The Problem of Faithless Trustees

There’s been quite a bit of press coverage of “fiduciary duties” when it comes to professionals giving financial advice.  Bank trust departments and trust companies always have been held to the fiduciary standard, and are proud of it.  Unfortunately, there are some documented cases when individuals with such duties simply ignored them.

Special needs

Lawrence and Millicent Stream, a successful professional couple, had an autistic son, Larry.  Although Larry’s condition was not severe, his parents saved for a trust to provide for him for the rest of his life after they had died.  They accumulated about $2 million in that trust for Larry.

The trustee of Larry’s trust was Layton Perry. We don’t know how the couple knew Mr. Perry, why they chose him as trustee, and why they did not choose a bank trust department or trust company for this important job.  We do know that Perry was a disbarred lawyer.

Fortunately, Perry was not named Larry’s legal guardian.  That job fell to Carolyn Crepps, who had worked as a legal assistant.  She investigated Perry’s management of the trust, and she found that he and his wife had used the assets to buy new cars for themselves, had made mortgage payments on their own home, and had made many personal withdrawals from the trust with no documentation or explanation.  The $2 million fund had been reduced to $200,000.

Crepps asked the probate court to remove Perry as trustee, and he was removed.  The court ordered the sale of the Perrys’ cars and home, with the proceeds returned to the trust.  However, that did not bring the trust fund back to its full $2 million balance.

Larry Streams was not stupid, but he was much too trusting of other people.  As were his parents.

Old Money

James Stillman, onetime Chairman of the National City Bank of New York (which years later would be renamed Citibank), was very rich.  At his death in 1918, his fortune was estimated at $1.8 billion in today’s dollars.  His son Chauncey used a portion of that fortune to create a family retreat, which he named “Wethersfield.”  He purchased art, built a mansion suitable for displaying it, and installed gardens in the style of 17th-century Italy.  A family foundation was created to manage the family’s money and implement their philanthropy.

In 1998 the family foundation was worth $103 million.  Unfortunately, there were no family members on the board of trustees to provide proper oversight.  The trustees made grants to institutions that had nothing to do with the Wethersfield Estate, including their own alma maters, and the ex-president directed over $700,000 for his personal benefit.  By April 2015 the value of the foundation had shrunk to $31 million, after 14 straight years in which grants made by the foundation exceeded its revenue.

The heirs finally woke up and brought suit against the trustees, and eventually, they won a settlement of $4.4 million.  The trustees were replaced, and the board now includes family representation.  The legal settlement won’t be enough to save the Wethersfield Estate, so now the heirs have agreed to sell some of Chauncey’s art collection, including works by Degas and John Singer Sargent.  They are hoping to raise $12 million.

There is a saying: Rags to rags in three generations.  The saying is usually interpreted to mean that the first generation creates wealth; the second conserves it, and the third squanders it.  In this case, it was the untrustworthy managers who squandered the fortune, but the third generation did their part by failing to supervise their advisors properly.

© 2017 M.A. Co.  All rights reserved.


The Wrong IRA Beneficiary?

Sometimes mistakes in an estate plan can be repaired after death. Sometimes not.

Charles Sukenik executed his will on November 4, 2004. His estate was to be divided between his surviving spouse, Vivian, and the couple’s private foundation.  His revocable trust was restated at the same time, giving Vivian certain real property and the balance to the foundation.

Roughly five years later, in 2009, Charles designated Vivian as the beneficiary of his IRA, worth some $3.2 million. 

When Charles died in 2013, the heirs discovered that the estate plan was not very tax efficient. Vivian was looking at potential income taxes of $1.6 million on the IRA distributions.  She proposed to reform the estate plan, giving the IRA to the private foundation in exchange for other estate assets of equal value.  The charity was not opposed to the plan.  Being tax exempt, the new plan would make the income tax obligation that comes with an inherited IRA disappear.  Certainly, this approach would more effectively implement Charles’ testamentary intentions.

The Court couldn’t swallow this one, because “the reformation requested here is prompted by neither a drafting error nor a subsequent change in law. Several years after executing his will and trust, decedent himself thwarted the tax efficiency of his own estate plan by making [Vivian] the beneficiary of the IRA. There is nothing in the record indicating why, after executing these estate planning instruments, [Charles] chose to leave additional assets to his wife in this manner or why, in the four years before his death, he did not take steps to cure the unfavorable tax consequences of his choice of IRA beneficiary.”

The Court concluded that if reformation were allowed in these circumstances, the decision “would expand the reformation doctrine beyond recognition and would open the floodgates to reformation proceedings aimed at curing any and all kinds of inefficient tax planning.”

