Picking the Perfect Trust
A well-crafted estate plan ensures that a person’s assets will be smoothly passed on to his or her chosen beneficiaries after one passes away. The absence of an estate plan can lead to family conflict, higher tax burdens, and exorbitant probate costs. While a simple will is an essential component of the estate planning process, sophisticated plans should also include the use of one or more trusts.
• A well-crafted estate plan involves pairing a simple will with the creation of a thoughtfully designed trust, to ensure a benefactor’s assets are transferred to their loved ones.
• Trusts may be broadly defined as “revocable”, which means they may be amended during a grantors living years, and “irrevocable”, which means they cannot be altered or revoked.
• Trust entities generally pay separate taxes and therefore must obtain a federal identification number and file an annual return.
• Trust funds can hold a variety of assets, such as money, real property, stocks and bonds, a business, or a combination of many different types of properties or assets.
• The dynamic of every family is different, so it’s important the trust(s) you select to care for your loved ones after your death is well-suited to your loved ones’ needs.
A trust is an account managed by a person or organization, for the benefit of another. A trust contains the following elements:
• Grantor: Sometimes called a “settlor “or “trustor”, a grantor refers to the individual who creates the trust and has the legal authority to transfer property into it.
• Trustee: This is an individual or organization who administers property or assets for the benefit of a third party, by temporarily holding onto the property, but without taking direct ownership of it. Trustees have the fiduciary responsibility to operate in the best interests of the grantor and the beneficiaries, and must faithfully execute the mandates outlined in the trust document. Therefore, it is critically important to appoint only reliable people to this position.
• Beneficiary: This is the party that benefits from the trust. There may be several beneficiaries to the same trust—each of whom may be entitled to different amounts of the assets.
• Property: This refers to the asset held in the trust, and may include cash, securities, real estate, jewelry, automobiles, and artwork. Sometimes called the “principal” or the “corpus”, such property can be transferred into the trust while the grantor is still alive, via a living trust. Alternatively, assets may be transferred into a testamentary trust after the grantor dies, as per the mandate of a will.
• Revocable trust: This type of trust may be altered as many times as desired, during a grantor’s living years.
• Irrevocable trust: This type of trust can never be altered, amended, or revoked.
• Taxes: Generally speaking, each trust pays separate taxes, and therefore must obtain a federal identification number and file an annual return. Some living trusts use the grantor’s tax identification number.
Types of Trusts
A living trust is usually created by the grantor, during the grantor’s lifetime, through a transfer of property to a trustee. The grantor generally retains the power to change or revoke the trust. But after the grantor dies, this trust becomes irrevocable and may no longer be changed. With these vehicles, trustees must follow the rules delineated in the creation documents, relating to the distribution of property and the payment of taxes.
Living trusts offer the following advantages:
• Healthcare/end-of-life provisions desired by the grantor
• Protection against incapacity of grantors and beneficiaries
• Elimination or reduction of probate delays and expenses
• An easy succession of trustees
• Immediate access to income and principal by beneficiaries
• Privacy during situations where the state requires the filing of an inventory of assets
Living trusts also have the following limitations:
• Titling of Property: In some cases, a piece of real estate property should be excluded from a trust. For example, in Utah, primary residences are shielded from creditors by way of a “homestead exemption”, but if the primary residence is placed in a trust, the homeowner may surrender that creditor’s protection. In such instances, a pour-over will can be used to coordinate the transfer of assets into a trust, after the grantor dies.
• Creditor Claims: A living trust generally does not provide protection from claims made by creditors, because the grantor of the trust is considered to be the owner of the trust’s assets, due to the fact that the grantor may revoke the trust at any time.
• Taxes: All income earned by the trust is taxable to the grantor’s personal tax return, as though the property had never been transferred to the trust. A living trust is often referred to as “inter-vivo”.
