ESTATE PLANNING - TECHNIQUES
 
 

TRUSTS AND OTHER ESTATE-PLANNING STRATEGIES

Many people can benefit from establishing trusts, although they may not know it. Trusts are often incorrectly viewed as inflexible arrangements reserved only for the wealthy. In fact, trusts can provide advantages both to you during your lifetime and to your heirs after your death. When you set up a trust, you (as the grantor) transfer assets to a separate legal entity that holds your assets and disburses them as you see fit.

Because you determine who will serve as trustee — whether it be yourself, one or more individuals of your choice, or a financial institution — certain trusts let you continue to maintain control over your assets even after you have transferred them to the trust.

Used effectively, trusts can accomplish many important estate-planning goals. They can ensure the sound management of your assets after your death; they can protect your property from creditors; they can minimize or reduce probate while guaranteeing that your estate passes to your heirs exactly as you wish; and finally, they can reduce estate taxes.

There are many different types of trusts that are designed to accomplish a variety of lifetime and after-death objectives. This section examines a variety of commonly used trusts and how they function — protecting your estate, reducing your estate taxes, or reaping the benefits of being charitable — as well as which type of trust may be appropriate for your particular needs.

Choosing Trustees

Because your trustee is considered your personal representative, designating the trustee may well be the most important decision you make in drawing up your trust. You can name any person or institution — including yourself, a member of your immediate family, or the beneficiary(ies) — as the trustee. Although a relative is a good choice in some circumstances, it is not if the main objective of the trust is to reduce taxes.

In general, the IRS frowns on naming the grantor or the beneficiary as the trustee if the main reason for drawing up the trust is to reduce income and estate taxes. From a tax perspective, appointing an independent party as a trustee — an unrelated business partner or a bank or trust corporation — is your best alternative. With such a third party, however, the factor of disinterest must be added to your concerns. A third party will never be as familiar with your family’s needs as a relative will be.

Furthermore, many bank and trust institutions prefer to deal only with trust funds of more than $100,000. A common compromise: Appoint your spouse or other close relative as a co-trustee along with an independent third party. From a tax-planning standpoint, as long as the spouse can be outvoted by the other trustee(s), the trust is considered sufficiently independent not to be included in the grantor’s income and estate tax return.

This arrangement is an especially popular alternative when the trustee is empowered to “sprinkle” income among the beneficiaries. The spouse’s or other family member’s concern and knowledge about the beneficiaries’ welfare can then be combined with the management expertise of the bank or other financial institution without forfeiting the tax advantage you worked so hard to provide.

When choosing a bank, trust company or other financial institution as a trustee, you should first examine the institution’s trust department. How long has the trust department been in existence? How qualified are its personnel? What has been the past performance of the trust portfolio? Are the fees for administration and services competitive?

Irrevocable and Revocable Trusts

An irrevocable trust transfers the trust assets outside your ownership, and the assets are immune from lawsuits and creditors’ claims against you. Revocable trusts do not have these advantages, although they have other benefits. Trusts are not subject to the same stringent rules regarding wills and are thus less likely to be successfully contested after your death.

Irrevocable Trusts

In general, an irrevocable trust is advisable when your primary concern is to reduce your estate tax liability. But transferring assets into an irrevocable trust is a big step that should not be taken lightly. Why? Irrevocable trusts significantly restrain your powers and freedom of action and therefore are considered primarily in the context of estate taxes. An irrevocable trust is a completed gift at the time of the property’s transfer into the trust, and gift taxes may therefore be assessed at the time of the transfer. You retain no reversionary interest and little power to control the trust. The best property to place in an irrevocable trust is property that is likely to appreciate in value, since any future appreciation in value will not be subject to either gift or estate taxes. This is one of the major advantages of irrevocable trusts. A less drastic but nevertheless effective way to accomplish a reduction in estate taxes is to make use of the $10,000 annual gift exclusion (or $20,000 with your spouse’s consent).

