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While a comprehensive estate plan that incorporates trusts has been a crucial tool for couples with joint assets approaching or exceeding $10.68 million — the current gift and estate tax exemption amount — to minimize their estate tax hit, families with assets well below this level are increasingly catching on to the trend, writes Andy Friedman in his latest white paper.
In his recently released paper, “Four Reasons to Consider a Trust to Protect Your Assets,” Friedman of The Washington Update cites four reasons families are turning to trusts to help them protect assets from creditors, manage and grow assets for future generations, and ensure that their assets ultimately are distributed in accordance with their wishes to their heirs.
Friedman — a former tax lawyer to Major League Baseball, the National Football League, the National Basketball Association and the National Hockey League — also discusses the difference between “revocable” and “irrevocable” trusts, and which option families should choose in their specific circumstances.
The first reason the wealthy use a trust is to allocate assets among family members. In this case, wealthy families look at ways to provide for a spouse and for future generations, as well as children and their education.
For instance, Friedman writes, suppose you have children who are young or irresponsible and might squander assets they receive outright. “You can instruct your trustee when to distribute income and principal to each child. Such instructions can be based on age or on a specified accomplishment (e.g., college graduation). In this manner, you can seek to influence your children’s behavior even after your death.”
The second reason to use a trust is to ensure professional management of assets. Individuals, Friedman writes, “might be concerned that their heirs’ lack of financial sophistication — or the heirs’ divergent interests and needs — will preclude the effective management of the assets. A trust allows an individual to ensure that assets continue to be managed properly and to grow.”
Indeed, professional management provides a buffer for battling heirs. “By putting the asset in a trust, you can appoint a trustee to manage the asset and distribute income to your heirs per your instructions, helping to preserve family unity,” Friedman says.
Professional management also prevents a child that’s named to administer assets for all of a family’s children from potential fiduciary breach suits if his actions are challenged. “Naming a professional manager alleviates this concern by shifting the management duties away from a family member,” Friedman says.
The third reason to use a trust is to preserve assets. Assets held in trust frequently are beyond the reach of creditors, Friedman writes, allowing the assets to be preserved for heirs.
For instance, in the event of divorce, placing assets in a trust, in some circumstances, may shield assets from split upon a later divorce property settlement, and a child who’s prone to racking up debt can also be protected under a trust.
The fourth reason to use a trust is to facilitate philanthropy. For instance, wealthy families wishing to donate the bulk of their assets to charity while still providing needed income for family members and heirs can do so through a charitable trust.
“Properly structured, a charitable trust also can provide immediate benefits, such as an income tax deduction for contributions to charity, and tax-free growth for future investment income,” Friedman says.
Revocable or Irrevocable?
As to when to use a revocable versus irrevocable trust, Friedman notes that an individual placing assets in an irrevocable trust cannot later reclaim the assets or make significant changes to their disposition. “Thus, the donor must be comfortable with the arrangement at the time assets are placed in the trust,” he says.
In contrast, a revocable trust can be changed at any time as long as the individual setting up the trust is alive and healthy. Upon the individual’s death or incapacity, the trust becomes irrevocable, Friedman says.
“Which trust makes sense depends on the particular situation. Many individuals prefer the flexibility of the revocable trust. However, an irrevocable trust often is necessary for certain functions, such as estate tax minimization or asset protection.”
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