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LIVING TRUST FREQUENTLY ASKED QUESTIONS

When should I set up a trust? Do I need one at all?

It depends on the size of your estate and the purpose of the trust. For example, if you mainly want a living trust to protect assets from taxes and probate but your estate is under the current federal tax floor ($675,000 for 2001) and small enough to qualify for quick and inexpensive probate in your state, some lawyers would tell you it isnít worth the cost. However, a trust can do a number of things a will canít do as well unless the will establishes a trust or pours over into a trust. If you want to avoid a court hearing if you become incompetent or unable to provide for yourself, or if you want to provide for grandchildren, minor children, or relatives with a disability that makes it difficult for them to manage money, a trust has many advantages. If you have a trust, your trustee can manage assets efficiently if you should die and your beneficiaries are minor children or others not up to the responsibility of handling the estate. And a trust can protect your privacy; unlike a will, a trust is confidential.

 

How do I decide which type of trust to use?

Two basic kinds of trust exist: revocable and irrevocable. Revocable trusts can be changed or even canceled any time after they are established. For this reason, they do not remove assets from a grantor's estate; the government considers those assets as being under the grantor's control. With a revocable trust, you must pay income taxes on revenue generated by the trust and those assets remaining at your death may be subject to estate taxes. Be absolutely sure of your decision before going ahead with an irrevocable trust. Irrevocable trusts cannot be altered or canceled once they are established. The assets placed into an irrevocable trust are permanently removed from your estate and transferred to the trust. The trust becomes a separate taxable entity that pays taxes on the income and capital gains it generates. Therefore, when you die, the appreciation of those assets is not considered part of your estate and thus avoids estate taxes.

What is an irrevocable trust and what are its tax advantages?

When you create a trust, you decide whether the trust will be revocable or irrevocable. A revocable trust can be changed or even dissolved by you at any time. An irrevocable trust, however, can never be changed. The assets you put into it must stay there. Beneficiaries cannot be added or deleted. And the only way to change the trustee is for that person to die or agree to resign. Why, then, choose to make your trust irrevocable? For tax advantages. An irrevocable trust or the beneficiary of the trust pays the income taxes on what its assets earn. When you die, the trust property is not part of your estate and will not be subject to death taxes. Conversely, revocable trusts offer no tax benefits at all. If you want lots of flexibility, make your trust revocable. But if you want tax breaks, you must forgo flexibility and form an irrevocable trust instead.

 

In regards to a trust, what is a settlor?

The settlor of a trust is the person who actually creates the trust. In other words, if you created a trust, you would be considered the settlor. Other terms synonymous with settlor include trustor, creator, grantor and trust maker. The settlor not only sets up the trust, but also names the beneficiaries. Other responsibilities include naming the trustees and choosing which property will be transferred to the trust.

What is a spendthrift clause in a trust?

Many types of trusts include a spendthrift clause. It's a provision that can prevent trust funds from being paid to anyone other than the trust's beneficiary. Including a spendthrift clause in a trust can, for example, prevent a greedy brother-in-law from getting his hands on assets that you left for your sister. In many cases, it can also keep the trust's assets away from creditors.

How can I use trusts to make sure my beneficiaries use their inheritance wisely?

To insure that an inheritance is used wisely, set up a trust in your will (called a testamentary trust). Trusts are popular among people with beneficiaries who arenít able to manage property well. This includes elderly beneficiaries with special needs or a relative who may be untrustworthy with money. It may be a good idea to require such beneficiaries to obtain money from a trustee who would exercise discretion about how to distribute it, instead of giving the money outright in your will. A discretionary trust gives the trustee leeway to give the beneficiary as much or little as he or she thinks appropriate. Another type of trust is a spendthrift trust. Itís simply a trust in which your instructions to the trustee carefully control how much money is released from the trust and at what intervals, so you can keep an irresponsible beneficiary from getting thousands of dollars in one stroke.

 

What is a charitable remainder trust (CRT)?