Revocable Trusts

A revocable trust, on the other hand, offers no tax advantages and therefore should be considered for reasons other than reducing the estate tax bite. There are a variety of possible benefits to establishing a revocable trust. For one, assets placed in a revocable trust will not be subject to the delays and inconvenience caused by probate. This assures the payment to beneficiaries of proceeds from life insurance, pension, and profit-sharing plans, and other benefit plans without going through probate. A revocable trust also reduces vulnerability to postdeath contest among heirs and reduces access of creditors and claimants to the decedent’s estate. The decedent’s financial affairs remain private, as the trust plan is not subject to public inspection.

Competent management by professional trustees, if desired, assures that the grantor’s wishes will be adhered to. At times, grantors have created a revocable trust as a “test run” for creating an irrevocable trust, to measure both the competence of the chosen trustees and the viability of the trust.

Testamentary Trusts

A testamentary trust is a trust created according to your will. Creating a trust this way has some advantages over leaving property outright. First, it allows you, rather than your inheritors, to control the disposition of your estate. (Otherwise, your inheritors would be able to have complete control over how they dispose of their share of your estate.)  Second, a testamentary trust may save on estate taxes that would have to be paid on the demise of your inheritor. For example, a married couple’s use of a testamentary trust can result in significant estate tax savings upon the death of the second spouse.

Third, a testamentary trust may provide for professional management of your estate after your death, and it can eliminate or reduce the need to sell stock and property for distribution of the estate among your heirs.

The major drawbacks of testamentary trusts (as opposed to living trusts) are their inclusion in the taxable estate. Because a testamentary trust can be created only by a will and all wills are subject to probate, a testamentary trust can be created only after the probate process. Sometimes an improperly drawn will that has been thrown out of court blocks the creation of a testamentary trust altogether. The property in the trust also is considered as part of your estate and thus is subject, after your death, to estate taxation. (An irrevocable living trust, on the other hand, would not be included in your taxable estate.)
 
 

TRUSTS THAT CAN PROTECT FAMILY MEMBERS

Minor’s Testamentary Trust

This trust is created in a will for the purpose of protecting the children’s inheritance. The trustee of this trust handles its assets for the children’s benefit. This prevents poor management of their inheritance by an incompetent guardian. Also, a minor’s testamentary trust can establish limits and control your heirs’ access to their inheritance until they reach the age at which you feel they are mature enough to handle the entire sum wisely.

Testamentary Discretionary Spendthrift Trust

This trust is also created in a will. It provides security for a disabled beneficiary. It supplements government assistance by allowing for the trustee to distribute income from the fund to the disabled beneficiary. If he or she is unable to handle the money, it is given to the guardian to spend in the best interest of the beneficiary.

Irrevocable 2503(c) Trust

Although the law limits the tax benefits of putting money in your minor child’s name, there are still reasons to open an irrevocable 2503(c) trust. When you establish this trust, you are giving up control of the trust property and the power to change the trust agreement. Thus, the trust’s assets are no longer a part of your taxable estate. With an irrevocable 2503(c) trust, you may restrict the beneficiary from obtaining the trust’s income and principal until he or she reaches the age of 21 or even older if the beneficiary fails to claim the assets within 30 to 90 days of turning 21. There may also be some income tax reduction possibilities with a 2503(c) trust.

Irrevocable Crummey Trust

This trust has essentially the same income and estate tax benefits as the irrevocable 2503(c) trust. But one major difference is that the Crummey trust does not have to terminate when your child turns 21. The beneficiary of a Crummey trust can withdraw up to $10,000 a year — the value of the annual gift exclusion. If the beneficiary waives the right of withdrawal (this is what the parents hope will be done), the money in the trust will accumulate. Establishing either a Crummey or a 2503(c) trust is an expensive proposition, so a considerable amount of money must be placed in the trust in order to make it cost-effective.

