First, I AM NOT AN ATTORNEY. DO NOT RELY ON ME FOR LEGAL ADVICE!
However, I have been a financial planner for a long time and do know something about the relevance of trusts and how they might be used in a financial planning context.
I decided to talk about this today ( and on the following two Friday’s…) is because I’m increasingly sick and tired of the negative news and crap going on in the world. I find our so called leaders are interested only in feathering their own nests and are willing to be complicit in the devolution of the United States. It’s depressing, it’s getting worse, and I’m worried about the world I’m leaving my children and grandchildren. I need something positive to write about.
For those of you considering whether or not a trust is appropriate, it’s useful to know there are more than 50 types of trust. Consider yourself lucky that I’m only going to describe ten of them.
They can be complex, involve legal fees and annual administrative costs. Sometimes the income inside a trust is taxed at the highest federal income tax bracket. But this cost often pales in comparison with the advantages trusts offer to shelter money and property from taxes, creditors, and/or mismanagement.
A trust can help save gift and estate taxes, manage assets in the event of a disability or death, handle the assets of children or grandchildren, and retain control of a family business.
The Bypass Trust – Estate taxes, often referred to as death taxes, exist at the federal level and state level. A dozen states plus the District of Columbia continue to tax estates and a half-dozen also levy inheritance taxes. Maryland collects both.
Until recently, financial planners like myself saw this tax as a opportunity to earn commissions. Sometimes lots of them. When I started my career, the threshold for calculating a federal estate tax was an “estate” of “only” $550,000. The threshold is now $11.4M(illion). That eliminates at least 99% of the people where I live. I also learned many years ago the estate tax was essentially a voluntary tax. If someone refused to do any pro-active tax planning, then they, or their estate, could expect to pay. But with some relatively simple planning steps, virtually all of it could be could be paid for with leveraged dollars if not eliminated entirely.
If you have a surviving spouse, no tax is levied. A potential problem surfaces at the second death. Here’s where the bypass trust can be useful.
The $11.4M exemption will be used to offset the estate tax when we die. But if you haven’t set up a bypass trust, the credit available at the first death will be lost. That may mean more taxes will be payable at the second death since that person has only one exemption amount. The bypass trust is designed to take effect at the first death and will absorb up to $11.4M of assets.
This effectively results in those assets not being taxes at the second death, if managed properly. What the survivor cannot do is change the ultimate beneficiaries which became irrevocable at the first death. At the second death the same rules apply.
The Q-Tip Marital Trust – A QTIP ( Qualified Terminable Interest Property Trust ) is a legal way to attach strings to assets left to benefit your spouse. It means you don’t forfeit your marital deduction. The most common use of the QTIP is in the case of a second marriage. Forget the size of your estate here; it’s designed to solve a different problem than estate taxes.
Suppose you accumulated a sizeable net worth during a first marriage and want the children of the first marriage to inherit the bulk of your assets. By setting up a QTIP that will receive the assets from your estate when you die, all the income from the assets can go to your spouse.
Upon the death of your spouse, all the principal in the trust can go to your children. It is relatively simple to set up, but a tax return will need to be filed annually by the trust. An independent trustee can oversee investments and distributions, and the surviving spouse can be given distributions from principal in case of hardship or other reasons if you leave discretion to the trustee.
If you are using qualified or as yet untaxed assets as the corpus to be transferred upon your death, you need to be sure the trust language is such that it satisfies the IRS to preserve the tax deferral of the asset.
Lastly, you might want to consider trust language that allows income to be a percentage of the principal and not strictly “income”. This is because traditional income stocks such as utilities no longer pay very much income and this can present a problem for both the person needing the income as well as the ultimate beneficiaries who see their inheritance invested in static positions and not growing to meet their ultimate needs.
The Grantor Trust – This is a trust set up in the children’s names. You’re allowed to make annual gifts to a grantor trust in the name of each child in the amount of $15,000 (currently) that is exempt from Federal Gift Taxes. This amount can double if we’re talking about a married couple as grantors. The income from the trust stays in the children’s names but flows to the parents tax return. The trust corpus grows faster since the trust pays no income taxes. The result is more assets transferred to the children over time thereby reducing exposure to possible estate taxes when both parents are gone.
Note: It’s my plan to create two more similar blog posts over the next couple of weeks. The idea is to provide a brief overview of trusts and their uses. Since many of my readers are old as dirt, I hope you’ll gain something from all this. And I welcome comments that correct mistakes I may have made. TK