Girls, Girls, Girls...Just Kidding, More Trusts

Last week’s Blog broached the subject of trusts; explaining what they are and how they function. We also looked at different marital trusts. This week we will cover the wonderful world of Trusts! Yep more trusts.

You may be asking yourself why focus on trusts. For starters, it has been my experience that, on average, people really don’t know a whole lot about trusts. And while its true some trusts will not serve you well if you have a modest estate, there are some that are perfectly suited to a modest estate. And it is important to know what they are and how they operate. I've been approached by people who never thought they'd need an estate plan, let alone a trust fund; and then they received a large settlement from a lawsuit, or got married, or took a job position with a substantial pay increase. Below we cover this versatile estate planning tool a bit more. 

Noteworthy Tidbits

• The 2014 Estate Tax Exclusion amount is $5.34 million for individuals and $10.68 million for married couples
• Estates over $5.34million will be taxed at a top rate of 40%
• Federal estate tax law says the when a spouse dies; the unused estate tax exclusion will transfer to the surviving spouse. This concept is called “Portability”. The surviving spouse is able to add the deceased spouse’s unused tax exclusion to his or her own federal estate tax exclusion.
• Portability provides that the deceased spouse’s unused exclusion will roll over to the surviving spouse so long as the surviving spouse makes an affirmative election on the deceased spouse’s federal estate tax return using IRS Form 706 to claim it within nine months following the deceased spouse's death.

• If the deceased spouse does not use any of their available federal tax credit, then the surviving spouse is left with a federal estate tax credit in the amount of $10.68 million
• Arizona does not have a state estate tax so the federal estate tax amount will be the applicable exclusion amount for cases in Arizona.
• Portability does not provide creditor protection

Bypass or “B” Trust also known as Credit Shelter Trust 

A Credit Shelter Trust is a revocable trust designed to shelter the estate from federal estate taxes. This trust doubles the amount of tax credit if you are married, very similar to the concept of Portability, however at the death of the second spouse's assets can pass to beneficiaries tax free and with protection from creditors. This trust plan generally splits a marital estate in half between the couple, keeping the trust funded with an amount lower than the federal exemption amount. When the first spouse passes, the second spouse will be supported from the trust's funds, at the discretion of the trustee. The second spouse is able to forgo taxation on her estate because she does not control the principal assets of the trust established by the first spouse. She is able to enjoy use of the assets but the trustee’s role in controlling distributions renders the estate safe from taxation because it is technically outside of the surviving spouse’s estate.

Pros

• Protects estates that may surpass the tax deduction limit from a 40% tax rate.
• Protects assets from creditors
• Protects assets inherited by marital children should surviving spouse remarry

Cons

• This method is generally of less use to a moderate estate because portability allows assets under $5.34 million to pass to a spouse tax free. But it does provide creditor protection to beneficiaries.

Noteworthy Tidbit

These type of trusts are usually used in conjunction with an A trust ("A" Trust explanation here)

Testamentary Trust

A Testamentary Trust is created at the death of the testator. It is created by operation of the testator’s will.

Pros

• Covers items accumulated during the life of the testator. Very useful to address those assets brought into the estate as a result of the testators death. For example, the estate sues and wins on the deceased testator’s behalf for a wrongful death claim. Proceeds from a settlement may be kept in a testamentary Trust.
• Is a good choice for a person with a very small estate that stands to make a large gain at death (usually through large life insurance proceeds). Particularly helpful if the deceased has young children who stand to inherit before reaching adulthood.
• Can be cheaper than most kinds of trusts.

Cons

• A Testamentary Trust still has to go through probate. The trust is created as a result of the Will going through the process of probate.
• Assets are not immediately available to beneficiaries.
• Assets are subject to taxes.
• Still must pay for the cost of probate.

Living Trust Also called an Intervivos Trust.

“Inter vivos” is Latin for “among the living". This definition defines the nature of this trust, which is created during the settlor’s lifetime and takes effect at the time of execution of the document. During the settlor’s lifetime the trust is completely revocable and amendable, but becomes irrevocable (unchangeable) on the death of the settlor. A settlor will usually name himself the trustee during his lifetime, with a named successor trustee who will be responsible for trust distributions and responsibilities at the death of the settlor.

