As part of your year-end planning, take some time to think about what would happen to your assets and loved ones if you were no longer able to care for them. Then consider the potential benefits of setting up a trust. Trusts are an effective means of helping to protect important assets, take care of beneficiaries and manage taxes. And, contrary to popular belief, trusts aren’t just for the wealthy.
A qualified lawyer can help you set up a trust fairly easily that can be used for a number of practical purposes, such as:
o Manage assets and provide security to beneficiaries.
o Caring for beneficiaries who are minors or need expert assistance in managing money.
o Avoiding inheritance or income taxes.
o Ensuring expert management of estates.
o Avoid maintenance costs.
o Preservation of privacy.
o Protection of real estate or a business.
Trust Definitions – A Quick Introduction
A trust is a legal arrangement whereby you, the owner of the estate and the grantor of the trust, transfer the legal title of that estate to someone else – the trustee – for the purpose of benefiting one or more third parties – the beneficiaries . The trustee, which can be an individual or a company, is granted title to the property in accordance with the terms of the trust agreement.
There are two general categories of trusts: revocable and irrevocable. Revocable trusts can be changed or ‘revoked’. Irrevocable trusts cannot be changed once established. Most revocable trusts become irrevocable upon the death or disability of the grantor. The assets you place in an irrevocable trust are permanently removed from your estate. Income and capital gains taxes on assets in the trust are paid by the trust. On your death, the assets in the trust are not considered part of your estate and are therefore not subject to inheritance tax.
A confidant for every purpose
There are many different types of trusts – each with specific needs and different tax and legal considerations. While a thorough discussion of the many different types of trusts is beyond the scope of this article, here is a brief overview of some commonly used trusts.
Living trust. A living trust allows you to be both the trustee and beneficiary of a trust while you are alive. You retain control over the assets and receive all income and benefits. After your death, a designated successor manages and/or distributes the remaining assets according to the terms set out in the trust, avoiding the probate process. Life trust is also an ideal way to provide for the management of your financial affairs in the event of disability. You, not the court or an improperly motivated family member, choose who manages your finances.
Credit Shelter trust. Married couples enjoy a great deal of protection with regard to estate planning. For example, under the unlimited marriage deduction, husbands and wives do not have to pay federal estate taxes on assets transferred to each other. This benefit works well until the death of the surviving spouse, after which time non-marital beneficiaries (usually children) could face a significant federal tax bill on any amount in excess of the current estate tax exclusion ($2 million through 2008). ).
To avoid this problem, couples should include a credit protection trust in their estate planning documents. With a Credit Shelter Trust you divide your estate into two parts. One portion is left to your partner and the other is placed in a trust. Any amounts left to your spouse are tax-free because of the unlimited marriage deduction, while those in the trust — up to $2 million — are protected by the estate tax exemption.
When your spouse dies, the trust assets pass to your children or whoever you named as beneficiaries. The trust assets are not taxed as part of your spouse’s estate. The assets that passed directly to your spouse will go to the one your spouse chose. These assets will be included in your spouse’s estate for tax purposes, but your spouse’s own exemption will offset some or all of the tax due. Using this planning technique, a couple can currently pass on up to $4 million tax-free to their children or other beneficiaries.
Irrevocable life insurance trust (ILIT). This type of trust is often used as a funding mechanism for estate taxes. Under this arrangement, you make donations to an irrevocable trust, which in turn uses these donations to purchase a life insurance policy for you. Upon your death, the death benefit proceeds from the policy are payable to the trust, which in turn provides tax-free cash to help beneficiaries meet estate taxes.
Qualified Personal Residence Trust (QPRT). With a QPRT you can remove your home from your estate at a discount. Under this arrangement, you are allowed to use the house for a predetermined number of years, after which time the ownership passes to the trust or beneficiaries. Any gift tax you could incur from giving the property away is discounted because you still have rights to the home for the years recorded in the trust. The possible downside is that if you die before the term of the trust expires, the property will be considered part of your estate.
Charity Funds. To help benefit your favorite charity while also serving your own trust purposes, consider a charitable lead trust (CLT) or charitable rest trust (CRT). CRTs and CLTs are often described as mirror images of each other: CRTs provide a stream of income that is paid to the donor, relative, or other heir over a period of time, after which the remaining principal goes to charity. CLTs, on the other hand, pay the charity a stream of income for a period of years, after which the remainder is paid out to designated beneficiaries, usually family members.
Perhaps one of the greatest benefits of trusts is that they allow beneficiaries to enjoy property ownership while minimizing tax exposure for those involved. Keep in mind that trusts are legal documents – an estate planning attorney can help you explain the complexities of specific trust arrangements.
This article is not intended to provide specific investment or tax and legal advice to any individual. Consult your financial adviser, your tax adviser and a qualified lawyer or me if you have any questions.