the planning.
If somebody comes to you and says, “Yeah, I’ve got all the stuff and life’s good but I got served with a lawsuit yesterday,” it’s probably too late and that point I would suggest that you talk to the really aggressive asset protection planners out there and bring them, I know a couple, if it gets there, but it’s usually too late after the claim has arisen because there’s something called fraudulent conveyance statutes.
These things go back to the time of Queen Elizabeth I and basically if you transfer assets with the intent to hinder, delay and defraud your creditors, those transfers can be set aside as far that creditor goes, and you can incur liability as a result of it. So the classic fraudulent conveyances, you get served with a lawsuit and you say, you know my brother‑in‑law is a good guy, I am just going to give all my stuff to him. No, those can be set aside.
A very classic fraudulent conveyance is I am just going to put it all in my spouse’s name. In some states that might work but in California where a community property estate your spouse owns half of it anyway, it’s not going to make any difference. But those transfers can be set aside and if you are not in bankruptcy the creditor that you are trying to avoid can undo them. If you are in bankruptcy the bankruptcy trustee can undo them, and there are criminal penalties for engaging in fraudulent conveyances.
You can spend five years in jail under California Law and under Federal Law. Another thing is if you are looking at a bankruptcy and engage in fraudulent conveyances before you file for bankruptcy, you can lose your discharge, which means you go through bankruptcy, you lose everything but you don’t get any of the relief that goes with it. This will not happen to any of you but it might it happen to some of your clients, and so hopefully you can do a little bit of issue spotting of when to do it and when not to do it.
The next slide is the how, and the first how is what we call exemption for your name. I will read these together as we go along what does this have to do with retirement benefits. We don’t have debtors prison here in California. Apparently in Colorado if you are really mad at somebody who owes money to you, you can have them put in jail as long as you pay for their incarceration expenses. I am not making this up but well I haven’t checked the statute recently. In California we do not authorize that.
The laws provide people who owe money, who are in financial trouble, who are going through bankruptcy to keep certain property. It is called their exempt property and is designed so that they don’t wind up on the street that people who owe money can continue to feed their family that they continue to earn a living and maybe pay off your debt. These exemptions apply before you are in bankruptcy, let’s say you just have one claim against you, or if you file a bankruptcy, or if our client files a bankruptcy. The law allows you to keep some of your stuff.
I can tell you that California is not a particularly debtor friendly state. I am sure you’ve heard the best example I know of somebody who is in financial trouble and did just fine was O J Simpson until he got in a little bit more trouble and he is now in jail. But he moved to Florida, he had a nice house, and he was living well.
That’s because under Florida Law his house, no matter what the size, what the value is exempt from the claims of creditors. The same rules apply in Texas. They apply in Kansas. I don’t know where else they apply, but you can have a house of any value. You can have a farm, you can have a mansion.
O J Simpson, most of his wealth came from his 401(k) and his retirement plan through the NFL, the National Football League. Those plans are qualified under ERISA, and those plans are exempt from the claims of creditors as long as you keep the money in that plan. Some states also say that your IRA is completely exempt from exemption. Kansas, Florida, Texas, I think Nevada. California does not. California has some limitations on it.
California allows you to keep not very much equity in your house, $75,000 if you’re single, $100,000 if you’re married, $175,000 if you’re over 65. You may say, “Well, where can you get a house for that kind of thing?” Well, you can do it in Needles or Weed otherwise it gives you a nice down‑payment on your house. You can keep a car. You can keep your household furnishings, and you can have $9700 cash value in a life insurance policy.
Things that bankruptcy attorneys do, is we do something called exemption planning. If somebody comes and they are in financial trouble, you can take a look at what they own and try and convert some of their nonexempt property, like the money in the bank, into exempt property.
Maybe you pay down the mortgage on your house a little bit, while you’re still in the exemption level, or you buy the life insurance policy. A husband and wife can shield not quite $20,000, so you have $20,000 cash value in the life insurance policy. You can buy a funeral plot. You can spend some money improving your home. Maybe you can buy an annuity based upon the rules.
There is case law that specifically says that exemption planning is not a fraudulent conveyance. It’s allowed. It’s something that you can do, and so, if a client comes to you in financial trouble, it’s time to sit down with a bankruptcy lawyer about exemption planning. I will give you one proviso. The cases are kind of across the board, and you just want to remember that pigs get fat, hogs get slaughtered.
