For many years, trusts have been the province of the wealthy, mysterious vehicles used to escape taxes and preserve assets for future generations. And for couples with joint assets approaching or exceeding $10.68 million — the current gift and estate tax exemption amount — a comprehensive estate plan that incorporates trusts is crucial for minimizing estate taxes.
More recently, however, families with assets well below this threshold are using trusts to help them protect assets from creditors, manage and grow assets for future generations, and ensure that their assets ultimately are distributed in accordance with their wishes to their heirs.
In setting up a trust, an individual appoints a trustee (an individual, a corporate trust company, or both) to act as a surrogate to manage and distribute assets in accordance with his or her wishes when (i) the individual later is not able to do so directly (due to, for instance, death, disability, incapacity, or geographic unavailability) or (ii) the individual wishes to shield the assets from possible later creditors. The individual sets out instructions in a trust document and appoints a trustee to act in his or her absence on his or her behalf. In this way, the trust ensures the ongoing preservation, protection, and control of assets.
Let’s consider some of the situations in which a trust can help someone control, protect, and preserve assets and address philanthropic goals.
Allocating assets among family members. Individuals often are concerned about leaving assets outright before heirs are ready to handle them. A child could dissipate assets too quickly, or lose assets in a later divorce. A spouse might remarry into a blended family. By placing assets in a trust, an individual can ensure that the assets are later distributed among family members in the time and manner intended.
Children: Suppose you have children who are young or irresponsible and might squander assets they receive outright. You can instruct your trustee when to distribute income and principal to each child. Such instructions can be based on age or on a specified accomplishment (e.g., college graduation). In this manner, you can seek to influence your children’s behavior even after your death.
Future generations: Suppose you wish to ensure that your assets remain available for future generations of your family, and that intervening generations do not squander assets to the detriment of generations that follow. For instance, if assets are left to a son, he might later give them to his wife, either voluntarily or in a later divorce, rather than leave them to your grandchildren. A dynasty trust ensures that each generation will receive sufficient income to live but be unable to divert remaining assets from future generations.
Surviving spouse: Suppose you want to preserve your assets for your offspring in the event you predecease your spouse. If you leave your assets to your spouse outright, he or she will have the power to determine their later distribution, perhaps giving them to a prior or later spouse’s offspring. By putting the assets in trust and providing for distributions to your spouse to maintain lifestyle, you can ensure that remaining assets go solely to your children. This planning can be particularly important if you have children from a prior marriage.
Education: An education trust can set aside assets to be used solely for educating or your children or grandchildren.
Special needs child: A special needs trust can be used to provide funds for an incapacitated child after the parent is no longer able to do so.
Provide for professional management. Individuals might be concerned that their heirs’ lack of financial sophistication – or the heirs’ divergent interests and needs — will preclude the effective management of the assets. A trust allows an individual to ensure that assets continue to be managed properly and to grow.
Preserve assets. Individuals in certain professions or businesses often are concerned that they might lose assets to creditors rather than preserve the assets for family members. Assets held in trust frequently are beyond the reach of creditors, allowing the assets to be preserved for heirs.
Facilitate philanthropy. Individuals might wish to donate the bulk of their assets to a charity, but still provide needed income for family members and heirs. A charitable trust can accomplish these goals.
Revocable vs. Irrevocable Trusts
A trust can be either “revocable” or “irrevocable”. An individual placing assets in an irrevocable trust cannot later reclaim the assets or make significant changes to their disposition. Thus, the donor must be comfortable with the arrangement at the time assets are placed in the trust. In contrast, a revocable trust can be changed at any time as long as the individual setting up the trust is alive and healthy. Upon the individual’s death or incapacity, the trust becomes irrevocable.
Which trust makes sense depends on the particular situation. Many individuals prefer the flexibility of the revocable trust. However, an irrevocable trust often is necessary for certain functions, such as estate tax minimization or asset protection.
In choosing the type of trust, there are other considerations to keep in mind:
Choosing between an irrevocable and revocable trust can be critical depending on the circumstances. For this reason (and others, including tax minimization and effective creditor protection), it is important to consult with a qualified attorney when establishing a trust, gifting assets, or considering any of the techniques described in this paper. Individuals establishing trusts also should retain a qualified professional fiduciary to assist in managing and administering the trust and directing the investment of trust assets.
A comprehensive estate plan, which typically involves the use of trusts, is crucial for couples with joint assets approaching or exceeding $10 million. But trusts also are important for couples or individuals with fewer assets, allowing them to protect assets from creditors, manage and grow the assets effectively, and distribute the assets to heirs or charities in accordance with their wishes when they are no longer able to do so themselves.
Andrew H. Friedman is the Principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He speaks regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. He may be reached at www.TheWashingtonUpdate.com.
Neither the author of this paper, nor any law firm with which the author may be associated, is providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.
Copyright Andrew H. Friedman 2014. Reprinted by permission. All rights reserved.
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