ESTATE PLANNING FOR NEW PARENTS

DECEMBER 2009 NEWSLETTER

REPORT FROM COUNSEL

        When a couple has their first child, they may be so overwhelmed with the new responsibilities of parenting that they may not even consider the importance of implementing an estate plan for their family.  However, the birth of a child is the perfect time for a couple to provide for the welfare and security of their family by either: (a) beginning their estate plan, if they have not done so already; or, (b) revisiting their existing estate planning documents to ensure that their documents properly protect their new family.

            For new parents, there are several reasons to prepare an estate plan upon the birth of their first child:

            (1)  To plan for the care of the child if both parents are deceased;

            (2) To ensure that the child’s inheritance is properly managed and to determine who will handle the child’s property during his/her minor years or in today’s world, until the child graduates from college or graduate/professional school; and

            (3)  To plan for the cost of the child’s future educational needs.

            Even though estate planning is essential for young families, many young couples postpone estate planning discussions due to the mistaken belief that they do not need an estate plan because they are young and healthy or these discussions conjure up negative feelings about death.  Yet, many couples fail to realize that being proactive and preparing an estate plan can actually alleviate some of the fear associated with death and dying.

            Guardian of Minor Children

            The most critical aspect of an estate plan for new parents is deciding who will take care of minor children upon the untimely death of both parents.  In a properly drafted Will, new parents can designate who will be the guardian of minor children if their spouse does not survive him/her.  Some parents delay writing a Will because they cannot decide on a guardian and thus, risk leaving a court with no guidance as to who should be the proper guardian for minor children.  Rather than postponing the drafting of a Will altogether, a couple should name a first and second choice of guardian and then change those choices later, if necessary.  Remember, a Will can be amended.  It is not a stagnant, unchanging document. 

In considering whom to name as the guardian of a minor child, several factors should be considered, including, but not limited to:

(1)  values and lifestyle;

(2) child rearing philosophy (for example, will the chosen guardian continue to allow a child to a attend a private school when the guardian’s own children attend a religious or public school which is not consistent with the parents’ own child-rearing philosophy?);

(3) the age of the child;

(4) the age and physical ability of the guardian (for example, should a grandparent who is sixty five (65) years of age be named guardian of a two (2) year old grandchild); and,

(5) the location of the guardian’s residence (parents should consider the detrimental effect of potentially up-rooting a child by naming a guardian who lives far away from where a child has been raised).

Other factors that could be considered when choosing a guardian of a minor child include the specific needs of the child, such as medical conditions or special educational needs, and when choosing a guardian new parents should be conscious as to who would be best suited, both physically and emotionally, to handle any of those needs.  Finally, the most important factor to consider when choosing a proper guardian for a minor child is naming someone who would be able to lovingly care for the child as the financial burden of raising a child can be alleviated through the proceeds of life insurance policies. 

 Property Distribution

            New parents should consider how an inheritance will be managed and distributed to a minor child if both parents die before that child reaches an age at which they can properly and prudently manage his/her own property.  A Will or Trust can provide for a number of financial management options and protections for property transferred to a child through an inheritance.  For example, a testamentary trust can own and provide for the maintenance and upkeep of a family residence and can specify that a child is to continue to live in the family home along with a guardian until a specified age.  Upon the child reaching such specified age, the house can first be offered for sale to the child at fair market or discounted value, or the house can be sold to a third party and the proceeds of such sale can be held in further trust for the child.

Also, money or other assets can be held in trust and the income and principal of the trust can be distributed on a discretionary basis by a trustee to the guardian of a minor child for the child’s health, support, maintenance and education until the child reaches the age of majority (18 years of age) or later specified age(s). 

If there is more than one child, the trust can be a sprinkle trust, meaning that the principal of the trust will be held in one share for all of the children’s health, support, maintenance and education until the youngest child reaches the age of majority or another later specified age.  At this specified age the trust will be split into equal shares for each child.  Sprinkle trusts are useful because of the varying needs of most children.  For example, if both parents die when their oldest child is a senior in college and youngest child is in lower-school and the residue of their estate is split equally between both children, the youngest child will be disadvantaged because the older child will have received the benefit of years of support plus an equal inheritance, while the younger child will only receive an equal inheritance and no additional support for those same formidable years.  A sprinkle trust is ideal in this situation because it pools all inherited funds and allows for unequal distributions to children depending on their specific needs.  Drafting a Will is especially important in this instance because if both parent’s die, state intestacy laws will distribute the property to the couple’s children in equal shares even though those children may not have equal needs. 

Further, a testamentary trust can ensure that children do not have complete or absolute withdrawal access to either the principal and/or income of the trust until they reach the age of majority or another later age.  Under the terms of a testamentary trust, children can be given absolute distribution rights to all of the income at a specified age on a monthly, quarterly or yearly basis and principal distribution withdrawal rights can occur in increments over a five (5), ten (10), twenty (20) or thirty (30) year period once the child has attained a certain age such as twenty-five (25) years.  The trustee can also be given the discretion to distribute the principal of the trust to a child at any age for his/her health, education, maintenance and support, including, by way of example, a marriage gift, down payment on a house, investment in a business or professional practice or such other purposes as the Trustee may deem appropriate prior to the child having absolute withdrawal rights. 