Living Trust

A living trust is a trust into which you transfer your assets while you’re alive. A living trust’s immediate advantage is that it can circumvent probate. This may be particularly advantageous if you live in a state that has particularly onerous probate laws. If all your assets are held in a living trust, there is nothing to transfer through the will. The trust is not obligated  (in most states) to pay any remaining debts, and it ensures continuous management of the assets, uninterrupted by your death. If at any point you become disabled or otherwise unable to make an important decision concerning the assets, your co-trustee can take responsibility. (If you do not want to manage all your assets during the remainder of your life, you can appoint a co-trustee.)

A living trust, compared with a simple will, provides more assurance that your desires will be carried out. A trust document can specify exact conditions about the distribution of your assets (such as at what age a child will receive an inheritance) and can allow the trustee the discretion to withhold or distribute extra assets if it is prudent or necessary.

A living trust can also serve as a receptacle for estate assets and death benefits from your employee-benefit plans and life insurance. Also, it can unify in one location all your assets and thus avoid administration of the estate in different places. Compared with a testamentary trust, this trust is protected from public inspection and may be less vulnerable to attack on grounds of fraud, incapacity, or duress.

Moreover, if your living trust is revocable, it permits you to alter it as necessary or desired. But while an irrevocable living trust is not included in your estate for estate tax purposes, a revocable trust provides you with no tax savings (although if you die without revoking the trust, it automatically becomes irrevocable).

Living trusts aren’t for everyone, and they’re vastly oversold, but they still merit your consideration.
 
 
 

TRUSTS THAT CAN REDUCE ESTATE TAXES
 

Even married couples whose estates are less than $1 million can take advantage of certain trust arrangements that can end up saving the next generation well over $100,000 in federal estate taxes.

Bypass

Bypass (or “unified credit”) trusts can be set up to hold that portion of the estate that is exempt from taxes upon the death of the first spouse by reason of the $600,000 unified credit. The bypass trust is designed to exempt the assets placed in it from estate taxation upon the death of the second spouse. This estate tax savings strategy can be accomplished with a general power of appointment trust or a qualified terminable interest property (QTIP) trust. Both are discussed below.

General Power of Appointment Trust

The most distinctive characteristic of a general power of appointment trust is that it gives the surviving spouse the power to name (usually in a will) the ultimate beneficiary of the trust’s assets. If the surviving spouse fails to name a beneficiary of the assets, they will go to the beneficiary named by the spouse who died first. Two other essentials for setting up a general power of appointment trust are that it must give the surviving spouse a lifetime right to the income earned on the trust property, and it must give the trustee or surviving spouse the power to withdraw and use the trust principal for certain purposes.

Qualified Terminable Interest Property (QTIP) Trust

This trust can be used to insure that you, rather than your surviving spouse, choose who is to ultimately inherit your estate. People who are concerned that their spouse may remarry and that the “new spouse” will end up with most or part of the estate will find QTIP trusts appealing. Like a general power of appointment trust, the lifetime right for the surviving spouse to receive income will qualify for the marital deduction, so the ultimate estate tax savings features remain. In essence, a spouse can get income from the trust over his or her lifetime, but upon death, the principal in the trust passes on to whomever you choose—usually your children.

In addition to the estate tax savings aspects of marital trusts, both the general power of appointment trust and the QTIP trust allow you to be sure that your spouse is adequately provided for without somehow squandering estate assets during the spouse’s lifetime. This may be particularly useful if your spouse is not very experienced in managing money.

Irrevocable Life Insurance Trust

In order to avoid incurring estate taxes on life insurance proceeds, you can place your policies in an irrevocable life insurance trust. By doing this, you prevent your heirs from having to raise money to pay taxes on the money they received from your life insurance. On the other hand, when you set up a life insurance trust, you must give up all ownership rights. This includes the ability to borrow against the policies and to change the beneficiaries. Also, if you die within three years of setting up the trust, your insurance will be included in your taxable estate anyway.

Charitable Remainder Trust

For information on charitable remainder trusts that can reduce estate taxes, click on