VOL. 113 | NO. 173 | Thursday, September 9, 1999
Why use trusts?
Trusts can be beneficial to everyone
not just those with wealthy estates
By Tara E. Bazzone
Waring Cox PLC
Special to The Daily News
What is a trust?
A trust can be a powerful and flexible financial-planning tool. Simply put, a trust is a legal entity that holds property designated by you, the grantor, for the benefit of you and/or your beneficiaries. The trust agreement names a trustee to manage the specified property according to your instructions. The trustee can be either an individual, an institution such as a bank or trust company, or a combination of the two as co-trustees.
Trusts can accomplish any of the following purposes: (1) ensure that at your death your property is transferred according to your wishes, (2) provide for your familys well-being after your death, (3) allow you to have some control over how your assets are used by your heirs after your death, (4) manage your affairs in case you are disabled, (5) reduce probate expenses and (6) reduce or eliminate estate taxes.
Who should use a trust?
Many people think that trusts are only for the very wealthy. In fact, trusts can be beneficial to almost anyone, even to those with estates of modest value.
Answer the following questions to see if a trust could help you:
Do you want to ensure that your assets are protected and managed according to your wishes should you become incapacitated?
Would you like to leave your entire estate to your spouse but make bequests to other beneficiaries after your spouses death?
Is the total value of your estate now or its projected value at your death $650,000 or more?
If you are remarried, do you want to provide for your current spouse as well as for children from your first marriage?
Are you afraid that your beneficiaries will be unable to manage their inheritance or may spend it unwisely?
If you answered "Yes" to any of these questions, you may be a good candidate for a trust. With professional guidance from tax and legal experts, you may wish to investigate how a trust might be used in your estate plan.
Types of trusts
There are many different kinds of trusts, depending on the type of beneficiary, the purpose of the trust, what assets are in the trust, how much power the trustee and beneficiaries have over the use of the trusts assets, and how much control the grantor has over the trust.
The most common distinction is between a testamentary trust and a living trust. A testamentary trust, which may be set up by a will, takes effect only when the grantor dies and the estate is probated. A change to a testamentary trust may require a change to the will.
A living, or inter vivos, trust takes effect during your lifetime. Living trusts may be either revocable (meaning the grantor can change or end them at any time) or irrevocable (meaning a trust cannot be changed once it is established).
Because a trust is so flexible, it can be tailored to work exactly as you wish. It can be written to accomplish a single purpose or several goals. The following are brief descriptions of some of the more common types of trusts and how they can be used.
Testamentary Bypass Trust (also called Credit Shelter Trust, Family Trusts or Credit Equivalent Bypass Trust): This type of trust takes advantage of federal estate tax law to reduce or eliminate federal estate taxes. A provision of the federal estate tax law called the unlimited marital deduction allows you to leave an unlimited amount of property to your spouse free of federal estate tax. In addition, the unified credit lets each person give away, during their life or at their death, a total of $650,000 free of federal estate or gift taxes.
For example, John and Mary Smith have a combined estate worth $1.3 million. If Johns will leaves everything to Mary (an "I love you" will), Johns estate will not owe any taxes.
However, at Marys death, the value of her estate over the $650,000 amount (for 1999) will be taxed at both the state and federal level. However, if John incorporates a bypass trust and a marital bequest in his will, the federal and state estate tax due at Marys death will be zero.
How does this work? Because Mary will be able to leave $650,000 to their children and grandchildren tax free, John takes advantage of their unlimited marital deduction and wills that amount directly to her.
He places the rest of the estate in a trust which "bypasses" Marys estate. The income from the trust goes to Mary during her lifetime, while the principal goes to children, grandchildren or other heirs when she dies.
Mary may also be able to use the part of the principal of the trust for "maintenance, education, support or health" according to Internal Revenue Service regulations.
Since Mary doesnt control the assets in the bypass trust, these assets are not considered part of her estate and are not taxed when she dies. Mary uses her $650,000 exemption to pass on tax-free the part of the estate willed directly to her.
