Total Return Trust:
for Your Surviving Partner in Same Sex Permanent Relationships
Effective estate planning for
gay or lesbian couples requires “thinking outside of the box.”
Since estate tax laws for same sex partners are so unfavorable, the
stakes are high. Estate tax rates range from to 37-55% for total
taxable estates over $675,000, whereas for traditional married
couples, the surviving partner receives an unlimited marital
The predominant high-level
estate planning practices use a variety of techniques revolving
around the unlimited marital deduction.
There is also a well-developed field of estate planning for
business owners. What about a gay or lesbian couple where one or
both partners have a lot of stock and retirement assets and neither
partner owns a business?
Same sex partners face
complications beyond not having access to the unlimited marital
deduction. If there are children, chances are, at least at this
point in time, the children will have only one of the partners as a
legal parent. Many gay
or lesbian life partners may wish to choose different ultimate
There is no one-size-fits-all
answer. This article, however, presents a detailed look at one of my
favorite methods for maximizing asset value for gay and lesbian
couples and their families—the total return trust.
(At the end of the article, I list a variety of other
techniques that I use in my estate planning practice.)
Let’s take it as a given that
you want to provide for the financial security and protection and
even over-protection of your life’s partner.
But, what do you want to have happen upon the death of your
partner? Creating a
trust is one effective way to have your wishes respected. In
general, there are good reasons for these trusts and they often
present an obvious solution to many problems. However, they also
pose a problem once they are funded.
The devil is in the details.
For the sake of this example,
we will assume that you want what remains of your money to go to
your sister’s children on the death of your partner. The trust
stipulates that upon your death, your life’s partner will receive
the income from the trust for the remainder of his or her life.
Upon the death of your partner, the principal remaining in
the trust will be distributed to your nieces and nephews.
The individual you pick as trustee has the responsibility of
managing the fund to satisfy the interests of both your partner and
your sister’s children.
Put yourself in the role of the
impartial trustee managing the trust:
The income beneficiary, that is
the surviving partner, comes to you and suggests that you invest the
money in a variety of junk bonds that are paying 7% interest.
This option would excellently serve the needs of the
surviving partner. However,
the junk bonds offer little in terms of long-term appreciation for
the principal beneficiaries. Then,
the children, the principal beneficiaries, come to you and recommend
that you invest in stocks like Microsoft and Intel that pay no
dividends, but do offer substantial growth opportunities—another
excellent choice, but only for the principal beneficiaries. It is
your duty to somehow satisfy both parties.
You opt to make prudent
investments regardless of the income distribution problem.
You choose a portfolio that includes a diverse mix of assets,
with a concentration in the stock market.
Unfortunately for the surviving partner, even a
well-diversified portfolio will provide little in the way of
“classic income” which is historically defined as interest and
your income beneficiary is unhappy.
You decide to compromise. You choose a portfolio that
includes a higher percentage of income producing assets even though
it does not make sense from a pure investment standpoint. Your best
solution results in moderate disappointment for both the surviving
partner and the principal beneficiaries. The truth of the matter is, that with the type of trusts
lawyers have been drafting for hundreds of years, there is no
perfect or even good solution.
The crux of the problem is how
we define income, i.e. interest and dividends from stocks and bonds.
Currently an investment portfolio that makes good economic
sense will include assets that have significant growth potential,
but that do not pay significant interest or dividends.
Managing the assets of the most common trusts presents a
dilemma. One choice limits income, the other limits growth, and
attempting to balance the two interests leaves everyone feeling like
they are missing out on strategic opportunities. What is the
Let's consider drafting a
different type of trust where we define income as a percentage
of principal. For
example, let's assume there is $1 million in a trust and
“income” is defined as five percent (5%) of the balance of the
trust. This means the income beneficiary is assured of earning
$50,000 annually even if the assets do not grow.
Of course, without being restricted to investments that
produce sufficient interest and dividends for the income
beneficiary, the trustee is likely to obtain a much better
investment rate of return than five percent.
Let’s assume the trustee is successful and achieves a
combination of income and growth equal to 10 % of the principal.
The trust balance the following year would be $1 million plus
$100,000 or $1,100,000. Of that, $50,000 is paid as income to the
income beneficiary (5% of the original $1M), leaving a balance of
$1,050,000. If income
and growth remain at 10%, the trust will continue to increase. The
balance of $1,050,000 in the first year, plus $105,000 from income
and growth of principal for the next year results in a balance of
$1,155,000 from which $52,500 (5% of $1,050,000) is distributed to
the income beneficiary. (More
realistically, distributions would probably be monthly or quarterly,
not annually.) Since the income beneficiary is receiving a percentage of the
principal, his or her income keeps growing as the investments grow.
Now everybody is on the same
page. The income beneficiary benefits when the corpus of the trust
increases, and the principal beneficiaries also benefit from the
growing principal because, after the death of the surviving partner,
they will get more money. The trustee is happy because he or she can now find
investments that will maximize the principal in the trust without
having to worry about offending, or perhaps even having legal
liability, to either the surviving partner or the principal
type of trust is much more likely to preserve peace and unity
between the income and principal beneficiaries, and the trustee.
It is a win-win-win situation.
J. Wolff pioneered this
concept. He has written eloquently on the benefits of this type of
trust—referred to as a Total Return Trust—particularly for
second marriages in which both spouses have children from prior
relationships. It came to me that this type of trust meshed
seamlessly with estate plans for many of my gay and lesbian clients.
And, to my satisfaction, the total return trust has enjoyed
The concept of having the
income beneficiary receive a percentage of principal is not new.
A typical endowment fund operates similarly.
The fund invests the money in both income and growth assets
and distributes a percentage of the assets each year. This is also
how a Charitable Remainder Unitrust (CRUT) works.
However, expanding the use of the total return concept to
trusts for same sex couples outside the charitable world will yield
huge dividends, or perhaps more accurately, more wealth for both the
surviving partner and the principal beneficiaries.
Of course, the total return
trust is only one strategy. Most
of the planning I do for gay and lesbian couples involves multiple
strategies including: sophisticated and multiple beneficiary
designations on retirement plans, Roth IRA conversions, irrevocable
life insurance trusts, family limited partnerships, charitable
remainder trusts, grantor retained interest trusts, gifting,
qualified personal residence trusts, self canceling installment
notes, life estates, first-to-die life insurance policies, Section
529 plans (qualified state tuition programs) and other popular
techniques. While these
techniques were not created for gay and lesbian couples, they will
often resolve planning problems and maximize assets for both
partners and surviving family members.
Without the benefits of the unlimited marital deduction and
other advantages that traditional married couples enjoy, same sex
couples need to aggressively seek out alternate solutions to
maximize their assets and reduce their taxes.
Lange is a tax attorney and CPA who provides specialized retirement and estate
planning services to same sex couples with significant retirement plan accumulations. He
has prepared over 450 simple and complex retirement and estate plans. These plans
include tax-savvy advice, will and trust preparation, and sophisticated beneficiary
designations for IRAs and other retirement plans.
You can contact Jim by phone at (800) 387-1129,
or (412) 521-2732, or by e-mail at firstname.lastname@example.org.