There are many reasons to include a trust in your estate plan. While you may think of trusts being used by wealthy individuals, there is no wealth requirement to establish a trust rather it is about choice and control.
A trust is a legal document created to accomplish certain family, tax, or other financial objectives. Think of a trust as a private agreement between the person who creates the trust (called “grantor” or “settlor” – same meaning) and the person the grantor designates to manage the trust assets (called the “trustee”) for the benefit of the trust’s “beneficiaries.”
There are at least three general types of trusts you may consider, namely a revocable trust, an irrevocable trust and a testamentary trust. A revocable trust is sometimes called a grantor trust or a living trust, it is a trust that exists and can own assets during the grantor’s lifetime, and provide for other beneficiaries even after the grantor’s death. An irrevocable trust is often used in Medicaid planning and to reduce or minimize tax liability of grantor. A testamentary trust is one created by the grantor’s will and takes effect only after the grantor’s death.
A revocable trust is frequently used in estate planning. Consider five reasons to include a revocable living trust as a part of your estate plan.
1. Avoiding probate. You may be able to minimize the time and expense involved in settling your estate while preserving your privacy. Probate is a public process, as the probate court file, including a list of the assets in the estate and their value, the expenses, debts and taxes that are paid by the estate, and to whom and in what amounts the estate assets are distributed, are part of the public record and availability to the information depends on state law. Assets owned by a revocable trust at the death of the grantor will avoid probate and the related delay and expense of a probate proceeding. Revocable trusts are private documents, which are not filed with the Court or made a part of the public record, maintaining the privacy of the grantor and the beneficiaries. However, it is important to note that in the state of Nebraska inheritance tax documents must be filed listing all assets – both probate and nonprobate – which are subject to the inheritance tax process. Simply, this means that even though you may be able to avoid probate and not file an inventory of assets for the probate purpose, Nebraska inheritance tax rules may require all assets be listed and filed with the relevant county attorneys and the court. Simply assets held in a revocable trust are generally subject to inheritance tax and must be inventoried and reported for inheritance tax purposes.
2. Protecting against old age and disability. You want to ensure that your assets are properly managed for your benefit if you become physically disabled or mentally incapacitated with the onset of dementia or following illness or an accident. An effective estate plan includes planning for how you will be cared for and how decisions will be made in the event you become incapacitated. By creating and funding a revocable trust of which you are the beneficiary during your lifetime, you provide a mechanism for your assets to be managed and used for your benefit during your life, including any period of incapacity, by a trustee that you name in your trust document. This type of planning may avoid the need for a guardianship or conservatorship proceeding in the probate court, which can be very expensive and intrusive, and allows you to maintain your privacy.
3. Providing for your family after your death, stating exactly how, and when, your descendants receive their inheritance. Parents often wish to leave their assets to their children after the death of both parents. However, if both parents die while a child is still young state law does not permit a child to receive money or real estate until the child reaches the age of majority unless the assets are held in trust or by a conservator. In Nebraska, that age is 19, in Colorado, that age is 21. For this reason, many parents with young children create a revocable trust as a part of their estate plan. Such a trust typically provides that after both parents’ deaths, the child’s inheritance will be held in trust for the child’s benefit and managed by a named trustee. The trust document will specify the age or ages at which the child will be entitled to receive principal distributions from the trust. While a child’s inheritance is held in trust, the trust will permit the trustee to use trust income and principal for the child’s benefit, including paying for the health, education and general support needs of the child. Holding assets in trust for a child will protect the child from making unwise decisions and may also offer protection from a child’s creditors. While the focus is often on providing for a child, a trust may be established to hold assets for an individual of any age. This is often of interest when a grantor is concerned about the beneficiary’s ability to manage finances, and sometimes to protect the beneficiary if he or she is in a bad relationship.
Another consideration important to the agricultural producers, especially landowners, is how to keep land in the family for future generations. Owning land in trust, is one way the grantor can control how the land is managed, who benefits and how long it is held in trust before it is distributed to individuals, even after the grantor has died.
4. Special needs children. Families who have a child with special needs must have a plan in place to ensure the child’s needs will be met in the future. There are really two reasons for this. First, it may be important to ensure assets will be managed for the child’s benefit for the child’s entire lifetime as the child may never be capable of managing assets. Second, many people with special needs are eligible for public benefits based on financial need, that provide medical care or income for food and shelter expenses. Qualification for those benefits can be adversely affected if the special needs child receives an inheritance. It is not necessary to disinherit a special needs child to protect the child’s eligibility for public benefits. Trusts can be used very effectively to maintain a special needs child’s eligibility for benefits before and after the parents’ deaths. A Special Needs Trust can also provide long-term management of the child’s inheritance and additional resources to meet the child’s needs that are not addressed by the public benefits the child may be eligible to receive. Special Needs Trusts provide an important safety net for a child with special needs that does not depend on the goodwill or good fortune of other family members. Such provisions may be used for any special needs family member, not just limited to children.
