Many financial planning objectives can be accomplished through the utilization of trusts. Here are several of the most common types of trusts and a brief overview of their purpose:
Children’s Trusts are often created so that minors will not have direct access to their inheritance upon their parent’s (or grandparent’s) death. Through the use of a children’s trust, it is possible to specify the age at which you want your child to receive principal distributions. For example, you can specify that your child receive one half of the trust value at age 25 and the other half at age 30. People often make the beneficiary (or contingent beneficiary) of their IRAs, 401(k) plans and life insurance policies a Children’s Trust instead of their children outright.
Revocable Living Trust
A living trust is created during a person’s lifetime and is utilized primarily for avoiding the public process of probate. A living trust is also effective in determining who will manage trust assets in the event of the grantor’s incapacity. Contrary to popular belief, there are no tax benefits in establishing a revocable living trust.
Credit Shelter Trust
The Credit Shelter Trust is a tool that helps married couples take full advantage of their lifetime exemption (currently $2,000,000 per person) for estate tax purposes. This type of trust is normally established to reduce the amount of estate taxes owed upon the surviving spouse’s death. Since the federal estate tax rate is 45% on estates that exceed $2 million, the use of a Credit Shelter Trust could significantly increase the money that is passed to heirs (at the IRS’s expense!).
A QTIP Trust is often utilized in second marriage situations, where one spouse would like his children from a prior marriage to ultimately receive trust assets. A QTIP Trust allows the current surviving spouse to have access to trust assets during her lifetime, but does not allow her to decide on the ultimate beneficiaries of the trust assets at her death.
Irrevocable Life Insurance Trust (ILIT)
An ILIT is a trust established that allows a decedent’s life insurance to be excluded from their “gross estate.” An ILIT is generally used as a way to reduce the estate tax and/or provide the funds to pay an anticipated estate tax liability.
An ILIT can be particularly helpful for people who have estates with significant illiquid assets (closely held businesses, family farms, investment property). For example, insurance proceeds held in an ILIT can be utilized to pay the estate taxes due on an estate whereby the largest asset is a closely held business. This prevents the business from being liquidated in order to pay an estate tax liability.
A charitable trust is a trust created to identify specific charities of which to support during a person’s lifetime or after death. Contributions to a charitable trust can not only avoid both income tax (in the case of gifting an appreciated asset or stock) and estate tax, but contributors can also receive a tax deduction. In addition to benefiting a charity, avoiding income and estate tax, and receiving a tax deduction, certain types of charitable trusts allow contributors to receive a periodic income stream.
The use of trusts can be a very effective component in a family’s overall financial planning strategy. Since there are a number of financial and non-financial implications involved in utilizing trusts, we believe that considering the pros and cons is imperative.
Using trusts to accomplish financial or non-financial goals requires careful consideration. Please let us know if you would like discuss opportunities to utilize trusts in your specific situation.