A testamentary trust, sometimes called a “trust under will”, is created by a will after the grantor dies. This type of trust can accomplish the following estate planning goals:
• Preserving assets for children from a previous marriage
• Protecting a spouse’s financial future by providing lifetime income
• Ensuring that beneficiaries with special needs will be taken care of
• Gifting to charities
Irrevocable Life Insurance Trust
An irrevocable life insurance trust (ILIT) is an integral part of a wealthy family’s estate plan. The federal government currently affords individuals an $11.7 million estate tax exemption for the 2021 tax year. But any portion of the estate above that amount may be taxed as high as 45%. So, for estates containing more than the $11.7 million applicable exclusion, life insurance can be an invaluable tool in the estate planning kit. ILITs provide the grantor a flexible planning approach and a tax savings technique by enabling the exclusion of life insurance proceeds from both the estate of the first spouse to die and from the estate of the surviving spouse. The ILIT is funded with a life insurance policy, where the trust becomes both the owner and the beneficiary of the policy, but the grantor’s heirs can remain beneficiaries of the trust itself. For this plan to be valid, the grantor must live three years from the time of the policy transfer, or else the policy proceeds will not be excluded from the grantor’s estate. Although trusts were established to allow IRA beneficiaries to receive the required minimum distribution (RMD) each year from the inherited IRA or 401(k), the Secure Act of 2019 states that non-spousal IRA beneficiaries must withdraw all of the funds in the IRA or 401(k) by the end of ten years following the death of the original account owner.2
Charitable Remainder Trust
A charitable remainder trust (CRT) is an effective estate planning tool available to anyone holding appreciated assets on a low basis, such as stocks or real estate. Funding this trust with appreciated assets lets donors sell the assets without incurring capital gains tax. Furthermore, charitable remainder trusts are irrevocable, meaning they cannot be modified or terminated without the beneficiary’s permission. The grantor effectively removes all of her rights of ownership to the assets and the trust upon the creation of its irrevocable status.
Qualified Domestic Trust
This special trust lets non-citizen spouses benefit from the marital deduction normally afforded to other married couples. Normally, a surviving spouse is eligible for a 100% marital deduction of any estate taxes owed on assets. This means the surviving spouse pays no taxes on assets with no limit. However, if the surviving spouse is not Utah citizen, the marital deduction is not allowable. The qualified domestic trust makes up for this rule.
Special Needs Trust
A special needs trust is a legal arrangement that lets a physically or mentally ill person, or someone chronically disabled, have access to funding without potentially losing the benefits provided by public assistance programs. Since public assistance programs set up for people with special needs are predicated on certain income and asset restrictions, money put into a special needs trust doesn’t affect their eligibility for public assistance.
What Types of Trusts Can Be Set Up for Minor Beneficiaries?
There are many different types of trusts that a grantor can use for their minor beneficiaries. A pot trust for example designates certain assets to a couple’s children after the death of the last surviving spouse. Education trusts set aside money for the specific purpose of higher education. There are also generation-skipping trusts.
What Type of Investments Are Allowed in Trusts?
Trust funds can hold a variety of assets, such as money, real property, stocks and bonds, a business, or a combination of many different types of properties or assets.
What Types of Trusts Are Available for People on SSI?
There are three types of trusts designed for people receiving Social Security income: third-party special needs trusts, self-settled special needs trusts, and pooled trusts.
What Type of Trusts Are Allowed for Shareholders of an S Corporation?
The three types of trusts most commonly used by shareholders of an S corporation are grantor trusts, qualified subchapter S trusts (QSSTs), and electing small business trusts (ESBTs). Estate planning is a complex process demanding professional oversight. The structure and dynamic differ in every family, so it’s important the trust(s) you select to care for your loved ones after your death is well-suited to your loved. Whether this means caring for a disabled family member or friend, protecting the security of your spouse, or simply helping to secure the financial futures of your children and/or grandchildren, a properly formatted trust can go a long way in effectively carrying out your wishes.
An A-B trust is a joint trust created by a married couple for the purpose of minimizing estate taxes. It is formed with each spouse placing assets in the trust and naming as the final beneficiary any suitable person except the other spouse. The trust gets its name from the fact that it splits into two separate entities when one spouse dies. Trust A is the survivor’s trust and trust B is the decedent’s trust.
