By Steven J. Oshins, Esq., AEP (Distinguished)

Read nearly every trust drafted by nearly every law firm and you’ll see provisions that make mandatory distributions at staggered ages. Why is this done? I have no idea. Maybe because their standard “form” trust agreement does that??? Is it good planning? Absolutely not!

STAGGERED DISTRIBUTION TRUST

A “Staggered Distribution Trust” is a trust that makes mandatory staggered distributions upon the beneficiary reaching staggered ages. The most widely-used provisions distribute one-third at age 25, one-half of the balance at age 30 and the balance at age 35.

The philosophy of doing this is that the beneficiary has three chances to make mistakes. The so-called “three strikes and you’re out” rule. Waste your money at age 25 and simply wait for the next distribution at age 30. Waste your money at age 30 and certainly you’ll be financially responsible enough at age 35 to be smarter with your money.

DISCRETIONARY TRUST

A “Discretionary Trust” is the polar opposite of a Staggered Distribution Trust. In other words, it’s good planning.

The primary beneficiary generally becomes the investment trustee upon reaching a selected age, and he or she can select a third-party distribution trustee with sole and absolute discretion over distributions. The primary beneficiary can remove and replace trustees. This is often called a “Beneficiary Controlled Trust”.

WHY IS A STAGGERED DISTRIBUTION TRUST BAD?

A Staggered Distribution Trust is bad for a number of reasons. Why not simply make that beneficiary the controlling trustee of a fully discretionary trust upon reaching that age and use a Beneficiary Controlled Trust?

Following are seven reason never to use a Staggered Distribution Trust:

1. Lack of Creditor Protection: A mandatory distribution adds to the recipient’s assets that are unprotected from creditors, whereas a continuing fully discretionary trust is protected from creditors.
2. Lack of Divorce Protection: With so many marriages ending in divorce, why force assets out of an otherwise protected trust? The divorce rate is very close to 50%. Therefore, shouldn’t every attorney’s trust “form” assume that there will be at least one divorce among the beneficiaries?
3. Lack of State Income Tax Savings: If the beneficiary lives in a state with a state income tax, why force the assets out to the beneficiary where the taxable income and capital gains will be borne by that person individually, whereas a trust can often be drafted to avoid state income taxes on undistributed taxable income?
4. Inability to Sprinkle Taxable Income to Beneficiaries in Lower Federal/State Income Tax Brackets: If the assets are forced out to the beneficiary, the income earned from those assets are forced onto that beneficiary’s income tax return and therefore possibly forced into the highest federal/state income tax brackets. This takes away the possibility of distributing some of the taxable income to that beneficiary’s children, for example, who may be in lower income tax brackets to take advantage of tax bracket arbitrage opportunities.
5. Forced Step-Ups and Step-Downs in Basis: If the assets are distributed outright to the beneficiary, then the assets get a new income tax basis at that beneficiary’s death. This is great for assets that have a fair market value in excess of the income tax basis, but not so great for assets that have a fair market value below the income tax basis. Had the assets been left in the trust, a Trust Protector could have given the beneficiary a power to cause all assets with a fair market value in excess of basis to receive a new basis at that beneficiary’s death, but not give that power over assets with a fair market value that is less than the income tax basis so as not to receive a step down in basis.
6. Inclusion for Federal/State Estate Tax Purposes: Assets distributed from a trust are includible in the recipient’s estate for estate tax purposes at the recipient’s death. Assets left in a generation-skipping trust avoid federal and state estate taxes.
7. Widow’s Election: The surviving spouse of a beneficiary who resides in a common law (i.e., non-community property) state may elect to take a percentage of the beneficiary’s estate at the beneficiary’s death. Many people want to give their surviving spouse nothing or a limited amount of assets, especially in a second marriage situation or a bad marriage situation. Therefore, there is no reason to make this problem even worse by forcing more assets into the hands of the beneficiary.

CONCLUSION

Through the years, more and more estate planning attorneys are using Beneficiary Controlled Trusts rather than Staggered Distribution Trusts. But the change is slow. One day the Staggered Distribution Trust will be nearly extinct.

But that day isn’t coming any day soon given how slow the demise of Staggered Distribution Trusts has been. When I got out of law school in 1994, it seemed that 99% of trusts were drafted as Staggered Distribution Trusts. That percentage seems to be in the 95% range nowadays, so the progress has been slow.

RELATED EDUCATION

If you found this article interesting, you might also be interested in these other educational programs and products by Steve Oshins:

• Estate Planning Techniques in a Time of Low Interest Rates
• The Installment Sale to an Intentionally Defective Grantor Trust
• The Grantor Retained Annuity Trust: Significant Estate Tax Savings with Nearly Zero Gift Tax Risk
• Advanced-Level Estate Planning Sales & Marketing Kits
• Steve’s FREE State Rankings Charts

ABOUT THE AUTHOR

Steven J. Oshins, Esq., AEP (Distinguished) is a member of the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011. He was named one of the 24 “Elite Estate Planning Attorneys” and the “Top Estate Planning Attorney of 2018” by The Wealth Advisor. Steve was also named one of the Top 100 Attorneys in Worth and is listed in The Best Lawyers in America® which also named him Las Vegas Trusts and Estates Lawyer of the Year in 2012, 2015 and 2018 and Tax Law Lawyer of the Year in 2016 and 2020.  He can be reached at 702-341-6000, ext. 2, at soshins@oshins.com or at his firm’s website, www.oshins.com.