1. © 2007 ME™ (Your Money Education Resource™) 1 Estate Planning for Financial Planners Chapter 8: Trusts

2. 2 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2 Introduction  Used for: Management of assets. Flexibility in the operation of the estate plan (except charitable trusts).

3. 3 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 3 Parties  Grantor (a.k.a. settlor, creator, trustor) Person who creates and initially funds the trust.  Trustee Manages the trust and carries out the provisions in the trust document. Must act in the best interest of the beneficiaries. Duty of loyalty and care Corporate trustee if you need a “bad cop” for problem child  Beneficiary Income – right to income. Remainder – right to property when trust terminates.

4. 4 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 4 Why Use a Trust? (1 of 3)  Management Assist those not capable of managing assets.  Creditor protection Spendthrift clause States beneficiary cannot assign, pledge or promise to give the assets of the trust to anyone, and if a promise is made, it is void. Also should allow the trustee to make distributions on a discretionary basis. Most states do not allow the grantor to create a spendthrift trust for protecting his assets.

5. 5 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 5 Why Use a Trust? (2 of 3)  Split interests in property Valuable asset that grantor does not want to sell or split up (e.g., gifting farm to 5 kids where only 2 will participate).  Avoid probate (living trust) Revocable living trust – managed by the grantor and is for the benefit of the grantor during lifetime. Becomes irrevocable at death. Does not avoid estate taxes.  Avoid taxes Transfer future appreciation. Avoid transfer tax on subsequent generations. Reduce gross estate

6. 6 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 6 Trust Duration – The Rule Against Perpetuities  All interests in the trust must vest within lives in being plus 21 years.  Some states have adopted statutory rule against perpetuities (90 years).  IRS recognizes both rules.  Some states have abolished the rule but include laws that prohibit the trust from not allowing the trustee to sell property.

7. 7 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 7 Taxation of Trust (1 of 2)  Income tax – Hybrid entities Distributed – Taxed to beneficiaries. Accumulated – Taxed at trust rates.  Simple trust – mandates distribution of income. Can not distribute corpus  Complex trusts – permits accumulation of income. Capital gains part of income

8. 8 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 8 Taxation of Trust (2 of 2)  Revocable – not a completed gift  Irrevocable – generally completed (unless retained interests)

9. 9 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 9 Classification of Trust Arrangements  Revocable trusts Avoids probate. Provides for management of the grantor’s assets if grantor is incapacitated.  Irrevocable trusts Used to achieve estate and gift objectives.  Inter vivos trust Created during life.  Testamentary trusts Created at death.

10. 10 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 10 Classification of Trust Arrangements  Standby trust Unfunded or minimally funded. Waiting for triggering event – usually incapacity.  Pourover trust Receives assets from another source.  Grantor trust Inter vivos trust for the grantor. Grantor pays all income tax.  Funded or Unfunded

11. 11 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 11 Specific Trusts Used in Estate Planning (1 of 8)  Inter Vivos Revocable Important in states with high probate costs. Privacy is maintained. No notice requirements. Terms are confidential. Will contests are discouraged. State law controls, but generally more difficult. NOT effective for reducing estate taxes.

12. 12 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 12 Specific Trusts Used in Estate Planning (2 of 8)  Inter Vivos Irrevocable Completed gift! Use annual exclusion – remember need present interest. Distributions of income are considered a present interest. Crummey – letter sent to guardian 30 days to exercise right Multiple beneficiaries, multiple exclusions

13. 13 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 13 Specific Trusts Used in Estate Planning (3 of 8)  Life Insurance (ILIT) Need present interest.  Bypass (Credit Shelter or B) Trust Spouse can still get the income, HEMS, “5- and-5.” Usually Testamentary, but can be Inter Vivos and exclude future appreciation.  Power of Appointment Trust Generally used to take advantage of the unlimited marital deduction. May be used to avoid GSTT.

14. 14 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 14 Specific Trusts Used in Estate Planning (4 of 8)  Qualified terminable interest property (QTIP) trust (Also called the “C” or “Q” trust) Used to take advantage of the unlimited marital deduction.  Grantor Retained Income/Interest Trusts (GRITs) Grantor retains an interest in the trust (usually an income interest). GRATS, GRUTS, QPRTS, TPPTs.

15. 15 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 15 Special Trusts Used in Estate Planning (5 of 8)  Grantor Retained Annuity Trusts (GRATs) Fixed percentage of the initial contribution for life or for a term of years.  Based on Section 7520 rate 2.2% as of January 2014 Lower rate = lower payments to grantor Excess earnings above 7520 rate and appreciation during trust term are go to trust beneficiaries (usually kids or grandkids)  But no gift tax implications  Works great with an asset that has declined in value but has a good chance of recovering value

16. 16 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 16 Special Trusts Used in Estate Planning (5 of 8)  Grantor Retained Annuity Trusts (GRATs) If trust “fails” (doesn’t earn 7520 rate), no downside.  Grantor gets assets back  No different that if he never transferred them to trust If the grantor dies within the trust term, the FMV of the trust property is brought back into the gross estate.  So short-term GRATs of two years are common

17. 17 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 17 Special Trusts Used in Estate Planning (6 of 8)  Qualified Personal Residence Trusts (QPRTs) Personal residence trust.  Tangible Personal Property Trusts Personal property – artwork, antiques, etc.  Dynasty Trusts Long periods of time. Used to avoid transfer tax at the death of each generation.  Grantor Trusts Income taxed to grantor. Completed transfer for gift and estate tax purposes. Incomplete transfer for income tax purposes.

18. 18 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 18 Special Trusts Used in Estate Planning (7 of 8)  Trusts for minors – Sec. 2503(b) and Sec. 2503(c) trusts. Minors are not generally permitted to own property. 2503(b) – May hold assets for beneficiary’s lifetime but must distribute income annually. Annual exclusion available for the PV of the income interest. 2503(c) – Allows income to be accumulated but assets must be available to child when they turn 21. Annual exclusion available for the contribution.  Crummey trust Discussed previously.

19. 19 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 19 Special Trusts Used in Estate Planning (8 of 8)  Charitable trusts Discussed in Chapter 9.  Totten trusts POD accounts (not really trusts).  Blind trusts Revocable trust used when self management might be a conflict of interest (e.g., a politician).