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First, the good news:
On 1/1/2022 the Arizona homestead exemption amount increases from $150,000 to $250,000. The homestead exemption, which is automatic in Arizona, is intended to protect an Arizona resident's primary residence ("homestead") from creditors.
But the new law includes several intricacies that make it more complex than it initially appears. For example, the new law requires any existing judgment liens (recorded in the same county) to be paid when the homeowner either sells or refinances the residence.
The prior law stated that a homeowner with less than $250,000 equity could still refinance a home loan without having to first pay off any existing judgment liens. The new law does the opposite - effectively preventing the homeowner from exercising a cash-out refinance.
The homestead exemption is also complicated by federal bankruptcy laws. If the home was acquired within 1,215 days (3 years, 4 months) of filing the bankruptcy case, the exemption amount is currently limited to $170,350.
Many people I meet would benefit from an irrevocable asset protection trust, a strategy generally assumed to be too complicated and too expensive. But I am not referring to families with vast inherited wealth or the Mark Zuckerberg-type entrepreneurs. So how do you know if an asset protection trust might be right for you? Consider the value of these assets you may own:
If the combined value of these assets exceeds $500,000, then you are an excellent candidate for an asset protection trust.
So how does the asset protection trust work?
An asset protection trust is created when a person transfers ownership of an asset into an irrevocable trust, which is managed by a trustee for benefit of one or more beneficiaries. The assets you contribute to an irrevocable trust may qualify for protection from your future or unknown creditors. The catch is that you cannot name yourself as both trustee and beneficiary like you would normally in a revocable living trust for probate avoidance. In other words, you cannot establish your own irrevocable asset protection trust and retain the sole discretion to make distributions back to yourself. This arrangement does not provide any asset protection and is against public policy in all 50 states.
Some states like Wyoming and Nevada do permit self-settled asset protection trusts using a third-party trustee in that state, which means residents of those states may remain a beneficiary of the trust and, after any applicable statute of limitations expires, protect the trust assets from their own future or unknown creditors. Although Arizona law does not permit self-settled asset protection trusts (at least not yet; see update below), an Arizona trustor may still obtain the desired creditor protection by establishing the trust in Arizona, excluding the trustor as an eligible beneficiary, and relying on spendthrift or discretionary trust provisions available under Arizona law to protect the trust assets from creditors of the eligible beneficiaries.
But there is good news on the horizon for Arizona residents. In 2020, the Probate and Trust Section of the State Bar of Arizona adopted a proposed statute permitting self-settled asset protection trusts (a/k/a “qualified spendthrift trusts”), which may soon be enacted into law by the Arizona legislature and governor. However, even if enacted, I will continue to recommend establishing the asset protection trust as a third-party discretionary trust. This “hybrid” approach omits naming the trustor as an initial beneficiary (i.e., not self-settled) but permits an independent trust protector to later add the trustor as an eligible beneficiary, subject to the then-applicable qualified spendthrift trust rules.
For Arizona residents, I recommend two options when naming trust beneficiaries:
Option #1- Family Gifting Trust (Trustor’s Children are Lifetime Beneficiaries)
In Option #1 you would name one or more children (or other non-spouse beneficiaries) as eligible beneficiaries during your lifetime, excluding yourself or your spouse. The advantage is that you may serve as trustee and maintain full control of the assets in the irrevocable trust. The trust may be established as an individual trust or a joint trust. Although your beneficiaries would have a right to information about trust assets, you retain discretion whether to make any distributions to them during your lifetime. The trust assets are protected from your future or unknown creditors - because you are ineligible to receive distributions - and from creditors of the beneficiaries (using spendthrift or discretionary trust provisions available under Arizona law).
