Balance your client’s inheritances with hotchpot and release clauses

The idea is that, when a financial professional meets with clients and needs to calculate how much each beneficiary receives from the estate given that the client made or is contemplating pre-death gifts or advances, the professional will immediately think to include the gifts/advances in the calculation (“in for calc”) and deduct them from the distribution payment (“out for payment”).

Here’s a simplified hypothetical example to illustrate the concept.

Francine, a testator, has three children: Angela, Ben and Claire. Francine decides to distribute some assets to her children during her lifetime. She gives a gift of $150,000 to Angela to buy her first home and an advance of $36,000 to Claire to buy a car. Ben does not receive a gift or advance. The will includes a hotchpot clause to address this situation.

Francine dies leaving an estate of $750,000 to be divided equally among her three children. If there were no hotchpot or release clauses (more on release clauses below), Angela, Ben and Claire would each receive one-third of the estate, or $250,000.

However, given that there is a hotchpot and a release clause, the value of the estate ($750,000) is combined with the value of the gift to Angela ($150,000) and advance to Claire ($36,000) resulting in a hotchpot amount of $936,000. This is the “in for calc” component of my tagline.

Notionally, each child would be entitled to one-third of the hotchpot amount, or $312,000. However, the purpose of the hotchpot clause is to ensure an equitable distribution. It equalizes the benefit to each child by deducting (“out for payment”) the amount that each beneficiary already received. Accordingly, Angela, Ben and Claire would receive the amounts in Table 1, below.

Table 1: Equitable distributions of Francine’s estate

	Angela	Ben	Claire	Total
Hotchpot amount	$312,000	$312,000	$312,000	$936,000
Less gifts and advances	($150,000)	$0	($36,000)	($186,000)
Amount to be received	$162,000	$312,000	$276,000	$750,000

The total of the amounts paid to Angela, Ben and Claire is $750,000, which is consistent with the actual value of the estate available for distribution.

Contrast the amounts to be received by each child versus the amounts if there were no hotchpot clause and each child received one-third of the estate ($250,000). Not including a hotchpot clause in a will could create an unintentional injustice for some beneficiaries and a bonus/windfall for others.

However, the clause by itself does not release the beneficiaries from the obligation to repay any debts owed by them to the testator’s estate (unless the will states otherwise). A release or cancelling clause typically accompanies the hotchpot clause, allowing any debt owed by the beneficiary to the deceased or estate to be offset against the beneficiary’s entitlement.

Hotchpot scenario without a release clause

The release is not just a formality, because it can materially alter the hotchpot clause calculation.

Let’s go back to Francine and assume prior to her death that she advanced $450,000 to Ben, and the release clause did not exist. As a result, the estate amount would be $1,236,000 ($750,000 + $450,000 + $36,000), as the amounts advanced to Ben ($450,000) and Claire ($36,000) are to be repaid to the estate before distributions. Recall, the amount paid to Angela ($150,000) is a gift and does not have to be repaid.

The estate amount is combined with the value of the gift and advances resulting in a hotchpot amount of $1,872,000 ($1,236,000 + $150,000 + $450,000 + $36,000). Based on this amount, Angela, Ben and Claire would each be entitled to one-third, or $624,000.

However, as shown in Table 2, below, the amount advanced to each would still need to be deducted from each beneficiary’s entitlement:

• Angela would get $624,000 less the $150,000 gift, or $474,000.
• Ben would get $624,000 less the $450,00 loaned to him for a total of $174,000; however, given that he had to repay the $450,000 loan, he is actually in a deficit position.
• Claire would get $624,000 less the $36,000 advanced to her, for a total of $588,000.

The total paid to Angela ($474,000), Ben ($174,000) and Claire ($588,000) is $1,236,000, which equals the estate’s revised value.

Table 2: Distributions of Francine’s estate when no release clause exists

	Angela	Ben	Claire	Total
Hotchpot amount	$624,000	$624,000	$624,000	$1,872,000
Less gifts and advances	($150,000)	($450,000)	($36,000)	($636,000)
Amount to be received	$474,000	$174,000	$588,000	$1,236,000

A release clause accompanying the hotchpot clause in the will would have helped minimize potential conflicts among beneficiaries by specifying the agreement to relinquish claims or disputes related to unequal distributions. It would also help promote a smoother distribution process and cooperation among heirs. As a result, it would contribute to the efficient and amicable distribution of estate assets.

The tagline “in for calc and out for payment” emphasizes the concept behind a hotchpot clause in a will. It signifies that assets included in the calculation (in) are considered for the purpose of determining equitable distribution, while those already received (out) are subtracted from future entitlements. It aids in conveying the principle that all relevant assets contribute to the fair allocation of inheritances, aligning with the hotchpot clause’s objective.

Michael Kulbak, MBA, CPA, CMA, TEP, is principal of Kulbak Trust Solutions in Mississauga, Ont.