Yes, there are still some more issues to address.  .  These issues fall into three major categories:

1. Dealing with the estate tax law changes passed by Congress in 2001
2. Dealing with the new Uniform Principal and Income Act being adopted by the various states; most but not all.
3. Dealing with the new Uniform Prudent Investor Act being adopted by the various states; most but not all.

DEALING WITH THE ESTATE TAX LAW CHANGES: In 2001, Congress amended the estate tax laws to slowly (between 2002 and 2010) increase the size of the estate that would be exempted from estate taxes.  In the year 2010, all estates, regardless of size, would be exempted from estate taxes.  Then, in 2011, everything reverts back to the exemptions contained in the prior law.  This means, unless Congress votes to extend the total exemption contained in the new law, we will go back to only a $1,000,000 exemption.  As a result, there is a great deal of uncertainty.  Who knows, Congress may well decide to start all over again and write an entirely new law between now and 2010 or 2011.  Therefore, how do you deal with this uncertainty?

If, when the first spouse dies, the total estate is below the estate tax exemption amount (whatever that may be at the time), there is no point in funding the Decedent’s Trust.  The chief purpose in funding this trust is to double the amount of your estate that is exempt from estate taxes.  However, if your total estate is already free from estate taxes there is no need to double the amount.  In that case, why fund this trust and give the surviving spouse all the hassles and headaches described previously?

Of course, you will not know when drawing up or amending your trust whether, at the first death, your estate will be below the threshold for the imposition of estate taxes – Congress has seen to that uncertainty.

Recommendation:  Draw your trust document to specify that at the death of the first spouse everything goes to the surviving spouse.  Then give the surviving spouse the power to “disclaim” all or part of this inheritance up to an amount equal to the estate tax exemption amount.  Once it is disclaimed, this amount would go into the Decedent’s Trust.  In other words, give the surviving spouse the power to fund or establish the Decedent’s Trust as she or he sees fit based upon the advice of your attorney and other advisors.

Is there any danger in this recommendation?  Yes, there are a number of them.

1. Congress could lower the estate tax threshold between the first and second death, thus subjecting some of the survivor’s estate to taxation.  If that happens, you would have been better off funding the Decedent’s Trust.  Discuss this risk with your attorney and financial planner before making a final decision on this issue.
2. The surviving spouse could decline to fund the Decedent’s Trust regardless of the benefit and use the assets that would have gone into that trust in a way contrary to the wishes of the deceased spouse.
3. With the best of intention, the surviving spouse could decide not to fund the Decedent’s Trust.  He or she could have every intention of adhering to the wishes of the deceased spouse only to find circumstances have changed over time.  For example, there could be a remarriage and there could be children from that marriage.  Or they could develop affection for the children of the new spouse.  Conversely, an estrangement could develop between the surviving spouse and one or more of the beneficiaries important to the deceased spouse. A myriad of circumstances could cause the surviving spouse not to carry out the wishes of the deceased spouse.

Do not do this IF you have any concerns about the willingness of the surviving spouse to carry out the wishes of the deceased spouse, or you do not have the utmost confidence in each others’ judgment should circumstances change.  You probably will not want to do this if there is a likelihood of remarriage during childbearing years.  Also, do not do this if one or both spouses have been previously married and have children from the earlier marriage. 

A secondary detail that springs from this recommendation is “Where do the disclaimed assets go?”  The disclaimer language can be written to direct them to go to the Decedent’s Trust or to the QTIP Trust.  There are too many variables here to discuss even some of them.

Recommendation: Be sure you discuss all issues particular to your situation with your attorney and financial planner before making any decisions.

DEALING WITH THE UNIFORM PRINCIPAL AND INCOME ACT: Some background information might be helpful.  In recent years, interest rates and dividends have been falling.  Long-term interest rates are about one-third of what they were 20 or 30 years ago.  Dividends are as low as 2.5% of the value of common stocks.  Interest rates on high quality government and/or corporate bonds is not much higher.  As a result, it is difficult to generate much income from a diversified portfolio of common stocks and bonds.  The Uniform Principal and Income Act also stipulates how expenses are to be charged.  Some must be taken out of the income.  Some must be taken out of principal.  Still, others must be charged to both.  To the extent that expenses must be taken out of income, the remaining income will be reduced still further from an already very low level.

