A trust is established by the grantor (also called maker or settlor) to hold and transfer his or her assets for the benefit of one or more beneficiaries. A trust transfers legal title to assets to an individual and/or corporate trustee to hold for the trust’s beneficiaries. A trust may be established during your lifetime in a separate document or following you death under your will. In addition, a trust can make distributions to beneficiaries as specified by the terms of the trust, it may earn income, and it may pay taxes on undistributed income. Generally, you may serve as your own trustee for trusts set up during your lifetime.

Trusts enable your assets to be managed after your gone, while providing income for your beneficiaries. Since trusts do not have to be approved by a probate court, probate costs are eliminated. Also, some trusts may reduce taxes for you heirs. Because trusts supersede the provisions of your will for those assets transferred to the trust during your lifetime, it is critical that you review how these assets will be transferred if you revise your will.

Some potential benefits of a trust are the following: they can help avoid, decrease, or defer federal estate and income taxes; they may provide ongoing financial support and professional asset management for minor or special-needs children, aging relatives, spouses, or other dependents who may not have the financial ability to handle large sums of money; they may provide greater legal protection for your assets and your estate plans; they may avoid probate to preserve privacy and reduce costs; and they may protect property from the claims of creditors.

A testamentary trust is a type of trust is created by the terms of your will after you die and is funded by your estate. A trustee is named in your will. This form of trust is often used to avoid estate taxes, control when or how assets will be distributed to beneficiaries, or have someone manage the assets after your death.

A revocable living trust (RLT) has the potential for being a primary estate planning instrument. It may even be more important to your estate plan than your will. The revocable living trust is an agreement between its grantor and a trustee. Pursuant to the agreement the maker transfers assets to the trustee and gives instructions to the trustee concerning the management of the assets while held in the trust. The instructions specify how the assets are to be held and used during the maker’s lifetime, as well as how the assets are to be distributed at the maker’s death.

A person can be both the maker and the trustee of a RLT. The term “revocable” refers to the fact that the maker has the power to change or do away with the trust. The maker also has the power to add or remove assets from the trust and control and direct all payments from the trust. If the maker is also the trustee, he can make all decisions concerning the assets in the trust. The trust agreement can provide that any assets held in an RLT will avoid probate at the maker’s death. Unlike wills, RLTs can provide a way to manage your assets during periods of disability.

Some common reasons to establish a RLT include the following:

  1. Organization of a person’s financial affairs prior to his or her death.
  2. Continued management of a person’s assets in the event of his or her incapacity (i.e., a similar function to the Durable Power of Attorney).
  3. Bridging the gap between a person’s incapacity and estate administration after his or her death.
  4. Organization of a person’s financial affairs prior to his or her death.  Continued management of a person’s assets in the event of his or her incapacity (i.e., a similar function to the Durable Power of Attorney). Bridging the gap between a person’s incapacity and estate administration after his or her death. Avoidance of some of the problems associated with probate of wills and administration of estates.

RLTs are tax neutral. Both wills and trusts can help avoid estate taxes, but must include specific provisions to do so. If you require tax planning, you should make sure that your King Law Offices attorney is aware and can confer with your CPA, whether you choose to do so by will or RLT.

Beware of many misconceptions about trusts. One such misconception of a RLT is that it can protect your estate from creditors. Although some instruments may assist in this function, because a RLT is revocable, the assets generally are not protected from creditors, although in some situations it could protect some estate assets from some types of creditors. Remember, only a licensed attorney should be giving you advice regarding the legal ramifications of a trust or other estate planning document.

A RLT avoids probate because your property is owned by the trust, so technically there’s nothing for the probate courts to administer. Whomever you name as your “successor trustee” will gain control of your assets and distribute them exactly according to your instructions. A will doesn’t take effect until your death, and is therefore no help to you during lifetime planning, an increasingly important consideration since Americans are now living longer. A RLT can help you preserve and increase your estate while you’re alive, and offers protection should you become mentally disabled.

Individuals who create most RLTs act as their own trustees. If you are married, you and your spouse can act as co-trustees, and you will have absolute and complete control over all of the assets in your trust. In the event of a mentally disabling condition, your hand-picked successor trustee assumes control over your affairs, not the court’s appointee.

Do not expect to avoid income taxes by using a living trust. The purpose of creating a RLT is to avoid probate and reduce or even eliminate federal estate taxes. It is not a vehicle for reducing income taxes. In fact, if you’re the trustee of your RLT, you will file your income tax returns exactly as you filed them before the trust existed. There are no new returns to file and no new liabilities are created. Also, assets in the trust can still be included in your gross estate for federal estate tax purposes.