You can read the cases where people were really aggressive about exemption planning. Those people tend to lose their bankruptcy discharges. The exemption planning tends to get put aside. It’s a very fine line to walk.
Next slide, please.
Another way of doing asset protection planning is entity planning. The way you own your stuff can shield you and can shield those assets. The classic one is setting up a corporation. Of course, for Brenda and me, we can create a corporation and it doesn’t do us any good because we’re still on the hook anyway.
If you own a hardware store, or something like that, and you own your hardware store in the name of your corporation, theoretically you are not personally responsible for the debts of the hardware store or the claims arising from the operation of your hardware store.
If somebody’s walking down the aisle and something falls off the top shelf and hits them on the head, you, personally, are not supposed to be responsible for that. Now, I could spend days talking about piercing the corporate veil. I won’t. Anyway, that’s a classic version of entity planning.
We now have Limited Liability Companies, which also provide us with some entity planning. Then, some ways it provides more protection than corporate planning because some states are selling their laws, basically, provide very debtor‑friendly planning for a Limited Liability Company. If a claim arises from the operation of a Limited Liability, the creditor can only look to those assets inside the Limited Liability Company.
If you have a claim against you, a creditor can seek to get your corporate stocks. So, Richard, I can get the Richard Musio Inc. stock, but if it’s Richard Musio LLC, I theoretically am only entitled to a charging order, which means that I’m only entitled to the income that comes out of the corporation, or of the LLC. If Richard is running the LLC, how much income do you think is going to come out of it? Probably not, right? So it’s a little bit more protection.
You can create a trust. In fact, most trusts probably have this provision. It’s called a spendthrift clause. You can create a trust that says the assets in this trust are not subject to the claims of creditors.
In California, if you create a trust for somebody, and it has spendthrift provisions for the beneficiary, those provisions are effective. Terry, I create a trust for your benefit, and I say, “Terry’s a good guy, but he needs to show a little bit more maturity and not spend so much money, and so we’re going to have a different trustee.”
If Terry gets in financial trouble, those assets are not subject to the claims of his creditors. His creditors can’t reach them. Those are effective under California law, and they’re effective under the bankruptcy laws, as well.
I can’t do that for myself in California. I cannot create the Jan Copley irrevocable trust, and it says this is not subject to the claims of my creditors. However, I can do that in some other states, Nevada, Alaska, Delaware. There are some other states that basically say if I create an irrevocable trust for myself, and the trust says that these assets are for my benefit, and my creditors can’t reach them, it is effective in those states.
Now, you generally have to have a trustee sited in that state. In Alaska, the statute was written by the brother of the fellow who owns the Alaska Trust Company. There’s some stuff that goes with this. I’m not making this up, but it is a way of protecting yourself.
Whether or not these are effective is another story, it goes to Constitutional Law. Let’s say you are a creditor and you bump up against Jan Copley, who’s created this Alaska Protection Trust for herself. I have to move my judgment to Alaska, talk to the Alaska trustee, have the Alaska trustee say, “Sorry. No way, Jose,” file a challenge to that in the federal court in Alaska. Am I going to do it? No. I’m just going to say, “All right, Jan. Pay me 50 cents on the dollar. I’m going away.” “Yes sir.”
Audience Member: If you have a property, say domicile, outside those states, and you wish to put it into the trust, if there is an encumbrance on that property, don’t you have to notify the lender, and they would have approval rights to accelerate the loan?
Jan: The question is what if I have real property with a lien against it, and I want to put the property into one of these irrevocable trusts, will the lender call the loan? I have to give you the lawyer answer, which is, it depends. It depends upon the lender, it depends upon their perspective. If you’ve got a loan with a lender and you’re paying eight percent, they’re probably not going to call the loan.
The other thing is that if it’s a personal residence, if it’s small, there’s no particular thing on it. On the other hand, that’s something to think about if you’re transferring property to the LLC or the irrevocable trust or those kinds of things.
