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Malpractice Issues XI – Henry & Associates

Seminar selling is a great marketing tool; it’s something designed to answer questions, present the speaker as a problem solver, motivate prospects, and generate referrals.  In this particular case, an elderly couple attended a seminar at the local senior center.  The seminar, co-hosted by a charity and three insurance agents, pushed charitable remainder trusts (CRT) by stressing how real estate makes for a problematic inheritance (e.g., estate and/or capital gains tax, liquidity, management concerns, etc.)  In rapidly growing states like California, every senior attending that seminar had a substantial percentage of their net worth in real estate.

imageSpeaker #1 met with elderly clients later and told them a CRT was the perfect tool for them.  Although their estate was valued at $1,200,000 and taxes shouldn’t have been an issue, he scared them with tales of high estate taxes and lack of liquidity.  They agreed to do a CRT benefiting the co-sponsoring charity and the charity’s development officer met with them.  Speaker #1 sold life insurance to fund a “Wealth Replacement Trust” or Irrevocable Life Insurance Trust (ILIT).  Speakers #2 and #3 handled the reinvestment of the real estate sales proceeds.  Speaker #3 is married to the charity’s representative, but this isn’t disclosed.

Speaker #1 brought in his attorney, arranged for insurance coverage, and while insurance is often useful, these clients are high-risk and uninsurable, resulting in a $40,000 premium instead of the projected $10,000.  Further complicating the planning, the rental properties used to fund the CRT had mortgages, and debt encumbered charitable trusts are tax bombs waiting to explode.  To save the sale, Speaker #2 (also a mortgage broker) arranges to transfer the rental property mortgages to the family home.  The charity’s representative also tries to save the sale by telling clients that they can increase the CRT payout rate by replacing the relevant page of the already signed and irrevocable document.  Speaker #1 continues to try to save the sale by implying that premiums will be much lower in years after the second year (he misrepresented that fact).  Speaker #3 also tried to save the sale by telling the clients that their CRT will simply repay the new mortgage on their home in full, once the trust was finalized

imageThe attorney didn’t draft the ILIT until the insurance policy has been in force for over a month.  No one bothered to tell the clients that they needed a qualified appraisal on the transferred properties, so no income tax deduction was available, but that was not a major issue since the clients had almost no income, so the deduction wouldn’t have helped much anyway.  The speakers told clients repeatedly that the income from the CRT would cover the insurance premiums, so clients were writing checks from the charitable trust accounts directly to the insurance company.  Over the next two years, no one did any trust accounting or advised the clients that trust accounting would be required.  Speakers #2 and #3 invested the CRT assets into a deferred annuity earning 6%, even though the CRT payout rate was set at 10%, producing a declining  income stream.  When all the dust settled, the clients had only $200,000 left outside of the CRT, an unaffordable and collapsing insurance policy, a decreasing annual income, and a staggering bill for the accounting work needed to re-file past years’ tax returns and pay penalties and interest.

What were the motivations for all of these shenanigans?  Speaker #1 earned a $30,000 commission.  Speaker #2 earned $4,500 in mortgage broker fees, speakers #2 & #3 earned $12,000 in annuity commissions, and the charity’s representative (married to Speaker #2) earned a percentage-based bonus for bringing in the gift.  Too bad, there should have been some consideration for the client/donor and there wouldn’t have been litigation generated.  If you aim for immediate gratification, you’re likely to do great harm with your toxic planning to all involved.

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Vaughn W. Henry

PhilanthroCalc for the WebCONTACT US FOR A FREE PRELIMINARY CASE STUDY FOR YOUR OWN CRT SCENARIO or try your own at Donor Direct Please note — there’s much more to estate and charitable planning than simply running software calculations, but it does give you a chance to see how the calculations affect some of the design considerations. This is not “do it yourself brain surgery”. When is a CRUT superior to a CRAT? Which type of CRT is best used with which assets? Although it may be counter-intuitive, sometimes a lower payout CRUT makes more sense and pays more total income to beneficiaries. Why? When to use a CLUT vs. CLAT and the traps in each lead trust. Which tools work best in which planning scenarios? Check with our office for solutions to this alphabet soup of planned giving tools.