Using trusts as an estate planning tool is often done to achieve tax savings. By setting up certain types of trusts, a high-net-worth individual can avoid exposure to estate taxes levied by the federal and state governments. While this is an important consideration if your estate is likely to be liable for death taxes, there are many other reasons to create a trust.
Here are seven reasons that are not estate-tax driven:
1. To Avoid Probate or Estate Administration. Assets in a trust don’t go through probate or an estate administration, the court-supervised process for distributing the assets. (Probate is when a person has a will and an estate administration is when a person does not have a will.) If your estate winds up in a probate or an administrative proceeding, the details generally become part of the public record. Every asset and debt of your estate, as well as the plan for distributing it to your heirs, could be open to scrutiny.
2. To Provide for Minor or Special Needs Children. Creating a trust to provide for the needs of children may allow for the management of the money for the best interest of the children. The trustee could be the guardian you name for a child or it could be someone else. This type of trust allows you to provide instruction for how the money is distributed. The children could get the money over time in multiple distributions or in a lump sum.
A special needs trust can be set up to provide money to a disabled child yet still keep the child eligible for government assistance programs.
3. To Achieve Flexibility. A trust can help ensure that your intentions are carried out no matter what happens in the future. It is a way to give gifts with strings attached. For example, a grandmother wants her granddaughter to go to college. She sets up a trust with $100,000 and instructions that the child is to receive the money in four installments after starting college. If the grandchild does not go to college, she receives the money at age 30.
In another example, an unmarried man set up a revocable trust to be the beneficiary of his Individual Retirement Account (IRA). He listed his four siblings as beneficiaries of the retirement account funds. However, if one of the sisters or brothers dies, the trust is directed to distribute the money to the children of that sibling — rather than to the other three siblings.
4. To Protect Assets from Creditors or Other Claims. After assets are moved into a trust, they may be hard to access by potential creditors and others who wants to make a claim against them. For example, let’s say you are concerned about tax liens imposed on your daughter. If she inherits money outright, it will likely be taken by the IRS or other government entity and your grandchildren will suffer. An asset protection trust can provide protection for your family.
5. To Fulfill Your Philanthropic Desires. Trusts can be used in different ways to benefit the charities of your choice. There are generally current tax breaks for you and future benefits for the not-for-profit organizations named. For example, let’s say you support your alma mater or strongly believe in the cause of a local charity. You’d like to leave some of your wealth to the organization. Here are a couple options:
- With a charitable remainder trust, you transfer assets to the trust and receive an annual income in the form of a percentage of the trust value. You also receive a tax deduction in the year the trust is funded. The remainder left in the trust when you die will go to the charity.
- With a charitable lead trust, you transfer assets to the trust and a qualified charity receives a percentage of the value. After your death, your beneficiaries (a spouse, children or others) receive what is left in the trust.
With both types of trusts, there are many complex steps (not described here) that you must take to stay in compliance with tax laws. For example, a charitable remainder trust must distribute at least 5 percent of the fair market value of the assets annually over the lifetime of an individual or for 20 years. The trusts are also irrevocable, meaning the gift cannot be withdrawn and the basic terms cannot be changed. Consult with your attorney about whether a charitable trust would be advantageous in your situation.
6. To Provide Medicaid Planning. Many older people are concerned they will wind up in a nursing home and all of their assets will be eaten up paying for it. If they simply transfer assets to their loved ones, they may be penalized if the transfer is done within the 60-month “look back period.” So they set up irrevocable trusts to provide some protection for the money. Consult with your attorney about whether this is appropriate in your situation. Medicaid planning is complex.
7. To Protect Children from a First Marriage. Trusts are often used by blended families where the spouses each have their own children. The first spouse to pass away can use a qualified terminable interest property (or Q-Tip) trust to preserve the interests of his or her children or other intended beneficiaries. Without this protection, a surviving spouse might create a will that ignores the children of the deceased spouse, instead diverting all the assets to his or her own children.
Including a Q-Tip trust in your estate plan allows you to provide your surviving spouse with a lifetime income from the assets in the trust, while ensuring that there is a legal framework in place for your children to receive their share of your assets after the death of both you and your spouse.
As you can see, there are many reasons to set up trusts. We have only listed some of them. The important thing to remember is that trusts can help you carry out your estate planning goals in ways that a Will cannot accomplish. Consult with your estate planning adviser about your situation.