Option #2- Spousal Lifetime Access Trust (Trustor’s Spouse is a Lifetime Beneficiary)
In Option #2 you would include your spouse as an eligible beneficiary during your lifetime, and if desired, name your spouse as trustee. Similar to Option #1 the trust assets will be protected from your creditors during your lifetime - because you are ineligible to receive distributions - and from creditors of your spouse and beneficiaries. The difference here is that your spouse is an eligible beneficiary, allowing your spouse to receive distributions from the trust if there is a legitimate need. The trust must be established as an individual trust with any contributions coming from your separate property or your one-half of community property after partition.
Both approaches may be referred to as hybrid asset protection trusts because either may be drafted to include a provision giving an independent person or company called a trust protector the power to move the trust to another state or country that permits self-settled asset protection trusts (or simply wait until Arizona permits them). This change of governing law might permit the trust protector to add you as an eligible beneficiary later.
 There are exceptions to this general rule. For example, Arizona law does not shield the trust assets from child support claims. Also, the strategy is not likely to work if you transfer all your personal assets to the trust. You must remain solvent on your personal net worth statement, even after contributing assets to the irrevocable trust.
 19 states permit self-settled asset protection trusts in some variation. The most well-known are Alaska, Nevada, Wyoming, and South Dakota. Unfortunately, the full faith and credit clause of the U.S. Constitution makes it unlikely an Arizona court would respect the governing law of a self-settled asset protection trust established in one of these states for an Arizona resident. Foreign asset protection trusts avoid this problem in theory, but if the full protection of the trust is triggered by an actual threat, case law has shown the beneficiary also loses access to the trust assets unless willing to move permanently outside of the United States. This is an unintended consequence most people are not willing to accept.
Will a LLC protect an Arizona resident's personal residence and non-retirement brokerage investments?
No, because the LLC must have a legitimate business purpose. A business purpose would include providing a service, product, or usable space to an unrelated person or company. Every small business provides a service or product, or both, to the general public, while investment real estate provides a place to live or do business.
Your personal residence does not have a business purpose and neither does your personal investment brokerage account.
Arizona residents qualify automatically for a homestead exemption, which protects up to $150,000 of equity even if a judgment creditor forces a sale of the home. For homeowners with more than $150,000 of equity, I may recommend either a major increase in homeowners liability insurance coverage or transferring the home into an irrevocable Arizona-based hybrid asset protection trust. Neither solution requires a business purpose to implement.
Other reasons you should not transfer your personal residence into an LLC are (1) loss of exclusion of taxable gain upon sale of a personal residence, (2) loss of mortgage debt interest deduction, (3) loss of homestead exemption, and (4) possible increase in property taxes.
Likewise, while some may argue that a personal investment brokerage account has a business purpose, most would not. Therefore, I would be wary of transferring a brokerage account into an LLC unless perhaps combined with other assets that do have a business purpose. The safer approach is to either increase umbrella-type personal liability insurance coverage or transfer the brokerage account into an irrevocable Arizona-based hybrid asset protection trust.
In May 2020 the executive council for the Probate and Trust Section of the State Bar of Arizona approved a proposed statute permitting the creation of Arizona qualified spendthrift trusts. This type of self-settled trust is more commonly known as a domestic asset protection trust. The proposed statute (A.R.S. 14-10821) would establish a framework for Arizona residents to protect personal assets from future claims in a manner consistent with and subject to Arizona fraudulent conveyances laws. If enacted, Arizona would become the 20th state to allow self-settled spendthrift trusts.
In order to be successful as an estate planning lawyer, I must break down complex topics to manageable teaching points. Here are a couple examples:
There are 3 tools in the estate planning toolbox for transferring assets upon death:
1- Beneficiary designation
There are no more tools.
Every estate plan will use a combination of these tools and each has its advantages and disadvantages. My job is to determine which tool is best suited for each asset, while making sure the client is comfortable using the tool.
There are 3 ways to leave inheritance to a beneficiary:
The outright approach is simple and everyone understands it.
The restrictive approach is useful when the inheritance would be subject to an identifiable clear and present danger (spendthrift habits, special needs, susceptibility to undue influence, need to maintain beneficiary's qualification for government-sponsored health benefits or supplemental income benefits).
