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Financial Planning > Trusts and Estates > Trust Planning

Does Your Client Need a Trust?

By Roger Wohlner

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What You Need to Know

  • There are a number of trust types that can be useful tools in your client’s estate planning strategy.
  • Trusts allow clients a level of planning flexibility that a will cannot offer.
  • Trusts can be used to help mitigate taxes and can allow for a trustee to oversee the distribution of the assets.

When many people think about estate planning, their first thought is having a will. A will is a basic and essential estate planning document.

Wills direct how your client’s property will be distributed and can also direct who will act as the guardian for minor children if both parents are deceased. Wills can be subject to probate, which can delay the distribution of assets and can become contentious and expensive for heirs in some cases.

Beneficiary designations direct how the assets in retirement plans and annuities are distributed upon the account holder’s death. They also determine who receives the death benefit for a life insurance policy.

Some of your clients will have estate planning needs that are more complex and may need something beyond a will and proper beneficiary designations. A trust might be the answer in many of these situations.

What Is a Trust?

A trust is a fiduciary arrangement that allows the trustee, generally a third party, to hold the assets in the trust on behalf of the trust’s beneficiaries. There are many types of trust arrangements that specify how and when the trust assets pass to the trust beneficiaries.

Unlike a will, trusts generally do not have to go through probate after the trust grantor dies if structured correctly. This saves time and expenses such as attorney fees and court costs that can be incurred during the probate process.

Trusts can offer a level of flexibility that a will cannot. For example, a will goes into effect only when your client dies. Depending upon how the trust is structured, it can encompass a situation where your client becomes incapacitated during their lifetime.

Why Would a Client Consider a Trust?

Perhaps the biggest reason for a client to consider using a trust in addition to a will and other estate planning strategies is specificity. A trust can be structured to be very specific regarding to whom and when the assets in the trust are distributed. A will does not allow this degree of specificity.

While there are many types of trusts your client can consider, all trusts fall under two main types.

Revocable trusts allow the grantor to retain control over the assets in the trust. They can revoke the trust or change it at any time. One downside is that any income is taxable to the grantor of the trust due to the level of control they have over the trust’s assets.

With an irrevocable trust, the grantor gives up control of the trust’s assets once the trust agreement is finalized. Irrevocable trusts will generally have their own tax ID, and the grantor is not responsible for taxes on the income of the trust.

There are a number of reasons that your client might benefit from using a trust for some or all of the assets covered by their estate plan. Here are some examples of situations and types of trusts that might be appropriate for your client.

Maintaining Privacy

The probate process is a matter of public record. For any number of reasons your client may want to keep the details of their estate private. Perhaps they are a prominent local businessperson or professional. There could be issues surrounding certain family members or relatives.

Only the trustee and the beneficiaries are involved in the process, so privacy can be maintained.

Beneficiary Protection

An irrevocable trust can provide the beneficiaries with protection from creditors, lawsuits and in the case of a divorce.

Additionally, a trust can be structured in a way that protects the interests of a minor child beneficiary by setting limits and guidelines as to when distributions are made. This can help protect these beneficiaries from their own overspending and from others who might try to take advantage of them financially.

Special Needs Trusts

A trust can be structured to help provide for a a minor child or an adult with special needs. If properly structured, this type of trust can help ensure that the beneficiary maintains their eligibility for Medicare and Social Security benefits.

Special needs trusts are irrevocable trusts and thus are not subject to the claims of creditors or the winner of a lawsuit against the grantor or the beneficiary of the trust.

Marital Trusts

These are several types of marital trusts.

A marital A trust is established to benefit a surviving spouse. When the first spouse dies, the assets covered by the trust are transferred to a trust for the benefit of the surviving spouse. This allows any estate taxes to be deferred until the death of the surviving spouse.

During their lifetime, the surviving spouse must be the only beneficiary; upon their death the trust assets can pass to other named beneficiaries such as children, grandchildren and others.

A qualified terminable interest property trust, or QTIP, is used to provide income to the surviving spouse. Upon their death, the remaining assets go to beneficiaries that were named by the deceased spouse (the grantor). A QTIP is often used in second marriages and in other situations to maximize estate tax flexibility.

A marital B trust, or bypass trust, is often used in harmony with an A trust. These trusts are also referred to as family or credit shelter trusts. The B trust keeps these assets out of the surviving spouse’s estate altogether and can help the deceased spouse’s estate avoid estate taxes when the surviving spouse passes.

Depending upon your client’s level of assets and their desires for passing assets to a surviving spouse and/or the next generation, these or other variations of the marital trust can be useful.

Irrevocable Life Insurance Trust (ILIT)

An ILIT or irrevocable life insurance trust is designed to hold a life insurance policy for the purpose of excluding the death benefit from the grantor’s estate. There are rules surrounding how long the policy must be held inside of the trust to receive the estate exclusion. This can be a solid option for clients who want to leave a life insurance death benefit to their beneficiaries, but who need to have that death benefit excluded from their estate value.

The grantor can also set the trust up to allow the trustee to manage the policy proceeds for the trust beneficiaries or to allocate the death benefit among the beneficiaries based on their financial need or other factors.

Charitable Trusts

For clients who have charitable inclinations, there are two types of charitable trusts that can provide a benefit to a charitable beneficiary as well as to family members or other beneficiaries. Both of these trusts are irrevocable.

A charitable lead trust can be established by your client (the grantor) during their lifetime or as part of their will. The trust provides benefits to one or more designated charitable organizations for a set period of time, with the remainder of the trust’s assets distributed to family members or other beneficiaries at that time.

With a charitable remainder trust, your client can receive benefits for a period of time with the remainder going to one or more charities after a period of time or upon their death.

In both cases, the trust can be funded with appreciated securities, which allows your client to avoid any capital gains taxes that would apply if the securities were sold outright. There are tax deductions associated with the donations to these trusts, but the formula is a bit complicated, and your client should work with a tax professional who understands this.

GRATs

Grantor retained annuity trusts, or GRATs, allow the grantor to freeze the value of their estate while transferring any future appreciation to the beneficiaries. This can be a solid strategy for clients who want to avoid estate taxes and pass these assets to the next generation of children, grandchildren or others.

GRATs run for a fixed term and then the assets are transferred to the beneficiaries. GRATs also allow the grantor to take annuity income stream from the trust during the term of the trust.

Summary

In addition to the trusts discussed above, there are a host of other trust vehicles that can be valuable tools as part of your client’s estate planning strategy. The key is to work with them to determine their estate planning goals, the nature of the assets in their estate, their marital and tax situation, and of course, changes in the estate planning rules.

You will want to connect your client with a trusted estate planning professional, as well as an experienced tax professional to ensure they receive the full benefit of their expertise along with your guidance. You will also want to be cognizant of any legislative changes that might affect a trust strategy you and your client are considering.

Roger Wohlner

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