Real estate may be transferred into your RLT. Otherwise, upon your death, depending on how you hold the title, there will be probate in every state in which you hold real property. When your real property is owned by your RLT, there is no probate anywhere.

An irrevocable trust is a permanent arrangement that cannot be revoked or changed. It can have enormous tax advantages since the assets in the trust may no longer be considered part of your estate for tax purposes. The trustee can be given discretionary powers and, with some qualifications, beneficiaries can say what happens to the assets in the trust. It is critical to remember that as the donor, you must be out of the picture and relinquish control for the trust to be effective as a tax savings device.

An Irrevocable Life Insurance Trust (ILIT) is a commonly used type of irrevocable trust. As a general rule, assets that you do not own are not taxable in your estate. You can use this to your advantage by transferring you life insurance out of your estate and into an ILIT. Proceeds from life insurance in an ILIT can pass to your heirs free of both estate and income taxes.

Generally, an ILIT is established to purchase and hold a life insurance policy. Typically, money is gifted to a trustee who is authorized to use those dollars to purchase a life insurance policy on your life. If structured correctly, the premium dollars paid into the trust qualify for the annual $12,000 per person gift-tax exclusion. By taking advantage of the annual gift-tax exclusion, you avoid losing any of your estate tax exclusion. Significant estate tax benefits can be gained because the trust owns the insurance.

Everything you own at the time of your death is included in your taxable estate. If you own a life insurance policy, the amount of the death benefit paid to your beneficiaries will be included in the total of your taxable estate. This can significantly increase the value of your estate, which may also increase the estate taxes due. New purchases of life insurance can be kept out of your estate from the very beginning. A policy will not be subject to the three-year look-back rule (a rule used by the IRS in determining you gross estate discussed below) if the trust is the original purchaser. You can create the trust, the trustee can purchase the policy, and the death benefit can be distributed to your heirs free of estate taxes. Because the payment consists of life insurance proceeds, it can go to your heirs free of income taxes too.

Once the trust is created, you could gift sufficient funds to cover the annual life insurance premium. To qualify this gift for the annual $12,000 per donee gift exclusion, the trust beneficiaries must have the absolute right to withdraw the funds that have been gifted to the trust. The beneficiaries, however, will normally decline this right to withdraw and will leave the money in the trust. The trustee is then authorized to use those dollars to pay premiums on an insurance policy on your life.

Upon your death, the proceeds from the life insurance policy are paid to the trust. The trust document will include provisions for use of the proceeds. Provisions may include an option to
loan money to the estate, to purchase assets from the estate, or to pay a lump sum (or possibly an income stream) to your beneficiaries.

It’s important to remember this type of trust is irrevocable, which means it cannot be changed. The trustee can cancel the life insurance policy if you decide to discontinue gifting money to the trust to pay the premiums, but the accumulated cash value cannot be returned to you. For this reason, it is important to carefully consider the advantages and disadvantages of this type of trust prior to utilizing it in your estate plan.

It is a less common approach, but you can gift an existing life insurance policy to the trustee to be held in the trust. Gifting a current policy can have negative gift and/or estate tax implications, so it is important to carefully evaluate the ramifications of such a transfer. These policies are subject to an IRS requirement known as the “three-year rule.” If you die within three years of transferring the policy to the trust, the policy’s benefits will still be taxed in your estate. If you live beyond the three-year period, the policy is not part of your estate. Selecting a trustee is another important consideration when setting up this type of trust. The trustee’s responsibilities include:

  • Setting up the trust account;
  • Selecting the insurance company and policy;
  • Receiving the gifts from you;
  • Notifying trust beneficiaries of these gifts; and
  • Paying the life insurance premiums.

This is not a job that should be taken lightly, as the documentation requirements are vital to ensure the trust achieves the desired estate tax benefits.

If you’re concerned about whether your spouse would or could manage your assets wisely after your death, you could leave them in a marital trust instead of leaving them outright. As with an outright bequest to your spouse, the trust can qualify for the unlimited estate tax marital deduction. Your spouse could have unlimited access to the trust funds, or you could limit the use of the trust assets for specific purposes. In either case, your spouse would benefit from responsible asset management. Upon your spouse’s death, probate would be avoided on trust assets and these assets would pass on to the beneficiaries you designate in the trust, such as your children or children from a previous marriage.