The protective approach is useful when there is a desire to protect the inheritance from future threats (lawsuits, divorce, debt collectors).
I have found these teaching points to be very effective in explaining key concepts in estate planning.
The SECURE Act, signed into law on December 20, 2019, is the most impactful legislation to affect estate planning in decades. Although the SECURE Act includes many positive changes in regard to tax-deferred retirement accounts, it no longer permits most non-spouse beneficiaries (e.g., children) to withdraw an inherited retirement account over the beneficiary’s life expectancy (aka “stretch IRA”). Instead, the default law now requires the entire account to be withdrawn and liquidated by the end of the 10th year after the death of the account owner (“10-year liquidation rule”). This change has major implications when considering whether to name an individual or trust as beneficiary of a retirement account.
The 10-year liquidation rule results in the acceleration of income tax due, possibly causing a beneficiary to be bumped into a higher income tax bracket and receiving less of the funds contained in the retirement account than under the prior law. However, the SECURE Act does provide a few exceptions to the usual rule that are available to surviving spouses, beneficiaries less than 10 years younger than the account owner, minor children, and disabled individuals. But these exceptions only complicate the analysis because your estate planning objectives likely include more than just tax considerations. For example, you might be concerned with protecting a beneficiary’s inheritance from future creditors and ex-spouses or preventing your spouse from disinheriting your children upon the spouse’s remarriage. All these issues should be considered simultaneously when naming beneficiaries of a retirement account.
If your estate plan currently names a trust as primary or secondary beneficiary of a retirement account (e.g., IRA, 401k, TSP), then you should reconsider whether this is still appropriate after the SECURE Act, and if yes, determine what type of trust to use. As a courtesy, I have written an article, “Decision Tree for Naming Retirement Account Beneficiaries after the SECURE Act” which provides a structured analysis, i.e., a decision tree, for determining the answers to these questions. This article is available on my website.
In some cases you may discover the reason you named a trust as beneficiary of a retirement account is no longer applicable, which permits you to name individuals as beneficiaries instead of a trust (although a trust restatement may still be appropriate in case circumstances change).
But in most cases the solution will be to integrate SECURE Act compliant provisions into your will or revocable living trust by restating it.
Arizona law provides a mechanism called a “decanting power” that gives your trustee a tool to fix the trust in the event you die before updating your estate plan. But relying on this mechanism invites an unnecessary hassle for your trustee. Doing nothing is a careless approach.
By integrating SECURE Act compliant provisions into your will or revocable living trust, we will accomplish the following:
While in-person office meetings are always preferable in the estate planning context, video conferencing is available through the Zoom app if you need to use this option. Please let the receptionist know that you prefer video conferencing when you schedule the appointment.
My new article regarding how the SECURE Act affects your estate plan is now available. Here it is:
"Decision Tree for Naming Retirement Account Beneficiaries after the SECURE Act."
On December 20, 2019, President Trump signed the Setting Every Community Up for Retirement Enhancement Act (SECURE Act). The SECURE Act, which is effective January 1, 2020, is the most impactful retirement legislation of the past decade. It increases the age for required minimum distributions from retirement accounts from 70 ½ to 72 years of age. However, among the many provisions in the new law involving retirement accounts, the most significant for clients with retirement accounts is the elimination of the “stretch” option for non-spouse designated beneficiaries who inherit a retirement account.
According to the SECURE Act, most non-spouse beneficiaries—with a few exceptions for beneficiaries who are not more than ten years younger than the account owner, the account owner’s children who have not reached the “age of majority,” disabled individuals, and chronically ill individuals—are now required to withdraw the balance of the inherited retirement account within ten years. Without prompt and proper planning taking the new law into account, this change could significantly increase the tax bill for non-spouse beneficiaries. Previously, beneficiaries of inherited retirement accounts could take distributions over their life expectancy. Under the SECURE Act, the shorter ten-year time frame for taking distributions will likely result in the income tax due being accelerated and possibly causing the beneficiaries to be bumped into a higher income tax bracket, thus receiving less of the funds contained in the retirement account than originally anticipated.
