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Financial Planning > Trusts and Estates > Trust Planning

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There is a mystique about trusts. Some first impressions I had came from my grandfather. He was a trustee of some “old money”–the grantors were two elderly sisters, who lived to ages 102 and 104. We visited the New York bank that administered the trusts with him. The beautifully appointed office fit every stereotype of wealth, with polished marble floors and exotic wood-paneled walls. A large chandelier in the boardroom filled only a small portion of a two-story atrium lined with antiques and fresh flowers. On a lower floor, in an open area unencumbered by the ubiquitous cubicle, I saw rows of professional staff who monitored the funds entrusted to them. The sisters’ trusts served several purposes: Friendships were rewarded and the endowments of some local charities grew to benefit recipients for years to come. Forty years ago, this was my introduction to the world of finance, taxes, estate planning, and trusts.

As a tax attorney responsible for reviewing many levels of financial planning, I have since had the opportunity to see thousands of trusts. There are some clear trends regarding what kinds of people create trusts and what motivates them to do so. Along the way I’ve observed a few myths about trusts. Here are some of them:

Myth #1

Trusts Are Only For the Old and Wealthy

Not so! Remember the movie Forrest Gump? Gump’s army buddy, Bubba, spent hours describing the dozens of ways to prepare shrimp. There are even more types of trusts. And because there are so many types of trusts, an ever-increasing number of us uses them.

A recent survey of 400 households aged 35 and above with a minimum of $250,000 in invested assets, conducted by Wirthlin Worldwide for The Lincoln Financial Group*, revealed several relevant trends.

One is that more young people are creating trusts. Almost 40% of the lowest wealth group surveyed ($250,000-$500,000 in invested assets) already have a trust. The larger the asset base, the more likely the household has a trust. Seventy-two percent of those surveyed with $1 million or more in invested assets have a trust. Examining the same issue by age groups we discovered 56% of those aged 35 to 44 have a trust. The percentage drops to 46% for the 45-59 age group, but jumps to 64% for those age 60 and above.

Why is this? It seems to defy a traditional view of who uses trusts. Two factors help: the democratization of information and a strong economy that has expanded the marketplace. Are you sick of the baby-boomer data? Me too. But it is relevant here. We have an increasing population of well-educated emerging wealthy and they will take advantage of wealth preservation techniques in ever-expanding numbers. Table 1 on the following page details some techniques used by the survey group by age and wealth.

If money management, tax and/or protection from future creditors are the problems facing a client

, trusts are often involved in the solution. In the survey the top two single reasons given for generating an interest in using trusts were “reaching a certain age” and “birth of a child.”

Trusts can have many different characteristics. Some are created during one’s lifetime, others are testamentary, created only at death. Some are revocable, others irrevocable. Some are simple (they distribute all income), others complex (it is OK to accumulate income). Some are grantor trusts (income tax falls on the person who set up the trust); others are non-grantor trusts (income is taxed to the trust itself or the beneficiaries).

The skill set of the financial advisor comes into play in mixing and matching these features and others to accomplish the client’s objectives.

Back to the young, not super-wealthy group from the survey noted above. Years ago my experience in drafting trusts for Army personnel in a Judge Advocate General office was that young parents were simply looking for trust management for their minor children. A testamentary trust was often used as a remainder beneficiary (after the spouse) to hold and coordinate assets for the children’s benefit until they reached a certain age.

The marketing of the living revocable trust as a probate-avoidance device is well known and sometimes oversold. Non-probatable does not equal non-estate taxable. Assets in a typical revocable trust are includable in the grantor’s estate. But for the family seeking privacy, coordination of assets in the event of a disability during lifetime and some simplicity in probate administration (depending on the state of domicile), the living revocable trust has much to offer.

Myth #2

Trusts Are Great Tax Shelters

Not so fast! The answer here is a mixed one. Long ago, trusts were used as a means of sheltering income using low tax rates in a progressive tax structure. As early as 1954 Congress changed this practice with a series of new rules. Come and gone are the “throwback rules” (designed to catch the higher tax bracket of the beneficiary or the trust) and the “two-year gift and sell” rule of IRC Section 644 (designed to tax the gain on appreciated property in the transferor’s income tax bracket).

Today several rules guard against the use of a trust as an income tax shelter. First, trust income tax brackets are severely compressed. In 2001, the top trust income tax bracket is reached with only $8,900 of taxable income. Compare that to the $297,350 taxable income breakpoint for a single person or married couple filing a joint return. Second, the Internal Revenue Code can hit losses incurred in sales between related parties, and trusts have a series of definitions that pull them into the related party grouping. Third, two or more trusts are treated as a single trust if they have substantially the same grantors and beneficiaries, and have a principal purpose of avoiding income tax. To see the IRS view on “abusive” trusts click on

Trusts gained little in the recently enacted tax legislation signed by President Bush. The marginal relief provided in the Economic Growth and Tax Relief Reconciliation Act of 2001 from the alternative minimum tax (AMT) by adding $4,000 to the AMT exemption for a married couple between 2001-2004 is not available to a trust.

On a positive and well documented note, a properly structured trust can shelter assets from estate taxes. The most common way is for one family member to create a trust for the benefit of others (beneficiaries), provide the beneficiaries with a lifetime of income and yet not cause the trust principal to be includable in the beneficiary’s estate. This type of trust takes one of several forms: It can be a non-marital trust (often equal to the “unified credit equivalent”–today, $675,000) as part of a traditional A/B trust design for a married couple, the other portion being an amount equal to the unlimited marital deduction. It can also be a family income trust–an irrevocable trust using life insurance on the life of an individual (e.g., the grantor) to leverage the amount that can be put into such a trust within certain gift tax limitations. The starting point of an effective gift tax strategy is to maximize the use of the annual $10,000 gift tax exclusion. Next year, you can also expect to see a segment of the market take advantage of the new increase in the exemption equivalent, as it jumps from $675,000 to $1,000,000 per individual. The extra $325,000 can be gifted without an immediate federal tax outlay, allowing those funds to grow or be leveraged outside of the donor’s estate.

