Trusts serve all kinds of purposes: from helping pass your wealth to future generations to making significant contributions to nonprofit organizations. The majority of trusts function as an estate and gift tax planning strategy. This is certainly an area in which trusts offer individuals and their families significant utility, however, it’s far from the only application.
There are many different types of trusts, each with unique characteristics and use cases. Many can be used in estate planning, such as Grantor Retained Trusts, Dynasty Trusts, and Revocable Living Trusts. Others, such as Charitable Remainder Trusts, deliver tax benefits while enabling donors to make contributions to charities they wish to support. While Special Needs Trusts help ensure beneficiary’s health and ongoing support is delivered.
Establishing a trust can unlock a wide variety of tax and legal benefits, but it’s important to understand the distinct types of trusts, the reasons that individuals typically establish trusts, and the process of setting up a trust. Throughout this process, the support of qualified professional advisors, including attorneys, accountants, and investment advisors is an indispensable asset.
In simple terms, a trust is a separate legal entity from an individual’s estate. The terms of the trust are memorialized in a legal document that governs how assets should be managed and disbursed to the beneficiaries of the trust.
There are several key terms you must understand:
Trusts can take many forms, offering individuals a much greater deal of flexibility than a will.
There are many distinct trust structures, each of which serves a different purpose. In general, trusts can be structured in one of two ways: as a revocable trust or an irrevocable trust.
Revocable trusts, sometimes referred to as living trusts, can be changed after they are created. They allow individuals to transfer their assets into a separate legal entity, allowing for some basic asset protection. However, in many senses, the grantor is still considered the owner of these assets. Among other implications, this means the grantor is responsible for filing tax returns on behalf of the trust.
Revocable trusts offer grantors more control over their assets during their lifetime while helping your successors avoid the often lengthy probate process after your death. In some instances, the assets of the trust will be disbursed to families upon the grantor’s death. In others, the trust will become an irrevocable trust.
An irrevocable trust cannot be altered after it is created. The grantor no longer has control over their assets – everything is considered the legal property of the trust. This affords your estate a greater level of protection and unlocks tax benefits that minimize estate and gift taxes after your passing.
Irrevocable trusts are common and there are many different options available. They can be used for everything from passing assets down to your children to establishing a fund to support a charitable cause you’re passionate about. Examples of irrevocable trusts include:
There are many reasons an individual may consider establishing a trust. For the majority of people, estate planning and asset protection are the primary drivers to establish a trust. The type of trust you choose to set up to manage your estate depends entirely on your financial situation, family, and goals.
Wealthy individuals might create a dynasty trust that disburses a specific amount of investment income to beneficiaries each year but maintains the principal. Perhaps you would like to disburse your estate to your children once they reach a certain age. Or maybe you have children with special needs who are unable to work full-time or manage their own finances, and need to make provisions for their care. Every family is unique, and to a certain extent, so is every trust.
Trusts also offer value in other ways. Transferring your individual assets to a trust protects them from creditors and can eliminate the need for your estate to go through probate. There are also potential tax benefits, such as the ability to move income to beneficiaries in a lower tax bracket or to a lower-tax jurisdiction.
While trusts offer many benefits, they are not always the optimal solution since they come with administrative burdens. For example, if the assets of the trust dip below a certain threshold, it may make financial sense to close the trust and distribute remaining assets between beneficiaries. Clauses giving guidance on when a trust might be fully distributed can be included in the trust documents, which is just one of the numerous ways trusts can be designed to fully incorporate grantor’s wishes for the management of their assets.
The decision to set up a trust should not be taken in isolation. It’s important to work closely with accountants, attorneys, and investment advisors to craft a trust that guides and protects your assets as you envision, both during your life and after your passing.
As accountants, our role is to outline the types of trust well-suited to your unique situation, explaining the benefits and drawbacks of each type, while consulting how the trust structure can enhance or hinder your individual estate plans. Attorneys work to ensure that you understand the legal ramifications and the entity structure of the trust, while investment advisors provide guidance on how to best conserve and grow the assets of the trust.
If you choose to appoint a trustee that is not yourself, it’s important to confirm that this individual is willing and able to take on this role. Serving as a trustee is a considerable responsibility, as the individual has a fiduciary duty to the beneficiaries to manage the trust consistent with the trust document. They are responsible for tasks such as protecting and managing the assets for beneficiaries, considering the impact and need for distributions, and ensuring all tax filing requirements are fulfilled. In some cases, using a corporate trustee may be an option to ensure the trust will be appropriately managed.
Once all parties are aligned, a legally binding document will be drafted, executed, and you will transfer your assets into the trust. Take note, however, that this is not the end of the compliance: the assets within the trust must be managed and tax filings must be completed annually since it is now a separate legal entity.
Crafting a trust that represents your wishes is a vital step for many individuals, ensuring that your family continues to be cared for for decades to come. It’s an extremely important element of estate planning that demands the support of sophisticated professional advisors.
At Smith + Howard, we provide a wide range of estate planning services related to the setup and ongoing management of a wide variety of trust vehicles. Our team takes a proactive approach, advising clients when they reach a point in their wealth-building journey where a trust is a good fit and providing guidance on the optimal estate planning strategy. We are also able to assist on an ongoing basis with tax filings and other compliance requirements.
To learn more about setting up a trust, contact an advisor.
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