If you haven’t stopped to consider how a trust may help you pass on your legacy, you could be making a critical estate planning mistake. For individuals with substantial assets, Fidelity believes 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 Christin Haley, a director of estate planning at Fidelity Investments. “Trusts are flexible—and powerful—tools that anyone with substantial assets can use to gain greater control over how they pass their wealth on to future generations.”
There are many types of trusts available, each designed to help achieve specific goals. A financial adviser can help you determine which type (or types) of trust is most appropriate for you. First, though, consider the estate planning goals that a trust may help you realize.
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. Without the appropriate documentation, you and your beneficiaries may not reap the benefits of a trust, 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 probate in the state courts. However, probate is a public legal process that can create several problems for your heirs, including:
- Delays: The probate process can take a year or more, during which time assets may not be easily accessible to pay for funeral arrangements and other expenses.
- Costs: Probate can cost up to 5% of the estate’s value, depending on the state you live in.
- Publicity: When your will is admitted to probate, it becomes a public record and your assets become known to the public. 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 egregiously 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 during your lifetime. 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 also can give the trustee the power to take immediate control of your assets in the event that you become incapacitated, a provision that can save your heirs the trouble and time of going to court for a conservatorship. Finally, revocable trusts are dissolvable, meaning you can pull your assets out or change the terms of the trust at any point during your lifetime.
2. Preserve assets for heirs and favorite charities.
If you have substantial assets, then you may want to consider creating and funding an irrevocable trust during your lifetime. Because the trust is irrevocable, you cannot amend the trust once it has been established. You would gift assets into the trust and the trustee would administer the trust for the trust beneficiaries based on the terms you determine. Significantly, while the value of the gift could use some or all of your lifetime gift tax exemption, any growth on these assets will not be subject to federal estate taxes at the grantor’s death. The individual lifetime federal gift tax exemption is set at $5.25 million in 2013.
Irrevocable trusts also can serve several specialized functions, including:
- Holding life insurance proceeds outside your estate. The death benefit from a life insurance policy ordinarily would be considered part of your estate—but not if the policy is purchased by an independent trustee and held in an irrevocable life insurance trust 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 nevertheless 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, so 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.
- 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 is 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 Haley.
3. Reduce estate taxes for married couples.
For a married couple, it may make sense to use a revocable trust to take full advantage of both spouses’ federal and/or state estate tax exemptions. Upon the death of the first spouse, the assets in a revocable trust can be used to fund a family trust—also known as a credit shelter or B trust—up to the amount of that spouse’s federal or state estate tax exemption. These 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 into a marital trust for the benefit of the surviving spouse or transferred outright to the surviving spouse, thereby avoiding estate taxes at the death of the first spouse on these assets as well.
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 has no state estate tax, and have a net worth of $12 million. If one of you dies in 2013, that spouse’s revocable trust can fund the family trust with $5.25 million without paying any federal estate tax. Over the next 20 years, this $5.25 million could grow to $17 million or more, based on a 6% growth rate, compounded monthly, all of which would remain outside the surviving spouse’s taxable estate. While the balance of the assets can be transferred into a marital trust or outright to your surviving spouse, these assets are included in the surviving spouse’s estate and are subject to estate taxation at the surviving spouse’s death.
4. Gain control over distribution of your assets.
A properly drafted trust enables you to structure the way your assets are distributed to multiple beneficiaries through succeeding generations. These provisions can give you a great deal of comfort knowing that your wishes will be carried out after your death.
Some common provisions include:
- Distributions for specific purposes. For example, you can stipulate that a trust will make money available to your children or grandchildren only for college tuition or perhaps for future health care expenses.
- Age-based terminations, which stipulate that the trust’s assets be distributed to your children at periodic intervals—for example, 30% when they turn 40, 30% when they turn 50, and so on.
If you want to make gifts to charity, you may also want to consider establishing a charitable remainder trust during your lifetime, 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.
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 also must 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 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. But if you name 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 required distributions (MRDs), based on the life expectancy of the oldest named beneficiary in the trust document. The trustee can then make distributions to the beneficiaries according to your wishes, whether this might be to retain and reinvest the MRD in the trust or to distribute the MRD to the beneficiaries.
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. A qualified terminable interest property (QTIP) trust provision can, in this case, be used to provide for your surviving spouse while also ensuring that the remainder of the trust’s assets are 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 about the kind of trust and provisions that are right for you. It is vitally important that the trust be properly drafted and funded, so that you and your beneficiaries can reap the benefits you intend.
- Contact your Fidelity representative to review your estate planning needs.
- Fidelity Personal Trust Company can serve as a professional trustee in a sole or co-trustee capacity and administer your trust according to its terms. Fidelity can also serve as trustee for irrevocable trusts, including those mentioned above.
- For more guidance on estate planning, visit Fidelity’s Trust & Estates.