Trusts for Estate Planning (Part 1)

Trusts are a valuable part of an estate plan. They are artificial entities that are set up to accomplish more complex goals than simple estate planning documents can accomplish. Trusts for estate planning can be broken up into two general categories, living or testamentary. Clients commonly use living trusts for planning purposes. While grantors commonly use testamentary trust to extend their control over their assets beyond their death. We can further divide living trusts into two categories: revocable and irrevocable. A revocable living trust can provide planning benefits for dealing with incapacity, extending control over assets and avoiding probate, amongst other things. Irrevocable trusts are less common, but in many ways more powerful planning tools. A grantor cannot change an irrevocable trust once it is created. Because of this, the presumption becomes that the grantor of the trust assets no longer owns those assets. This change in presumption potentially changes the grantor’s benefit eligibility, creditors’ access to these assets and taxation. Within these general categories, there are a large number of trusts a grantor can use to accomplish specific goals. In this article we will give a short overview of a few of the more popular ones.

Irrevocable Life Insurance Trust

This type of trust allows a grantor to transfer a life insurance policy into an irrevocable trust. The grantor makes the trust the beneficiary of the policy. The life insurance contract pays the proceeds into the trust, excluding the proceeds from grantor’s taxable estate. The trustee of the trust can use the proceeds to pay estate costs and provide tax-free income to the trust beneficiaries. These types of trusts are especially valuable to grantors with illiquid assets or whose estates will be subject to estate tax.

Charitable Remainder Trust

Type of irrevocable trust that allows a grantor to make a charitable gift and retain an income stream from the asset. Grantor usually funds the trust with a highly appreciated asset. The trustee is able to sell that asset without it being subject to capital gains tax. The grantor or a beneficiary receives an income stream from the trust for their life. This trust gives an income tax deduction, reduces estate tax, provides an income stream and gives money to charity. There are no fewer than four varieties of this type of trust based on how the income is distributed.

Grantor Retained Interest Trust

Grantors use this type of irrevocable trust if they have an asset that they believe will greatly appreciate in value. The IRS will create a valuation of the trust asset using a rate based on the market interest rate at the time the grantor made the gift and the number of years the trust will be in existence. If the asset outperforms that rate, the excess value passes to the beneficiaries tax-free. Unfortunately, if the grantor dies before the trust ends, the market value at that time will be include in the grantor’s estate. There are three versions of this type of trust, differentiated by the type of interest the grantor retains. A Qualified Personal Residence Trust is a special carve-out version of a Grantor Retained Income Trust.

Qualified Personal Residence Trust

This type of trust is valuable if you want to give your primary residence or vacation home as a gift, while maintaining control over the property for a period of time of your choice. During the time when the grantor retains control, they are able to live in the property. After the term of control ends, the trustee transfers the property to the beneficiaries. The IRS discounts the value of the gift based on the number of years the grantor maintains control. This reduces the grantor’s taxable estate by lowering the value of the taxable gift and removing the property appreciation in value. If you do not live past the years of control, the IRS will include the full market value of the property at time of death in the taxable estate.

This is just a small sample of the special trusts that are available to help you accomplish your estate planning goals. We will continue to overview common trusts for estate planning in part 2 of this article. In future articles we will be diving deeper into these individual trusts, discussing how they work, who they are for, and how you can fit them in your estate plan. Trusts are complicated and technical documents; they are not a do-it-yourself project. If you are interested in using trusts in your estate planning, speak to an estate planning attorney who can help you choose what trust is right for you, and then draft the required documents.