Please note: I AM NOT AN ATTORNEY. DO NOT RELY ON ME FOR LEGAL ADVICE!
This is the last installment of Top Ten Trusts. And a reminder there are dozens more than ten but these are the ones I’ve talked about with attorneys who have advised my clients over the years. Some of these trusts have lost some of their appeal due to rule changes at both the federal and state level.
Given that all of us are mortal, it helps our followers if we somehow minimize the chaos and uncertainty that will follow our respective deaths. To the extent we can make this easier for them, I want to do that. For some of us, the presence of a trust may be the best way to make sure the transition to the next generation goes as smoothly as possible. The language of the trust will allow us to speak from the grave. That may or may not be a good thing but…
REVOCABLE LIVING TRUST
This type of trust has been the subject of much controversy, largely the result of mass marketing to seniors and promoted as something you must have. It has virtually no effect on income taxes or estate taxes. What it does is allow you to speak from a hospital bed if you are laid up and unable to, or from the grave if you have reached the end. This is because it allows you to provide for the management of your assets in the event of a disability. A trustee is appointed to act on your behalf. You get to name the trustee, and successor trustees and only in a worse-case scenario, is there a court appointed guardian. It helps keep your assets out of the hands of people who might otherwise not have your best interests at heart. It keeps your assets from being subject to probate which can be a good thing. While you no longer own the asset, since you effectively transfer ownership when you fund the trust, you still have full control over your affairs. You simply act as trustee for yourself.
LIFE INSURANCE TRUST
If you were to purchase a $1 million life insurance policy and quickly died, there is a good chance the $1 million will be included in your estate for estate tax purposes, even though life insurance proceeds are exempt from income tax. If your spouse is the beneficiary, it‘s included in the his or her estate when he/she dies. If your estate is large enough to be taxable under the Estate Tax rules, you‘ve paid for $1 million of insurance but only benefited by something less than that. The solution is to set up an irrevocable life insurance trust (ILIT) before you purchase the insurance. You gift the premium to the trust, the trust owns the life insurance policy and when it‘s time for the company to pay up, the money flows to the trust income tax free and outside your taxable estate. Even if the estate tax is abolished, and there is no assurance as of this writing that it will be, you can choose in advance who will be the trustee to manage the proceeds and all the money will be there for your heirs.
CHARITABLE LEAD TRUST
With this trust, you can give money to charity and provide for your children at the same time. Suppose you give $1 million to a charitable lead trust. The charity of choice receives annual payments during the life of the trust. The children receive what‘s left at the end of the trust term. The primary benefit from this type of trust is that the dollar amount of the ultimate transfer to the children is discounted due to the income paid to charity as well as the for the time delay of the gifts. You should be able to avoid paying gift tax and you should receive an income tax deduction for the charitable contribution.
Many people open brokerage accounts for their children under state law which is usually called the Uniform Gift to Minors rules available in each state. When the child reaches age 18 or 21, depending on your state, the assets belong to the child. That could be a problem if the child decides against college and would rather use the money for some other purpose. This type of trust may be a better idea even though there are annual administrative costs. You probably know that you are entitled to gift $11,000 per year without the gift qualifying for the gift tax. So if you want this money to fall under the gift tax exclusion, the child must be entitled to all the income from the trust, or be able to withdraw up to $11,000 per year. To comply with tax laws, you must send each beneficiary a “Crummey” letter each year. Named for the 1968 Crummey v. Commissioner tax case, Crummey powers give your child or other beneficiaries as little as 15 days to withdraw money from the trust. This qualifies the annual gifts for the gift-tax exclusion. The gifts won‘t be taxed, and can then go to pay the insurance premium. However, for the strategy to work, the trust has to be maintained properly. Every year, Crummey letters must go to each ILIT beneficiary, and the letters must be signed and retained. Otherwise, the money used to purchase the insurance could be thrown back into the estate and trigger other complications. In most cases, if the beneficiary takes the money and runs, there is little likelihood that you will make the gift again in the future. Beneficiaries rarely exercise their “Crummey” rights.