FPA Financial
Planning Perspectives
Provided by
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Trusts have become very
popular, especially as fortunes are made in the stock market and baby boomers
inherit wealth. At their most basic, trusts are nothing more than a legal
vehicle for managing financial assets for the benefit of yourself or someone
else. As simple as that may sound, they can be very complex, and there remain
many misconceptions about trusts that often lead to their being unused or
misused. Here are a few of those misconceptions.
All trusts save estate
taxes.
Contrary to popular belief, one of the most popular trusts today, the living
trust, does not necessarily save estate taxes. Properly designed and executed,
it can avoid the expense and public exposure of probate. It can be a good
vehicle for managing assets for someone who is not capable of managing the
assets. But as often used, a living trust does not save a dime in estate taxes,
though with special provisions, it can defer estate tax upon the death of the
first spouse.
The purpose of most trusts
is to save estate taxes. That’s a major purpose for many of the over 50 trusts available, but
it’s far from the only one. Trusts are also designed to manage assets and
control their distribution. Trusts can save income taxes. For example, with a
charitable remainder trust (CRT), the donor puts assets in the trust that
qualify for an income-tax deduction. At the same time, it removes assets from
the estate and thus saves estate taxes. In addition, the CRT pays out regular
income to the donor, and then upon the donor’s death the assets pass to the
charity.
When a person remarries,
they might use a bypass trust to ensure that at their death their
assets—regardless of whether the assets are subject to estate tax—go to their children
rather than the children from the previous marriage of their surviving spouse.
You don’t need a trust
unless you have a big estate. Certainly trusts are more common for larger
estates. However, the estates of middle-income households can be larger than
they realize with today’s retirement plans, insurance and escalating home
prices—large enough to be subject to estate tax. Furthermore, even if your
estate isn’t large enough to be taxable, or should Congress eventually
eliminate or reduce estate taxes, you may still have reason for a trust. For
example, a family with a disabled adult child receiving government assistance
for basic living and medical expenses might want to create a special needs
trust. Friends and family can donate money to the trust, which in turn uses the
money to provide extras for the child such as a vacation or a stereo system. As
long as the trust doesn’t use the money for basic living or medical expenses,
it won’t jeopardize government assistance.
Creating a trust means giving
up control and flexibility. Any form of revocable trust or living trust remains completely under
the control of the trust creator. However, even an irrevocable trust, which
can’t be changed while you’re alive or which is created at your death, can
still provide considerable control and flexibility. For example, “incentive
trusts” may stipulate that the beneficiary graduate from college or reach a
certain age before receiving trust income or assets. Often the worst problem is
that irrevocable trusts are drafted with too many restrictions and not enough
flexibility for the trustee.
You should always name a
friend or relative as a trustee. The job of a trustee is to manage and distribute
the assets according to the terms of the trust. Not all relatives or friends
are up to that task, particularly for a complex trust. Failure to administer
the trust properly can be costly from an investment and tax standpoint. In
addition, a long-term trust could outlive family trustees. Thus, professional
management may be appropriate either as a co-trustee or the only trustee.
Trusts automatically protect
assets from creditors. No, but some trusts are designed to protect assets from creditors.
It’s a very complicated and expensive area, so only deal with experts. Even
trusts set up for asset protection won’t protect assets resulting from events
that occurred before the trust was formed, such as back taxes claimed by the
IRS.
February
2001— This column is produced by the Financial Planning Association, the
membership organization for the financial planning community, and is provided
by Rich Chambers,
CFP, a local member in good standing of the FPA.
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