Financial Life Advisor

Trust Applications for Estate Planning - Demystifying Trusts part 3 of 3

Trusts are commonly used to achieve estate planning goals. The use of various trusts can preserve the Estate Tax Credit of the first spouse to die, minimize estate taxes upon death, protect children from a potential remarriage of the surviving spouse, and create provisions to protect children from themselves, future spouses, creditors, and predators.  Trusts can also be used for charitable giving in a way which can still retain assets for heirs or provide for lifetime income for the Grantor. As always, you should consult a qualified attorney or subject matter expert to discuss your particular situation.

Preserving the Estate Tax Credit

If a couple has a combined estate near or in excess of the Estate Tax Credit [$3,500,000 in 2009, No limit in 2010 (currently), $1,000,000 in 2011 (currently)] and have wills that leave everything to the other spouse, it is common for an estate planning attorney to recommend an AB Trust structure.

Generally, with an AB Trust structure, two trusts are created when one of the spouses die. The A trust is sometimes called a Survivors Trust. The assets of the surviving spouse go into this trust. The surviving spouse retains complete control over the assets in the A trust.  The assets which flow into the B Trust, sometimes called a Credit Shelter Trust, are subject to certain restrictions to ensure the Estate Tax Credit is not lost.

In order to maintain the Estate Tax Credit, the surviving spouse must not have complete control over the assets in the B Trust. If too much control is retained, the IRS may find that the assets in the B trust are to be included in the surviving spouse’s estate. If this happens, anything over the Estate Tax Credit amount is taxable. In recent history, this tax rate has been 45%-55% of the amount above the Estate Tax Credit (currently no tax in 2010, scheduled to be 55% in 2011).

The biggest concern of the surviving spouse is maintaining access to the assets in the B Trust. The surviving spouse is usually named Trustee and primary beneficiary of the B Trust. Although the surviving spouse is usually Trustee, the trust document will only allow certain control be given to the Trustee on behalf of the beneficiary. Generally, all income can be distributed annually, and if needed, the corpus (principal) of the trust can be used for the “health, education, maintenance, and support” of the beneficiary. So, in laymen’s terms, the assets can be accessed if the beneficiary (surviving spouse) needs the money for their customary lifestyle.

You might be asking yourself that if the surviving spouse can use the money to support their usual lifestyle, “What access is not allowed?” This mostly has to do with the contingent beneficiaries of the trust. Once the surviving spouse has passed away, the kids (or charity) could be the next beneficiaries. As the Trustee, you cannot change the contingent beneficiaries nor can you decide to gift assets of the B Trust to anyone, so it is important to contemplate which assets should go into the B Trust as to not interfere with anticipated gifting strategies. Most people view the AB trust structure a minor inconvenience to retain both Estate Tax Credits when estate planning for a married couple. It can, after all, potentially save millions of dollars in estate tax.

Family Trust

The Family Trust can refer to a broad range of trust structures. The basic common theme is to manage and transfer assets to members of the same family.  The advantage of using a Trust is that special restrictions can be placed on how that transfer takes place. Common trust provisions can be used to protect beneficiaries from both themselves and potential life events which could adversely affect the intentions of the parents who are transferring wealth.

A common feature found in a trust is a spendthrift provision. The Trustee is granted full control of the disbursements of income and principal. If the beneficiary is someone whom is irresponsible with money, such as an addict, the Trustee can choose to withhold resources. If the beneficiary has gotten into a large amount of debt, creditors cannot attach to trust assets because they are not owned or controlled by the beneficiary. If a beneficiary is going through a divorce, the trust is not a marital asset. It is separate and not even owned by the beneficiary.

In most cases, it is not advisable to drop considerable wealth upon young adults or children. The spendthrift provision provides lots of leeway for the Trustee by allowing decisions as to what is appropriate for those children. It is not uncommon for trusts to give chunks of a trust to children as they reach milestones like graduating college or turning a certain age.

When dealing with second marriages, another common feature added to a trust is a QTIP (Qualified Terminal Interest Property) provision. When blending families, it may be the desire of each spouse to ultimately have their property passed on to their children. If each spouse leaves their assets to the other, then the surviving spouse could get remarried or decide to leave all the marital property to their own children, thus disinheriting the deceased spouse’s children. The QTIP provision allows the surviving spouse to use the assets of the trust for their own health, maintenance and support but identifies the ultimate beneficiary (the deceased spouse’s children) when the surviving spouse dies.