Myth #3

Who Needs a Trust? Estate Taxes Are Repealed!

Don’t blink! Over the next 10 years the new tax act has three features: relief, repeal, and reappearance. A future Congress will likely decide the longer-term fate of the transfer tax system. In the immediate future a segment of the affluent market will get some gradual relief and be less concerned about estate taxes. The U.S. Treasury data show there were 47,483 decedents with taxable estates in 1999 but that only 58% of these had estates above $1 million. Estates below the $1 million mark only paid 4.5% of the total revenue collected. Even in the new tax regime a relatively few estates will pay significant estate taxes.

In 2002 the top estate, gift, and generation-skipping tax rates will drop from 55% to 50%. The estate and gift tax exemptions will increase from $675,000 to $1,000,000. Most of the relief is back-loaded. By 2009 the estate exemption equivalent reaches $3,500,000, while the gift exemption equivalent stays at $1 million. In 2010, the estate and generation skipping tax is repealed–but only for one year. The transfer tax system returns to the pre-tax act levels in 2011.

The increase in the exemption equivalent highlights the continuing advantage of the classic A/B trust strategy. Table 2 (see page 84) estimates the tax savings available to a $5 million estate, growing at 6%, in each of the next several years as rates drop and the exemption equivalent increases, by using a unified credit trust at the first death compared to an outright transfer to the surviving spouse. For example, in 2009 when the estate tax exemption equivalent peaks, the benefit of the A/B trust can be $1.6 million over an outright bequest to the surviving spouse.

Because the gift tax exemption equivalent does not increase past $1 million, starting next year other types of trusts will become more popular. These include the “time-value-of-money” type of trusts such as a GRAT (Grantor retained annuity trust). This type of trust allows a gift to a beneficiary be delayed by a predetermined time and that delay allows the value of property placed in the trust to be reduced for gift tax purposes. This in turn allows for some “asset-packing” in order to fit within the $1 million exemption equivalent. For example, assume $1.7 million was placed in a 10-year GRAT in August 2001 with a 6% payout to the grantor. The value of the delayed gift to the beneficiary is considered to be worth less than $1 million for gift tax purposes.

Myth #4

Trusts Are Inflexible

Imagine a trust as a financial butler–it does what it is told to do. So, within the context where a trustee has fiduciary obligations to th

Trust Resources

For additional information on trusts, consult the following sources:

On the Web

Commerce Clearing House

Research Institute of America

Westlaw Publishing

Cornell University

(search on keyword “trusts”)

In Print

Research Institute of America’s estate planning treatises, notably:

Esperti and Peterson, Irrevocable Trusts,

Analysis With Forms (updated twice yearly);

Harrington, Plaine and Zaritsky,


Transfer Tax (updated twice yearly);

CCH’s financial and estate planning books, especially

Callaghan, Estate and Personal Financial Planning

e beneficiaries, the range of possibilities for investments, distributions and accomplishing most client objectives are considerable.

One trust feature that is still evolving is the use of the unitrust concept. The unitrust is designed to balance the interests of an income beneficiary (who normally only gets income) and a remainderman (who eventually gets principal). In a low interest-rate environment it can take large blocks of capital to generate a livable income stream. Thus, it is common for an income beneficiary to demand that the trustee maximize income from a given investment portfolio. The conflict with a remainderman is obvious. A conservative income-generating portfolio may not be diversified and has less opportunity to grow the principal base of the trust. Hence, the unitrust concept: Instead of limiting the income beneficiary to the “income rule” format, a payout would be based on a percentage of the value of the trust. Discord between the trustee and the two groups of beneficiaries may never be totally solved (that’s life) but this technique can align their interests by allowing them to focus on long-term investment choices and give clarity to the cash flow expectations of all parties. This technique is not a cure-all; it doesn’t work well for trusts holding business interests and unproductive real estate. Tax issues, including some GST issues, are not fully resolved. Some states are adopting rules that will permit court reformation of existing trusts into a unitrust format. Stay tuned. This concept can add flexibility for certain trusts in a positive way.

Myth #5:

Let’s All Move To Alaska, Or Delaware…

The first state, Delaware, is very proud of its reputation as a corporate headquarters and choice-of-trust jurisdiction. Alaska, in 1996, began a series of legislative efforts to attract trust business. How? By knocking down some barriers to the rule against perpetual trusts (see July 2001 Investment Advisor, “For the Ages”) and creating certain creditor protections. Eleven other jurisdictions have already altered their rules to gain some market leverage. In short, we have seen a new round of border wars for trust business. You can hear the baby-boomer statistics bouncing off the legislative halls. National conferences and the information explosion, made possible with the Internet, have opened a new generation of professionals to “out of the box” possibilities. You don’t need to be a resident of these jurisdictions in order to establish a trust there.

Not everyone will jump on the bandwagon. There is a natural inclination to want to be able to easily access all trustees. There is comfort, a trust factor (no pun intended), in working with the local family law and accounting firms. If there is a lawsuit, the need to hire counsel in a distant jurisdiction is not always seen as a “cost-of doing-business” but a practical detriment.

Trusts have been used for centuries. If trusts didn’t exist today they would be created by a massive market demand for investment management and ease of administration. In addition, the features of transfer tax benefits and future creditor protection enhance the draw of this well-established legal construct. It further appears that the market for a slice of immortality via the dynasty trust continues to gain favor.


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