Keeping an eye on tax consequences and asset protection needs, there are several strategies that are available to address this new paradigm.
Revocable Living Trust (RLT) or Stand-Alone Retirement Trust (SRT)
Now that most beneficiaries are required to withdraw the entire balance of a retirement account within ten years of the owner’s death, an RLT or SRT might be the best estate planning tool for these unique assets. We should, however, reconsider the use of “conduit” trust provisions because they require any required minimum distributions (RMDs) to be distributed directly to the beneficiary through the trust. Under the SECURE Act, the balance of the account would have to be distributed directly to the beneficiary at the end of year ten, which is an outcome our client might want to avoid. Now, an “accumulation” trust provision may be more beneficial. This provision allows the trustee to receive the RMDs from the retirement account as often as required by law but allows the trustee to exercise discretion as to when and how much of the funds are distributed to or used for the benefit of the beneficiary. Although the trust will pay income tax on any of the distributions from a retirement account that are not distributed to the beneficiary, for many beneficiaries, it is equally or more important to protect the money from the beneficiary’s creditors, divorces, or lawsuits.
If you named your RLT or SRT as beneficiary of a retirement account, you should have your estate plan reviewed now. If the trust contains “conduit” provisions, an amendment to the trust may be appropriate. I can help with this.
Charitable Remainder Trust (CRT)
For charitably inclined clients, a charitable remainder trust may be the right solution to plan for the disposition of their retirement accounts. Such a trust would allow the client, as the grantor, to name beneficiaries to receive an income stream from the retirement account for a period of time, with the remainder going to a charity named in the trust agreement.
When the trust is created, the net present value of the remainder interest must be at least ten percent of the value of the initial contribution. It can be payable for a term of years, a single life, joint lives, or multiple lives. Upon the plan participant’s or account owner’s passing, the estate will receive a charitable deduction for distributing the retirement account to the trust, and the distribution from the retirement account to the CRT is not taxed. However, distributions from the CRT to the beneficiaries will be subject to income tax. Another benefit to this strategy is that the distributions to the beneficiaries will be smaller and therefore subject to less income tax liability.
It is important to note that this strategy is best for individuals who are already charitably inclined. This strategy may not result in the beneficiaries getting more than they would have utilizing other estate planning strategies, but if you already wish to provide for a charity, this may achieve your goals in a more tax favorable way.
Irrevocable Life Insurance Trust (ILIT)
Due to the new ten-year mandatory withdrawal rule, there will be an acceleration of the beneficiaries’ income tax on inherited retirement accounts, potentially moving them into a higher income tax bracket. The new rule may also result in the amount of cash available to beneficiaries being less than the client originally anticipated. In order to help offset this shortfall, you may want to consider using funds from your retirement accounts during your life to purchase additional life insurance and transfer ownership of the policy to an ILIT. The ILIT will help protect the insurance funds from the beneficiary’s creditors and, if desired, can be designed so that the proceeds from the life insurance policy are not includible in your estate.
Multi-Generational Spray Trust
Any number divided by a large number results in a smaller number. The same philosophy is true with distributions involving retirement accounts. While the distributions must be made within ten years, by distributing the retirement account to multiple beneficiaries at the same time over the ten-year period, the RMDs received by each beneficiary will be smaller, and the resulting tax liability per beneficiary will be reduced.
For asset protection purposes, it is always advisable that the distributions be made to a trust for the benefit of a beneficiary instead of directly to the beneficiary.
 If a beneficiary is not considered a designated beneficiary, distributions must be taken by the fifth year following the account owner’s death. Common examples of beneficiaries that are not designated beneficiaries are charities and estates. See Treas. Reg. § 1.401(a)(9)-3, Q&A (4)(a)(2) and 1.401(a)(9)-5, Q&A (5)(b).
Thomas J. Bouman