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Is your financial situation “trust” worthy?

Why a trust may help you do much more than potentially reduce estate taxes.

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The 2015 inflation adjustment to the federal estate tax exclusion gives some investors another good reason to look at the role of trusts in helping them achieve their financial goals. Circumstances differ from family to family, but one clear fact is emerging: Trusts remain an important tool in many situations—and for a range of reasons.

“The increase in the federal estate tax exclusion to $5,430,000 per person, up from $5,340,000 in 2014, coupled with the annual gift tax exclusion remaining at $14,000, are providing incentives for families to take a fresh look at their estate planning and wealth transfer strategies,” says Kevin Bartlett, president of Fidelity Personal Trust Company. “Many people are surprised to learn that there are many benefits to having a trust other than potential tax savings.”

Trust strategies

Traditionally, trusts have been used as a strategy for reducing estate taxes on wealth that is eventually transferred to children, grandchildren, or other heirs. By funding an irrevocable trust, you can remove assets from your estate—and avoid a potential estate tax. Over time, the trust will enjoy the growth of the assets you transferred outside your estate, and your named beneficiaries will enjoy the use of the assets according to the terms you set out in the trust. Additionally, those assets transferred into the irrevocable trust may provide you with protection from creditors.

In 2015, the lifetime gift and estate tax exclusion increased to $5,430,000, while the top federal tax rates remain at 40%. In addition, “portability” of the federal estate tax exclusion continues. This means that a spouse can capture any unused portion of the federal estate tax exclusion from his or her deceased mate and reserve it for future use, bringing the effective estate or gift tax exclusion amount per married couple to $10,860,000. For individuals who have remarried, portability is limited to only the most recently deceased spouse. Be sure to speak with your attorney or tax adviser regarding your specific situation.

On the surface, the increased exclusion amount might cause a married couple with assets below $10.8 million to regard the creation of trusts as unnecessary. However, the reality is that there are many other reasons to consider employing trusts as part of your overall estate plan. Says Bartlett: “Though taxes are important, protection of your assets and assuring your family’s well-being in the event of incapacity far outweigh the benefits of tax savings for most people.”

Understanding the benefits of trusts

“As married couples examine the role of trusts in their wealth transfer planning, they should look well beyond federal estate tax considerations,” Bartlett says. He points out that trusts can be used for many other purposes, including:

Control of your wealth. Should you become incapacitated, a funded and properly constructed revocable trust may ensure that the trust assets will remain available for your benefit. After you’re gone, the same trust can control who will receive distributions from the trust, as well as when the distributions will occur and on what terms. It can be especially important, for example, for families with children from multiple marriages, because the trust can help ensure that a decedent’s specific wishes for the distribution of his or her wealth are carried out.

Protection of your legacy. A properly constructed trust can protect your legacy from your heirs’ creditors—or from the spendthrift ways of the beneficiaries themselves.

Privacy and probate savings. Whether you’re married or single, the assets included in your will must pass through your state’s probate process. This requirement raises several concerns: First, there are fees associated with probate; second, depending on your state, probate may be a time-consuming ordeal lasting more than a year; and third, probate records are generally accessible to the public. By putting assets into a revocable trust during your lifetime, however, you can avoid having these assets pass through probate at your death and retain your family’s privacy, while at the same time retaining full use and control of those assets during your lifetime.

Gift tax considerations. By making large outright gifts during their lifetime, some taxpayers are taking advantage of the elevated lifetime gift tax exclusions as a way to remove future appreciation from their estates. While this may be a sound strategy for removing the money from the donor’s estate, Bartlett points out that the donor is relinquishing all control over the money. By gifting the money to a trust, instead of outright to the beneficiaries, the benefactor can at least establish control over how and when it is to be distributed to beneficiaries.

State inheritance taxes. Estate taxes aren’t solely under the province of the federal government. As of 2015, 19 states and the District of Columbia also impose some form of estate or inheritance tax. Such taxes can be far from inconsequential, and often apply to estates worth much less than the current federal estate tax exclusion of $5.43 million. For those who live in a state that does impose such a tax (or those who have assets—real estate, for example—located in such a state), a properly constructed trust can be an effective estate-planning tool for reducing state level estate taxes, just as it can be for potentially reducing federal estate or generation-skipping transfer taxes.

Picking the right trust for you

The type of trust you consider creating—including any provisions— will depend on your individual circumstances and goals. While the variety of trusts and their uses are too many to list and discuss fully at this time, here are a few examples:

As already discussed above, funding a revocable trust—also known as a living trust—during your lifetime can be useful in keeping your assets out of probate and helping to provide privacy and efficiency for the settlement of your estate.

If making gifts during your lifetime makes sense for estate tax savings or for other reasons, the use of a specifically designed irrevocable trust to receive such gifts may be warranted, given your personal circumstances and needs. For example, a qualified personal residence trust (QPRT) may allow you to transfer a primary residence or vacation home out of your estate, while allowing you to use that residence during a specified period of time.

Those with a blended family may want to consider a qualified terminable interest property (QTIP) trust, which may help provide income to a spouse from a second marriage. If funded and properly constructed, a QTIP trust may also be used to ensure that any principal goes to any children from a first marriage once the second spouse dies—while being useful in deferring estate taxes payable. If you believe your current estate-planning documents contain QTIP trust provisions, you should speak with your attorney to ensure that this type of trust still meets your goals and objectives, especially in light of the increased federal estate tax exclusion.

The uncertainty over future legislation governing gift and estate taxes clearly presents an ongoing challenge for keeping your estate plan aligned with your wishes or your desire to minimize the amount of tax that could be imposed. Married couples who have estates that may or may not be valued below the federal estate tax exclusion at the death of the first-to-die spouse may want to consider a disclaimer trust. This type of trust allows the first-to-die spouse to leave everything to the surviving spouse, but allows the survivor to disclaim the inheritance, in a timely fashion, and have the assets pass into a trust instead. Such a strategy would allow the surviving spouse to base his or her decisions on the laws in effect at the time of the first-to-die’s death.

Getting good advice

Clearly, deciding which trust to use, if any, is a complex challenge that requires the advice and guidance of a trusted estate-planning attorney. “For people who have been putting off addressing their wealth transfer strategies, now is the time to consider a trust that meets their needs,” Bartlett says.

For those couples who already have a traditional estate plan in place that includes the creation of a trust upon the death of the first-to-die spouse, a reexamination of the plan in light of the increased exclusion amount may be very important to ensure that it continues to work as desired. “The many complexities of estate planning and wealth transfer strategies require professional guidance,” Bartlett adds. Your Fidelity representative can provide direction for helping you get started.

You should always speak with your attorney or tax adviser regarding your specific situation. Says Bartlett: "The current attention being given to trusts and estate planning is making this the perfect time to make sure your plan is aligned with your personal objectives and is one that offers the desired level of control over, and protection of, your legacy.”

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The tax information and estate-planning information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such information is accurate, complete, or timely. Laws of a particular state or laws that may be applicable to a particular situation may have an impact on the applicability, accuracy, or completeness of such information. Federal and state laws and regulations are complex and are subject to change. Changes in such laws and regulations may have a material impact on pre- and/or after-tax investment results. Fidelity makes no warranties with regard to such information or results obtained by its use. Fidelity disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Always consult an attorney or tax professional regarding your specific legal or tax situation.
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