If you are examining options for planning the eventual transfer of your wealth to your family beneficiaries, the establishment of one or more trusts may be an optimal choice. If you are unfamiliar with these types of financial structures, the purpose of this article is to fundamentally describe the mechanisms and possible uses.
What is a “Trust”?
A trust enables the holding of the legal title of property separate from its equitable ownership (i.e., the “beneficiaries” or the parties for whom the property is being held). Instructions can be provided to the “trustee,” i.e., the legal representative of the trust, concerning the investment, management, and distribution of the property held within the trust. The trustee can be either another individual (who must have integrity and an understanding of the responsibilities of a trustee) or a corporate trustee, such as a bank.
Uses and Types of Estate Planning Trusts
Trusts are used in many different situations to enable the holding of the legal title of property separate from the equitable ownership. These situations are not limited to estate planning. You might use one or more trusts in the estate planning context to facilitate the transfer of your wealth to your intended beneficiaries. In some (but not all) instances, significant tax benefits might be achieved through the use of trusts that are “irrevocable,” i.e., cannot be changed.
The following are possible basic options for the use of a trust in your situation:
a) Revocable or “Living” Trust
During your lifetime, you can transfer your assets into a revocable trust. You can be the “trustee” during your lifetime (or earlier because of mental incapacity). You can designate who will be the successor trustee upon the occurrence of either of these events.
The advantages of having a living trust include:
- the coordinated management of various properties in the trust;
- facilitating the transfer of the trust assets after your death without the impediment of probate court proceedings;
- because you do not technically own that property for state property law purposes (it is held by another owner, the trust), any information about this property can be kept private at the time of death because it is not involved in the probate process; and
- facilitating the transfer and management of property by using provisions to specify the distribution of the trust property after your death, or the maintenance of the property in trust for management and subsequent periodic distributions to designated beneficiaries.
HOWEVER, a Revocable trust does not achieve any income tax, gift tax, or estate tax savings because the person funding the trust is the true “economic owner” of the trust assets. The economic ownership, rather than the nominal, legal ownership, is the basis on which tax application occurs.
b) Testamentary Trusts
If you directly own your properties at the time of death (i.e., they have not been transferred during lifetime into a revocable trust), in your Last Will and Testament you can specify the transfer of your properties into one or more trusts created under your Last Will and Testament. Many varieties of trust arrangements can be specified here, including for your spouse (enabling the postponement of any applicable estate taxes), a “family trust” or “credit shelter trust” to enable segregation of assets into a trust to benefit from the then available “unified credit,” and other specialized trusts, e.g., generation-skipping trusts for the eventual benefit of grandchildren.
c) Lifetime Irrevocable Trusts
During your lifetime, you can transfer certain assets irrevocably into one or more trusts for the benefit of others. In this situation, your objective will be to transfer these assets by gift (exposed to the federal gift tax) under circumstances where they subsequently will not be included in your estate for federal estate tax purposes.
- the value of the assets held in the trust (including any post-transfer appreciation) will not be included in your gross estate for federal estate tax purposes;
- the income from these assets will not be included in your gross income for federal income tax purposes.
Careful planning is necessary to achieve these tax objectives, particularly the individual transferring the property may not retain rights to control the property or dictate its distribution.
d) Irrevocable Life Insurance Trust
An irrevocable trust can be created to hold one or more life insurance policies on the life of the creator of the trust. The most important objective is to ensure that the life insurance policy proceeds received after death by the trust (as the designated beneficiary under the life insurance policy) are not included in the insured’s gross estate for federal estate tax purposes.
(1) acquisition of the life insurance policies directly by the trust and;
(2) no retention by the insured of “incidents of ownership” in these policies.
Options for Distributions of Income and Principal from Trusts
Many options exist for making distributions of both income and the principal from a trust to the beneficiaries:
- Income and principal can be retained until a future date, including only for grandchildren or great-grandchildren at that future date.
- Income can be distributed currently with principal held for future distribution.
- Principal can be scheduled to be distributed periodically at specified dates.
- Income and principal can be distributed to a specified beneficiary solely within the discretion of the trustee.
- Income and principal can be distributed to one or more beneficiaries (to the possible exclusion other beneficiaries) within the discretion of the trustee.
- Income and principal can be distributed to one or more beneficiaries pursuant to an “ascertainable standard,” i.e., for health, education, support, or maintenance.
These are representative of the types of alternatives that can be molded to the particular situation for disbursing income and principal from a trust.
Other Valuable Benefits from Trusts
Many other non-tax benefits exist with the use of a trust, particularly for protecting property from certain creditors:
- The trust may be structured as a “spendthrift” trust, meaning that a beneficiary is not able to obtain trust benefits until the due date for distributions (e.g., by selling the anticipated payments to be received in the future).
- An ex-spouse of a beneficiary will not ordinarily be entitled to receive any of the beneficiary’s trust benefits as a result of a property settlement in a divorce proceeding.
- Children and grandchildren can act as advisors to the trustee or (if the trust provisions are appropriately constructed) as trustee or co-trustees, enabling them to participate in the active management of the family wealth. However, they would not have the capacity to waste the trust assets for their own benefit.
A trust can be useful in the arrangement and separation of who controls property from who can receive the economic benefits. In addition to making sure that the beneficiaries are protected from poor decision making that may deplete assets or from importuning individuals seeking the beneficiaries’ assets, different types of trusts may also help you achieve gift and estate tax protection.