In our last entry, we explained three reasons why a trust can be a better choice than a will. We will complete the series here with three more scenarios that would call for the utilization of a trust.
Reaction to Estate Tax Exposure
We have a federal estate tax in the United States that packs a wallop with a 40 percent top rate. The exclusion is the amount that can be transferred before the estate tax would be applicable on the remainder. For the rest of this year, the exclusion is $11.58 million.
Each year, there are adjustments to account for inflation, so the figure will be somewhat higher in 2021.
We should point out the fact that the legislative provision that allows for this record high exclusion is going to sunset at the end of 2025. At that time, it is scheduled to revert to the 2017 level of $5.49 million adjusted for inflation.
There is a gift tax that is unified with the estate tax, so you can’t give large gifts to avoid the death tax. However, you can leave unlimited assets to your spouse tax-free, because there is a marital deduction.
Here in New York, we have a state-level estate tax to contend with, and the exclusion is just $5.85 million this year. There is no gift tax, but there is a three year clawback provision. Any large gifts that you give within three years of your passing would count as part of your estate for tax purposes.
If you are exposed to the federal estate tax, the state-level tax, or both, you can use irrevocable trusts of various kinds to gain estate tax efficiency. These would include grantor retained annuity trusts, generation-skipping trusts, qualified personal residence trusts, irrevocable life insurance trusts, and charitable lead trusts.
You maybe have concerns about leaving a large inheritance to someone that could lose the motivation to achieve their full potential. Under these circumstances, you can make the individual in question the beneficiary of an incentive trust.
When you establish the trust, you name a trustee to act as the administrator. Many people use a professional fiduciary like the trust department of a bank or trust company. When you use a corporate trustee, you can be certain that the trust will be effectively managed.
Plus, the professional trustee would be completely dispassionate without any heartstrings that could be pulled at in any way.
To provide an example of one way that you can use an incentive trust, you could provide a dollar for dollar match of money that is earned on the job by the beneficiary. If the person has not yet completed college, you could provide distributions while they remain a student in good standing.
This type of trust can also be used to guide someone away from self-destructive behavior such as a gambling or substance abuse problem.
These are a couple of examples, but you include any incentives as long as you are not requiring the beneficiary to do something that is not legal.
Next Generation Inheritance Protection
You may have concerns about the inheritances that you want to leave to your children if you are getting remarried. This can be a pressing matter if you have considerable resources and you are marrying a younger person.
Under these circumstances, you can create a qualified terminable interest property (QTIP) trust. Once again, you fund the trust, and you name a trustee. Your spouse would be the first beneficiary, and your children would be the successor beneficiaries of the trust.
If you die first, the trustee will distribute the trust’s earnings to your spouse for the rest of their life. They would also be able to use assets that are owned by the trust, but they would not be able to change the terms or directly access the principal.
After their passing, your children would become the beneficiaries of the trust. The assets would be distributed to them in accordance with the terms that you recorded in the trust declaration.
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