Increasing numbers of Americans are discovering the potential benefits of a trust—how it can help protect their assets, reduce their tax obligations, and define the management of assets according to their wishes in a private, effective way. A trust provides protection for family members who may be unaccustomed to dealing with financial matters and may offer protection of assets in case of divorce or other litigation. Trusts can assure funding is available for specific needs, such as education, healthcare, or charitable interests. A trust provides a framework in which money is managed in a predictable fashion, by people you choose, according to standards you set including guidelines for current and future distributions that reflect your wishes. A trust may also have substantial tax benefits and provide an expedient method to transfer assets.
There are two basic types of trusts. Revocable or living trusts are the foundation of many clients’ estate plans. An irrevocable trust is used for many specific transfer and tax benefits and to handle assets after you’ve passed away.
A revocable or living trust is a trust you can change or cancel during your lifetime. You control a revocable trust and the trust’s earnings are consolidated into your income tax returns. You may continue to manage the assets or your financial advisor will manage your assets under your supervision and upon your disability.
Similar to a will, a revocable trust can also be used to transfer assets at death, yet without the formal, court-supervised process of probate. In many states, the probate process is slow and expensive, and also opens your estate to public scrutiny. Once you pass away, your wishes are final and thus the trust becomes irrevocable.
An irrevocable trust is a trust that cannot be changed or cancelled at any time. It’s a separate legal entity and its own taxpayer. The terms of many irrevocable trusts, however, allow tremendous flexibility. While many irrevocable trusts come into being at death, irrevocable trusts set up before death are often used to hold life insurance policies, gifts of assets to be made available to beneficiaries at a future time, or funds for future charitable contributions. To achieve beneficial tax results, many irrevocable trusts are written to follow patterns based on the rules in the Internal Revenue Code. The structure most suited to your needs can best be determined with the help of financial, legal, and tax advisors who specialize in these fields.
Different kinds of trusts are designed to meet different objectives. For example, if your goal is to ensure privacy in the settlement of your estate, to centralize control of assets, or to take full advantage of estate tax credits provided by the IRS, you might choose a living or revocable trust.
A living or revocable trust allows you to remain both the trustee and the beneficiary of the trust while you’re alive. You maintain control of the assets and receive all income and benefits. Upon your death, a designated successor trustee manages and/or distributes the remaining assets according to the terms set in the trust, avoiding the probate process. In addition, should you become incapacitated during the term of the trust, your successor or co-trustee can take over its management.
A special needs trust is typically designed to benefit a disabled individual. Instead of giving assets directly to the beneficiary, assets are transferred to a special needs trust by family members or as damages paid because of a lawsuit and those assets are available for the beneficiary without disqualifying him or her from government programs, such as Social Security income and Medicaid. A special needs trust provides for supplemental care—which consists of items over and above necessities such as housing, food, and clothing.
To help benefit your favorite charity while serving your own trust purposes, you might consider a charitable lead trust (CLT). This trust lets you pay a stream of income to a charity from a particular asset for a designated amount of time, after which the principal goes to the beneficiaries who can receive the property free of estate taxes.*
Another charitable option, the charitable remainder trust (CRT), allows you to receive a stream of income and a tax deduction at the same time, and ultimately leave assets to a charity. Through this trust, the trustee will sell the donated property or assets, tax-deferred, and establish an annuity payable to you, your spouse, or your heirs for a designated period of time. Upon completion of that time period, the remaining assets go directly to the charity. Highly appreciated assets are typically the funding vehicles of choice for a CRT.*
If you want to leave money to your grandchildren, you might consider a generation-skipping trust. This trust can help preserve your generation-skipping transfer tax exemption on bequests to your grandchildren and avoid the tax on bequests exceeding that amount, which can be up to 45%.
An irrevocable life insurance trust (ILIT) is often used as an estate tax-funding mechanism. Under this trust, you make gifts to an irrevocable trust, which in turn uses those gifts to purchase a life insurance policy on you. Upon your death, the policy’s death benefit proceeds are payable to the trust, which in turn provides cash to help beneficiaries meet estate tax obligations.*
Also known as an individual retirement trust, a trusteed IRA is a trust account that provides preservation and control of your IRA assets. It allows you to combine your estate planning and retirement goals within a single framework.
It’s important to consider who you want to manage your assets and who will benefit from the trust, both now and in the future. Your BOS Investment Services advisor in conjunction with your legal counsel and accounting professionals can help you evaluate types of trusts as well as your options to determine if it may be appropriate for your circumstances.