• An A-B trust is a joint trust created by a married couple; upon one spouse’s death, the trust splits into a survivor portion (the A trust) and a bypass portion (the decedent’s trust, or B trust).
• Via the split, the A-B trust effectively minimizes estate taxes and defers them until after the death of the surviving spouse.
• The surviving spouse has limited control over the decedent’s trust but the terms of the decedent’s trust can be set to allow the surviving spouse to access the assets, and even draw income from them.
• A-B trusts are no longer widely used as the estate tax exemption, which is now indexed to inflation, is sufficient for most estates.
Understanding an A-B Trust
Estate taxes can bite deeply into a deceased person’s assets. For example, consider a married couple that has an estate worth $20 million by the time one of the spouses dies. The surviving spouse is left with the whole $20 million, which is not taxed due to the unlimited marital deduction for assets flowing from a deceased spouse to a surviving spouse. But then, the other spouse dies, leaving the money to their children. The taxable portion of the estate (the amount that exceeds the current exemption threshold of $12 million) will be $8 million. This means that $8 million will be taxed at 40%, leaving only $4.8 million for the beneficiaries. To circumvent the estate from being subject to such steep taxes, many married couples set up a trust under their last will and testaments called an A-B trust. In the example above, if the couple instead had an A-B trust, the death of the first spouse would not trigger any estate taxes as a result of the lifetime exclusion. However, a sum of money equal to the current exemption amount will be transferred into an irrevocable trust called the bypass trust, or B trust. This trust is also known as the decedent’s trust. The remaining amount, $8 million, will be transferred to a survivor’s trust, or A trust, which the surviving spouse will have complete control over. The estate tax on the A trust is deferred until after the death of the surviving spouse.
Advantages of an A-B Trust
The A trust contains the surviving spouse’s property interests, but they have limited control over the assets in the deceased spouse’s trust. However, this limited control over the B trust will still enable the surviving spouse to live in the couple’s house and draw income from the trust, provided these terms are stipulated in the trust. While the surviving spouse can access the bypass trust, if necessary, the assets in this trust will bypass their taxable estate after they die. After the surviving spouse dies, only the assets in the A trust are subject to estate taxes. If the estate tax exemption for this spouse is also $12 million and the value of assets in the survivor’s trust is still valued at $8 million, none of it will be subject to estate tax. The federal tax exemption is transferable between married couples through a designation referred to as the portability of the estate tax exemption. If one spouse dies, the unused portion of their estate tax exemption can be transferred and added to the estate tax exemption of the surviving spouse. Upon the death of the surviving spouse, the property in the decedent’s trust passes tax-free to the beneficiaries named in this trust. This is because the B trust uses up the estate tax exemption of the spouse that died first, hence, any funds left in the decedent’s trust will be passed tax-free. As the decedent’s trust is not considered part of the surviving spouse’s estate for purposes of the estate tax, double-taxation is avoided.
Net Worth and A-B Trusts
If the deceased spouse’s estate falls under the amount of their tax exemption, then it may not be necessary to establish a survivor’s trust. The unused portion of the late spouse’s federal tax exemption can be transferred to the surviving spouse’s tax exemption by filling out IRS Form 706. While A-B trusts are a great way to minimize estate taxes, they are not used much today. They were popular in the decades around the turn of the 21st century when the estate tax which hadn’t been adjusted for years—could be triggered on estates as small as $1 or $2 million. Nowadays, each individual has a combined lifetime federal gift tax and estate tax exemption of $11.7 million in 2021, rising to $12.06 million for 2022. So only people with estates valued over $11.7 million will opt for an A-B trust in 2021. With the portability provision, a surviving spouse can include the tax exemption of their late spouse, allowing up to $23.4 million as of 2021 and $24.12 million in 2022, which can be transferred tax-free to beneficiaries.
Individuals who are considering drafting a trust or a will may wish to consult with an estate planning lawyer. He or she can explain the advantages of using a trust as well as a will. He or she can make recommendations based on the specific considerations of the client. He or she may even recommend using both documents, such as by using a pour-over will that places any property owned at the time of the testator’s death into the trust.
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