EstateTalk™
Planning with Trusts, the Basics
Trusts can be grouped in to the following categories:
Living Trusts can be:
Revocable – meaning that the trust creator can decide to revoke the trust, or a portion of the trust, and resume ownership of the assets Irrevocable – meaning that the trust creator has permanently given up ownership of any assets placed in the trust
See Revocable v Irrevocable Trusts below.
There are a variety of reasons to set up a trust. In some cases you may even want to do so many years before you might expect to die. People often ask, “When should I consider a trust?” Here are some of the reasons for setting up a trust:
Avoiding probate - This is a common reason for establishing a living trust Asset Management - Having a particular individual, or a professional asset manager manage all of your assets; may apply to all kinds of trusts. Timed Disposition of Assets - Controlling the timing of disposition of your assets to your heirs; may apply to all kinds of trusts Privacy - Keeping your affairs away from public scrutiny. Trusts usually do not become public documents, while wills do, although the pour-over will that should accompany every living trust does require probate, and may cause the living will to become a part of the public record; may apply to living trusts Appropriate Disposition - Being certain that both the trust grantor, and later, the grantor’s heirs are cared for as their needs arise; may apply to all kinds of trusts. Asset Protection - Insulating your estate from the claims of creditors (depending on your state’s laws the trust may need to be irrevocable for such protection); may apply to living trusts Fairness and Clarity - Being certain that you dispose of or distribute assets effectively while you are still of a clear mind; may apply to all kinds of trusts Care of Loved Ones - Providing for children or other loved ones by setting aside assets in trust for them; may apply to all kind of trusts Estate Tax and Inheritance Tax Considerations - Saving taxes (applies principally to estates subject to federal estate tax – see A-B Trusts and Taxes below).
If any of these are considerations that may apply to your personal circumstances you might wish to create a trust. Of course there may be other reasons why you might want a trust. Regardless of the reasons for the trust, you will need to determine the terms of the trust, decide upon a trustee and a successor trustee, outline their responsibilities and name the trust beneficiaries. Once the trust is established, you will need to transfer title of any assets you want in the trust into trust name, and you should review the terms of the trust at least annually.
With respect of setting up a living trust, you should consider that it might be possible to accomplish your goals more effectively by means of a well-written Last Will and Testament. The costs of establishing, reviewing, maintaining and managing a living trust sometimes more than offset the advantages hoped for when setting up the trust.
As is obvious, there are many decisions to make. While the planning can be complicated it is also usually well worth the effort. You are urged to talk to an attorney with expertise in the area of estate planning. He will know the laws in your state and can help you assure that your trust(s) accomplish your goals.
Revocable vs Irrevocable Trusts
A revocable trust is a trust that can be changed or canceled (revoked) by its grantor or by another person if the trust so provides. Such a trust does not avoid estate taxes. Although frequently set up for asset protection, revocable trusts may not actually provide the protection the trust creator seeks. Since the grantor can easily transfer assets in and out of such a trust or revoke the trust entirely, the grantor’s creditors essentially stand in the same position as the grantor and can compel the grantor to re-transfer assets out of the trust for their benefit. However, the language of the trust and state law may occasionally offer protection. In a few states laws provide that, absent a fraudulent transfer, assets in a revocable trust are beyond the reach of creditors. In addition, creditors must often proceed against the assets in the debtor’s name first before looking to the trust assets. Finally, depending on how the trust is named, a grantor’s assets may not be readily apparent to potential creditors when held in the trust name.
An irrevocable trust is a trust that cannot be changed or canceled after it is set up unless the beneficiary consents to the change or cancellation. The grantor usually cannot take assets out of an irrevocable trust once they are placed there. Irrevocable trusts offer tax advantages that revocable trusts don't, for example, by enabling a person to give away assets before death. An irrevocable trust is preferred in asset protection planning since it provides better protection from creditors. Note: Transfers to such a trust must occur at a time when they cannot be challenged as fraudulent transfers.
A trust may be made either revocable or irrevocable by the terms of the trust agreement. In some states current law says that a trust is revocable unless it is expressly stated in the trust that it is irrevocable. In other states for the trust to be revocable the trust agreement must expressly state that is revocable.
Some issues for consideration:
In an irrevocable trust established for children or others, if its purpose is to avoid estate and income taxes, the trust grantor should not: (1) Act as trustee, (2) Receive income or other benefit from the trust, or (3) Receive the assets from the trust. In an irrevocable trust set up for asset protection, the effectiveness of the protection might depend on the degree of control that the grantor retains over the trust. The more control the more exposure to creditors. At a minimum, the grantor should not: (1) Retain any power to revoke, distinct or amend the trust; (2) Reserve any rights to take back property once transferred to the trust; (3) Have any authority on how trust property will be managed or invested; (4) Have any control over income distributions from the trust; and should not (5) Serve as trustee.
