The Smiths are in their 50s and remain employed. They’ve always worked hard, consistently earning a good living while shepherding their three children through the “growing up” minefields.
The couple has accumulated savings in liquid investment accounts as well as two well-managed individual retirement accounts. The IRAs aren’t as large as the savings investments because Mr. Smith always believed in maintaining freedom to access his money should he decide he needed or wanted to, a privilege that doesn’t attach to IRA accounts without some important income tax considerations. The savings accounts total close to $950,000, while both IRAs total around $400,000.
The strategy we’re discussing here isn’t necessarily driven by money, though, and rarely depends on having significant wealth.
The Smiths’ three children are grown and on their own. While they continue to work in their careers, the Smiths are thinking more and more about their future. Their attorney has warned them about the possibility of losing their life savings should the unexpected occur or an unanticipated creditor materializes as the result of a liability claim that proved successful.
Both their attorney and accountant have advised there’s no issue of their estates incurring estate tax so long as their deaths occur while tax exemption amounts remain sufficiently large.
So the Smiths quickly recognized three primary concerns:
Can they protect their retirement assets against potential, but unknown, creditors?
Can they retain access to and the use of the assets within the accounts for their future financial needs?
Can they avoid potential estate taxes should exemption amounts drop or their assets substantially increase in value?
One suggestion was to place their investment accounts into an irrevocable trust. That, they thought, would provide protection from creditors, yet allow them to access the assets within the trust to meet their accustomed standard of living. Their CPA immediately pointed out that such a trust could be considered a “self-settled trust” and, at least in Colorado, not likely provide that protection. Their attorney agreed and recommended they visit with an estate planning attorney.
The Smiths took that advice and learned, among other things, a self-settled trust isn’t necessarily a bad choice in Colorado, but the question is close enough the cautious might decide to avoid it. There remain at least two very good options, however.
One option would be to create a self-settled trust in one of the many other states where it’s perfectly acceptable.
The other option would be to create two separate irrevocable trusts in Colorado. One would be created and funded by Mr. Smith with his half of the investment assets and name Mrs. Smith as the income beneficiary with certain access rights to principal. The other trust would be created and funded by Mrs. Smith with her half of the assets. The rationale is that Mr. Smith’s trust is obviously not self-settled if he settled it for Mrs. Smith.
Other considerations and drafting skills come into play since this is an advanced estate planning strategy. But it could provide protection from unknown creditors and predators while allowing the couple access to assets for retirement. In addition, the transferred accounts are effectively removed from the taxable estate of the particular Smith that transferred them.
These trusts have various names around the country, but I like to call them Bert and Ernie trusts — buildup equity retirement trusts.