If you haven’t stopped to consider how a trust may help you pass your wishes and wealth on, you could be making a critical estate planning mistake. Especially for individuals with substantial assets, protecting wealth for future generations should be top of mind.
“People often fail to appreciate the power a trust can have as part of a well-crafted estate plan, but that can be a costly mistake,” says Rodney Weaver, estate planning specialist at Fidelity. “Trusts are flexible and powerful tools that can be used to gain greater control over how they pass their wealth to future generations.”
A trust is a legal structure that contains a set of instructions on exactly how and when to pass assets to trust beneficiaries. There are many types of trusts to consider, each designed to help achieve a specific goal. An estate planning professional can help you determine which type (or types) of trust is most appropriate for you. However, an understanding of the estate planning goals that a trust may help you achieve is a good starting point.
Benefits of a trust
An effective trust begins with documentation carefully drafted by a qualified attorney with knowledge of your specific situation as well as current federal and state laws. Without the appropriate documentation, you and your beneficiaries may not reap the benefits of a trust, which are described below.
|1.||Pass wealth efficiently and privately to your heirs.|
Perhaps the most powerful and straightforward way to use a trust is to ensure that your heirs have timely access to your wealth. When you transfer your assets to your beneficiaries through a will, your estate is settled through a procedure known as “probate,” which is conducted in state courts. However, probate is a public, legal process that can carry with it some unforeseen negative consequences for the administration of your estate, including:
- Delays: The average uncontested probate could take longer than a year. Additionally, if you own property located in states other than your home state, probate may be required in each such state.
- Costs: Probate fees can be quite substantial, even for the most basic case not involving any conflict. A rule of thumb is that probate attorney’s fees and court fees could take up to 5% of an estate's value.
- Publicity: The probate process is a public. When your will is admitted to probate, it becomes a public record, and your assets are there to be viewed by anyone who wishes to see them. Such transparency can create unwanted scrutiny. It may make your beneficiaries a target for unwanted solicitation, either by individuals or by companies that may be looking to provide a cash advance on an inheritance in exchange for an excessively high interest rate. In addition, an unoccupied residence listed as an asset of probate may become an easy target for vandals.
With proper planning, the delays, costs, and loss of privacy can often be avoided.
You may be able to avoid probate and gain greater control over how your estate is settled by establishing and funding a revocable trust. Because the trust is revocable, it can be altered or amended during the grantor’s lifetime. After a grantor’s death, the trust acts as a will substitute and enables the trustee to privately and quickly settle the grantor’s estate without going through the probate process with respect to assets held in the trust.
A grantor can also give the trustee the power to take immediate control of the assets held in trust in the event that the grantor becomes incapacitated (and the grantor generally has the ability to define what constitutes “incapacity” within the trust document). This provision can save heirs the time, financial cost, and emotional distress of going to court to request a conservatorship over a loved one’s assets. Finally, revocable trusts are dissolvable, meaning the grantor can generally pull assets out of trust at any point during the grantor's lifetime.
|2.||Preserve assets for heirs and favorite charities.|
If you have substantial assets, you may want to consider creating and funding an irrevocable trust during your lifetime. Because the trust is irrevocable, in almost all circumstances, the grantor cannot amend the trust once it has been established, nor can the grantor regain control of the money or assets used to fund the trust. The grantor gifts assets into the trust, and the trustee administers the trust for the trust beneficiaries based on the terms specified in the trust document.
Significantly, while the gift could use up some or all of a grantor’s lifetime gift tax exclusion, any future growth on these assets generally will not be includable in the grantor’s estate and therefore will escape estate taxes at the grantor’s death. The individual lifetime federal gift tax exclusion is set at $5.49 million for 2017.
Irrevocable trusts can also serve several specialized functions, including:
- Holding life insurance proceeds outside your estate. Generally, without trust planning, the death benefit payout from a life insurance policy would be considered part of an estate for the purposes of determining whether there are estate taxes owed. However, this is not the case if the policy is purchased by an independent trustee and held in an irrevocable life insurance trust (ILIT) that is created and funded during the grantor’s lifetime, with certain limitations (please consult your attorney).
Despite not being subject to estate taxes at death, the life insurance proceeds received by the ILIT can be made available to pay any estate taxes due by having the insurance trust make loans to, or purchase assets from, the estate. Such loans or purchases can provide needed liquidity to the estate without either increasing the estate tax liability or changing the ultimate disposition of the assets, as long as the life insurance trust benefits the same beneficiaries as the estate does. In particular, this means that illiquid assets like real estate, or tax-inefficient assets like taxable retirement accounts, may not have to be sold or distributed quickly to meet the tax obligation.