A charitable remainder trust, or CRT, is a trust designed to help you do well by doing good. If you form a charitable remainder trust, you place assets in the trust and get a charitable deduction to reduce the income taxes you owe for the year the trust is created. The trust can be tailored so that the revenue that its assets generate is passed along to you or whomever else you wish. When you die, whatís still left in the trust-the remainder-usually must go to the charity you have selected. Charitable remainder trusts can be fairly complicated to set up and also involve some complex tax issues. As a result, itís imperative to get the help of an attorney, estate planner and tax expert familiar with the way these trusts operate.

How does a charitable remainder trust compare to a gift annuity for charitable estate planning purposes?

If youíre planning to leave a good part of your estate to charity, youíll likely choose one of two vehicles to do so: a charitable remainder trust or a gift annuity. Your decision should be based on a number of factors, including flexibility and control issues. Charitable remainder trusts (CRTs) and gift annuities are similar in several ways. Both can provide you with a handsome charitable deduction. Both are designed to leave a charitable remainder to qualified charities. And, both can help you avoid paying capital gains taxes on the assets you donate. A charitable remainder trust, however, is generally more flexible than a gift annuity. If you use a CRT, you can eliminate, add or change the charity or charities you choose at any time. A gift annuity doesnít provide that option. In addition, a CRT can be structured to provide flexible income payments or even the cessation of income payments to the income beneficiaries. A gift annuity provides no such flexibility: the beneficiaries will receive scheduled payments even if they donít want them for tax reasons or would like to get more. A CRT also allows you to direct how the money in the trust will be invested. Still, a gift annuity can provide at least one important tax benefit that a charitable remainder trust usually doesnít. In a gift annuity, each payment consists of a portion of interest and a portion of principal. The principal portion of the payment isnít taxable. In a CRT, all the income that is paid to the beneficiary is usually taxed. As a result of these and other considerations, you should discuss your options with a qualified tax or estate planner as well as with an experienced attorney.

Donít you need to be worth a few million dollars to benefit from creating a charitable remainder trust?

Forming a charitable remainder trust (CRT) can make good financial sense for just about anyone, including most middle-income workers. According to Money Troubles: Legal Strategies to Cope With Your Debts (Nolo Press, Berkeley, Calif.), "These trusts once made sense only when giving away millions of dollars. But today, you can set up a CRT at little cost or effort for gifts as small as $20,000. So take a close look at these trusts. You could help yourself, your family and a charity."

Why do people set up a charitable remainder trust?

A charitable remainder trust can provide a variety of benefits, most having to do with taxes. According to the National Network of Estate Planners in Denver, "charitable remainder trusts are used for many reasons: "[The trustís] assets generally avoid federal estate tax by removing them from their makersí taxable estates. "Non-income-producing assets can be converted into income-producing assets without recognizing a taxable gain. "There is no capital gains tax on assets that are sold by the trustee. "A meaningful income stream of the trust makerís choosing can be generated by the trust. "A significant current income tax deduction is often created that can usually be carried forward for 5 additional years. When charitable remainder trust assets are invested, the resulting income is almost always higher than it would have been before the transfer. This occurs because the typical asset given to a charitable remainder trust is a portfolio of stocks, mutual funds. raw land or similar assets with a low cost basis and which are typically low income producers. After the tax-free sale of these highly appreciated but low income-producing assets, the resulting portfolio can be invested in assets that produce higher income under the direction and control of the trust maker acting as trustee.

How can I calculate the tax deduction I could take by creating a charitable remainder trust?

Creating a charitable remainder trust (CRT) can provide some important tax deductions, but you will likely need the help of a CPA, tax attorney or other specialist to calculate them. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "Your tax deduction is based on a complex formula involving the value of the trustís assets, the annual income youíre to receive, and how long youíre to receive it. The IRS publishes tables determining these figures. Also, there are limits on tax deductions for charitable gifts and the Alternative Minimum Tax could apply if your gift involves appreciated property." -- Robert K. Doyle, CPA, PFS

Does a charitable remainder trust have to make payouts every year?