Finally, you can do offshore planning. You can do planning in the Cook Islands or the Isle of Man. Basically, those countries say, “Yeah, fine. You’ve got a judgment against you, we don’t recognize California law.” You can have the stuff here, but you have a trustee in the Cook Islands who’s managing your stuff. Basically, if somebody gets a judgment against you and tries to get the assets that are held inside the Cook Islands trust, the trustee says, “Sorry, we don’t recognize judgments.”
There’s one very famous case where somebody did that. They were involved in a Ponzi scheme, and the Federal Trade Commission got a judgment against them and they couldn’t get at the assets in the Cook Islands. The debtors wound up in jail for contempt of court, but the FTC never did get their stuff, and after a couple of years the debtors got out of jail.
Now, it’s your decision about how much you want to risk this. Can you see the kind of leverage you get with that kind of things? When I teach asset protection on a visual level, and maybe you want to flip your page over, you can write “asset.”
Then you can draw a box around it that’s exemption, and then you can draw a box around it that says “limited liability company.” Then you can draw a box around it that’s a domestic asset protection trust, and then you can draw a box around it that says “offshore trust.”
For some people, this kind of planning is useful. It especially works if you’ve got somebody that sold a business, because very often, the people who buy the business can’t do it and they blame it all on the seller. In the mean time, the seller has retired to Costa Rica and they really need this money to retire on. You like that. The domestic asset protection trust and the offshore trust planning is a good way of shielding them.
Let’s go next to retirement plan basics. That’s your asset protection primer. Do not do this at home. I’m just giving you the very, very most basic ideas, but it’s an idea to give you the concept. Retirement plans, you’re familiar with ERISA plans. You’re familiar with IRAs. You’re familiar with required minimum distributions. You’re familiar with the concept of stretch outs. I just put this up there because it all blends in within the context of asset protection planning.
One problem with asset protection planning for retirement benefits is only people can own them. You can’t put them in the LLC. Maybe you can do it in the domestic asset protection trust. We’ll get to that in a minute. You can own the IRA. You can also have a trusteed IRA.
This is something that was really cool for me to learn about, is if you have a trust that is a grantor trust, and this is a technical term, and Brenda and I can spend some time opining upon it after class, but basically the trust is invisible for income tax purposes.
You run it under your social security number. If you are the sole beneficiary of your trust, that trust can own your IRA. It is not deemed to be a withdrawal. You can still take the required minimum distributions based upon your life expectancy.
Now, I have to say that this theory works on a legal level. The IRS and some PLRs, private letter rulings, have blessed these, especially for people who have inherited IRAs and created a trust to own their inherited IRA. There’re a couple of other private letter rulings that aren’t quite so clear. The theory is you can set up a trust to be the owner of your retirement account.
I like this concept not just for the asset protection planning concepts, but one of the problems that Brenda and Brad and I find with estate planning is people have the $2 million retirement account. They have the $2 million IRA, and we can’t put it in their living trust, or we may not be able to put it in their living trust because the living trust says, “These assets are available for the benefit of my spouse, my kids, whatever, as well as me,” and so you can’t do that.
If the plan participant gets sick, the assets are managed pursuant to the terms of a power of attorney. An institutional trustee is perfectly happy to be trustee of the trust during incapacity, but they’re not willing to be the agent under the power of attorney.
One reason you may have named the institutional trustee is because you don’t trust anybody around you, but who are you going to name as your agent under the power of attorney if the institutional trustee’s not going to work? For some, in certain instances, this might be something very worthwhile to look at. For the elderly person who’s alone, for the people who don’t trust their kids, that kind of stuff.
I want to say, because I run into this daily, it is the bane of my existence. If I’m insulting you, please let me know, but I am always told by financial institutions, “No, you can’t name a trust as a beneficiary of an IRA.” You can, you can, you can, you can, you can, and sometimes it’s a good idea.
There are five aspects to this. A trust has to be valid under state law. I’ve got to tell you, if you can’t get your trust valid under California law, you have no business being anywhere. It is so easy, and if you want to check with me the statute after class, let me know.
It has to be an irrevocable on the participant’s death. That’s a no‑brainer. That’s what trusts are. The beneficiaries have to be identifiable. That doesn’t mean I name Terry, I name Richard, I name Lan, I name Albert as my beneficiaries. You can say “my issue,” and when you die, people will know who your issue are. They will know your kids, your grandkids, whatever. You don’t have to be specific by name.
