If you haven’t stopped to consider how a trust may help you pass your legacy on, you could be making a critical estate planning mistake. 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 Christine Finn, Estate Planning Specialist at Fidelity. “Trusts are flexible and powerful tools that anyone with substantial assets can use to gain greater control over how they pass their wealth to future generations.”
A trust is a more complex legal structure that contains a set of instructions on exactly how and when to pass assets to trust beneficiaries. Trusts are a tool that can allow you to control when and to whom your assets will be distributed. 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.
The estate planning 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 the governing federal and state laws. Without the appropriate documentation, you and your beneficiaries may not reap the benefits of a trust, which are described herein.
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. With proper planning, these delays, costs, and loss of privacy can often be avoided. Additionally, if you own property located in states other than your home state, then 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 process. 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.
You can 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 your lifetime. After your death, the trust acts as a will substitute and enables the trustee to privately and quickly settle your estate without going through the probate process. You can also give the trustee the power to take immediate control of your assets in the event that you become incapacitated, (and you have the ability to define what constitutes “incapacity” within your trust document) a provision that can save your heirs the time, financial cost and emotional distress of going to court to request a conservatorship over your assets. Finally, revocable trusts are dissolvable, meaning you can pull your assets out of the trust at any point during your 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, 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. You would gift assets into the trust and the trustee would administer the trust for the trust beneficiaries based on the terms you provide in the document. Significantly, while the value of the gift could use some or all of your lifetime gift tax exclusion, any future growth on these assets will not be includable in your estate for and therefore escape estate taxes at your death. The individual lifetime federal gift tax exclusion is set at $5.43 million for 2015.
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 ordinarily be considered part of your estate for 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 [an “ILIT”] that is created and funded during your lifetime. Despite not being subject to estate taxes at your death, the life insurance proceeds received by your irrevocable life insurance trust can be made available to pay any estate taxes due by having the insurance trust make loans to, or purchase assets from, your estate. Such loans or purchases can provide needed liquidity to your estate without either increasing your estate tax liability or changing the ultimate disposition of your assets, as long as the life insurance trust benefits the same beneficiaries as your estate does. In particular, this means that illiquid or tax-inefficient assets, such as real estate or taxable retirement accounts, may not have to be sold or distributed quickly to meet the tax obligation. See 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 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. As such, 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 Finn.
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”, or “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, for instance, 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 2015, that spouse’s revocable trust can fund the family trust with $5.43 million without paying any federal estate tax. Over the next 20 years, this $5.34 million could grow to $17 million or more, based on an annual 6% growth rate, all of which would remain outside the surviving spouse’s taxable estate.
4. Gain control over distribution of your assets.
- Distributions for specific purposes. For example, you can stipulate that the trustees of a trust shall make money available to your 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 your children 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 you, and possibly your spouse and children, to receive an annual payment from the trust during your lifetime, with the balance transferring to the charity when the trust terminates. You may also receive an income tax charitable deduction based on the charity’s remainder interest when you contribute property to the charitable remainder trust. See Viewpoints: Charitable giving that gives back.
Naming the right trustee
Selecting the right trustee can give you peace of mind that your vision for your estate will be realized. While you may choose to serve as trustee or co-trustee of your revocable trust, it may not make sense for you to serve as trustee or co-trustee of other trusts that you are considering.
You must also determine who will serve when you are no longer willing or able. You might be tempted to choose a friend or relative as trustee, based on the idea that this individual knows the beneficiaries and is best equipped to make distributions accordingly. However, in even the most loving families, relationships can sometimes become difficult and emotionally charged.
While your intentions and directions may be clear, it can be difficult for a trustee who is a friend or relative to act objectively. Moreover, the trustee must be investment savvy—someone who can effectively invest the trust assets in a manner best suited to benefit the trust's beneficiaries.
Finally, the trustee is also responsible for preparing accountings and tax filings and for keeping up with complex and ever-changing laws regarding trust administration.
An independent trustee with professional experience on both fronts, investment management and trust administration, may turn out to be the best choice. Or, perhaps having co-trustees—one independent and one related—could be the right answer for you. Be sure to discuss potential candidates, and the pros and cons of each, with your attorney or financial adviser.
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 your death, the trustee can limit withdrawals to the retirement account’s minimum 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 your 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 you’ve chosen.
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 that 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 the all of the benefits available.
- Contact your Fidelity representative to review your estate planning needs at 800-544-6666.
- Fidelity Personal Trust Company, FSB ("FPTC") can serve as a professional trustee in a sole or co-trustee 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.
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