Contrary to what many people think, estate planning trusts are not necessarily reserved for just the wealthy. Even if you’re not among the top 100 moneymakers in the country, you may be able to benefit from the tax-saving benefits of certain trusts. A trust is a three-part agreement in which the owner of an estate, or the trust’s “grantor,” transfers the legal title to assets to somebody else (the trustee) for the purpose of benefiting one or more third parties (the beneficiaries). Trusts may be revocable or irrevocable and may be included in a will to take effect at death.
For this reason, the government considers the specified assets to still be included in the grantor’s taxable estate. Therefore, you may possibly have to pay estate taxes on those assets remaining after your death. In addition, you may have to pay income taxes on revenue generated by the trust during your lifetime.
In general, the assets placed into an irrevocable trust are permanently removed from a grantor’s estate and transferred to the trust. Income and capital gains taxes on assets in the trust can be paid by the trustee on behalf of the trust or the grantor, depending on the type of trust. Upon a grantor’s death, the assets in the trust generally are not considered part of the estate and are therefore not subject to estate taxes.
The trust’s grantor names a trustee to handle investments and manage the portfolio. In some cases, the grantor can work with the trustee on major decisions, or the trustee can be assigned full authority to act on the grantor’s behalf.
A trustee may be an individual such as a relative, friend, an attorney or accountant, or it may be an entity that offers experience in such areas as taxation, estate law, and money management.
Different kinds of trusts are designed to meet different needs and objectives. For example, if your primary goal is to ensure privacy in the settlement of your estate and to provide expert management of your affairs should you become incapacitated, you might choose a living trust.
Allows you to remain both the trustee and the beneficiary of the trust while you’re alive. You maintain control of the assets and receive all income and benefits. Upon your death, a designated successor trustee distributes the remaining assets according to the terms set in the trust, avoiding the probate associated with a will. Should you become incapacitated during the term of the trust, your successor or co-trustee can take over its management.
Allows you to remove a residence from your estate if certain conditions are met. For example, you can turn over your vacation home to a trust but still use it for a designated period of time, after which the home belongs to the trust or its beneficiaries, depending on mandates outlined in the trust. The benefit is that any gift tax you might incur from giving away the property is decreased because you still have rights to the house. The potential drawbacks are that if you die before the term of the trust ends, the home is considered part of your estate and if you live beyond the term of the trust, you must pay rent to continue to use the home.
Is used to leave money to your grandchildren. It can help preserve your generation-skipping tax exemption ($5 million in 2011 and 2012) on bequests to your grandchildren and avoid the tax on bequests exceeding that amount, which currently can be up to 35%. Note: The generation-skipping exemption is equal to the federal estate tax exclusion.
For example, even if you put $50,000 in a generation-skipping trust and allow it to accumulate earnings for many years, your lifetime exemption would be eroded by only the original $50,000.
Can help you benefit a favorite charity while serving your own trust purposes. This trust lets you pay a charity income from a particular asset for a designated amount of time, after which the principal goes to the beneficiaries, with reduced estate taxes. Although gift taxes are paid up front, the amount of the gift is reduced by the charity’s or gift’s income interest.
Allows you to leave assets to a charity and receive income and a charitable income tax deduction. Through this trust, the trustee can sell the donated property or assets, tax-free, to the trust, and establish an annuity payable to you, your spouse, or your heirs for a designated period of time or life expectancy. Upon completion of that time period, the remaining assets go directly to the charity.