When liquidation of estate or trust property is required for any purpose, including the paying of the decedent's debts, expenses of administration, and satisfaction of gifts, the Probate Code specifies priority for liquidation based on how the property if gifted (Prob. Code, § 21401):
- First, any property not disposed of by the instrument.
- Second, residuary gifts.
- Third, general gifts to persons other than the transferor's relatives.
- Fourth, general gifts to the transferor's relatives.
- Fifth, specific gifts to persons other than the transferor's relatives.
- Finally, specific gifts to the transferor's relatives.
“A specific gift is a transfer of specifically identifiable property.” (Prob. Code, § 21117, subd. (a), emphases added.) E.g., “my home to my daughter,” “all my shares of Apple stock to my son,” “my wedding ring to my daughter,” or “my Smith Bank Account to my neighbor Sam.” The key is that the language clearly and unambiguously identifies the property transferred to the beneficiary.
“A residuary gift is a transfer of property that remains after all specific and general gifts have been satisfied.” (Prob. Code, § 21117, subd. (f), emphases added.) Essentially, a gift that is neither specific or general.
A general gift is a general transfer of assets without reference to specific property (Prob. Code, § 21117, subd. (b), emphases added), and includes:
- Demonstrative gifts, meaning a “general gift that specifies the fund or property from which the transfer is primarily to be made.” (Prob. Code, § 21117, subd. (c).) g., “$200,000 to my spouse, to be satisfied first from the proceeds of the liquidation of my separate property brokerage account.”
- General pecuniary gifts within the meaning of Probate Code section 21118.
- Annuities, meaning a “general pecuniary gift that is payable periodically.” (Prob. Code, § 21117, subd. (e).)
The shares of beneficiaries abate pro rata within each class of gift. (Prob. Code, § 21403, subd. (a).) However, for the purposes of abatement, annuities and demonstrative gifts are treated as specific or general gifts (Prob. Code, § 21403, subd. (b)):
- An annuity or demonstrative gift is treated as a specific gift to the extent it is “satisfied out of the fund or property specified in the gift.”
- An annuity or demonstrative gift is treated as a general gift to the extent it is “satisfied out of property other than the fund or property specified in the gift.”
Example of Probate Code section 21403: The decedent's will states "$200,000 to my son, paid first from the my Wells Fargo bank account, and any reminder from my other assets.” The bank account yields $150,000. For abatement purposes, $150,000 of the gift is considered a specific gift, and $50,000 is considered a general gift. (Prob. Code, § 21403, subd. (b).)
How the Default Abatement Rules Become Problematic
Abatement rules become problematic when they conflict with the testator's intent. Consider these examples:
Example 1: The decedent desires that the decedent's three children receive an equal share of the estate, but the decedent wants one particular son to receive the decedent's residence. The decedent asks the attorney to make this happen. The resulting trust states:
My son Jack shall receive my residence at 123 Black Pearl Lane, Laguna Niguel, CA. The rest and residue shall be divided equally between my three children. However, the residual share of my son Jack shall be reduced by the value of my residence as of the date of death of the second of us to pass and that amount split equally between my other two children.
As of the date of death of the second spouse, the decedent's estate consisted of the residence valued at $1 million and $2 million cash. Jack (son) will receive the residence and the other two children receive $1 million each from the residue. However, the residual gifts will abate first to the extent necessary to pay the decedent's debts and expenses (excluding any encumbrance on the residence (e.g., mortgage) -- see Prob. Code, § 21404) and the specific gift to Jack will not abate unless the residual estate is exhausted. (Prob. Code, § 21402; see also Prob. Code, § 12002 regarding payment of expenses attributable to specifically devised property.) In this case, Jack's share will likely be larger than the individual shares of Child 1 and Child 2.
Example 2: The decedent wanted to disinherit Child 1 and give the entire estate to Child 2. After consulting with an attorney, the decedent decides to make a gift of $100,000 to Child 1, believing this “life changing” amount sufficient to avoid a contest of the estate plan due to the no-contest clause, and leave everything else gifted to Child 2. Based on the decedent's financial situation at the time, this favors Child 2 significantly. The decedent's will states:
The sum of $100,000 to Child 1, with the rest and residue to Child 2.
The decedent dies with a gross estate worth $500,000. However, the decedent's debts (incurred after the estate plan was drafted) and costs of administration run $350,000, leaving $150,000. The residual gift to Child 2 abates first. Child 1 then receives $100,000 and Child 2 receives only $50,000 -- not what the decedent intended.
Avoiding Abatement Problems
Of course, an estate plan with only one class of gift, such as “equally divide my estate between my children,” will never run into an abatement problem. However, once a client starts making gifts of different classes, abatement becomes a concern. Some simple techniques to avoid problems include:
- Rewrite the default abatement rules in the instrument itself. (Prob. Code, § 21400.) A simple direction in the trust that satisfaction of debts and expenses shall be divided among the beneficiaries pro rata based on the total value of each beneficiary's share and without regard to the type of gift avoids the problem in Example 1. (son Jack may avoid abatement of the specific gift by making a contribution out of his other property; Prob. Code, § 21405, subd. (b).)
- When making an unequal division of estate property (Example 2), consider using percentages instead of a specific dollar amount, and keep all gifts in the same class. This will ensure the default abatement rules divide the debts and expenses between the beneficiaries pro rata. (Prob. Code, § 21403, subd. (a).)
- Gain a good understanding of your assets, liabilities, and future financial outlook to better understand what abatement issues may arise in the administration of your estate. The old adage is “you can't just set it and forget it.”
With a good understanding of the abatement rules your intentions and desires, can be carefully crafted in your estate plan to avoid abatement issues during administration.