Bilocation

o Discourage reckless or irrational actions

o Last for an extended period of time

o Are managed professionally to maximize the amount of funds available

In the U.S. there is a vehicle that can potentially meet all of these objectives: it’s called a generation skipping transfer (GST) trust, and other countries may provide similar vehicles under their laws. A GST can be structured so that one or more trustees will have the discretion to make distributions to family members who face financial emergencies.

You may want to establish the GST trust in a state that permits the trust to last for multiple generations and perhaps forever. The trust may have provisions to prevent discrimination in favor of one family member or one branch of the family over another. Since it is impossible to know in advance exactly how, when, or by whom the money will be needed, the trust will usually be structured to be flexible to protect the interests of all family members.

Investments to Fuel a GST Trust

The GST trust can be a good legal structure to hold funds and manage them for the future. But what investment “fuel” could the trustee employ to efficiently retain and accumulate funds in the trust so they are liquid, tax efficient, and easily accessed when a beneficiary has an urgent need? Cash, mutual funds, or a portfolio of securities may be used, but these options may not be tax-efficient and may not produce much long-term growth.

Another possible option for fueling a GST trust is cash value life insurance. Here’s how it may work:

o One parent or grandparent establishes the trust and provides the funds to purchase the life insurance policy. The other (non-grantor) spouse can be a beneficiary of the trust and may be entitled to receive distributions at the discretion of the trustee in a financial emergency.

o The trustee purchases a life insurance policy on one or more of the senior family members (parents or grandparents).

o While the insured is alive, the trustee has the discretion to use policy cash values or other trust assets to make distributions to other family members in need.

o At the insured’s death, the trustee generally receives the policy’s death benefits free of income tax. If the trust is properly drafted, these death benefits can be free of estate tax as well.

These death benefit proceeds can be held and invested for later distributions to family members when future financial emergencies arise. This can be particularly helpful if family members living abroad have a financial crisis and need distributions from the trust to weather it.

Funding the GST

Gift, estate, and generation-skipping taxes are usually in play when funding the trust. Fortunately, the U.S. Congress has provided exemptions for certain transfers. With good planning these exemptions may potentially shelter many thousands and even millions of dollars of trust distributions from these transfer taxes.

Gifts are commonly used for transfers because of four available exemptions in 2009: the gift tax annual exclusion for present interest gifts ($13,000 per recipient); the lifetime gift exemption ($1,000,000 for gifts that do not qualify for or which exceed the gift tax annual exclusion; the unlimited exemption for gifts between spouses; and the $3,500,000 generation-skipping tax exemption on transfers that benefit grandchildren or other beneficiaries more than 37 1/2 years younger than the donor.)

But there’s a twist for international families. If an American citizen marries a citizen from another country, and they settle in the U.S., the unlimited marital deduction for lifetime and testamentary transfers between spouses is not available. In its place, Congress established a large gift tax “super exclusion” that eliminates the tax on present interest gifts up to $133,000 per year for 2009.

The simplest way to use this “super exclusion” is for the American citizen spouse to give $133,000 directly to the non-citizen spouse. This spouse may then invest the proceeds of the gift in any type of financial asset, which might include a life insurance policy on the American spouse’s life. In the life insurance policy scenario, the non-citizen spouse is the policy owner and beneficiary, and he or she may choose to use the death proceeds to benefit the citizen-spouse’s children and grandchildren. These death benefits should not be subject to estate taxes at the insured’s death so long as the insured never would have had an incident of ownership in the policy.

Note that making the “super exclusion” gift directly to the non-citizen spouse removes the American spouse’s rights and control, so it’s wise to get expert advice before taking this approach. An alternative might be to make gifts directly to the GST trust rather than to the non-citizen spouse. A GST family safety net or incentive trust also can be structured to take advantage of the $133,000 non-citizen spouse annual gifting limit.

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Peter McCarthy, JD, CLU, ChFC, is a senior advanced sales consultant on ING’s Life Sales Support Team. He can be reached at [email protected].