Did Charles have any understanding of the tax time bomb that he included in his estate plan?  It appears probable that he did not consult his attorney before designating his wife as his IRA beneficiary, which is an ordinary, everyday occurrence.  But he should have.

© 2017 M.A. Co.  All rights reserved.

More Trouble for Long-Term Care Insurers

More than 400,000 long-term-care insurance policies were sold in 1992, according to figures published by The Wall Street Journal.  These are the policies that help seniors cover the costs of nursing home stays at the end of life.  At least 400,000 additional policies were purchased each year in the subsequent ten years, peaking at about 750,000 in 2002.

Then sales collapsed, and never again reached the 400,000 level. Last year, reportedly only 105,000 such policies were sold.  What’s more, two Pennsylvania providers of long-term care insurance were on the verge of being liquidated in December.

The need for long-term-care insurance never has been greater.  What happened to the market?

Actuarial errors

A series of actuarial errors were made when long-term-care insurance was first introduced.  The most important of these was the “lapse rate,” the number of policies that will be terminated without ever paying a benefit. This occurs either because the insured stops paying premiums or the insured dies without making a claim.  The actuaries chose a fairly conservative lapse rate of 5%.  At that rate, if 1,000 policies were sold in year one, only 400 would be in force 20 years later.  As it turned out, the buyers of long-term-care insurance thought of their purchase primarily as an investment, not as insurance, and so the lapse experience was closer to 1%, which implies that 800 of every 1,000 policies still will be in force after 20 years.  That led to far higher payouts than projected.

When the unanticipated expenses started to pour in, insurance companies had to raise their rates.  However, in many cases, state insurance regulators would not approve the full amounts requested for existing policyholders.

Two more errors compounded the damage.  The first is that medical advances have lengthened life expectancies, which, in turn, increases the likelihood of making a claim on a long-term-care insurance policy. The second is that the actuaries generally assumed a 7% rate of return on the invested premiums on these policies.  That assumption was fine in the 1990s, but interest rates have been at historic lows since 2008.  When long-term-care policies are priced today, the projected rate of return on premiums is likely to be 2% to 3%, which drives premium costs still higher.

Getting coverage

If you already have a long-term-care policy, you probably want to hang on to it.  For the most part, those who have purchased these policies have profited from them.

New long-term-care policies still are available, although they are more expensive than in the past, and the terms may be less favorable than older policies.  Insurance companies are now using much more conservative actuarial assumptions.

Hybrid policies that combine life insurance with long-term-care coverage have emerged, and they have proved popular as well.

The poorest seniors may have the costs of their long-term care picked up by the government through Medicaid.  The wealthiest may be able to cover the costs without insurance—even though a year’s stay in a nursing home can easily run to $100,000 or more.

For everyone in the middle, planning is necessary. Despite the price increases, long-term-care insurance will prove an important part of that plan for many affluent families.

© 2017 M.A. Co.  All rights reserved.

Strategic Asset Management With a Revocable Living Trust

Developing a sound investment management strategy is more than allocating assets and diversifying among the various asset classes. It is also about attaining your financial goals in life. The long-term security of your family is likely to be a key goal. To reach it, you want to ensure that your assets will continue to grow—providing the income that your loved ones will need to live comfortably, should you not be able to provide for them. And one of the most valuable resources available to help you achieve that goal of long-term financial security is a revocable living trust.

Living trusts: the facts

A revocable living trust allows you to arrange for the management of your assets both while you are alive and after you are gone. By establishing your trust now, you may be able to reduce the stresses and strains that your family may experience when they are forced to make difficult financial and investment decisions after you’re gone.

Think of a trust as a container, a place where you can transfer your securities, real estate or other property. This transfer is accomplished by making the trust the new owner of your assets. However, you retain control while you live, and you can direct what happens to the assets after you are gone, or are unable to make the necessary decisions about their management. These instructions are contained in a trust agreement that will be implemented and administered by the trustee that you name to oversee the trust.

Neither the instructions in the trust agreement nor the trust itself need have a permanent life. The directions that you give today may be altered in any way, at any time. The trust itself, if necessary, can be revoked, and your assets transferred back to you.

A strategy designed to your specifications

Your trustee will serve as the manager of the trust’s investments. When you name a corporate trustee, such as our institution, we can assist you in developing the strategy that will best serve you and your family, based upon your personal circumstances. For example, we will review your long- and short-term objectives, your risk tolerance, liquidity needs, tax considerations and a host of other variables in order to make certain that the investment choices made match your needs and expectations.