Special Needs Trust

When dealing with people who are disabled and those who qualify for governmental assistance, a Special Needs Trust may be the best type of trust to make sure assets are maximized. A Special Needs Trust has special protection under the law which allows for a disabled person to have assets in a trust and not be required to exhaust those assets prior to receiving government aid such as Social Security Disability or Medicaid.

The major caveat to a Special Needs Trust is that someone cannot fund their own trust. If this was the case, someone could place their assets in a trust prior to going into long-term care and have the government foot the bill first.  A Special Needs Trust generally only works when an inheritance or gift funds the Trust for a disabled person.

Irrevocable Life Insurance Trust (ILIT)

When an estate exceeds the Estate Tax Credit and an AB Trust structure is not enough to cover the estate, people often consider an ILIT. An ILIT is an irrevocable trust which owns life insurance. The idea is that an individual can gift the trust enough cash to purchase a life insurance policy. The proceeds of the life insurance policy are tax-free, and by gifting to an irrevocable trust (a completed gift), the life insurance/trust proceeds will not be included in the estate of the Grantor.  

It is not uncommon for closely held businesses or family farms to be worth more than the Estate Tax Credit. In these cases, selling the asset to pay the taxes would greatly diminish the value of the asset and might be counter to the wishes of the family.  If a properly drawn up and funded ILIT is used, the proceeds from the insurance can be used to cover the cost of the estate tax due. If the life insurance premiums are less than the annual gift exclusion, it may be possible to avoid both gift and estate tax.

Charitable Trusts

Trusts can also be very powerful tools for achieving charitable goals, as well as maximizing the tax efficiency of wealth transfer. With a charitable trust, the income stream generated by an investment can be separated from the principal (corpus) of the trust.

For instance, with a Charitable Remainder Trust (CRT), the Grantor donates the property to a qualified charity and retains use of, or the income, from the property. The Grantor also receives an income tax deduction for the value of the remainder interest in the donated property. When the Grantor dies, their estate does not count the asset in the estate, but the Grantor retained use during his/her lifetime and received tax benefits to it. Based upon how the trust is structured and prevailing interest rates, this type of charitable giving can provide significant tax benefits.

A Charitable Lead Trust (CLT) is almost the opposite of a CRT. The income is donated to the charity, and the remainder interest is retained for the Grantor or heirs. A Grantor could set up and fund a CLT. The named charity would receive income until a specified time, and then the assets would either go back to the Grantor or to heirs.  Like the CRT, significant tax savings can be achieved, especially when interest rates are favorable. It may even be possible to transfer much of the estate tax free to heirs with the right circumstances.

As you can see, there are many types of trusts, and they can perform all sorts of functions. It is always important to consult with a qualified professional before implementing any type of estate planning. Hopefully, though, this series has raised some provocative questions in your mind.

If you missed Part 1, “What is a Trust and Why Do People Want Them?” click here to read it.
If you missed Part 2, “The Advantages and Disadvantages of a Living Trust” click here to read it

Posted by Ben Gurwitz on 1st February, 2010 | Comments (5) | Trackbacks
Tags: Financial Planning, Estate Planning, Feb 10

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Comments

Can a Will supersede a Trust

Thanks for the the info. This is very odd: Can a Will (revealed a day before a parents death to the surviving children) supersede a Living Trust?The Will has an entirely different distribution and was not witnessed.One sibling wants an agreement asap to break the Living Trust (the Will is more favorable to them)

Posted on 19 January, 2011 by Aimee

Aimee Reply

Aimee, It does sound odd. Let me first explain that a will is a legal document which changes ownership of the deceased. If you want to sell your car you sign it over, when you die you can't sign it so through a probated will the court "signs" for you to change ownership to someone else. With a living trust, the trust owns the assets and the will is not used to transfer anything out of the trust because the person who died doesn't own it, the trust does. Many wills have provisions in which assets which were never transferred to the trust are placed in the trust after death through probate (deceased to trust).

In your case, you said the will was not witnessed. Most states require that a will be properly witnessed to be valid. If the will is not valid it is as if it never existed.

Hope that answers your question.

Posted on 19 January, 2011 by Ben Gurwitz

Thank you so much. You've made this very clear to me. Is the Will normally considered instruction on how the Trusts assets should be dispersed?

Posted on 19 January, 2011 by Aimee

No, the reason most people set up a Living Trust is to avoid probate (the will) altogether. Now if the trust is unfunded (assets have not been retitled to the trust) then wills will govern, but usually the will and trusts have their own individual disbursement instructions.

Posted on 20 January, 2011 by Ben Gurwitz

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