When you form a charitable remainder trust (CRT), the trust must pay out a portion of its assets annually. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "This trust annually must pay out at least five percent of its initial market value. You decide who gets the income, how much they get, and for how long-and you can name yourself if you want. Assuming you take the income for as long as you or your spouse live, the charity will receive whateverís left at the second death."

Is it possible for me to make a gift to charity through a charitable remainder trust and still benefit my heirs?

You can set up a charitable remainder trust to pass on assets to your favorite charity. This can be arranged with your alma mater, a hospital that once cared for you, or your church or synagogue. If you deposit appreciated assets such as stocks or bonds in the trust, you receive an immediate income tax deduction for your contribution and pay no taxes on the gain in value of those assets. During your lifetime, or for a specified period, you or other individuals (such as your heirs) also receive an annuity generated by the trust assets. At your death, the assets are retained by the charity. Consult your tax adviser, your favorite charity and your estate lawyer for help with these complex trusts.

How can I form a charitable remainder trust so that all my assets go to charity when I die, and still leave an inheritance to my children?

If you form a charitable remainder trust and all of your assets are earmarked for a charity after you die, it doesnít mean that your kids and grandchildren will be left out in the cold. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "To replace that inheritance, the trust buys an insurance policy on you and your spouse equal to the size of your gift, naming your children (or whomever) as beneficiaries. "Premiums are paid from the income produced by the trustís assets and, upon the last death, theyíll receive the policyís death benefit-which is as much as they would have gotten had you left the original assets to them in the first place." Another advantage to this arrangement: Because your heirs receive their inheritance from insurance, not your estate, the cash passes to the kids free of income taxes, estate taxes, and probate.

Can I be my own trustee in a charitable remainder trust?

If you form a charitable remainder trust (CRT), you can name yourself the trustee if you want to be in charge of the trustís management. Or, if you want to sell assets whose value isnít easy to ascertain, you can name a special independent trustee to sell those assets and then become the sole trustee again after the sale is completed. According to the National Network of Estate Planners in Denver, most people "like to be in control of their assets and income; those who donít wish to manage their assets can certainly name professional trustees to administer their charitable remainder trusts. Alternatively, you can serve as trustee, assign investment responsibility to a bank or trust company, and retain the power, as trustee, to replace a company, if necessary."

How can a charitable remainder trust be established for different kinds of income beneficiaries?

A charitable remainder trust can be established for income beneficiaries in one of three ways. Here are those methods, as described by the Denver-based National Network of Estate Planners: 1. The charitable remainder trust can be established to pay income to a beneficiary for his or her life only. When the beneficiary dies, the trust will distribute the remainder of the assets to the charity. 2. The trust can be established for the life of joint beneficiaries, and will pay income to them until the death of the survivor. At that time, the balance of the funds will pass to the charity or charities. 3. The trust can be established for a specified number of years. The trust would pay income to the income beneficiaries for the specified term, and at the end of that term the remainder will be paid to a charity. This term cannot exceed 20 years.

Can I retain the lifetime right to name different charities as principal beneficiaries of my charitable remainder trust?

One of the benefits of a charitable remainder trust (CRT) is that you, as trust maker, have the power to change the charity or charities that benefit from the trustís creation. According to the National Network of Estate Planners in Denver, "Until the trust makerís death, he or she can reserve the right to change the charitable beneficiaries, if provided in the trust, as long as he or she replaces the charities with other charitable beneficiaries that qualify as such under the income tax laws." This feature can be especially handy if the charity you originally designated as the beneficiary either dissolves or falls out of your favor. If you donít like the way the charity spends the money it receives, you can remove its name from the trust and replace it with another charity thatís more to your liking.

If I give most of my assets to a charitable remainder trust, can I also name other charities to receive the payouts the trust will make?

If you create a charitable remainder trust (CRT), you can name other charities as the beneficiaries to receive payments from the trust-but thereís a hitch. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "You can name more than one person or organization to receive income, but at least one must be a non-charity."

Would it make sense to donate my Individual Retirement Account (IRA) to a charitable remainder trust?