Providing for Your Kids
Suppose, through some unfortunate accident, you and your spouse both die leaving minor children. Absent a will and trust(s), by law in almost every jurisdiction, your children will each take an equal share of your assets. If they are minors, the court will appoint someone, possibly someone you didn’t know, and/or might not have liked, as trustee of each child’s assets. It may be the same person, or a different person for each child, and each child will have only his or her share of your assets for support.
On it’s face all of that sounds appropriate, leaving out the fact that a third party that you may not know or like is in control of your children’s assets. On the other hand, consider what you would have done if you were alive: You would have cared for your children as their individual needs arose, possibly resulting in very different amounts of time and money being allocated to each child. One child might have substantial medical expenses, one child may want and would benefit from some special education including perhaps a Masters or PhD achievable only with some parental assistance. One of your children might marry someone wealthy while you still have other minor children, freeing you to distribute all your assets to your younger children. One of your children may need permanent financial assistance and care due to an accident or injury. Consider how you would have handled these and countless other possibilities. You would have provided for each child as his or her needs arose. By establishing a trust, administered by an individual you choose, who can evaluate the circumstances in conjunction with a guardian, you can continue to provide appropriately for the individual needs of your children, or others, in a manner similar to how you would have done had you still been alive. Simply allowing each of your children to receive an equal share of your estate will not accomplish these same ends. If you are fortunate, you will be able to find an individual who has the qualities necessary to serve both as guardian and trustee of your children’s trust(s).
A-B Trusts and Taxes
If the total estate accumulated by you and your spouse exceeds the federal estate tax credit (also called the unified credit, or the exclusion amount) whichever of you is the surviving spouse could, at death, leave an estate subject to substantial federal estate taxes and in many states, state inheritance or estate taxes as well. State taxes vary, usually have a much smaller impact on an estate than federal estate taxes and will not be discussed in depth here. An attorney can best advise you as to tax impacts in your state. Currently the Federal Estate Tax Exclusion Amount is increasing annually. For a chart of the credit, click here.
Due to inflation over the last 40- 50 years, many individuals who never considered themselves wealthy find that their cumulative assets form an estate of considerable value. Lets consider an estate owned equally by a husband and wife with a total net worth of $2,500,000.00. Assume that they have three children. Assume each spouse has a will that passes his or her entire estate to the surviving spouse. Since the decedent’s half of the estate would be less than $1,500,000, the survivor would owe no federal estate tax. However, the survivor is left with an estate of $2,400,000.00 earning income. Next, assume that the surviving spouse dies within a few years having expended only income from the estate and leaving the value of the total estate substantially intact. The total estate of $2,500,000 would be subject to federal estate tax and, depending on what other tax planning has been done, the heirs could owe substantial federal estate taxes plus state inheritance taxes. In many estates there will not be sufficient liquidity to pay the IRS and the state without selling at least some of the assets of the estate.
Now assume the same figures, except that before the death of either spouse, the couple have wills drawn providing for A / B trusts. Suppose that the husband dies first – event A. As we have seen, his half of the estate is less than the federal estate tax credit. His wife owes the IRS nothing and she does not have to file a federal estate tax return. The husband’s will provides that his portion of the estate is placed in a trust for the benefit of the couple’s three children, meaning that they then own the property in the trust. However, the provisions of the trust also provide that all of the income generated by the property in the trust is payable to the surviving spouse for as long as she lives. She has income from her half as well as her late husband’s half, a total of $2,500,000.00, just as she would have had in the first example. Now, assume that she dies within a year or two leaving her half of the estate substantially intact. Her half is worth $1,250,000.00. Her children need file no federal estate tax return, and owe NO TAX. Because of the trust, the survivor received the same income and the heirs receive the estates of both decedents, just as in the first example, but the heirs avoid paying any federal estate tax, and may avoid state inheritance taxes as well, depending upon what state they live in. Event B, in which the wife dies first, would have had the same outcome – hence the name A/B trusts.
A note of caution: A trust requires a trustee. It is tempting and convenient to name the surviving spouse as trustee of the A or B trust. However, there is a potential conflict of interest since the surviving spouse, who receives income from the trust, may have priorities different from the heirs who own the assets in the trust. In addition, the IRS may view the trust as a sham and rule that all assets passed directly to the surviving spouse, undoing the tax planning benefits of the trust unless the trust provisions are carefully drawn. Similarly the heirs owning the trust corpus may be questionable choices as well. Depending on the trust provisions, a third party trustee may be advisable in these circumstances. You should consult a local attorney about such circumstances.
Achieving your goals should be your first priority in estate planning. The fact is that you may not even know what questions to ask, and what problems you face, regardless of how much reading and research you do. Not the least of considerations is the fact that laws vary from state to state and the differences may be subtle. You are advised to consult an attorney who is an expert in estate planning in your state. Estate planning is usually relatively inexpensive compared to the cost of most other legal work. Don’t be afraid to ask an attorney what a will, or a will and trusts might cost. Establish your goals, and then work with your attorney to accomplish them. Finally, once in place, review your will and trusts, if any, annually to assure that they remain appropriate.
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