5. Minimizing estate and income taxes. Estate taxes may be payable at death if the value of the assets, both probate and nonprobate assets (including life insurance, retirement accounts, real estate, investments, cash, etc.) owned by the deceased person exceeds $5.34 million in 2014, indexed for inflation. Prior to 2012, a certain type of revocable living trust, called a “credit shelter trust,” could be used by married couples to reduce the estate tax payable after both spouses’ deaths. Under current federal estate tax law, the value of the married couple’s estate is considered following the second death, meaning that the use of a credit shelter trust is unnecessary for tax planning purposes. The concept of “portability” recognizes a married couple as a unit and allows the individual exemptions to be shared with or “ported” to the surviving spouse. Under current law, if you had a credit shelter trust prepared under the old estate tax law rules, it is likely your plan will still work as you wish, as the special tax planning provisions will not need to be exercised. However, your plan may be unnecessarily complex and you may want to consult with your attorney to see if your plan needs to be revised in accordance with current estate tax law.
A revocable trust is still a good tool to use to control the distribution of assets for income tax purposes. This is especially true for appreciating assets which may be held in trust for the benefit of the grantor until death, and then transferred upon death so that the beneficiary receives a step-up in basis to minimize a capital gains (income tax) consequence upon a subsequent sale of the asset by the beneficiary. However, if the value of the estate of the grantor (and grantor’s spouse) is close to or exceeding the estate tax exemption amount, the trustee may instead opt to transfer an appreciating asset to a beneficiary of the trust during grantor’s life (provided the trust terms allow for a lifetime transfer) to reduce the value of the estate and accordingly estate tax liability. True, a lifetime transfer means the beneficiary will take the carryover basis of the grantor, likely a lower basis, so that the beneficiary would potentially experience a greater income tax consequence in terms of capital gains if the beneficiary sells the asset. Whether the appreciated asset is transferred as a gift during life of the grantor or upon grantor’s death, there is no immediate income tax consequence to the grantor or to the beneficiary. The only potential income tax consequence is to the beneficiary if he/she sells the asset as any gain will be subject to income tax.
The grantor may also establish a trust to benefit a charity(s). There are a number of options, and in general the grantor may receive income from the trust during the grantor’s life and leave the principal of the trust to the charity upon death. These trusts may provide income and estate tax benefits to the grantor, while allowing the grantor to support his/her favorite charity(s).
Irrevocable Trusts should be considered carefully as once such a trust is put in place and funded, as the name indicates, the provisions of such a trust may not be revised or revoked, and the grantor gives up all control of the assets in the trust, and in most cases cannot serve as trustee nor receive any benefit of the trust. There are a couple of situations an irrevocable trust may be an option.
1. Irrevocable life insurance trust (ILIT). An ILIT is a type of an irrevocable trust that is specifically designed to hold and own life insurance policies. You may purchase life insurance with the idea that the proceeds will be used to pay federal estate tax liability of your estate. Without an ILIT, if you own the policy in your own name, the value of the policy will be included in your gross estate which means your good intention to cover estate tax liability has actually increased the value of your estate. This type of irrevocable trust can be a very good option to consider with your professional planning team.
2. Medicaid planning. While this is a risky plan, some people choose to transfer assets to an irrevocable plan, usually naming their children as beneficiaries, so that the assets will be out of their estate. The thought is if the assets are in an irrevocable trust the value of the assets cannot be considered assets for purposes of qualifying for Medicaid. It is important to remember that currently the Medicaid “look back” period is five years. This means that when you apply for Medicaid, you must include on your application any gifts you made including any transfers to an irrevocable trust during the previous five years. Simply, this is a very complex area and you should consult with our firm or another qualified attorney who is experienced in Medicaid matters.
A testamentary trust is one created by the grantor’s will and takes effect only after the grantor’s death. As previously mentioned, a revocable trust may include provisions to provide for your family after your death, namely children including special needs children. In some cases, those types of provisions may be included in your last will and testament as a testamentary trust, rather than a separate revocable trust.
Again, there are many reasons to include a trust in your estate plan, and while they are frequently used in the plans of wealthy families, there are many families with modest estates that could benefit by using trusts in their planning. Estate planning is about choice, and it is important that you consider the various options available to you to design an appropriate estate plan for you and your family. Estate planning in general, as well as the decision to incorporate a trust requires careful consideration by you and a qualified attorney. This article is designed to provide you with an overview of the use of trusts and is not designed to provide specific legal advice. You are encouraged to consult with your attorney or contact us if you would like to further discuss your specific situation.
