As part of your year-end planning exercise, take a moment to consider what will happen to your assets and those of your living family if you can no longer afford to care for them. Then consider the potential benefits of setting up a trust. Trusts are an effective way to help protect important assets, provide for beneficiaries, and manage taxes. And, contrary to popular belief, trusts aren’t just for the rich.
A qualified attorney can easily help you set up a trust that can be used for a number of practical purposes, such as:
o Controlling assets and providing security for beneficiaries.
o Provide beneficiaries who are underage or who need expert assistance in managing money.
o Avoid estate taxes or income taxes.
o Provide expert plantation management.
o Avoid probate fees.
o Maintain privacy.
o Protect ownership of real estate or business.
Definition of Trust – A Quick Guide
A trust is a legal arrangement in which you, the owner of the estate and the trustee, transfer the legal ownership of the estate to another person – the trustee – for the purpose of benefiting one or more third parties – the beneficiary. The trustee, which can be a person or a legal entity, is granted property rights in accordance with the terms of the trustee agreement.
There are two general categories of trusts: revocable and irrevocable. A revocable trust can be changed or “revoked”. An irrevocable trust cannot be changed once it is established. Most revocable trusts become irrevocable upon death or disability of the grantor. Assets you place in an irrevocable trust will be permanently removed from your inheritance. Income taxes and capital gains on assets in the trust are paid by the trust. After your death, the assets in the trust are not considered part of your inheritance and are therefore not subject to property tax.
Trust for Every Purpose
There are many different types of trusts – each serving a specific need and involving different tax and legal considerations. While a thorough discussion of the different types of trusts is beyond the scope of this article, here is a brief review of some of the widely used trusts.
Life Trust. A living trust allows you to be both a trustee and a beneficiary of the trust while you are still alive. You retain control of the assets and receive all income and benefits. Upon your death, the designated successor guardian manages and/or distributes the remaining assets according to the terms set out in the trust, avoiding probate processes. A living trust is also an ideal way to provide management of your financial affairs in the event of disability. You, not the court or an ill-motivated family member, chooses who will manage your finances.
Credit Shelter Trust. Married couples enjoy many protections with regard to inheritance planning. For example, under indefinite marital deductions, husband and wife 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, at which point nonspousal beneficiaries (usually children) may face a significant federal tax bill on amounts that exceed the current estate tax exemption ($2 million to 2008).
To avoid this problem, couples must include a credit shelter trust in their inheritance planning documents. With a credit shelter trust, you divide your estate into two parts. One part is left to your partner, and the other is placed in trust. Any remaining amount to your spouse is tax-free due to unlimited marital deductions, while those in the trust – up to $2 million – are covered by the estate tax exemption.
When your spouse dies, the trust assets will be passed on to your children or whoever you name as a beneficiary. Trust assets will not be taxed as part of your spouse’s estate. Assets assigned to your spouse will be directly assigned to whomever your spouse has chosen. These assets will be included in your spouse’s estate for tax purposes, but your spouse’s exemption will offset some or all of the tax owed. Using this planning technique, current couples can give up to $4 million to their children or other beneficiaries tax-free.
Irrevocable Life Insurance Trust (ILIT). This type of trust is often used as a property tax funding mechanism. Under this arrangement, you give a gift to an irrevocable trust, who in turn uses the gift to purchase a life insurance policy for you. Upon your death, the proceeds of the policy’s death benefit are paid to the trust, which in turn provides tax-free cash to help the beneficiary meet real estate tax obligations.
Qualified Personal Residence Trust (QPRT). A QPRT allows you to remove your residence from your estate at a discount. Under this arrangement, you can use the home for a set number of years, after which ownership is transferred to the trust or beneficiary. Any gift taxes you may incur from giving away the property are discounted because you still have title to the home for the term of the years specified in the trust. The potential downside is that if you die before the guardianship expires, the house is considered part of your inheritance.
Charity Trust. To help benefit your favorite charity while serving the purposes of your own trust, you might consider a charitable lead trust (CLT) or charitable residual trust (CRT). CRT and CLT are often described as mirror images of each other: CRT provides a stream of income that is paid to the donor, family member, or other heir for a set period of time, after which the remaining principal goes to charity. CLTs, on the other hand, pay a charitable income stream for a period of years, after which the remainder is paid to a designated beneficiary, usually a family member.
Perhaps one of the greatest benefits of a trust is that it allows beneficiaries to enjoy ownership of the property while minimizing the tax exposure of those involved. Remember that a trust is a legal document – an estate planning attorney can help explain the complexities of certain trust arrangements.
This article is not intended to provide specific investment or tax and legal advice to any individual. Consult your financial advisor, your tax advisor and a qualified attorney or me if you have any questions.
