Clients often like to designate an individual or entity as a pecuniary beneficiary because of a particular affinity for the person or its cause. It is worth noting that there is an estate tax deduction when leaving a pecuniary gift to a tax-exempt charity although that is usually a secondary factor. A problem can arise if a pecuniary gift is so large such that it disrupts the orderly distribution of the estate. Hence, I advise clients to be mindful of life's financial fluidity when making a large pecuniary gift. Clearly there is nothing wrong with leaving a large sum of money to a person, it is just that there can be unexpected complications that arise from this.
Assume John Doe, an unmarried man without any children, wishes to leave his 3 nephews $100,000 each and the residue to his niece. When the trust is initially funded, John has $400,000 in liquid assets and an $800,000 home located in Campbell, CA. John writes these provisions into his trust with the intent to primarily benefit his niece, as she is the residual beneficiary. Since the niece is the residual beneficiary, she will inherit whatever is left after the three $100,000 gifts have been satisfied.
Yet prior to his death and a short time after writing the trust, John incurs substantial debt as he failed to procure medical insurance despite the provisions of the Affordable Care Act. He has to spend months in the hospital because of complications from a surgery. Ultimately John's medical bills amount to $900,000 when he passes away. Whereas John's estate lacks the liquidity to satisfy the three $100,000 gifts, the trustee is then obligated to sell the home in order to satisfy said specific gifts to each nephew.
The reason for the home's liquidation is because of the law of abatement, i.e. the reduction of testamentary gifts. California's abatement law is found in Probate Code § 21402. The abatement law says that specific gifts are abated last, meaning the niece, as the residual beneficiary, bears the brunt of the abatement.
The end result is that the niece inherits zilch because there is nothing in the estate after the specific gifts have been satisfied. That is, the sale of the home causes the gross estate to be worth $1,200,00 and $900,000 is deducted from that to account for John's medical bills. The remaining balance is $300,000 and each nephew receives $100,000 from such, leaving a grand total of $0 for the residual beneficiary. A better solution for John would have been to allocate percentages in order to preserve the niece's inheritance. In such case, the trust would have said that each nephew receives a 1/12 of the estate and the niece receives 3/4 of the estate, instead of using a specific gift and residual beneficiary formula.