You have to provide certain documents to the plan administrator. Basically, that means that you have to provide a copy of the living trust to the plan administrator by October 31st of the year following the year of your death. You can do some shortcuts, but that’s the easy thing to remember.
Finally, all beneficiaries are individual. You’re all familiar with the concept that you cannot have a designated beneficiary if that person is your estate, if that person is a charity, if that person is the state for whom you’re paying taxes. If you draft the trust, or if Brenda and I and Brad draft the trust appropriately, the trust can be the beneficiary and the assets can flow through.
Now, why would you do that? How many of you know 19‑year‑olds who aren’t particularly good at managing their money? Or, I did this yesterday afternoon. I created some separate standalone retirement plan trusts for some clients, and they have a son, and son is a responsible fireman. Son has a five‑year‑old. They like his wife well enough, but they’re tired of being an ATM for their son. They have some concerns about son’s wife’s family’s visions of money.
Also, he has about a million and a half dollar IRA and he wants that to be a safety net for his son. What we’ve done is provided that the assets are held in trust for the benefit of son. He sees the required minimum distributions based upon his life expectancy, because you can get the stretch out if you flow it through a trust, and that somebody else is the trustee until son turns 50.
That way, they’re preserving the wealth. They’re making sure somebody else is controlling it. This means that son’s wife’s family can’t get at it because it’s held in trust. It means that if son and his wife break up, wife can’t call that community property. It means if son gets in some kind of financial trouble, creditors can’t get at it.
If son inherits the IRA outright, you may not have those protections. Son can go down to the bank and say, “I want it all, give me,” so much for the safety net, right? Son might then roll it over into the joint bank account and then wife says, “I’m tired of living with you. Half of that is mine.”
That’s one problem with naming somebody individually as the beneficiary of a retirement account. You have none of the structures and controls that many, many people want for protecting their wealth throughout their bloodline for other purposes.
Now, under California law, your public retirement benefits are exempt period, end of story. If you have a 403(b) or a pension plan through CalPERS or something, those assets are exempt, end of story. Your 401(k), your defined benefit plan under ERISA are exempt under the ERISA rules.
If you have an IRA or a private retirement plan, those are only exempt to the extent necessary for your support and your family’s support upon your retirement. My client with the million and a half dollar IRA, if he were in bankruptcy, he would probably see some of that go to the bankruptcy trustee. These people are in their 60s. They may say, “You’re going to have to sell a couple of your houses, and your lifestyle’s going to be a little bit more modest,” but some of that would go.
You may say, “Yeah, but I’ve heard that in bankruptcy you have this million dollar exemption,” but not in California. That’s a federal exemption, and California has opted out of it. There are some real restrictions on protection of your retirement account.
You can maybe use some of the money for other exempt property. There are some laws, and it’s complicated, I’m only going to touch on it. If you can trace the money in your IRA that came from another exempt account, like you rolled over your 401(k) or your pension plan into an IRA, if you can trace it that might be exempt. There’s a California case that says that.
Anyway, that’s asset protection planning for the plan participant. If you’re working with somebody who is looking to retire and it’s really important that they keep all of this, they need this or you see a problem on the horizon with maybe protection, the easiest way to protect it is to keep it in the ERISA plan. That way, you may not get control of it.
You certainly don’t have the flexibility under the company 401(k) that you do with a retirement account, but you might want to be very careful that you don’t roll this IRA money into the other IRA that they put together with their $2,000 a year that they went to the bank and got the toaster from. You might want to set it separately. That’s the first step of asset protection for the plan participant.
The other thing is if somebody’s really looking like they’re in trouble, tell them to move. Move to Texas, move to Kansas, move to Florida. Maybe it’s protected there. There are some statutes that say that if you do this and then you filed for bankruptcy, you have to have lived in that state for 10 years. This is when somebody owns the apartment building. You say, “Let’s move to Florida now.”
One other thing is I like the idea, I haven’t experimented with this and I don’t know if it’ll work, and I haven’t read any cases, but remember I was talking about the trusteed IRA? What if you created a trusteed IRA with the domestic asset protection planning stuff in it? What if you created the trust to own your IRA that is exempt from the claims of creditors under Delaware or Alaska law?