For more on ILETs, read Viewpoints: “Can life insurance help your estate plan?”
- Ensuring protection from creditors, including a divorcing spouse. An irrevocable trust, whether created during your lifetime or at your death, can include language that protects the trust’s assets from the creditors of, or a legal judgment against, a trust beneficiary. In particular, assets that remain in a properly established irrevocable trust are generally not considered marital property. Therefore, they generally won’t be subject to division in a divorce settlement if one of the trust’s beneficiaries gets divorced. However, a divorce court judge may consider the beneficiary's interest in the trust when making decisions as to what constitutes an equitable division of the marital property that is subject to the court's jurisdiction.
Keep in mind, though, that irrevocable trusts are permanent. “The trust dictates how the funds are distributed, so you want to fund this type of trust only with assets that you are certain you want to pass to the trust beneficiaries, as specified by the terms of the trust,” cautions Weaver.
|3.||Reduce estate taxes for married couples.|
For a married couple, a revocable trust may be used as part of the larger plan to take full advantage of both spouses’ federal and/or state estate tax exclusions. Upon the death of a spouse, the assets in a revocable trust can be used to fund a family trust—also known as a “credit shelter,” “bypass,” or “A/B” trust—up to the amount of that spouse’s federal or state estate tax exclusion. The assets held in the family trust can then grow free from further estate taxation at the death of the surviving spouse. Meanwhile, the balance of the assets in the revocable trust can be transferred to the surviving spouse free of estate tax pursuant to the spousal exemption. At the death of the surviving spouse, of course, these assets may be included in the surviving spouse's estate for estate tax purposes.
The estate tax–free growth potential for funds in a family trust can be significant. Say, hypothetically, that you and your spouse live in Florida, which does not have a separate state-level estate tax, and have a net worth of $12 million. If one of you dies in 2017, that spouse’s revocable trust can fund the family trust with $5.49 million without paying any federal estate tax. Over the next 20 years, this $5.49 million could grow in value, all of which would remain outside the surviving spouse’s taxable estate.
|4.||Gain control over the distribution of your assets.|
By setting up a trust, the grantor is able to establish ways that the assets are to be passed on to the beneficiaries. For example:
- Distributions for specific purposes. For example, a grantor can stipulate that the trustees of a trust shall make money available to children or grandchildren only for college tuition or perhaps for future health care expenses.
- Age-based terminations. This provision can stipulate that the trust’s assets shall be distributed to heirs at periodic intervals—for example, 30% when they reach age 40, 30% when they reach age 50, and so on.
If you are charitably inclined, you may also want to consider establishing a charitable remainder trust, which allows the grantor, and possibly the grantor’s spouse and children, to receive an annual payment from the trust during his or her lifetime, with the balance transferring to the charity when the trust terminates. The grantor may also receive an income tax charitable deduction based on the charity’s remainder interest when property is contributed to the charitable remainder trust.
For more on charitable trusts, read Viewpoints: “Charitable giving that gives back.”
|5.||Ensure that your retirement assets are distributed as you’ve planned.|
You may be concerned that a beneficiary will liquidate a retirement account and incur a large income tax obligation in that year as a result. By naming a properly created trust as the beneficiary of a retirement account at the grantor’s death, the trustee can limit withdrawals to the retirement account’s minimum required distributions (MRDs), required of each beneficiary.
|6.||Keep assets in your family.|
You may be concerned that if your surviving spouse remarries, your assets could end up benefiting his or her new family rather than your own loved ones. In this case, a qualified terminable interest property (QTIP) trust provision can be used to provide for a surviving spouse while also ensuring that at his or her subsequent death, the remainder of the trust’s assets are ultimately transferred to the beneficiaries identified by the grantor in the trust document.
Building your legacy
The purpose of establishing a trust is to ultimately help you better realize a vision for your estate and, in turn, your legacy. Therefore, it’s important to let your goals for your estate guide your discussion with your attorney and financial adviser as they help determine what kind of trust and provisions make sense for you. It is vitally important that the trust be properly drafted and funded, so that you and your beneficiaries can fully realize all the benefits available.
For help in picking an estate planning attorney, read Viewpoints: "How to find an estate planning attorney."
- Contact your Fidelity representative at 800-544-6666 to review your estate planning needs.
- Fidelity Personal Trust Company, FSB (FPTC) can serve as a professional trustee in a sole or cotrustee capacity and administer your trust according to its terms. FPTC can also serve as trustee for irrevocable trusts, including those mentioned above.
- For more guidance on estate planning, visit Fidelity’s Trust & Estates.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917