Trusts trace their origins to the feudal system in thirteenth-century England. The use of a trust grew out of the king granting use of his land to feudal overlords. The idea of giving to another person the legal ownership of property, not for the benefit of the recipient, but rather for the benefit of others has evolved over the centuries into what has become known as a trust. Today, the use of trusts has become an enormously popular tool in financial and estate planning, especially with the development of modern trust laws.
All trusts will generally have the following components:
Trusts will fall into two basic categories: revocable and irrevocable. A revocable trust gives the grantor complete control over the funds held in the trust. Here, the grantor has not given anything away as he reserves the right to amend, revoke or terminate the trust at any time and thereby reclaim the funds transferred to it. This means there is no gift for transfer tax purposes and upon the grantor’s death the funds are includible in the grantor’s gross estate for estate tax purposes. With a revocable trust, any income earned on the funds flows to the grantor’s personal income tax return.
An irrevocable trust is created when the grantor does not retain the right to revoke or reclaim the property. In this case, the grantor has given away the funds transferred to the trust and there is a gift for transfer tax purposes. A gift tax return may need to be filed if the transfer is made during the grantor’s lifetime. Unlike the revocable trust, at the grantor’s death, the irrevocable trust will not be included in the grantors’ gross estate for estate tax purposes. Any income earned on the funds in the irrevocable trust is reported on an income tax return filed by the trustee. The income may flow to the grantor or may be taxed to the beneficiaries depending on the type of irrevocable trust.
The most critical decision you will make in creating a trust is who you will identify as the appropriate trustee(s) to oversee the trust property. Family, friends, advisors, institutions are typical choices most people make. Professional trustees, whether it is an accountant, attorney, financial advisor or corporate institution, can add significant managerial value by ensuring proper record keeping, adequate attention to detail and proper implementation. Family and friends should have a clear understanding of the grantor’s wishes. A combination of these choices may be the best solution. The advisors at Lexington Wealth can help you make this decision having helped many clients with it in the past.
Historically, planners have used trusts to save taxes. The generation skipping trust is the most common transfer technique used to escape gift or estate tax. Sometimes called a “dynasty trust,” these trusts are designed to continue as long as the law allows for the benefit of the grantor’s descendants. The grantor’s children can enjoy the benefits of a dynasty trust even though the name generation skipping implies otherwise.
In addition to saving taxes, a grantor can design a trust for anything he or she desires as long as it is not illegal or against public policy. The emphasis nowadays is on wealth preservation. Clients are creating trusts to preserve assets from a variety of risks, such as, mismanagement of investments, spendthrift or wasteful beneficiaries and disabled beneficiaries. Some practitioners also argue more clients should use trusts rather than making outright bequests to family members during lifetime or at death. Again, the reason being asset protection. Please remember outright bequests to a family member can become subject to a judgement should your family member get sued by a creditor or a divorcing spouse.
At first blush, you may be reluctant to use trusts for transferring wealth because you believe it may restrict the control and beneficial enjoyment of the property left in trust. Furthermore, you don’t want to be perceived “as ruling from the grave.”
Modern trust law provides great flexibility to enable beneficiaries to obtain a high degree of control that usually only comes with outright ownership. This enjoyment can be managed by including provisions that:
Competent legal counsel will be required to properly achieve the dual objectives of wealth preservation for future generations and flexibility found only with outright ownership.
Trust don’t come without some costs and administrative complexities. So, you must weigh the benefits outlined above with the following costs & complexities:
Costs are easy to tally up and may discourage you from using a trust. However, the tax saving you may enjoy over generations and the funds that may not be depleted due to lawsuits, divorce and mismanagement can be enormous. Please contact your Lexington Wealth advisor to ask your questions about trusts.
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