When
most people think of trusts they often times think of a gilded estate-planning
tool for the ultra wealthy, but a trust can be a great way of protecting the
assets of the average person. This week we’ll discuss, what can be the most
useful estate-planning tactic in your toolbox.
To
keep the discussion stream lined this week will cover trust basics and the
three kinds of Marital Trusts.
What is a Trust and how does it work?
A
trust is a legal arrangement in which a person (can be more than one person or
a business entity) entrusts a third party with power (and/or property) for some
determined time for the benefit of another person or parties.
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The person who creates the trust by giving away the power or property to the
third party is the settlor/Trustor/grantor.
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The third party with whom the power or property is entrusted is called the trustee.
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The person the trustee is holding power or property for, is the beneficiary.
Ex. John
(settlor) designates Martha as trustee of his estate, until John’s daughter Sara
(beneficiary) reaches the age of 21.
A
trust documents the designation of power and property and names the
beneficiaries. The trust document must reflect a clear intention of the settlor
to create a trust, the property that is the subject of the trust must be clearly
identified, and the beneficiaries must be identifiable.
Revocable
vs. Irrevocable
What
is the difference between a Revocable Trust and an Irrevocable Trust?
A
Revocable trust may be revoked (changed or terminated) at any time during the
life of the person who created the trust, ie the settlor. A revocable trust
becomes irrevocable when the Trustor passes away.
- Assets held in a revocable trust
are still subject to creditors because the settlor still has access and control
over the assets.
An
Irrevocable trust may not be revoked (changed or terminated) at any time after
it is created.
- Assets held in an irrevocable
trust are insulated from creditors because the settlor no longer has power over
the assets. Assets held in an irrevocable trust are considered property of the
trust.
Marital
Trusts
No
that we've covered what a Trust is, how it functions; and defined revocable and
irrevocable, we will take a trip into the wonderful world of Marital Trusts.
As
the name implies, a Marital Trust, aka an “A Trust” is established for the
benefit of a settlor’s spouse and their children. There are three types of
Marital Trusts: 1) Qualified Terminable Interest Property (QTIP) Trust, 2)
Power Of Appointment Trust, 3) The Estate Trust.
It
is critical to note that All U.S. residents can use the Unlimited Marital Deduction,
which allows for property to be transferred to a spouse before or after death.
The spouse must be a U.S. citizen in order to take advantage of this deduction.
At
the first death assets are passed tax-free to the second spouse, then to the
children at the death of the second spouse. The second transfer, the one made
to the children of the marital couple, is subject to tax if there is not a Tax
Credit Trust aka a “B Trust” set up. In general these trusts will operate
together to maximize savings.
Pros
-Makes
sure that the marital children inherit even if the surviving spouse remarries.
Ordinarily the new spouse would be able to lay claim to the estate according to state
statute.
-
Great way for married couples to take advantage of tax breaks.
Cons
-
Must be used in conjunction with a “B Trust” to minimize taxation at the second spouse’s
death.
Noteworthy Tidbit:
If
the surviving spouse is not a U.S. citizen, he will inherit subject to all
permissible estate and transfer taxes after the first $145,000. A well-drafted
Qualified Domestic Trust aka “QDOT” will qualify for the marital tax deduction
and can insulate a large portion of the assets used for the the benefit of a
non-US citizen. (QDOTs will be explained in another post- but you should know
that they exist)
1) Qualified Terminable
Interest Property (QTIP) Trust-
Creates
a life-long interest in the asset of the trust in the second spouse, but prevents him from passing the money on to subsequent spouse. Normally a settlor may not
take advantage of the unlimited marital tax deduction if the surviving spouse
is able to lose an interest in the property.
For
example, if wife leaves her husband a property that belongs to him so long as he
doesn’t get married. Whether or not he gets married is not relevant, but rather
the fact that the act of getting married can cut off his interest in the
property according to the terms of the wife’s trust. Wife would not be able to take
advantage of the tax deduction in order to avoid taxation on the property.
However the husband’s interest will be qualified for the tax deduction is wife
grants him a life estate. That is he owns the home until he dies. When husband
dies, his life estate ends and then the home becomes property of the estate and
subject to the terms of the trust that give the home to the children rather
than new wife.
Pros
-Gives
the settlor power to prevent the estate assets from going to a new spouse.
-- The settlor can grant the surviving spouse some power to alter distributions.
-Delays
taxation until the death of the second spouse.
-Also
may be used to ensure that children of the second marriage are provided for from
the marital assets of the second marriage.
Cons
-
Taxation at second death
-
Limits the surviving spouse's power to name new beneficiaries or exclude
existing beneficiaries.
2) Power Of Appointment
Trust
This
trust is similar to the QTIP trust because it gives the surviving spouse a life
interest, that is the right to use the assets during her lifetime and then whatever
assets remain at the death of the surviving spouse, are distributed. However, the key difference here is that the surviving spouse has the general power of
appointment and may alter the distributions made at their death.
Pros
-Ultimately
gives surviving spouse power over final distributions of the assets.
-
Most liberal grant of power to the surviving spouse when comparing marital trusts.
Cons
-
Marital assets could end up in the hands of a new spouse.
3) (Marital) Estate Trust
Does
not necessarily give the surviving spouse rights to the entire marital estate
during lifetime. It is usually used to make discretionary distributions to the
surviving spouse. Discretionary distributions are distributions made at the
discretion of the trustee (usually not the surviving spouse). This can be the
most restrictive type of marital trust. Even if all of the assets are not
available to the surviving spouse during her lifetime, any assets that remain
in the marital trust must become the property of the surviving spouse’s estate.
This is different from the QTIP trust, which prevented the remaining marital
assets from becoming a part of the surviving spouse’s estate and instead
streamed them directly to the marital children.
Pros
Can
be used to provide for a spouse with a gambling or drug problem. Ensures the
spouse will be taken care of but not use the trust assets recklessly.
Cons
Can
be very restrictive.
Noteworthy Tidbits
Used
alone, Martial Trusts do not completely eliminate taxes, but rather delay when
the estate is taxed. This is desirable if the first spouse to pass is the
primary breadwinner, the surviving spouse gets to enjoy the assets of the
estate free from taxes. Taxes are levied against the estate when the second
spouse dies and has little impact on the quality of life of the surviving spouse.
Marital
Trusts are typically set up in conjunction with a B Trust also called a Tax
Credit Trust, which we will discuss next week.
The subject of Trusts is a vast but we will tackle a variety of trusts that can exist outside of a marital estate next week.
Keo'vonne W.
"Turn Your Dream Into Your Legacy"
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