Client interest in establishing spendthrift trusts for beneficiaries is picking up steam, partly due to the fact that wealthy clients are becoming more risk-averse, according to financial advisers.
Spendthrift trusts are put in place when the estate holder isn't certain that the beneficiary will make the best use of the money.
"People are risk averse; they're shellshocked," said Stuart Pastrich, managing director at Compass Financial Group, a Plainview, N.Y.-based firm that oversees $100 million.
"We're seeing interest in spendthrift trusts," he said. "Clients are dealing with larger estates, and sometimes the kids don't have the wherewithal to manage the money."
The instruments are irrevocable third-party trusts created for another individual's benefit, said Gary Altman, principal and founder of Rockville, Md., law firm Altman & Associates.
Wording makes all the difference in a spendthrift trust: Provisions in this trust should dictate that the assets "may" not go toward one's health and support to ensure that luxuries may be covered as well.
If the language indicates that the money "shall" go toward support and health, then the trustee has no right to provide for anything other than those basics. That would make it a "support" trust.
These are just two types of trusts.
Assets in the trust are shielded from creditors, and distribution of the proceeds is up to the trustee.
Advisers noted that there would have to be sufficient money to justify the administrative expenses behind establishing the trust in the first place.
In fact, when cost and estate size prohibit one from creating a spendthrift trust, advisers can work with strategies that use variable annuities to create results similar to those offered by a spendthrift trust, said Lisa Plotnick, associate director of Cerulli Associates Inc. in Boston. "The parent can set up a variable annuity, usually with a guaranteed-lifetime-withdrawal benefit that would encourage beneficiaries to withdraw at a reasonable rate," she said.
Although actual usage of variable annuities to help transfer wealth remains pretty low, estate-planning departments at insurance companies and at distribution firms expect greater use of the products for estate planning, Ms. Plotnick said.
Advisers have mixed opinions on the idea of using an annuity in a wealth transfer context.
"The bells and whistles are great, but how long do you have to live with it, and how much are you willing to pay?" asked Dave Samuels, a certified financial planner with Corinthian Wealth Management LLC, a San Jose, Calif., firm with $45 million in assets. Illiquidity makes the variable annuity less than attractive, and products that are saddled with extra benefits can heap taxes onto an estate, he said.
One of Mr. Samuels' clients has a variable annuity that comes with a life insurance benefit, with the client's wife as the designated beneficiary.
Although the product looks good on paper, any proceeds going to the wife and through the couple's estate upon her death will be hit with income and estate taxes, he said. Mr. Samuels is searching for a way to get the client out of the product.
However, some advisers noted, a deferred variable annuity by itself can work to transfer wealth and provide protection from creditors, depending on the state in which it is purchased.
"If you don't need the money, you can have an asset growing at a minimum rate or at the market rate and give your kids the death benefit," Mr. Pastrich said. For instance, if a client has a life insurance policy with a lot of equity in it but the individual no longer needs the policy, then he or she can perform a 1035 exchange into a variable annuity with a guarantee, he said.
Beneficiaries can also stretch their payouts over their lifetime as they would in an individual retirement account, Mr. Pastrich added.
Alternatively, clients with a limited amount of assets can work with an immediate annuity, said David Mendels, New York-based director of planning at Creative Financial Concepts LLC. The Sedona, Ariz.-based firm manages $30 million.
"If you have a deferred annuity and the beneficiary gets it, it's still theirs to do with as they please," Mr. Mendels said. "If you set up an immediate annuity, you can limit the extent a beneficiary can squander."
Finally, though annuities and trusts may work well separately, attorneys and advisers warned against mixing the two.
"The annuity is a toxic asset in the estate plan," Mr. Samuels said. "You have income tax to the beneficiary, and estate tax if the asset is large enough.
E-mail Darla Mercado at [email protected].
