DO YOU NEED A TRUST?

A trust is a legal “bucket” to which you transfer assets. Those assets are then not subject to probate, which is court supervision of the distribution of assets . When used in estate planning, they usually contain the instructions for holding, investing, and distributing your assets at your death. They do not add to or reduce taxes. Also, trusts are established for many purposes, not just to reduce avoid probate. Here’s how some common trusts are used.

• Revocable Living Trust

What it is: With a revocable living trust, ownership of assets is transferred to the trust while you are alive. You can keep any or all of the income, act as trustee, change the trust’s provisions, or terminate the trust. You can provide for a successor trustee to take over administering the trust if you become mentally or physically disabled. Assets in the trust are controlled by the trust agreement and aren’t subject to probate.

Why you might need one: If you want to avoid the hassle and public record created by a probate; if you are concerned that you may become incompetent, and want to make things easy for your survivors; if you just like things to be “in order” as best as you can make them.  These trusts have nothing to do with reducing estate taxes, so their use won’t change even if the tax laws do..

• Bypass or Credit Shelter Trust

What it is: This trust is used to ensure that both you and your spouse can minimize estate and income taxes after one of you dies. It also is very useful for second marriages, where you want to make sure your children get some of your assets.  It usually won’t directly transfer assets to other heirs until both spouses have died. Often, you direct that assets equal to the estate tax exclusion amount are placed in trust after your death. Your spouse may then use the income in if he or she needs it, or it can go to your children (or even grandchildren). Then the remaining assets automatically transfer to your other heirs after your spouse’s death.

Why you need one: Since the estate tax won’t be repealed until 2010, the use of this trust will continue until then. However, make sure to review the amounts that will be placed in the trust. With the applicable exclusion amount increasing significantly the formula you set up a year or more ago may put more in this trust than you originally intended, possibly to the detriment of your surviving spouse.

• Qualified Terminable Interest Property (QTIP) Trust

What it is: This trust is typically used when a spouse has remarried and wants to financially protect children from a previous marriage. Assets in excess of those placed in the credit shelter trust are placed in a QTIP trust. Income from the trust is distributed to the surviving spouse during his/her lifetime. This qualifies for the unlimited marital deduction, meaning that there are no estate taxes after the first spouse’s death. After the surviving spouse’s death, the principal is distributed to the first spouse’s heirs.

Why you need one: The purpose of the this trust incorporates more than estate tax reduction – it benefits a second spouse during life, but assures the trust creator that the assets will eventually go to his or her descendants. So its use is likely to continue even if there is no estate tax.

• Irrevocable Life Insurance Trust

What it is: This trust is used to ensure that the proceeds from a life insurance policy are not subject to estate taxes.  Annually, you can make gifts to the trust, possibly using your annual gift tax exclusion, so the trustee can pay the policy premium. After your death, the trust receives the insurance proceeds, distributing them in accordance with the trust’s terms. It is not considered part of your estate, so is never taxed.

Why you need one: Due to irrevocable nature of this trust, it’s future use is uncertain. It probably makes sense to continue any existing trusts, since the estate tax will not be fully repealed until 2010.  Even if the proceeds aren’t needed for estate tax purposes, you may have other uses for them. Deciding whether to set up a new irrevocable life insurance trust is a tougher call, requiring careful analysis of all factors, including state death taxes. 

• Charitable Remainder Trust

What it is: This trust is typically used to provide a large charitable contribution while avoiding a large taxable capital gain. You transfer a low basis, highly appreciated asset to the trust, Since the trust is part of a tax-exempt organization, it can then sell the asset without paying any capital gains taxes and reinvest the proceeds. You receive an immediate charitable contribution deduction equal to the present value of the property. You also receive the income from the trust, with the remaining principal going to the charity after the trust terminates.

Why you need one: This type of trust is established for income and estate tax purposes.  Because of its income tax advantages, its use should not change under the new law.

• Qualified Personal Residence Trust

What it is: With this trust, you place your home or vacation home in an irrevocable trust, retaining the right to live in it for a specified number of years. When the trust terminates, ownership passes to your beneficiaries. The gift tax value is determined on the date the house is placed in trust, by calculating the present value discounted over the trust’s term. If you die before the trust ends, the home is included in your estate at its fair market value.

Why you need one: This trust is typically used to remove assets from your taxable estate.  If the estate tax is repealed, it may not be a useful planning tool.  In the short run, since present value calculations are used to determine the gift’s value, this trust may allow you to use your $1,000,000 lifetime gift exemption to your family’s advantage.