A “family bank” professionalizes intrafamily lending

If you’re interested in lending money to your children or other family members, consider establishing a “family bank.” These entities enhance the benefits of intrafamily loans, while minimizing unintended consequences.

Upsides and downsides of intrafamily lending

Lending can be an effective way to provide your family financial assistance without triggering unwanted gift taxes. So long as a loan is structured in a manner similar to an arm’s-length loan between unrelated parties, it won’t be treated as a taxable gift. This means, among other things:

  • Documenting the loan with a promissory note,
  • Charging interest at or above the applicable federal rate,
  • Establishing a fixed repayment schedule, and
  • Ensuring that the borrower has a reasonable prospect of repaying the loan.

Even if taxes aren’t a concern, intrafamily loans offer important benefits. For example, they allow you to help your family financially without depleting your wealth or creating a sense of entitlement. Done right, these loans can promote accountability and help cultivate the younger generation’s entrepreneurial capabilities by providing financing to start a business.

Too often, however, people lend money to family members with little planning and regard for potential unintended consequences. Rash lending decisions can lead to misunderstandings, hurt feelings, conflicts among family members and false expectations. That’s where the family bank comes into play.

Make loans through a family bank

A family bank is a family-owned, family-funded entity — such as a dynasty trust, a family limited partnership or a combination of the two — designed for the sole purpose of making intrafamily loans. Often, family banks are able to make financing available to family members who might have difficulty obtaining a loan from a bank or other traditional funding sources or to lend at more favorable terms.

By “professionalizing” family lending activities, a family bank can preserve the tax-saving power of intrafamily loans while minimizing negative consequences. The key to avoiding family conflicts and resentment is to build a strong family governance structure that promotes communication, group decision making and transparency.

Establishing clear guidelines regarding the types of loans the family bank is authorized to make — and allowing all family members to participate in the decision-making process — ensures that family members are treated fairly and avoids false expectations.

Contact us to learn more about the ins and outs of intrafamily lending.

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It’s a matter of principle — and trust — when using a principle/ethical trust

For many, an important estate planning goal is to encourage their children/grandchildren or other beneficiaries to lead responsible, productive lives. One tool for achieving this goal is a principle trust (we sometimes call these “ethical trusts”).

By providing your trustee with guiding values and principles (rather than the set of rigid rules found in an incentive trust), a principle trust may be an effective way to accomplish your objectives. However, not everyone will be comfortable trusting a trustee with the broad discretion a principle trust requires.

Discretion and flexibility offered

A principle trust guides the trustee’s decisions by setting forth the principles and values you hope to instill in your beneficiaries. These principles and values may include virtually anything, from education and gainful employment to charitable endeavors and other “socially valuable” activities.

By providing the trustee with the discretion and flexibility to deal with each beneficiary and each situation on a case-by-case basis, it’s more likely that the trust will reward behaviors that are consistent with your principles and discourage those that are not.

Suppose, for example, that you value a healthy lifestyle free of drug and alcohol abuse. An incentive trust might withhold distributions (beyond the bare necessities) from a beneficiary with a drug or alcohol problem, but this may do little to change the beneficiary’s behavior. The trustee of a principle trust, on the other hand, is free to distribute funds to pay for a rehabilitation program or medical care.

At the same time, the trustee of a principle trust has the flexibility to withhold funds from a beneficiary who appears to meet your requirements “on paper,” but otherwise engages in behavior that violates your principles. Another advantage of a principle trust is that it gives the trustee the ability to withhold distributions from beneficiaries who neither need nor want the money, allowing the funds to continue growing and benefit future generations.

Not for everyone

Not everyone is comfortable providing a trustee with the broad discretion a principle trust requires. If it’s important for you to prescribe the specific conditions under which trust distributions will be made or withheld, an incentive trust may be appropriate.  But keep in mind that even the most carefully drafted incentive trust can sometimes lead to unintended results, and the slightest ambiguity can invite disputes.  It is possible to create a hybrid between the two, allowing your principles to guide the trustee’s discretion on the incentive provisions.

On the other hand, if you’re comfortable conferring greater power on your trustee, a principle trust can be one way to ensure that your wishes are carried out regardless of how your beneficiaries’ circumstances change in the future. We can help you decide which trust type might be more appropriate for your specific situation.

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Prepaid funeral plans may not provide peace of mind

The cost of a funeral has increased steadily during the past two decades. In fact, once all funeral-related costs are factored in, the typical traditional funeral service will cost an average family $8,000 to $10,000.