This may or may not be a problem, depending on the size of the estate and its ability to generate income compared to the income needs of the surviving spouse.  Unfortunately, in order to deal with this problem, you have to be somewhat prescient.  You have to ask, “If one of us were to die today what would be the income needs of the survivor?  How much income would the Decedent’s Trust produce?  Would this be enough income, along with all the other sources of income, for the surviving spouse?”  These are not easy questions to answer, especially before the event occurs.  You will have to sit down with your financial planner and attorney to work out a “best guesstimate” answer. 

If the answer is that there is still a need for more income, what can be done?  If significantly more income is needed, it will entail responses that are beyond the scope of this article, such as the use of a life insurance trust, purchase of life insurance, or other solutions.  But if a marginal improvement is all that is necessary you can jigger with the expense allocation mandated by the Uniform Principal and Income Act.  You can write into the Decedent’s Trust instructions to the trustee to charge all expenses against the principal of the trust and none against income.  In other words, override the Uniform Principal and Income Act.  You can also override the Act by mandating the trustee to characterize all distributions received from mutual funds and other registered investment companies such as real estate investment trusts and royalty trusts as income.  This will allow the trustee to distribute long-term capital gains distributions as income as well as distributions from real estate investments and royalty income that would otherwise have to be considered return of principal and retained by the trust.  You can override the Act in the QTIP trust, if funded, or in the Decedent’s Trust, if the QTIP Trust is not funded.

Recommendation: Based upon a hypothetical distribution of your estate at the first death between the Decedent’s and/or QTIP and the Survivor’s Trust, have your financial planner determine what the surviving spouse’s income is likely to be.  Then decide whether or not to override the Uniform Principal and Income Act as described in the previous paragraph.  As a guideline only, you should pay particular attention to this issue if the estate is below $5,000,000.  This is only a guideline.

Is there a danger to this recommendation?  Yes!  By maximizing the income from the Decedent’s Trust, you will be diminishing the growth of the trust commensurately.  A major objective of this trust is to pass as much as possible to the next generation free of estate taxes.  The best way to do that is to maximize growth and diminish income.  However, this recommendation would do just the opposite by diminishing growth and maximizing income.  But, if the surviving spouse needs income, the need would seem to override the desire to maximize the growth of the trust.  If it turns out that the surviving spouse doesn’t need all of the income, then he or she could always give it away, during his/her lifetime, to the ultimate beneficiaries of the Decedent’s Trust.  As long as the gifts don’t exceed the gift tax threshold each year for each recipient, this will accomplish the same objective as letting the trust grow except for any income tax due before the gift is made.  Discuss this possible danger with your attorney before making a final decision.

Occasionally it is recommended by financial and estate planning professionals that you take advantage of the Uniform Principal and Income Act to allow the calculation of the distribution from a trust to be based upon the “total return” of both income and growth of the trust. I used to make the same recommendation but I have backed off from this recommendation.  There are three reasons why this can not and should not be done.  First of all, if the trustee is also a beneficiary of the trust, it can not be done.  This is usually the case with most trusts set up for estate planning purposes.  Secondly, if the assets held by the trust include assets other than stocks, bonds and mutual funds it is almost impossible to calculate the “total return”.  Finally, in periods of declining markets total return can, and often is, negative.

DEALING WITH THE UNIFORM PRUDENT INVESTOR ACT: In years gone by, trustees were governed by what was known as the "Prudent Man Rule" with respect to the investment of trust assets.  This rule was applied to each individual security and not to the portfolio as a whole.  It also emphasized safety of principal over growth of principal.  Consequently, trustees could lose money to inflation without recourse, but if they lost principal on an individual investment decision, they could be in trouble.  In other words, the whole portfolio could be out-performing the rate of inflation, but if one investment lost money, they could be held accountable by the beneficiaries of the trust.  That has all changed.  Now trustees are held accountable at the portfolio level rather than on a security-by-security basis.  They will be held accountable if the portfolio under performs other investments of a similar nature, and if they fail to take into account the impact of inflation.  They have to maintain diversified portfolios. 

