Trusts
DISCLAIMER: The following information is purposely general in nature; please consult your state's and locality's specific laws and/or contact an attorney for specific information and advice.
What is a trust?
A trust can be a powerful and flexible financial planning tool. Simply put, a trust is a legal entity that holds property designated by you, the grantor, for the benefit of you or your beneficiaries. The trust agreement names a trustee to manage the specified property according to your instructions. The trustee can be either an individual, an institution, such as a bank or trust company, or a combination of the two as co-trustees.
What purpose does a trust serve?
Trusts serve a number of purposes:
What is in a trust?
The trust contains only property that you put into it. If no property is put in the trust then the trust has nothing. A trust has value only if property is put into it.
What property can be placed in a trust?
Generally, any property of value can be placed in a trust: cash, stocks, bonds, life insurance policies or proceeds, bank accounts, certificates of deposit, income from a business or investment, real estate, family home, automobiles, benefits from a retirement fund, jewelry or fine art. These are just a few of the examples.
Who should use a trust?
Many people think that trusts are only for the very wealthy. In fact, trusts can be beneficial to almost anyone given the right circumstances.
Answer the following questions to see if a trust could help you:
If you answered "Yes" to any of these questions, you may be a good candidate for a trust. With professional guidance from the experienced tax and estate planning firm of Ivester, Ivester & Ivester, you may wish to investigate how a trust might be used in your estate plan. 1-800-891-2319.
Types Of Trusts
There are many different kinds of trusts, depending on the type of beneficiary, the purpose of the trust, what assets are in the trust, how much power the trustee and beneficiaries have over the use of the trust's assets and how much control the grantor has over the trust.
The most common distinction is between a testamentary trust and a living trust.
A testamentary trust, which may be set up by a will, takes effect only when the grantor dies and the estate is probated. A change to a testamentary trust may require a change to the will.
A living, or inter vivos, trust takes effect during your lifetime. Living trusts may be either revocable, meaning the grantor can change or end them at any time, or irrevocable, meaning the trust cannot be changed once it is established.
Because a trust is so flexible, it can be tailored to work exactly as you wish. It can be written to accomplish a single purpose or several goals. The next few pages briefly describe some of the more common types of trusts and how they can be used. Most of these trusts can be either testamentary or living trusts, depending on their purposes.
Bypass Trust (also called Credit Shelter Trust, Family Trust or Credit Equivalent Bypass Trust): This type of trust takes advantage of federal estate tax law to reduce or eliminate federal estate taxes. A provision of the federal estate tax law, called the unlimited marital deduction, allows you to leave an unlimited amount of property to your spouse free of federal estate tax.
In addition, the Unified Estate and Gift tax lets each person give away, during his or her life or at death, a specified amount of assets free of estate or gift taxes. The Taxpayer Relief Act of 2001 introduced annual increases in the unified tax credit and gift tax exclusion amounts. In 2002, the ceiling is raised from $675,000 to $1,000,000. These increases will continue through the year 2009 when the maximum value of estates exempt from tax will reach $3.5 million, as indicated in the chart below and the estate will be totally repealed in 2010.
Year of Death Exempt Amount
2002, 2003 $1,000,000
2004, 2005 $1,500,000
2006,2008 $2,000,000
2009 $3,5000,000
2010 unlimited
To better understand the use of the Unified Estate and Gift Tax exclusion in conjunction with trusts, consider this example: Assume that John Smith dies in the year 2003 and his estate is worth $1.2 million. He may leave the entire estate to his wife, Mary, and his estate will owe no federal taxes.
However, now assume Mary also dies in the year 2003. Mary's estate would only by exempt from $1,000,000 in federal taxes (unless she remarried). The remaining $200,000 would be subject to federal estate taxes.
To avoid this taxation, John may utilize a bypass trust. Here's how it works. First, John's will directs the current maximum exemption amount, $1,000,000 in our example, into a trust which "bypasses" Mary's estate. The income from the trust goes to Mary during her lifetime, while the principal goes to children, grandchildren or other heirs when she dies. Mary may also be able to use part of the principal of the trust for "maintenance, education, support or health," according to Internal Revenue Service regulations. John then uses the marital deduction and wills the remaining balance of $200,000 directly to Mary, which she may then pass along to her heirs at her death free from federal estate taxes. (Remember the current federal estate tax rate is 37% rising to 55% so Mary’s estate would pay approximately $74,000 in taxes on the $200,000.)
