Dealer Insights - September/October 2013 - Estate Planning: In Trusts, We Often Trust
Dealership owners set up trusts to protect their assets from a variety of threats, transfer their wealth to their heirs and reduce tax liability. Different kinds of trusts serve different purposes.
To name just a few, there are simple/complex and grantor trusts; special trusts to hold S corporation stock; split-interest trusts (multiple parts); dynastic trusts; term certain trusts; and income vs. total return trusts. But all of these break down into two basic types: revocable, which can be revised, and irrevocable, which generally can’t be revised.
LIVING WITH A REVOCABLE TRUST
The principal purpose of a revocable trust, also known as a living trust, is to avoid probate, a potentially lengthy, public and expensive process. A living trust allows you to:
- Manage your assets during your life as if you still owned them outright — you become the trust’s trustee, and
- Select a trustee who will manage all trust assets immediately after your death until they’re distributed.
The trustee can also manage your assets during your life should you become incapacitated and unable to do so. Your trustee can be an institution (a bank, for example) or an individual (such as a family member, close friend or trusted advisor). Special tax-saving clauses also can be drafted into your revocable trust, which becomes an irrevocable trust, and serves to dispose of your assets at death.
SAVING TAXES WITH AN IRREVOCABLE TRUST
Trusts with the most tax advantages are typically irrevocable. They can provide significant tax savings while preserving some control over what happens to the transferred assets. There are many examples, including:
Credit shelter (or bypass) trusts. These can help minimize estate tax by taking advantage of both spouses’ estate tax exemptions.
Qualified terminable interest property trusts. This trust type can benefit first a surviving spouse and then children from a previous marriage. Like the credit shelter trust, it can be set up during your lifetime or at death by your revocable trust or will.
Qualified personal residence trusts. These allow you to give your home to your children today. By doing so, you remove it from your taxable estate at a reduced tax cost (provided you survive the trust’s term) while retaining the right to live in it for a certain period.
Grantor retained annuity trusts. A business owner can put assets in this trust and transfer the growth on those assets out of his or her estate tax-free.
Generation-skipping transfer (GST) or “dynasty” trusts. This trust type can help you leverage both your gift and GST tax exemptions and potentially lock in the currently high exemptions.
You can supercharge the benefits of many of these trusts by making them “grantor” trusts for income tax purposes. This increases the effectiveness of the trust benefits in transferring wealth to your heirs.
GIVING TO CHARITY
If you want to benefit a charity while retaining an income stream yourself and diversifying your portfolio in a tax-advantaged way, consider a charitable remainder trust (CRT). You fund a CRT (also an irrevocable trust) with appreciated assets, which it can then sell tax-free and reinvest.
For a given term, the CRT pays an amount to you annually. You’ll owe tax when you receive the payments. But because of a special income distribution mechanism that identifies the character of the income taxable in the payments to you, much of the liability on the capital gain will be deferred.
At the term’s end, the CRT’s remaining assets pass to one or more charities. When you fund the CRT, you receive an income tax charitable deduction for the present value of the amount that will go to charity, and the property is removed from your estate.
Another vehicle, a charitable lead trust (CLT), lets you benefit charity while transferring assets to loved ones at a reduced tax cost. You transfer assets to the CLT and, for a given term, the CLT pays an amount to one or more charities. At the term’s end, the CLT’s remaining assets pass to one or more of your “remainder beneficiaries.”
When you fund the CLT, you make a taxable gift equal to the present value of the amount that will go to the remainder beneficiaries. As with the CRT, the property is removed from your estate.
Trusts vary in their tax advantages and have other pros and cons. Ask your tax advisor which type would work best for you.
Sidebar: Look Ahead With A Spendthrift Clause
When setting up a trust, you can take steps to protect your heirs from wasteful spending. A spendthrift clause sets up rules for distributing funds to the trust beneficiaries. For example, you could stipulate that each heir receive $5,000 per year until funds in the trust are depleted. Or you could arrange that your children receive $2,000 per year from the trust until they turn 30, and then get the balance of their trust money.
Spendthrift language also can protect your heirs from external threats, such as creditor claims, lawsuit settlements and life changes (such as divorce).
Dealer Insights - September/October 2013 Issue