The Wealth & Wisdom Blog

There is beauty in brevity.  Less is often more. In my experience, the shorter the document, the more likely it is to be read and understood. In this month’s update, I briefly describe how the inclusion of a short but powerful legal standard in a trust agreement provides significant estate planning benefits.

The Ascertainable Standard of “Health, Education, Maintenance and Support”

Many of our clients want to name their adult children or other adult beneficiaries as the successor trustee, while also seeking the tax and legal protections of a testamentary trust for the benefit of the same beneficiary.  If this trustee is also the trust beneficiary and holds unfettered access to the inherited assets under the terms of the trust agreement, the IRS will consider the assets to be “owned” by the trustee/beneficiary.  In contrast, if the terms of the trust agreement limit the trustee/beneficiary’s legal rights to a distribution standard of “health, education, maintenance and support,” the assets of the trust are not considered to be owned by the trustee/beneficiary.  This legal standard, often referred to as “HEMS,” is therefore an important tax and legal element of an estate plan.¹

Where the Standard Matters

Because Minnesota’s estate tax exemption is not portable, married couples with larger estates typically fund a Family Trust at the first death, and the surviving spouse often serves as its trustee. Likewise, the generation-skipping trust that I described in an earlier update can allow a child to serve as his or her own trustee. In both cases, HEMS language allows the beneficiary to manage the trust without pulling its assets into his or her estate.

What the Standard Allows

The Treasury regulations are more generous than the acronym suggests. “Support” and “maintenance” are synonymous and are not limited to the bare necessities of life, and a standard that refers to the beneficiary’s “accustomed manner of living” qualifies. Education includes college and professional education, and health includes medical, dental and hospital expenses.

Planning Considerations

• Use the right words. Distribution language that strays from the HEMS vocabulary, even with good intentions, can have adverse tax results.²
• Consider an independent trustee for broader purposes. Some of the purposes I listed in a previous blog post, Trust Distribution Standards (such as help with a wedding or a business) may fall outside of HEMS. A trustee who is not also a beneficiary can be given discretion to make those distributions without estate tax consequences.³

A distribution clause can look like insignificant boilerplate language, but a handful of words can significantly affect the plan.  Since this blog post is only 437 words long, please do not hesitate to contact any member of our Estate Planning team with questions.  We look forward to hearing from you.

¹ If the trustee can distribute trust assets to himself or herself without limitation, the trustee holds a “general power of appointment,” and the trust assets are included in that person’s taxable estate at death.

² A power to distribute for a beneficiary’s “comfort, welfare or happiness” does not qualify, and an open-ended phrase such as “best interests” is likely to fail as well.

³ I discuss the attributes to look for in a trustee in Appointing Human Fiduciaries.