You’re going to have to file a plan custodian who’s willing to do it, but I bet the Alaska Trust Company would. That might be another way of protecting wealth and protecting your client. That’s asset protection planning for the plan participant.
Asset protection planning for the beneficiary goes through trust planning, which is what asset protection people do for beneficiaries. Like I said, I’ve already riffed on this, that if you name your kid as your beneficiary it goes to them out right, and there’s basically no protection for them.
You can have an inherited IRA, and it’s easy. The IRA is set up as Jan deceased for the benefit. Who haven’t I picked on here? Elizabeth. Elizabeth, you just inherited a couple hundred thousand bucks. It’s not going to change your lifestyle, but it’s something that would be tempting to the 19‑year‑old. You, of course, would be responsible and deal with it.
But an inherited IRA, the IRA may be exempt for the plan participant, but the case law is really quite contradictory as if that exemption applies to inherited IRA. So let’s say I live in Florida. I have an IRA. It’s exempt. It’s completely exempt from the claims of my creditors. I die. I leave it to Elizabeth.
Elizabeth didn’t earn that money, and that’s not really earned by Elizabeth for the purpose of her retirement. It’s kind of a windfall that may or not be exempt. The cases are going both ways on that one so I would not rely upon this inherited IRA as being exempt. At that point what you may want to do is create the…leave the IRA in trust for the benefit of Elizabeth, or Brenda, or Albert, or whomever. I can’t read your tag. Anyway, everybody here wants to inherit my IRA.
There are two ways to leave your wealth in trust for a beneficiary, because just because somebody has inherited your IRA doesn’t mean that’s the only discussion. I already walked you through the five things that you have to have in the trust in order for the trust to quality as a designated beneficiary. But how the trust is set up upon your death affects how the distributions are handled to the beneficiaries and the extent of the asset protection.
The first one is call the conduit trust, and remember I was talking to you about this husband and wife who were creating the trust for the benefit of their son, and they want the son to get the required minimum distributions based upon his life expectancy to be distributed out of the trust every year to son. That is a classic conduit trust.
The distributions are distributed to the beneficiary. If you have multiple beneficiaries the stretch out is based upon the oldest beneficiaries’ lives. You can do some things in your beneficiary designations to fix this, but that’s another hour‑long presentation.
To the extent the assets are held inside the trust for the benefit of the beneficiary and the trust has a spendthrift clause those assets are not subject to the claims of the beneficiary’s creditors. However, the minute the money comes out creditors can get it.
In my particular case, son, he’s 36, so what’s he going to get, one sixtieth right now? If that one sixtieth of dad’s retirement account is distributed to his bank account, and a creditor can glom onto it, not that big a deal.
But what if son is 60? It’s a much bigger distribution, and the minute it comes out it’s subject to the claims of creditors, and under a conduit trust it has to come out. So in this particular case mom and dad are more, I think, concerned about their daughter‑in‑law’s family then they are son’s creditor stuff. They want this money available for a safety net for son and for their granddaughter. Well, incidentally daughter‑in‑law’s going to benefit from them so this works for them.
But another problem with the conduit trust planning is let’s say your beneficiary is a special needs beneficiary. They qualify for…they have a disability. They qualify for disability. They qualify for Medi‑Cal benefits.
You set this stuff up in a conduit trust. The required minimum distribution is paid to the beneficiary. You may have just disqualified them from public benefits. You say, “OK, cool, fine. That’s fine. We really want to support people on public benefits,” don’t provide people with great lifestyles anyway, but at least through the end of this year you’ve also disqualified them from health insurance.
I don’t know how the Affordable Care Act is going to affect this kind of thinking, but very often it is hugely important to keep somebody on disability if only for those reasons, to keep them on Medi‑Cal.
Naming a special needs child or a special needs person as the outright beneficiary of a retirement account or the beneficiary of a conduit trust is probably not going to accomplish what you want it to do. Brad, do you agree with me on that one? Not here, not talking.
The other thing you can do is an accumulation trust. An accumulation trust is a trust where the retirement account pays the required minimum distributions based upon the beneficiary’s life expectancy to the trustee, but the trustee holds on to them rather than passing it outright to the beneficiary.
