Retirement Income Blog

Trusts play a big part in estate planning. What you don’t know about them can hurt you and your beneficiaries’ financial health and possibly your own.
 
A trust is a legal entity - just like a corporation or a person. It holds assets for a beneficiary.  The beneficiary could be you or another person. A trust document states the purpose of the trust and how it’s to be carried out. A trustee is the person (or entity) that carries it out. The grantor (e.g. you) creates and generally funds the trust.  Trusts in estate planning play a major role as you shall see.

A trust can be revocable or irrevocable. Revocable means that the grantor can decide to revoke the trust and take all the assets back for his use. In fact, such a revocable trust is really an extension of the grantor and taxed as if all the trust assets and their income were his. The most well known type of revocable trust is the living trust.  During your lifetime, this trust is transparent–it does not affect anything.  But upon death, the living trust contains a set of instructions that states how assets are to be divided.  As you see, the use of trusts and estate planning go hand in hand.

Revocable trusts serve to avoid probate. Probate – the court process of transferring assets in a deceased’s name by will or intestate - is a very public process. Trusts are not subject to probate – being a separate entity from the deceased – and can privately pass assets according to the terms of the trust. One of the objectives of trusts and estate planning is to retain privacy.  The additional benefit of a revocable trust is that it allows the grantor to control the assets and income of the trust as he wishes while he’s alive.

An irrevocable trust –once created by the grantor – is no longer under his control. It’s controlled solely by the trust document and the trustee. In this case, it’s taxed as a separate entity –unlike the revocable trust – and has an existence all its own.  In our tax system, whoever has the ability to control an entity is taxed and responsible for what that entity does. The irrevocable nature of a trust breaks that connection relieving the grantor of any subsequent tax or control issues. However, in reality, the trustee is usually a friend, relative or confidant of the grantor over which the grantor has influence and thus, can still exert indirect control over trusts assets. In this case trusts and estate planning serve to separate control (which the grantor still exerts) from ownership.  Assets are removed form the grantor’s estate with favorable estate tax and asset protection consequences.

The legal separateness of an irrevocable trust allows key benefits. First, that the grantor determines how the assets he puts in it are to be handled and distributed to his assigned trust beneficiaries – according to how he writes up the rules of the trust document. Second, the trust as a separate entity, can survive him indefinitely allowing his wishes to continue beyond his death. Third, the beneficiary, the object of the trust, benefits from the trust. Last, the trust’s legally protected from others (i.e, creditors) who may try to invade it or take the trust assets. Trusts in estate planning play these four major roles as just explained.

The use of trusts in estate planning have a clear objective to achieve. Examples of such trusts are:
o Spendthrift protection
o Charitable trust
o Life insurance trusts
o Asset protection trusts
o Bypass Trusts
o Qualified Personal Residence Trust (QPRT)
o Qualified Terminal Interest Property Trust (QTIP)
o Generation-Skipping Trust
o Irrevocable Life Insurance Trust ILIT

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A trust serves to separate legal and equitable title.  In plain English, this means that a trust holds an asset (any asset like a house, car, or bank account) in the name of one person (called the Trustee), but that the asset is really for the benefit of someone else (called the beneficiary).  Why have trust and pursue trust planning?  The use of trusts gives flexibility and power in controlling how your assets are used if you become incapacitated or pass away or desire to control or protect your heirs.  Different types of trusts can actually be created for all kinds of purposes, and you will hear terms like “Special Needs Trust”, “Land Trust”, and “Revocable Trust”.  Trust planning requires that you simply be precise about your desires and what you wish to accomplish so that you get accurate retirement help from a trust attorney who can draft the documents properly. Proper trust and estate planning can result in several benefits:

• reduction of estate taxes
• protection of assets from creditors
• managment of assets for those who don;t have the knowledge or ability to do so
• control of how your bequest i8s used after you’re gone
• avoidance of probate

A Trust is simply words on a piece of paper–words that rare recognized by the legal system as valid documentation of your desires. The most common trust used in estate and trust planning is a revocable living trust, sometimes referred to as a revocable inter vivos trust.  Within the generic living trust are “sub parts” or flavors, such as A-B Trusts, Disclaimer Trusts, QTIP, and QDOT Trusts.  Living trusts are the most flexible type of trust used in trust planning because the trust can be amended or revoked at any time by the competent trustor (the trustor is the creator of the trust- synonymous with grantor or settlor).  Revocable living trusts are the most basic type of trust and often acts as the starting point for estate and trust planning.