Since the surviving spouse doesn't control the assets in the trust, they're not considered part of her estate and are not taxed when she dies. She uses her exemption, $1,000,000, if she also died in the year 2003, to pass on tax-free the part of the estate willed directly to her. Both spouses set up identical trusts in their wills, so regardless of who dies first, both can reduce or eliminate federal estate taxes. To take full advantage of the rising estate tax exemption amount, make sure your will and other estate planning documents refer to the credit only in general terms – "maximum allowable amount," for example.
Qualified Terminable Interest Property Trust (Q-TIP): This type of trust can ensure that, after your death, children from a first marriage are not disinherited by a second spouse; it can protect your estate in case your spouse remarries. The grantor places his or her property in a trust. When the grantor dies, the surviving spouse does not inherit the property but receives income from the trust at least annually. At the surviving spouse's death, the value of any assets remaining in the trust are taxed in that person's estate. Then the assets are distributed to the beneficiaries named in the trust, usually children from the previous marriage.
Revocable Living Trust: A revocable living trust is often touted as an alternative to a will because a trust usually avoids probate. Probate, the legal validation of your will and your assets, can be a lengthy and costly process. However, you should never use a trust as a substitute for a will. Even if you put a large portion of your assets in a trust, a will instructs the distribution of the portion of your estate not contained in the trust. In addition, a will is the best way to provide for the care of minor children and to name an executor for your estate.
The most important reason to use a revocable living trust is to manage your assets in case of disability. This type of trust can be set up with yourself as trustee and another person or institution named as successor trustee. You have complete control over the assets in the trust until you become disabled or incapacitated. At that point, the trust becomes irrevocable, and your successor trustee takes over using proceeds from the trust for your care and distributing the assets after your death as you directed in the trust agreement. The trust should include a definition of disability or incompetence, such as opinions by two or more physicians. In addition, a living trust should be accompanied by a "pour-over" will, which directs any assets not held in the trust be added to it at your death.
There are several advantages to a living trust. For example, it can be more comprehensive than a power of attorney naming someone to act on your behalf should you become incapacitated. It will also be universally accepted at financial institutions, whereas the power of attorney may not. You can also specify in the trust how and where you wish to be cared for and give specific investment instructions to your trustee. If you become incapacitated without a living trust or durable power of attorney, a court must appoint conservator or guardian for you – someone you may or may not want to manage your affairs. A trust may also be more readily accepted as expressing your wishes – and therefore less subject to challenges – than the actions of a court-appointed guardian or someone acting under your durable power of attorney. If you own property in more than one state, a living trust can transfer property directly to your heirs without the cost and delay of multiple probates. In addition, a living trust can help keep private the details of your estate. It does not usually become part of the public record as a probated will does.
Grantor-Retained Income Trust (GRIT): These irrevocable living trusts are designed to reduce gift taxes and remove highly valued assets from your taxable estate. You receive income from assets placed in the trust for a set period; at the end of the term, the assets pass to your heirs. Assets placed in the trust may be your personal residence or income-producing assets. To benefit from this type of trust, you must outlive the trust so that the assets are given to the named beneficiaries and removed from your taxable estate.
Spendthrift Trust (also called a Minor’s Trust): This type of trust is used if you fear your heirs will not be able to manage the estate, either because they are too young or might foolishly spend it. The trust can specify the investment objectives that the trustee must follow, as well as set the criteria for eventually distributing the estate to the heirs, often when they reach a certain age.
Life Insurance Trust: If you are the owner of life insurance on your own life, proceeds from a life insurance policy will be included in your taxable estate. If your estate is worth more than the current maximum exemption amount, a life insurance trust often makes sense. An irrevocable living trust is set up to own a policy on the grantor’s life, and the trust is also named beneficiary of the policy. At the grantor’s death, the trustee can use the policy proceeds to provide for the grantor’s survivors. For large estates, a life insurance trust funded with a policy in the expected amount of the tax obligation can provide the funds to pay estate taxes.
However, a life insurance transfer from you to the trust must be made at least three years before your death. Otherwise, the trust proceeds will be included in your taxable estate. To bypass the three-year rule, a new policy can be issued with either the trust or your spouse as owner.
Other Trusts
Generation-Skipping Trusts transfer property to second-generation beneficiaries, usually grandchildren, without the trust proceeds becoming part of your children's estates. Qualified Domestic Trusts (Q-DOTs are for spouses who are not U.S. citizens. The rules for property transfer in these cases are very complex; Q-DOTs help these spouses gain the benefits of the marital deduction. Charitable Remainder Trusts let you give an asset to a charity but keep the income from the asset; Charitable Lead Trusts provide income from an asset to a charity, while you reclaim the principal at the end of a set period of time.
