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:
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.
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 www.treas.gov/irs/ci.