Life Insurance

When a child is born, life insurance can be purchased on the lives of either or both parents to provide the necessary liquid funds for the care of the minor child should one or both parents die before that child reaches an age at which he/she is able to support himself/herself.  Life insurance policies should not be owned by either parent and neither parent should be named as a beneficiary of the policy to ensure that the life insurance proceeds are not subject to federal estate tax in either parent’s estate.  Rather, life insurance policies should be owned by and payable to an Irrevocable Life Insurance Trust (ILIT).  The child can be the beneficiary of the ILIT and he/she can benefit from the proceeds of such policy under the terms of the ILIT pursuant to the same withdrawal rights and distribution terms discussed above for testamentary trusts (i.e. trusts under a Will).

            Gifts to Children

            Three types of vehicles that can be used to plan for a child’s future and facilitate the transfer of property to minor child are: (1) custodianship accounts; (2) Section 2503(c) Trusts; and, (3) Section 529 Tuition Plans.  As it is undesirable to give a minor child unfettered access to significant assets since they neither have the desire nor the capacity to manage such assets, all of these vehicles restrict a child’s access to the property transferred.

            Custodianship Accounts

Custodianship accounts are governed by state statutes modeled after the Uniform Transfers to Minors Act (“UTMA”) and are simple to create.  In Pennsylvania, a donor can create a custodianship account by the language “to X as custodian for Y under the Pennsylvania Uniform Transfers to Minors Act.”  The donor should not be the custodian of the account to avoid federal estate tax inclusion.  Thus, a parent-donor should carefully consider who to designate as custodian because a custodian has broad powers to manage, sell and reinvest custodial property. 

When a minor reaches twenty-one (21) years of age, the custodian must distribute all of the custodial property to the child and this can be a major disadvantage if parents want to restrict a child’s access to the custodial assets beyond the age of twenty-one (21) years.

            Section 2503(c) Trusts

            A Section 2503(c) Trust is a special kind of trust which allows a donor to transfer property to a minor and delay the receipt of the property by the minor, while still qualifying the transfer for the gift tax annual exclusion.  One of the benefits of a Section 2503(c) Trust is that it can be used to transfer real property for the benefit of a minor as a custodial account generally cannot own real property.   Under Section 2503(c) the beneficiary has no right to the trust corpus until reaching the age of twenty-one (21) years; yet, the gift still qualifies for the gift tax present-interest annual exclusion. 

There are four (4) requirements to qualify a Section 2503(c) trust for present-interest gift tax annual exclusion treatment: (1) the trustee must have the unrestricted right to distribute the income and principal of the trust until the beneficiary reaches the age of twenty-one (21) years; (2) the trust corpus must be paid to the beneficiary once he/she reaches the age of twenty-one (21) years; however, if the beneficiary does not exercise his or her right of withdraw, the funds can continue in trust past the age of twenty-one (21) years; (3) the beneficiary must have a general power of appointment by Will, or the remainder of the trust must pass to the beneficiary’s estate if he/she dies before age twenty-one (21); and, (4) the trust cannot have more than one minor beneficiary.

Section 529 Tuition Plans

            A Section 529 Tuition Plan is a special vehicle designed to encourage families to save for college.  Section 529 Plans authorize qualified state tuition (QST) programs and vary from state to state.  Generally, a QST program does either of the following: (1) allows an individual to purchase tuition credits or certificates at a discount for a designated beneficiary, who is then entitled to a waiver of payment of qualified higher education expenses (“prepaid tuition plans”); or, (2) permits an individual to make contributions to an account to meet a designated beneficiary’s qualified higher educational expenses (“college savings plans”).  Qualified higher educational expenses include tuition, fees, books, supplies, and in some cases the reasonable cost of room and board.

The benefit of establishing a Section 529 Plan is that it offers some unique federal income tax benefits.  For example, if the assets in the plan are used for the educational expenses of the named beneficiary, no federal income tax will ever be paid on the income accumulated on those assets.  Further, contributions to a 529 plan qualify for the present-interest annual exclusion and a person can contribute an amount equal to five (5) years worth of annual exclusions with no gift tax or generation-skipping transfer tax consequences. 

Establishing a Section 529 Plan can have some significant tax benefits for donors. However, because these plans can vary, the specific features of a plan should be considered before making any decisions and if unsure, donors should seek the advice of legal or financial counsel before deciding which plan is right for them.

            Conclusion

            In summary, the birth of a child presents many challenges along with many estate planning opportunities for new parents and because of the importance of selecting and appointing a guardian for the care of minor children, estate planning is perhaps most important for new parents.  Thus, to ensure that a child’s interests are properly protected should the unthinkable occur, estate planning should not be postponed. 

If anyone has any questions or inquiries concerning this subject matter, do not hesitate to contact us.  Feel free to email us your questions or comments concerning this newsletter.

Please visit our website:  www.pozzuolo.com

Publications

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