When we assist you in formulating and developing an investment management strategy, you may delegate to us in the trust agreement the authority to execute all of the investment decisions. Alternatively, you can require us to submit recommendations for your approval. In all cases, as trustee, we will be responsible for all the paperwork and chores associated with the management of your assets.

Here’s an added benefit, and it’s an important one: By setting up a living trust now and naming us to serve as your investment manager, you can “preview” our performance. By observing our actions now, you will have the peace of mind of knowing that you will be leaving a capable, knowledgeable investment advisor to serve your family later.

Just in case

If you haven’t yet made the decision to integrate an “active” living trust into your current financial plans, you may want to look at an alternative—a standby trust.

A standby living trust offers you the opportunity to achieve a high degree of protection for yourself and your family should you become ill or incapacitated. Yet you maintain total control of your investments. The trust is activated only when you are unable to manage your investments, and only for as long as necessary.

In addition, the trustee can be directed to use the trust’s assets to pay household bills and taxes, for example. At a time when your loved ones are apt to be burdened by concerns other than financial ones, they will have the confidence of knowing that professionals are managing the family’s finances in your absence.

Additional protection: an estate planning strategy

When you establish a living trust, you designate two types of beneficiaries. There are the income beneficiaries (typically, yourself and your spouse), who receive regular payments of the trust’s income or principal as outlined in the trust agreement. At the termination of the trust—at your death or some other specified time—those whom you name as your remainder beneficiaries will receive the assets in the trust. But the trust may continue beyond your lifetime, and become an integral part of your estate plan. There are good reasons for coordinating a will and a living trust.

A living trust can operate as a highly efficient organizational tool, providing a unified approach to the management of your assets. For instance, assets such as the proceeds from a life insurance policy or a retirement plan may be paid to a living trust that you have established and which, at your death, becomes irrevocable.

As a result, you can ensure that your family will have a continuous, uninterrupted flow of income. In addition, you can set up an orderly distribution plan for your assets, either over a certain number of years or keyed to certain circumstances.

Finally, having all of your assets “under one roof” will make it easier for your spouse and other beneficiaries to keep track of how the family’s assets are being managed and to know where to turn with questions or concerns.

Additional benefits

At your death the assets in your living trust will not be subject to the potential delays and costs associated with the probate process. In addition, although the terms of your will can be made public, a trust is a private document and, generally, escapes public scrutiny.

This latter point can be especially important in the event that you become disabled and cannot manage your financial affairs. Contrast the privacy of a standby living trust, which springs into action immediately and without fanfare, with the potential for publicity, time and expense when formal conservatorship proceedings must be commenced in a probate court setting.


In sum, then, a revocable living trust offers a wide range of features and benefits that can help you reach the goal of securing your family’s financial future. If you would like more information about how a revocable living trust can be shaped to your financial goals and needs, call upon us at any time.

© 2015 M.A. Co. All rights reserved.

2016 IRA Deadline Approaches

If you haven’t yet made an IRA contribution for 2016, there’s still time to make one, until the tax filing deadline. Taxpayers have until Tuesday, April 18, 2017, to file their 2016 returns and pay any taxes due. The deadline is later this year due to several factors. The usual April 15 deadline falls on Saturday this year, which normally would give taxpayers until at least the following Monday. However, Emancipation Day, a D.C. holiday, is observed on Monday, April 17, giving taxpayers nationwide an additional day to file. By law, D.C. holidays impact tax deadlines for everyone in the same way that federal holidays do.

If you already have made your 2016 contribution, it would be financially wise to go ahead and make one for 2017.  That will give your account an extra year of investment returns.  The contribution limit for each year is $5,500.  Those who are 50 and over may make an additional “catch-up” contribution of $1,000.

The deduction for IRA contributions phases out for those higher-income taxpayers who also are covered by an employer’s retirement plan.  The phase-out range was bumped up slightly for 2017 contributions, as shown in the table below.

IRA deduction thresholds

Taxpayers below the threshold may take a full deduction for their contributions to traditional IRAs.

IRA deduction thresholds

Source: IRS Notice 2016-141

For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $186,000 and $196,000 in 2017, up from $184,000 and $194,000 in 2016.

(March 2017)

© 2017 M.A. Co.  All rights reserved.

UPDATE: Michael Jackson’s Estate

More than seven years after his death in 2009, controversy continues to plague Michael Jackson’s estate.  The remaining problem, and it’s a big one, is the federal estate tax.