The emphasis of the Uniform Prudent Investor Act on overcoming inflation and diversification could have a negative impact on the income needs of the income beneficiary.  The income beneficiary is usually the surviving spouse who is also the trustee. The Act gives the surviving spouse/trustee a conflict of interest if his/her income needs can’t be adequately serviced by a diversified portfolio balanced between stocks and bonds especially if the portfolio is skewed towards growth so as to overcome the impact of inflation.

Recommendation: The benefit of the Decedent's Trust is to grow the value of the portfolios to take advantage of the estate tax by-pass nature.  If you decide it is more important to service the income need of the surviving spouse, then build in language in the two trusts allowing the trustee to emphasis the income needs of beneficiary rather than growth.

Is there a danger to this recommendation?  Yes!  Again, implementing this recommendation will diminish the amount that can be passed to the next generation free of estate taxes.  Nevertheless, it is likely you will want the income needs of the surviving spouse to supercede a desire to pass assets free of estate taxes. 

Recommendation: Discuss this danger with your attorney.  Because the QTIP Trust is taxed in the estate of the surviving spouse you may want to include this language only in the QTIP Trust.  However, exclude this language in the Decedent’s Trust since it bypasses the survivor’s estate, and passes the estate tax-free to the ultimate beneficiaries.  Wherever possible, grow the Decedent’s Trust and emphasize income to a greater extent in the QTIP Trust.  In the parlance of the investment management community, the Decedent’s Trust should be a “growth with income secondary portfolio” while the QTIP Trust should be an “income with growth secondary portfolio”.  REMEMBER: this assumes that you will have a QTIP Trust.  If the QTIP Trust will not be funded at the first death, then the language in the Decedent’s Trust must alert the trustee to investigate the existence of the QTIP Trust.  If not, they have the privilege of investing the Decedent’s Trust assets with an emphasis on “income with growth secondary”. 

Remember that most Decedent’s Trusts give the income beneficiary the right to take up to 5% of the value of the trust each year as a principal distribution in addition to the income generated by the trust. Ask yourself if the surviving spouse will have enough to live on if the trust produces a net income (after expenses) of 1 or 2% each year along with 5% of the principal considering all other sources of income

Complicated?  That’s why we have attorneys to draft all this language.

WHAT’S THE BOTTOM LINE RECOMMENDATION?  It might be helpful to summarize all of this into a few bullet points.

1. Give the surviving spouse the power not to fund the Decedent’s Trust by leaving all of the estate to him or her and giving the surviving spouse the right to disclaim a part of his/her inheritance into the Decedent’s Trust.
2. Have your attorney develop a hypothetical “funding” model for your estate allocating your existing assets to the various trusts that might be created at the first death.  Then have your financial planner develop a forecast of the amount of income that might be available to the surviving spouse under this model.  Determine if this is sufficient or whether it needs to be supplemented.

a) If it is sufficient, don’t change the normal language that your attorney would include in the trusts for the determination of income and its distribution.
b) If it is not sufficient, determine if invading the Decedent’s Trust and QTIP Trust principal up to 5% a year plus the income, would create sufficient income.  Instruct your attorney to add this language.
c) If you are still concerned that there might not be enough income, then instruct your attorney to add language that would allow the trustee of the QTIP Trust and maybe the Decedent’s Trust to:

i.  Characterize all dividends and distributions from mutual funds and registered investment companies as income.
ii.  Charge all expenses against principal.
iii. Give the Trustee the authority to develop an investment policy for the QTIP Trust that emphasizes income with growth secondary.  This language should be included in the Decedent’s Trust also if

1) if the QTIP Trust is not formed or
2) If the potential income from the QTIP Trust and all other sources will not be enough.

WHERE THE 1997 UNIFORM PRINCIPAL & INCOME ACT HAS BEEN ADOPTED (2009).

Alabama                     Maine                      Ohio

Alaska                        Maryland                  Oklahoma

Arizona                      Massachusetts          Oregon           

Arkansas                    Michigan                  Pennsylvania

California                    Missouri                   South Carolina

Colorado                    Montana                  South Dakota

Connecticut               Nebraska                 Tennessee

District of Columbia      Nevada                   Texas

Florida                       New Hampshire        Utah

Hawaii                       New Jersey              Virginia

Idaho                        New Mexico             Washington

Indiana                      New York                West Virginia

Iowa                         North Carolina          Wisconsin

Kansas                       North Dakota           Wyoming
            Kentucky