That way rather than the beneficiary getting these ever increasing required minimum distributions, distributions are made to the beneficiary based upon traditional trust planning structure ‑ health, education, maintenance, and support ‑ maintaining your lifestyle. If they’re a special needs person enhancing their life based above what the public benefits buy, buying the flat screen TV, maybe paying for the private room in the convalescent facility.
Once again, the stretch out’s only on the oldest beneficiaries, the requirement of distribution are retained in trust. As long as they’re retained in trust creditors can’t get at the stuff. The state can’t get at the stuff for special needs planning, and you have a lot more asset protection planning.
You may be saying, “Why in heavens name would anybody do anything other than an accumulation trust?” There’re really two reasons. The first one is trust rates for income taxes tend to be much higher than trust rates for individuals.
Now, if somebody’s a special needs person they’re not earning a whole lot of money. Maybe that’s especially a consideration. But trust rates go up to the maximum…who’s the CPAs in this room? It’s like $12,000 or something like that. It’s amazing, and it’s suddenly is taxed to the federal rate of 35 percent. Whereas if the assets are…the required minimum distributions are passed out to the beneficiary you’re probably going to have lower income tax rates.
The other problem is it’s really hard with accumulated…you have to be very, very careful with an accumulation trust to make sure that you don’t have a beneficiary down the line who’s going to disqualify the retirement account from being a designated beneficiary.
Remember I said the designated beneficiary can’t be your estate. It can’t be used to pay taxes, can’t be a charity, something like that. With a conduit trust the IRS says, “Yes, it’s going to them. They’re the beneficiary. We can determine the oldest lifestyle.” Good.
But with an accumulation trust you have to take a look at who the first beneficiary is in trust and then who might inherit it from them until you find the last person ‑‑ and that has to be a human beating heart. It can’t be your cat. It can’t be the American Cancer Society ‑‑ who will inherit that money. If it is your cat, if it is the American Cancer Society, the whole thing, all the retirement benefits have to be paid within five years, pay all the taxes.
If for some reason or another one of those people potentially is older than your beneficiary the required minimum distributions are based upon the life expectancy of the oldest beneficiary. I have a trust, and I say, “My husband’s older than I am. He’s got enough money, fine. We’ll take it out of there.” I leave this to my issue. My issue are by definition younger than me, but if I adopt somebody I could go nuts and adopt somebody older and the required minimum distributions would be based on their life expectancy.
Or if I leave it to my heirs, well after my husband my next heir is my 88‑year‑old mother so you have to be very, very careful about naming this. I think the thing is this is a very good concept to talk to your clients about, especially if they’re worried about their children, especially if they’re worried about their wealth. But don’t do the beneficiary designation without at least consulting with somebody who has some expertise in this area.
For the wrap‑up the moral of the story is this stuff isn’t easy. Every time I delve into retirement benefits I sit there, and I think, “Who made this stuff up?” This is crazy, and why should it matter if you die if you’re 70 and 6 months and 10 days versus 70 and 5 months and 29 days?
Why should it matter if it’s a conduit trust or an accumulation trust? Why should it matter that the life expectancy is based upon my mother’s life expectancy when it’s just so unlikely to happen? But nobody asked me when they put together the rules, and those are the rules that we have to put together.
On the other hand it’s not easy, but it may very well be worth it, and I’m hoping that if nothing else today’s presentation opens up some ideas to you about some additional planning you can do to help your clients and when it might be worth it.
Another thing is something else might be simpler. Let’s say you have three kids. One’s a special needs child, and the other two are responsible people. Maybe you don’t want to make that special needs child the beneficiary of the retirement accounts at all.
Maybe you use your required minimum distributions to fund the life insurance policy in the special needs trust for your child, because then you don’t have all this required minimum distribution, and does it qualify as an accumulation trust, and do all of this other kinds of things. It might be better for you. Your clients will appreciate the simplicity, and you might make a little bit of a premium on it so that’s not such a bad thing either. But the moral of the story is if you do it right it can be done.
Now, I’ve zapped through what could very much be like two days of legal education. I’ve tried to avoid the lawyer problem of telling everybody everything I know and then just scaring them to death. I brought printouts of the California exemption statutes, the appropriate case law, a whole mess of stuff. I can talk to you about those detailed questions, but does anybody have any questions for me from today’s presentation? Yes, sir.
