We've all heard of the illustrious "trust fund babies" – those lucky few who've been supplied with family income in the form of trusts. But trusts are not just for the jet-set crowd. They are in fact an extremely valuable tool for anyone who has accumulated even a modest amount of wealth and have become one of the most common ways to transfer your assets to your loved ones.
Benefits of trusts
- You can require that the funds be invested conservatively
- Protects the money from creditors -- this money cannot be taken from the beneficiary to settle a debt
- Can designate how and when the beneficiary receives the funds
The players
There are three basic players involved in any trust:
- The grantor, or donor, who puts the assets into trust.
- The beneficiary is the person who receives the benefits from the trust.
- The trustee is an independent manager who makes sure that the assets left in the trust are used in the way that the grantor had wanted. The trustee can be you (which may create estate tax problems), a relative, a friend, a financial professional such as a lawyer or an accountant, or an institution such as a bank.
Types of trusts
There are many different types of trusts to consider. It's important to have a basic understanding of each of them so that you can select the one that is most appropriate for you. The most common ones are:
- Living trusts
- Insurance
- Testamentary
- Support
- Educational
- Discretionary
- Spendthrift
- Q-TIP
- Charitable
- Generation Skipping
A. Living trusts
Living trusts are trusts that are set up and funded while you are alive. When you die, the assets in a living trust do not need to go into probate court, saving your beneficiaries both time and money. Once you have set up a living trust, you must transfer the title of your assets to the trust. For example, instead of keeping your assets in the name of Sally Smith, you need to change ownership to The Sally Smith Trust. This applies to your home, investments, bank accounts, and other major assets.
Living trusts can be either revocable or irrevocable.
1. Revocable -- Revocable living trusts allow you to revoke or change the trust until you die. Because you always have access to these assets, the assets in your revocable trust are taxed at your death in the same way they would be taxed if you had owned the assets directly. The primary benefit of a revocable living trust is that the assets do not have to go through the probate court and are therefore passed on privately.
2. Irrevocable -- Irrevocable living trusts can not be changed once set up. They are usually set up to remove property and its growth from your estate to save estate taxes and to provide for your beneficiaries. Like revocable living trusts, the assets in the Irrevocable living trust do not have to go through Probate Court thereby saving time and expense in passing them through to beneficiaries.
B. Insurance trusts.
A life insurance trust, which is irrevocable, is simply a trust that owns an insurance policy. At your death, the policy proceeds are paid directly into your trust rather than directly to a beneficiary. The trust receives the insurance proceeds after you die, which avoids both estate tax and probate.
You can decide how and when the insurance money will go to your beneficiaries by providing for these matters in the trust. Remember to be careful, because these provisions cannot be changed.
C. Testamentary trusts
Testamentary trusts are funded when you die. In this case, you are leaving money to the trust rather than to a beneficiary. A trustee manages the trust in any way you deem fit.
D. Support trusts
If you have children or a spouse who depends on your income for their daily needs, you might want to consider a support trust. Beneficiaries of these trusts receive enough money to support them in a comfortable pre-determined lifestyle – as long as the money lasts!
E. Education trusts
With an education trust, you put money into trust for the purpose of providing for your child's (or other person's) education. The funds can only be used for educational purposes. With the recent rise of Section 529 Plans, education trusts have become less popular.
F. Discretionary trusts
A discretionary trust is similar to a support trust except that the trustee is given more latitude in deciding how much income and principal may be spent to support beneficiaries' lifestyle. The trustee can use his or her discretion in deciding what is necessary, even if the beneficiaries desire more pay-out.
G. Spendthrift trusts
A spendthrift trust is designed for the person who feels that his or her child, spouse or other beneficiary is inclined to spend money irresponsibly, or is incapable of making educated financial decisions. In such a trust, you instruct your trustee to set strict limits on how much money can be given out at any time.
This type of trust can protect your assets from creditors if your beneficiaries incur significant debts. The trust expressively states that a beneficiary cannot mortgage his interest in the trust and cannot assign this interest to a creditor.
H. Q-TIP trust (Qualified Terminable Interest Property)
A Q-TIP trust allows you to pass money along to your husband after you die, and also to designate whom ultimately inherits your estate after your spouse passes away. There is no tax paid when you die. The tax is paid from the trust when your spouse dies and the money moves to your designated beneficiary.
For example, Jane can leave money to Fred in the form of a Q-TIP trust and no estate tax is paid upon her death. Tax is paid when he dies and the money is passed to your designated beneficiary. The benefit now is that even if Fred remarries and has children, Jane can ensure that her money goes to her own children rather than Fred's new family.
I. Charitable trusts
Charitable trusts enable you to pass assets on to your favorite charity. If you place assets in the trust, you receive an immediate income tax deduction for the present value your contribution.
During your lifetime, you can also receive an annuity that is generated by these trust assets. When you die, the assets remain with the charity of your choice. Although you can give an unlimited amount of assets to a qualified charity with no gift or estate tax limitations, income tax charitable deduction limitations do apply. Generally, a charitable deduction is limited to thirty or fifty percent, depending on what is given, of your adjusted gross income for the year.
J. Generation skipping trusts
Generation skipping trusts, also known as Dynasty trusts, are a special option available to grandparents. As a grandparent, you can leave up to $1 million to your grandchildren.
Even though parents can access the assets held in the trust if need be, the trust's holdings will not be taxed as part of the parents' estate.
Continue to: Part VI: Retirement pension plans and insurance contracts
*WFN at Siebert and Muriel Siebert & Co., Inc. do not provide tax or legal advice.
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