A type of marital trust, called the Qualified Terminable Interest Property Trust (QTIP Trust), gives your spouse all the investment income from the trust assets, but can also limit your spouse’s access to, or control over, the trust principal. The QTIP trust is often used when there is a second marriage and a desire to keep the trust’s principal intact for children from a previous marriage. It can also be used to protect assets from the spouse’s creditors and/or imprudence. The Internal Revenue code and North Carolina law grant an unlimited gift and estate tax deduction for all transfers to a spouse whether made during life or death. Thus, anyone may give or leave his or her entire estate to the surviving spouse without gift or estate taxes and, furthermore, may do so in such a way as to minimize taxation of the portion for the benefit of their family after the surviving spouses death.

The following qualify for marital deduction:

  • outright gifts and bequests
  • jointly-held property
  • life insurance
  • joint and survivor annuities
  • certain life estates in real estate
  • trusts of which the surviving spouse is sole income beneficiary for life

Married couples wishing to leave assets to their children and other family members can create a credit shelter trust, to be funded with their applicable exclusion amount. You can establish a credit shelter trust during your lifetime or at your death through your estate planning documents. The balance of your assets can be distributed as gifts or through a marital trust. The main benefit of a credit shelter trust is to protect the assets funding the trust from gift and estate taxes at your death and following the death of your surviving spouse. Once assets are transferred to a credit shelter trust, distributions of trust income or principal (including any future appreciation in the value of the principal) are free of gift or estate taxes for your family, regardless of when they are made or to whom (spouse, children, grandchildren, etc.). Following your spouse’s death, the assets in the credit shelter trust are distributed or held in the trust for the benefit of your children or others, according to the terms you have provided in the trust.

A note of caution about credit shelter trusts: A credit shelter trust can only be funded by property held in the individual name of the decedent; it is not generally available where property is jointly-held since this property passes automatically to the survivor. And jointly-held property between spouses will not be available to fund the unified credit, because the value of the property which passes to the surviving spouse automatically qualifies for the marital deduction.

Various estate planning strategies can help protect assets from potential tort, regulatory, contract, marital, and other creditors. Asset protection does not include hiding assets, committing fraud or perjury, or engaging in fraudulent transfers.

There are many techniques to preserve and protect assets, including holding title to them in an exempt form, purchasing life insurance, having a retirement or IRA account, and transferring property to others. An irrevocable trust, established for valid tax and estate planning purposes,  may also provide creditor protection as a side benefit. Asset protection strategies are usually best applied on a case-by-case basis and depend on applicable state law.

A Charitable Remainder Trust is a tax-exempt, irrevocable trust that allows a donor to make a current gift of cash or appreciated assets to a trust while receiving an income stream from the trust for his or her life. At the donor’s death, the trust terminates, and the appointed trustee  distributes the remaining assets to charities as directed by the donor. The trust provides a current income tax deduction, freedom to sell assets without immediate capital gains realization, and potential for reduction or elimination of estate taxes.

After King Law Offices has set up your trust, cash and/or appreciated assets can be transferred into the trust. In most cases, the trust will name you and your spouse as income beneficiaries, which means you will receive income for the duration of your lives. T he trust will also name qualified charities, selected by you, to receive the trust proceeds as remainder beneficiaries.

If the Charitable Remainder Trust sells an appreciated asset, no capital gains taxes are owed at that time. As a result, more money is available for reinvestment inside the trust than would be if the asset was sold outright.

If the trust’s beneficiaries are IRS-qualified charities, you will receive an income tax deduction at the time you make the gift to the trust. The amount of the deduction will be a percentage of the value of the gift. This percentage is determined by a number of factors:

  • Payout rate selected in the trust;
  • Life expectancy of the person(s) receiving income from the trust;
  • Type and value of the asset that is gifted; and
  • Applicable Federal Rate (AFR), which fluctuates monthly. In most cases, the greater the income paid to the donor, the lower the deduction.

A special needs trust can be established to provide financially for persons 65 and younger who cannot care for themselves because of a mental or physical disability. Properly arranged, it preserves assets (including gifts or inheritance) while still allowing the family member to remain eligible for Social Security and Medicaid benefits. A guardianship is commonly established in conjunction with a special needs trust to oversee financial and personal considerations on the person’s behalf.

For persons over 65 with a disability, a pooled trust, in which separate accounts are maintained for each beneficiary, but funds are pooled for investment, can be created. Proceeds from a lawsuit (such as a personal injury lump sum or structured settlement) are protected through a settlement trust to retain government program eligibility. If a disabled family member of any age will not be receiving government benefits, a support trust can provide for basic needs; a trustee handles the money on his or her behalf.

King Law Offices is dedicated to assisting our clients in making good decisions regarding estate planning. However, we do strongly recommend that our clients seek independent advice from a certified public accountant (CPA) and a financial advisor to thoroughly review every aspect of the estate plan and ensure that the completed plan is proper.