For many investors, trusts are an ideal way to keep
portfolios safer for the long term. The hard part is knowing what kind of
trusts to set up and how to do it. Trusts can protect assets from taxes and
legal threats, and provide income for family and descendants for years to come.
But if a trust isn’t set up correctly, it can be ignored by the courts. Here’s
a look at several kinds of trusts, which ones work best for whom, and mistakes
What It Is: This
is used to buy life insurance on behalf of the person establishing the trust.
The trust owns the insurance and pays the premium, and the benefits are paid
into the trust.
Life-insurance payouts can raise the risk that the insured’s
estate will be taxable. And if the estate is already taxable, the payouts make
the taxes worse. With a trust, the payouts won’t increase the beneficiary’s
estate. The death benefit can be paid immediately or stay in trust for
generations. The insured can put more than one policy into a single trust, or
create multiple trusts for different beneficiaries. Policies in a trust also
have some creditor protections.
Best for: The
trusts are ideal for someone younger, who can obtain life insurance at
affordable rates, and wants to protect any large insurance benefits from facing
Mistakes Often Made: Mr.
Weiss says he has seen people set up a trust but never put the policy into it;
others pay the premiums from their personal assets rather than from the trust.
In such cases, those payments are not protected from any wealth-transfer taxes.
What It Is: Also
known as GRATs, these trusts are typically short term, most commonly two to
five years, and allow people to transfer their wealth to family members with
little to no exposure to wealth-transfer taxes.
The granter places assets—such as cash, stocks or bonds—into
the trust and each year receives an annuity payment. At the end of the trust’s
term, if the trust’s assets have outperformed a “hurdle rate” set by the
IRS—also known as the 7520 rate—those excess returns are distributed to the
trust’s beneficiaries or into another trust, free of gift and estate tax. In
recent years, low interest rates have resulted in an especially low hurdle
rate, giving people more confidence their assets will outperform.
Best for: GRATs
are ideal for granters who want to pass on assets to their own children while
avoiding a hefty wealth-transfer tax. Through these short-term trusts,
investors often try to take advantage of market volatility, placing assets in
the trust that are expected to perform well in the next few years.
Mistakes Often Made: One
critical point: The granter must survive the term of the trust. If the granter
dies before the trust reaches the end of its term, the trust collapses and the
assets are returned to the granter’s estate.
What It Is: These
trusts allow families to use wealth-transfer tax exemptions of up to $5.34
million per person to place assets into trust and let them grow untouched. The
idea there is that you’re creating a family resource that’s a pool for future
Best for: They
are for individuals thinking very, very long term. Then later, the trust can
make tax-free distributions to the granter’s children, grandchildren or future
generations. The trust can specify whether beneficiaries will have access to
its income or principal, and when. Such trusts can provide a great deal of tax
Mistakes Often Made: Not
all states allow dynasty trusts. Delaware, Pennsylvania, Rhode Island, Idaho
and Louisiana are among the states that do. Also, granters should use the
trusts for assets they are confident will appreciate. If they use a
wealth-transfer tax exemption to fund a trust with a stock that falls in value,
the exemption ends up being wasted.
What It Is: A
homeowner can place a residence in this trust—often a second home—to transfer
the property later without paying full transfer taxes. The granter pays gift
tax when the home goes into the trust, but on a reduced value of the house,
since they reserve the right to live in it for the term of the trust. The value
of the home for gift-tax purposes is the fair market value minus the present
value of the granter’s right to use it during the length of the trust.
The trust lasts a certain number of years, and when it ends,
the beneficiaries—often children—will own the residence. Any appreciation of
the home since being placed in the trust is transferred to beneficiaries free
of gift and estate tax. If the granter dies before the trust’s term ends, the
home is transferred back to the granter’s estate.
Best for: People
with vacation homes who know they want to give them away to their children or
other family members down the line.
Mistakes Often Made: These
trusts are most beneficial when interest rates are higher, since that results
in a lower gift-tax value on the residence when it is placed in the trust.
What It Is: This
is a trust created to hold and protect assets during an individual’s lifetime.
While it doesn’t provide any tax savings, it does protect assets from probate.
The individual creating the trust can also assign a successor trustee in the
case of his/her death or incapacitation, which is a critical benefit.
Best for: A
revocable living trust makes sense for someone middle-aged or older who has
money or investments that they wouldn’t want the court to take over if there’s
something that happens to them. It also could be a good fit for someone seeking
privacy, as a living trust is shielded from public scrutiny, rather than the
estate being settled through probate.
Mistakes Often Made: Some
investors don’t put all the assets they should in the trust, so those assets
are not protected from probate.
What It Is: Here,
a granter puts assets into a trust and takes at least a 5% income interest, or
assigns it to another beneficiary. What is left at the end of the trust’s term
goes to charity, and the granter receives an income-tax deduction for that
amount. The beneficiaries pay income taxes on the distributions.
Best for: These
trusts are ideal for an investor who has assets that have already grown, since
assets in the trust can be sold without incurring capital gains taxes.
Mistakes Often Made: It
is advised working with a trusted professional, as the rules are very detailed.
here to access the full article on The Wall Street Journal.