Audience Member: I just wanted to know about the look back period when you’re trying to protect these assets. Is there a set period of years?
Jan: Is there a look back period if you’re doing exemption planning? I’ll run you through some statutes. If you create a domestic asset protection trust the bank…and you file for bankruptcy, your trustee can look back 10 years.
Actually, there’s a case that came out this month where somebody created the Alaska Asset Protection Trust, and everything was copasetic when they did it, but they’ve since got into financial trouble, and it’s only been six or seven or eight years. The bankruptcy court said, “Uh‑uh. It’s all coming back into the estate.”
The statute for fraudulent conveyance laws in California is four years from the date of discovery of the transfer, because generally people don’t broadcast these transfers when they do them, or seven years from the date of the transfer, whichever is, but no later than seven years. In California if you’re not doing asset protection planning it’s seven years.
With exemption planning where I talked about you turn the un‑exempt asset into the exempt asset, there’s no particular bright line, but the longer it is the better it looks, and there’s a whole totality of the circumstances kind of deal.
Let’s say your client has…they’re getting in financial trouble, and you decide to set up a private retirement account for them, or they suddenly set up a 401(k) in the business that they’ve run for 25 years, and they’ve never had one before.
They do that, and then two weeks later they file for bankruptcy. Trustee’s likely to say, “Uh‑uh.” And if your creditors are really kind of upset with you, they’re likely to say, “No.” but if you set up a 401(k) a year ago and funded it as much as you can, that’s probably not a problem. Sorry, I have to give you the lawyer answer, which, it depends, but I’m hoping this is a little bit useful to you. Yes, sir, you got your hand up first.
Audience member: Life insurance in California, is it an exempt asset?
Jan: Is life insurance in California an exempt asset? It’s exempt up to…let me look it up so I can give you the exact figure. It’s exempt up to…where’d it go? I have to do this, because I wrote it down. It’s exempt up to 9,700 dollars of the cash value, and a husband and wife can shield 19,400. The death benefit a creditor can’t reach, but if you have cash value of 200,000 in your policy, yes, a creditor can get at that. You had a question.
Audience Member: Yes, you mentioned that under the accumulation trust there’s a potential problem with the RMD because the RMD is based on the oldest person’s life expectancy. So the question is can you have two trusts to break it up?
Jan: The question is can you have two trusts. You can have one accumulation trust, and so you’ll take the risk that maybe my heir will be my 88‑year‑old mother, and I don’t much care, and can I set up a separate trust as a conduit trust for my special needs child? The answer is absolutely yes.
Maybe your beneficiary designation says that 50 percent of my retirement account goes to the conduit trust created for the benefit of my doing well adult children, and the other 50 percent goes into the trust for the benefit of my special needs child. Yes, you can do that.
Audience Member: Can I set up a trust for each of my beneficiaries so everybody can use their own age?
Jan: The question is can I set up a trust for each of my beneficiaries so each of them can use their own age? The answer is yes. Another way of doing it is I create the Jan Copley Stand Alone Retirement Plan Trust, and I’ve got one trust for the benefit of my husbands, one trust for the benefit of my 40‑year‑old stepson and another for the benefit of my 45‑year‑old stepson.
My beneficiary designation can say a third to my husband, a third to my stepson, a third to my step‑daughter,” and they should be able to each take their own life expectancy. But you can’t just do the beneficiary designations saying, “I leave everything to the Jan Copley Trust.”
That tends to mess things up. It requires a little bit more than mindlessly filling out the form, which I’m sure none of you have ever done, but some other people do it. One more question, and then I think I get yanked off the stage.
Audience Member: You mentioned that the RMDs in the conduit trust would be subject to the creditors. What about other distributions that would emanate from the IRA?
Jan: The question is if we make distributions from the IRA other than the required minimum distributions are they subject to the claims of creditors? Anything that winds up in the trust beneficiary’s personal bank account is subject to the claims of their creditors.
I hope it’s been useful. If you have more questions, see me after class. Like I said, I came way over prepared. I want to thank Brenda for the opportunity to do this, because it means I’m feeling much more confident about these rules than I was before I tackled the project. Also, if I can be of assistance to you, please let me know. Thanks.