Typically, you will be the initial trustee (e.g. person who controls the assets in the trust) of your trust and you will name Successor trustees to manage and control your assets when you are unable or after you pass. As long as you are living and have the mental and physical capacity to act as trustee, you will continue to do so and have full control over all of your assets as you would without a trust including spending, moving assets around, buying and selling real property and investments.  At the time you become incapacitated or upon your death, the named successor trustee (usually a family member but often an attorney or CPA) will gather your assets, pay valid debts, claims and taxes and distribute your assets according to your wishes as directed in your trust.  Selecting a knowledgeable succesor trustee is a crtical issue in trust planning as you want someone who will make good business decisions to settle your estate.

Although a trust allows assets to pass without probate (which can be lengthy and costly court process), a complete estate plan includes a pour-over Will, as a safety mechanism to move any assets into the Trust that may have accidentally been left out.  A will is also necessary to name guardians for any surviving minor children.  Even in the process of trust planning, wills are used.

A Trust can contain provisions that can reduce or eliminate some estate taxes (by divisions of an estate into parts) and a trust permits you to specify conditions for the distribution of your assets.  A living trust does not require a separate tax return during your lifetime, but other types of trusts which are irrevocable are separate financial entities and will have their own taxpayer ID and complete a tax return.   While trust planning may sound complex, it is a common and straight forward process when done by an experienced estate planning attorney.

Typically, trust planning is am arena of financial planning that does not lend it self to tools like a retirement income calculator, financial planning software or monte carlo simulations as this planning is very individualized and is qualitative vs quantitative in nature.

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When an individual dies, assets of the decedent may be transferred based on how their titled or a named beneficiary.  For example, assets held as joint tenants with right of  survivorship pass directly to the other joint owner.  Similarly, IRA accounts pass directly to the named beneficiaries as do payable on death accounts, transfer on death property, and most life insurance and retirement benefits.  For other assets that do not have a named beneficiary, an estate/trust Administration process is necessary.  In the case of a person who dies with a will, that process is called probate and requires proceedings in probate court.  In the case of a person dying with assets in a trust, then probate is avoided and the estate/trust administration duties fall to the successor trustee named in the trust, typically a family member.

It is the probate court’s responsibility, as it is the successor trustee’s in the case of a trust, to ensure the assets are collected, maintained, and distributed among the decedent’s heirs, beneficiaries, and/or creditors according to the direction of the decedent as expressed through a will or the trust.  This process is known as estate/trust administration of a decedent’s estate.
 
After the death of an individual, an estate may be opened by any interested person filing an application to administer the estate. This is usually done by the executor, a family member named in the will.  In the case of a trust, the estate/trust administration is handled privately, not involving the court and can often be accomplished in a matter of weeks, not months.  That is one advantage of estate/trust administration with a trust–speed.  The other advantage of estate/trust administration is privacy.  While matters involving a will involve the court as explained above, these matters become public.  Estate/trust administration handled when the decedent has a trust is handled privately by a family member or someone close to the family and there is no public record.
 
In both cases, will and trust, the estate/trust administration process involves the following steps:

Application for authority to administer the estate and admit the will to probate if one exists;
Appointment by the court of a  fiduciary (in the case of a will);
Gathering assets and obtaining appraisals as required;
Filing the inventory in a timely manner;
Payment of creditors;
Filing of estate and income tax returns and payment of taxes, if any;
Distribution of remaining assets to beneficiaries;
Closing the estate by filing a final account or certificate of termination in a timely manner.

While it’s usually the case that estates are closed once all assets are distributed, in the case of a trust, the estate/trust administration process can continue for years.  For example, the decedent may have specified in his trust to have $20,000 distributed annually to his 20-year-old grandson.  The would require the trustee to administer the trust over the next 60 years or so. While this is not a difficult job by the trustee, the desires of decedents who use trusts can be more involved and require estate/trust admininstartion over decades.
 