Selecting A Trustee
Selecting the right trustee may not be easy. If the trust is set up to benefit your children after your death, your spouse is a logical choice. If the trustee is also a beneficiary of the trust, restrictions are usually placed on that trustee’s power to use trust assets to his or her benefit.
No matter whom you name as trustee, you should also name at least one, but preferably several, successor trustees. If your trustee or successor trustee can’t serve and you have not named other successors, the court will name a replacement who may be someone you would not want to handle your affairs.
A good trustee must be willing to serve and should have no conflict of interest with the interests of your trust and its beneficiaries. The trustee should have the ability to manage assets effectively and make sound investment decisions. Even if you specify certain investment objectives in the trust agreement, the trustee will have to make choices. A trustee should also be someone whom you feel comfortable with making decisions affecting your family; sometimes those decisions will need more sensitivity than business sense.
A friend or family member serving as trustee has the advantage of familiarity with the family and your wishes. However, that person may not be experienced in making investment decisions and might let emotions or favoritism cloud his or her judgment. A professional trustee, such as the trust department of a bank or trust firm, brings impartiality, stability and business and investment knowledge to the role. On the down side, the professional is not as familiar with you or your family as a friend is and will most likely charge higher fees. A good solution is often naming joint trustees – one a friend or family member, the other a professional. If you set up a living trust, it's a good idea to keep your investment advisors, accountants and bankers involved as you manage the trust. After your death, they will be familiar with your investment goals and can continue to advise your trustees.
Can A Trust Save You Money?
Maybe. Trusts are valuable estate-planning tools that can save money on estate taxes, probate and other expenses. But trusts aren't always the least expensive alternative. Cost depends on many variables, such as the size and complexity of your estate, estate or inheritance taxes, attorney fees and probate costs.
Trusts usually cost more to prepare than simple wills. A recent survey by the American Association of Retired Persons found attorneys charged on average about $400 more to prepare a living trust than a will. Costs can range from $600 to several thousand dollars in attorney fees, depending on the complexity of the trust. You or your heirs may also have to pay for professional management with an annual fee ranging from 0.20 percent to 1.5 percent of your trust’s assets, depending on its market value. Assets placed in the trust must be retitled, involving extra time and expense. Some trusts must also file annual income tax returns.
In general, estate taxes are due on property you own at the time of your death. The federal estate tax starts at 37 percent on assets above the current maximum exemption amount of $1,000,000 in 2002, rising to 55 percent for estates valued at more than $3 million. State-imposed inheritance taxes may add another 5 percent. Because property placed in a revocable trust remains under your control, it is subject to estate taxes. Only property in an irrevocable trust avoids estate tax; however, a transfer of property to an irrevocable trust is usually considered a gift, so gift tax liability may be a consideration.
Property transferred to a living trust avoids the procedure and costs of probate. Probate costs include court costs and fees, which may be based on hourly rates or a state imposed schedule based on a percentage of the estate's value. In many states, individuals can handle probate quickly and with minimal legal fees using the help of probate court officials.
Estate Planning
It’s easy to delay estate planning until it’s too late. And while it’s often difficult to think about providing for your family after your death, it’s one of the most important and most loving things you will ever do for them.
Trusts are just one facet of effective estate planning. Trusts should work hand-in-hand with the other elements of your estate plan, not replace them.
A well-designed plan strategically incorporates your will, life insurance coverage, investments, anticipated Social Security or retirement benefits and other financial interests.
Review your estate plan regularly, especially when there is change in your marital status, your financial situation or your place of residence. Review your estate plan also on the birth of children or grandchildren or the death of a beneficiary or trustee. Your financial adviser can also help you watch for changes in tax laws and consider special needs, such as a relative who would be unable to manage an inheritance because of illness or disability.
Since estate and inheritance tax laws vary from state to state, creating a trust requires consultation with an attorney or estate planner experienced in dealing with the law of estates and trusts. It’s also a good idea to talk to trust professionals such as those found in banks or accounting firms. They have the expertise to help you develop a workable estate plan that will not only protect your family, but also help preserve more of your estate for the family’s benefit.
Estate planning is a complex procedure. The larger your estate, the more complex it can be – making it all the more important to plan carefully. With professional guidance from the experienced tax and estate planning firm of Ivester, Ivester & Ivester, you may wish to investigate how to prepare an effective estate plan. 1-800-891-2319.
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