Jackson’s reputation was at a low point when he died, and his debts totaled half a billion dollars. His executors valued his name and likeness at just $2,105, and they tallied the total net estate at $7 million.  We don’t know what their reasoning was, but given the enormous size of Jackson’s debts, some observers at the time expected the estate to be bankrupt.

The IRS disagreed on the valuations.  Most importantly, the IRS figured that Jackson’s celebrity value was an astounding $434 million, which contributed to a total estate value of $1.3 billion!  Taxes and penalties could have run to $700 million.  Negotiations between the estate and the IRS have been ongoing since 2013, and the Service reportedly has backed off on the celebrity value, down to $161 million.

Even that figure is completely unrealistic, according to the lawyer for Jackson’s estate.  That is a far higher value than any other celebrity identity ever has commanded, and it is far more than Jackson himself earned from his celebrity (as opposed to his music) during his entire life!

The evidence that the estate low-balled the value of Jackson’s assets comes from the fact that the executors have netted about $1 billion for the estate during the period of administration.  This includes music sales, the documentary “This Is It,” a Cirque du Soleil tribute show and the sale of Jackson’s 50% stake in Sony/ATV Music Publishing.  They have paid off all of the debts owed at Jackson’s death and now have roughly $500 million for his heirs.

But there is still that estate tax to be paid, and a trial on the valuation began in February. The tricky question presented is, how much were Jackson’s assets worth at the moment of his death?  Without the skilled work of his chosen executors, they most likely would have been worth nothing at all.  How much of the success of those executors was foreseeable at Jackson’s death?  Certainly, he left them a lot to work with.  But was the surge in popularity of Jackson’s music and image foreseeable when he died?

This is a case for the record books.

(March 2017)

© 2017 M.A. Co.  All rights reserved.

IRA Errors

James Theissen and his wife worked for Kroger or its subsidiaries for 30 years. They lived in Colorado, and in 2002 Kroger informed Mr. Theissen that his job would be moved to Ohio.  As the Theissens did not wish to move, they retired and rolled their 401(k) money into “his and hers” IRAs, totaling some $432,076.41.

 Because Mr. Theissen was interested in metal fabrication, he began shopping for a company to buy.  He planned to use the IRA money to fund the purchase and let the IRA own the new company.  A corporation was formed, Elsara, and the couple’s IRAs purchased all the Elsara stock.  A suitable metal-fabricating firm was found.  The price was $601,000.  The couple contributed $60,000 from their savings; Elsara paid $341,000; and Elsara also provided a promissory note for $200,000, to be paid over five years at 7% interest.

Unfortunately, the Theissens also personally guaranteed repayment of the note.

 Apparently, the note was properly repaid according to its terms.  However, in 2010, six years after the transaction, the IRS challenged the financial structure used for the acquisition of the business.  According to the IRS, the personal guarantee of the note was a prohibited transaction. It amounted to an extension of credit to the IRAs by the beneficiaries of the accounts.

Federal law has some very strict rules concerning transactions between qualified retirement plans, which includes IRAs, and those who are the beneficiaries of such plans. The public policy being served is the preservation of the money in the plan for retirement.  

 Before adopting this structure for their business purchase, the Theissens consulted with a CPA firm and an attorney. They didn’t come up with this idea on their own.  Nevertheless, the Tax Court ruled that they had, in fact, committed a prohibited transaction when they personally guaranteed the loan.  That caused two unfortunate consequences.  First, the IRAs stopped being tax qualified in 2003.  That meant the entire amount in them was deemed distributed to the Theissens in that year and subject to ordinary income tax, which came to nearly $190,000.  Second, because neither was yet 59½ at the time of the distribution, they owed an additional 10% penalty tax!  Plus interest since 2003.

 It’s not entirely clear how this will enhance the Theissens’ retirement income security, but perhaps that was not the point.

Another Problem

Dr. Mark Vandenbosch decided to loan $125,000 to a radiology technician whom he had befriended, John Carver. Carver needed the money for an investment opportunity.  The source of funds was Dr. Vandenbosch’s Simplified Employee Pension (SEP).  However, the SEP did not distribute funds to Carver, nor did it execute a promissory note for the loan.  Rather, the money went into Vandenbosch’s personal checking account, and the loan document showed the doctor and his wife as the lenders.

 The couple argued that they were acting as conduit, and that the loan to Carver was essentially a tax-free IRA rollover.  The Tax Court held that it was not.  The $125,000 was a taxable early distribution to the doctor, subject to income taxes and the 10% penalty for early distribution.  Fortunately, the balance in the doctor’s SEP was not tainted by the transaction, so it continued to be tax deferred.