Good Trust Plans Gone Bad

Have you ever had plans go awry despite of your best efforts?  Unfortunately, excellent planning does not guarantee excellent execution.  Consequently, we frequently consult with new clients when their results aren’t quite what they expected.

Have you ever heard those radio contests that advertise a “lifetime supply” of something for the winner?  One of the more recent ones that I heard was “free gas for life” from a company I won't mention here.  As it turns out this was not an unlimited supply of gas for as long as you live, but a new $1200 gas card each year for the next 50 years (http://www.msnbc.msn.com/id/9916588/).  I might live longer than 50 years, and I might spend more than $1200 a year on gas – especially if prices keep going up at the pump.  I don't know about you, but that just isn't what I thought it would be.

We have clients at Council Financial that are the trustees of a charitable remainder trust or CRT.  As it was originally designed, the assets in the charitable remainder trust would generate enough lifetime income to supplement their living expenses and fund annual gifts to another trust for the benefit of their family.  In this case, the second trust happens to be an Irrevocable Life Insurance Trust, or ILIT.

It's a pretty good design and very useful to avoid paying capital gains on highly appreciated securities or real estate and transfer wealth to the next generation while reducing estate taxes.  Of course, since this is not specific advice, you should consult with an advisory team that involves a financial planner, tax professional and an experienced attorney if you are considering a similar strategy.

Unfortunately, in this case the problem surfaced a few years after the trusts were established.  The original aggressive investment portfolio (one we were not managing!) resulted in significant losses of nearly 70%.  This negatively impacted the income they planned to use to fund the rest of the plan.  Ultimately the plan just didn’t provide the intended benefits.

How did this happen?  Well, to be blunt, it was poor investment management.  Our clients hired professional help that failed.  By the time they realized the problem, the damage was done.  The Uniform Prudent Investor Act says that you should manage the assets of a trust in accordance with the interest of all beneficiaries being taken into account equally.  In this case, the income beneficiaries were not given the same consideration as the residual beneficiary.  Suddenly, the inadequate income could not accomplish the intended goals.

Since then, we have helped the income beneficiaries manage the assets in a more comfortable way with the goal of increasing the assets while still providing reasonable income from the portfolio.  We have also helped them review the life insurance in the irrevocable life insurance trust to identify ways that they might be able to cut costs.  In the end, they seem very happy with the results and we continue to help them achieve their goals year by year, quarter by quarter.