Pros

•  Estate will avoid probate, unlike the testamentary trust. One of the most alluring features of a trust is the fact that the trust assets bypass the probate process which can be costly and lengthy.
• Truly preventative measure in the case where incapacity is an issue.
• Seamless transition of power over the trust from grantor/trustee to the successor trustee upon death or incapacity of the grantor/trustee. 
• Beneficiaries have immediate access to the trust income because the trust assets do not have to go through probate.
• The details of the trust remain private, whereas the details of a will are accessible by the public. 

Cons

• Some property is best left outside of the trust, but this will depend on what your estate planning goals are.

            For example- Ordinarily a life insurance policy with a named beneficiary is generally best held outside of the trust because life insurance policies are paid out almost immediately after the death of the insured party. So it is usually best to let Life Insurance policies pass outside of a trust.

            However, if your estate-planning goal is to pass the proceeds from your life insurance policy to a minor grandchild, it may be a good idea to name the trust as the beneficiary of the life insurance policy with your grandchild named as beneficiary of the trust with a designated age or event to trigger disbursement.

• A living trust does not insulate the trust assets from creditors while the grantor is still alive. He still has the power to revoke the trust and stills controls the assets. Creditor protection doesn't kick in until the grantor passes and the trust becomes irrevocable.
• Income earned by the trust is taxable and is the personal tax responsibility of the grantor.

Noteworthy Tidbit

- The Average (uncontested) probate case can take about six months to a year and start at $3000 (not including filing fees and other costs).

- While the estate is being probated the executor is prohibited from distributing the estate property. 

Qualified Domestic Trust (QDT- called a Q-dot)

A Qualified Domestic Trust allows a spouse who is not a U.S. citizen the ability to take advantage of the marital tax deduction that is otherwise granted to married couples.

Pros

•  The only way for couples consisting of one non-us citizen to still take advantage of the marital deduction.

Cons

• At least one trustee of the QDT must be a U.S. citizen. This may include a U.S. corporation.
• Only awarded to surviving spouses whose spouse died after November 10, 1988.

Irrevocable Life Insurance Trust also called an ILIT

 An ILIT is a trust that is funded with the proceeds of a life insurance policy. The trust is named as the beneficiary of the policy and owner of the policy, and precludes taxation even after the death of the second spouse. In the previous post, we noted that the common factor in all of the marital trusts was that the trusts provided a delay on taxation until the death of the second spouse. Unlike a marital trust, the ILIT assets are not included in the estate of the second spouse. 

 Pros

• Ordinarily the proceeds of a Life insurance policy is included in the estate of the owner of the policy and will be included in the owners estate at death. So your estate will be taxed at a rate that includes the life insurance. 
• Ex. If you own a $2 million dollar life insurance policy, at your death the estate taxes will be assessed considering the $2 million dollars a part of the estate. This will eat into your $5.23 million estate tax exemption.
• If your estate planning goals are to provide for your children and grandchildren, and ILIT can be set up as a Generation Skipping Trust (Dynasty Trust).

 Cons

• This is not ideal for families who need liquid assets( ie a family who is reliant on access to the life insurance policy proceeds).
• This is one of the types of trusts that should only be used if the family is substantially flushed with liquid asset, (ie this is one for the rich folks or very, very good savers).
• The insured person must give up control over the insurance policy; he may not act as trustee of the trust. 
• This type of trust is irrevocable.

Generation Skipping Trust or a Dynasty Trust

As the name implies a Generation Skipping Trust (GST) is a trust where the assets are transferred in trust to the testator’s grandchildren, hence it "skips" a generation.

Pros

• The assets are not subjected to estate taxes. The assets would be taxed would be if the assets were in trust for the settlor’s children.
• Helpful if you want to provide for grandchildren whose parents are financially irresponsible.
• Insulates assets from children’s and grandchildren’s creditors and or a divorced spouse
• An individual may give Grandchildren up to $5.34 million without transfer taxation.
• The settlor’s children do have access to the income generated by the assets. 
• Ex. If an asset is rental property or stock that produces dividends, the grantor's children may access the profits from the rent and the dividends.

Cons

• May not be advantageous where the assets do not generate income the children of the testator may not receive financial benefits.
• May not be advantageous in very modest estates that will automatically avoid the Generation Skipping Tax consequences.

Next week we will cover Charitable Trusts. If there is a term or explanation in this post that is still unclear please ask for clarification by posting your inquiry in the comments section or emailing us at Info@KeovonneWilsonLegal.com

Keo'vonne W.

"Turn Your Dream Into Your Legacy"

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