Note that the eatate/trust administration issues have no impact on estate taxes due.  Whether the decedent has a trust or will, the same estate tax impact can be accomplished in the design of the documents. Avoiding probate does not mean avoiding estate taxes. Assets left in trust are subject to estate and inhertiance tax just as assets left through a will.  Avoiding estate taxes requires that tax and estate planning be done well before death, coordinated by an experienced retirement advisor.
 
If a decedent has no will or trust, the estate/trust administration process is similar as if a will had existed. However, the State may decide on the distribution of certain assets because there is no documentation of desires from the deceased.

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Will planning, trust planning and estate planning is not just for older people.  It’s for anyone that wants to avoid heartache for those they love. It’s simply a asset of instructions to distribute property to those who you want to have your property. 

If you have a will your property will go to those you want to have it and there is no other way for you to have this assurance because the State will determine who gets your assets if you don’t have a will.  Additionally, by planning your will, friction and arguments will be lessened among beneficiaries.  Without your instructions, how will they know who gets what?  Moreover, the potential for large legal fees and court costs can be minimized because you avoid litigation among family members.  And of course, with proper will planning, The estate will be settled more promptly.  A good retirement planning calculator will help you estimate the size of your estate to be planned.

The major aspects of the planning are
1. To decide who you want to name as beneficiaries (both primary and contingent)
2. What you want each beneficiary to receive
3. You can name an executor/executrix to manage the distribution of your assets
4. If you have children, can name a guardian to care
5. Make an charitable bequests

Some people avoid will planning because of superstition—that if they plan the distribution of their assets they will die.  You will be comforted to know that there is no research or statistics to support this.  In fact, there’s a statistics floating around that 75% of attorneys die without a will.  That would support the case that people without a will are more likely to die!  So plan and prepare your will now!

Don’t delay because there are things you cannot decide.  For example, if you are torn about which beneficiaries to indicate or what to leave them, just have a will made anyway with your “best guess.”  You can always change it later.  And since you can use will planning and preparation software, you can change your mind as often as you desire without cost.  Or you may be undecided about charitable beneficiaries.  Again, you can change, add or delete charities at any time to your will.

Below find the information you need.  If you don’t want to prepare your own will, it’s a relatively inexpensive attorney’s fee to have it done. 

• Names and address of each beneficiary.  If a relative, state relationship.
• If any of your beneficiaries were to predecease you, name the contingent beneficiary (next in line)
• List specific bequests to be made to each of those persons listed above. Describe the gift, the amount of money or percentage of the estate to each recipient.  It’s best to use percentages.
• Names and addresses of charities for charitable requests and amount (again, best if a percent of your estate)
• If minor children are living at the time of making a will, you should name a guardian for their care. 
• Appoint your executrix/executor. Husband and wife often name each other. Specify if they will serve without being bonded in administering your estate. Again an alternate should be named.

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One of the topics we cover on this blog is estate planning as its unlikely you will spend every last dime before you die.  So let’s consider trust planning and how to leave assets to your heirs, just in case there’s some money left over.

I am a big fan of leaving money in trust to provide trust income to your heirs and not leaving assets outright.  Leaving assets outright has several problems:

• Your heirs may blow the money, intentionally or not
• The creditors of your heirs can get at it
• An alienated spouse can get at it (if they are clever)

If you leave money in trust, you can set it to give your heirs a trust income and not expose the principal to any of the above problems.  Of course, you can provide additional flexibility through the trustee.  You can empower the trustee (the person who is responsible for the trust on behalf of your heirs), to make discretionary distributions of trust income.  For example, if you your heirs get $20,000 annually from the trust, you can empower the trustee to make additional distributions of trust income or trust principal for certain purposes such as education or starting a business or buying real estate.

It’s important that the trust distribute its income each year because trust income left in the trust is taxed at very high rates:

By distributing the trust income to the beneficiary, the trust will not pay any tax and the income will be taxed to the beneficiary at much lower rates.

How important is trust planning?  You can consult retirement income calculators to see how much income you need, how much of your assets are likely to not be exhausted and to what extent to carry out estate planning.

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