To relieve their families of the burden of planning a funeral, many people plan their own and pay for them in advance. Unfortunately, prepaid funeral plans are fraught with potential traps.

Avoiding the pitfalls of prepaid plans

Some plans end up costing more than the benefits they pay out. And there may be a risk that you’ll lose your investment if the funeral provider goes out of business or you want to change your plans. Some states offer protection — such as requiring a funeral home or cemetery to place funds in a trust or to purchase a life insurance policy to fund funeral costs — but many do not.

If you’re considering a prepaid plan, find out exactly what you’re paying for. Does the plan cover merchandise only (casket, vault, etc.) or are services included? Is the price locked in or is there a possibility that your family will have to pay additional amounts?

In addition, the Federal Trade Commission recommends that you ask the following questions:

  • What happens to the money you’ve prepaid?
  • What happens to the interest income on prepayments placed in a trust account?
  • Are you protected if the funeral provider goes out of business?
  • Can you cancel the contract and get a full refund if you change your mind?
  • What happens if you move or die while away from home? Can the plan be transferred? Is there an additional cost?

Another option

One alternative that avoids the pitfalls of prepaid plans is to let your family know your desired arrangements and set aside funds in a payable-on-death/transfer-on-death (POD/TOD) bank account. Simply name the person who will handle your funeral arrangements as beneficiary. When you die, he or she will gain immediate access to the funds without the need for probate.

If you have questions on the best way to fund your funeral expenses, we’d be happy to be of assistance.

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Worried about challenges to your estate plan? Make it “no-contest”!

Estate planning is all about protecting your family and ensuring that your wealth is distributed according to your wishes. So the idea that someone might challenge your estate plan can be disconcerting. One strategy for protecting your plan is to include a “no-contest” clause in your will or revocable trust (or both).

Our firm, Hill & Watchko, uses these clauses as a matter of regular practice.  Unless the client expressly directs us to remove the no-contest clause, it will appear in our Wills and Revocable Living Trusts.  We firmly believe in the right of our clients to leave their property to whomever they choose and in the proportions that they want.  The no-contest clause can help carry this out.

What’s a no-contest clause?

A no-contest clause essentially disinherits anyone who contests your will or trust (typically on grounds of undue influence or lack of testamentary capacity) and loses. It’s meant to serve as a deterrent against frivolous challenges that would create unnecessary expense and delay for your family.

Most, but not all, states permit and enforce no-contest clauses. And even if they’re allowed, the laws differ — often in subtle ways — from state to state, so it’s important to consult state law before including a no-contest clause in your will or trust.  Georgia law allows for such provisions.

Some jurisdictions have different rules regarding which types of proceedings constitute a “contest.” For example, in some states your heirs may be able to challenge the appointment of an executor or trustee without violating a no-contest clause. And in some states, courts will refuse to enforce the clause if a challenger has “probable cause” or some other defensible reason for bringing the challenge. This is true even if the challenge itself is unsuccessful.

Are there alternative strategies?

A no-contest clause can be a powerful deterrent, but it’s also important, wherever you live, to design your estate plan in a way that minimizes incentives to challenge it. To avoid claims of undue influence or lack of testamentary capacity, have a qualified physician or psychiatrist examine you — at or near the time you sign your will or trust — and attest in writing to your mental competence. Also choose witnesses whom your heirs trust and whom you expect to be able and willing to testify, if necessary, to your freedom from undue influence. Finally, record the execution of your will.

Of course, you should also make an effort to treat your children and other family members fairly, remembering that “equal” isn’t necessarily fair, depending on the circumstances.

The provisions do not work if you exclude someone from the Will or Trust

The no-contest provisions are helpful and should be very strongly considered for inclusion in your estate plan, but those provisions are only enforceable against someone who is named in the document to receive an asset.  If you were to simply exclude a person expressly in the document, there is no incentive for that person not to file a challenge to the document in court.  They have already been cut out so they have “nothing to lose” by lawyering-up and trying to blow up the estate plan.

What to do?

One method is to give a cash bequest to the person you seek to otherwise exclude, thereby making him or her subject to the no-contest provision. The cash bequest would need to be significant enough to make him or her seriously consider whether hiring a lawyer and incurring litigation costs and chancing losing the bequest is worth it.

Protect yourself

As you develop or update your estate plan, it’s important to think about ways to protect yourself against challenges by disgruntled heirs or beneficiaries. We can help you determine if a no-contest clause can be an effective tool for discouraging such challenges.

 

 

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