Both spouses set up identical trusts in their wills so, regardless of who dies first, both can reduce or eliminate federal estate taxes. For this type of trust to avoid federal estate taxes, both spouses must own property in their own names.
Revocable Living Trust: A revocable living trust is often touted as an alternative to a will because a trust usually avoids probate. Probate, the legal validation of your will and your assets, can be a lengthy and costly process.
However, you should never use a trust as a substitute for a will. Even if you put a large portion of your assets in a trust, a will instructs the distribution of the rest of your estate. In addition, a will is the best way to provide for the care of minor children and to name an executor for your estate.
The most important reason to use a revocable trust is to manage your assets in case of disability. This type of trust is set up with yourself as trustee and another person named as successor trustee. You have complete control over the assets in the trust until you become disabled or incapacitated.
At that point, the trust becomes irrevocable and your successor trustee takes over, using proceeds from the trust for your care and distributing the assets after your death as you directed in the trust agreement. The trust should include a definition of disability or incompetence, such as opinions by two or more physicians. In addition, a living trust should be accompanied by a "pour-over" will, which directs any assets not held in the trust be added to it at your death.
There are several advantages to a living trust. For example, it can be more comprehensive than a power of attorney naming someone to act on your behalf should you become incapacitated.
It will also be universally accepted at financial institutions, whereas the power of attorney may not. You can also specify in the trust how and where you wish to be cared for and give specific investment instructions to your trustee.
If you become incapacitated without a living trust or durable power of attorney, a court must appoint a conservator or guardian for you someone you may or may not want to manage your affairs.
A trust may also be more readily accepted as expressing your wishes and therefore less subject to challenges than the actions of a court-appointed guardian or someone acting under your durable power of attorney.
If you own property in more than one state, a living trust can transfer property directly to your heirs without the cost and delay of multiple probates. In addition, a living trust can help keep private the details of your estate. It does not usually become part of public record as a probated will does.
Selecting a trustee
Selecting the right trustee may not be easy. If the trust is set up to benefit your children after your death, your spouse is a logical choice.
If the trustee is also a beneficiary of the trust, restrictions are usually placed on that trustees power to use trust assets to his or her benefit.
No matter whom you name as trustee, you should also name at least one, but preferably several, successor trustees. If your trustee or successor trustee cant serve and you have not named other successors, the court will name a replacement who may be someone you would not want to handle your affairs.
A good trustee must be willing to serve and should have no conflict of interest with the interests of your trust and its beneficiaries. The trustee should have the ability to manage the assets effectively and make sound investment decisions.
Even if you specify certain investment objectives in the trust agreement, the trustee will have to make choices. A trustee should also be someone whom you feel comfortable with making decisions affecting your family. Sometimes those decisions will need more sensitivity than business sense.
Estate planning the first step
Its easy to delay estate planning until its too late. And, while its often difficult to think about providing for your family after your death, its one of the most important and most loving things you will ever do for them.
Further, review your estate plan regularly, especially when there is a change in marital status, financial situation or residence. Review your estate plan also on the birth of children or grandchildren, or the death of a beneficiary or trustee.
Trusts are just one facet of effective estate planning. Trusts should work hand-in-hand with not replace the other elements of your estate plan towards your financial goals.
A well-designed estate plan strategically incorporates your will, life insurance coverage, investments, anticipated Social Security or retirement benefits and other financial interests.
Since estate and inheritance tax laws vary from state to state, creating a trust requires consultation with an attorney or estate planner experienced in dealing with the law of estates and trusts. It's also a good idea to talk to trust professionals such as those found in banks or accounting firms. They have the expertise to help you develop a workable estate plan that will not only protect your family, but also help preserve more of your estate for their benefit.
Estate planning is a complex procedure. The larger your estate, the more complex it can be making it all the more important to plan carefully.