Creating a charitable remainder trust (CRT) automatically entitles you to several tax benefits. But you can get some extra benefits if you donate your IRA to the trust. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "Another good idea if you want to make bequests to a CRT is to donate your IRA (or a portion of it) instead of your cash or other assets. Why? Because when you make a donation from your IRA, you avoid both the estate tax and the income tax on that money. That, in effect, leaves more for your family -- or the charity itself."

What are charitable lead trusts?

If you create a charitable lead trust and place some or all of your assets into it, the charity you select will get all the annual income the trust generates for the length of time you specify in the trust agreement. When the trust ends, your heirs will get back whatís left. Whatís in this type of arrangement for you? The primary advantage is that the gift to your heirs will be taxed at a reduced gift-tax rate that could save thousands or even tens of thousands of dollars-even if the assets in the trust have greatly appreciated over the years.

What is a NIMCRUT?

A net income makeup charitable remainder unitrust, or NIMCRUT, is a trust containing special language that allows the trustee to defer making distributions of income. A NIMCRUT is fairly flexible, in part because income can be deferred to later years. This allows the trustee to distribute income to the trust maker only when the maker needs it. Deferred income inside the trust can grow tax-free.

What is the difference between a charitable remainder unitrust and a charitable remainder annuity trust?

The key difference between a charitable remainder unitrust and a charitable remainder annuity trust is the way each trust determines the income that is paid to the income beneficiaries. If a charitable remainder unitrust (CRUT) is used, the trust maker will select a fixed percentage of the trustís principal that must be received. If the value of the trust goes up, the payments will go up accordingly. If the value falls, payments will fall as well. In a charitable remainder annuity trust (CRAT), a specified dollar amount is determined, and the payments will remain the same regardless of whether the trust principal goes up or down.

 

What is a life insurance trust?

Death benefits paid on a life insurance policy pass to the beneficiaries of the policy free of income taxes. But life insurance proceeds may be subject to federal estate taxes instead. You can make sure that your life insurance pays your beneficiaries free of both federal estate taxes and income taxes by having your insurance owned by an irrevocable life insurance trust. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "Because your irrevocable life insurance trust will be considered the owner of the life insurance upon your death, the value of your life insurance will be excluded from your gross estate. There is one exception to this estate tax-free rule, however. If you transfer the ownership of an existing policy on your life to your irrevocable life insurance trust and you die within three years of the transfer, the entire value of the policy is brought back into your estate for federal estate tax purposes." To guard against such a trap, some financial experts say that you should have the trustee of your irrevocable life insurance trust purchase a new policy on your life so that if you die within three years, the policy is excluded from your estate.

What is a Crummey trust?

A Crummey trust is a type of irrevocable life insurance trust that allows the trustís beneficiaries to demand that the trustee pay them their share of the monies contributed to the trust within a specified period. The name comes from D. Clifford Crummey, whose court case resulted in the approval of the demand right technique. Those rights, called Crummey rights or Crummey power, have since been expanded to beneficiaries of many other types of trusts as well. Premiums must be paid on the life insurance in the trust. Typically the grantor makes gifts to the trust of up to $10,000 per beneficiary. However, these gifts must be gifts of a present interest or the $10,000 gift exclusion will not apply. The Crummey power solves this problem.

Whatís the purpose of establishing an irrevocable life insurance trust?

The aim of an irrevocable life insurance trust is to keep the death benefits from a life insurance policy outside of the policyholderís estate -- and thereby remove the chance that the proceeds will be subject to a federal estate tax that can reach as high as 55%. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver, Colo.), "A properly established irrevocable life insurance trust owns life insurance on the life of the trust maker, thereby keeping the life insurance proceeds outside of his or her estate and avoiding federal estate tax (federal income tax is also avoided for different reasons). An irrevocable life insurance trust keeps policy proceeds free of federal estate tax upon the death of the trust maker and also on the subsequent death of his or her spouse. "The proper use of this type of trust allows the trustees to satisfy the trust makerís estate settlement costs and death tax obligations without subjecting the insurance proceeds to those costs and taxes. By utilizing this planning vehicle, a 50% federal estate tax bracket taxpayer can purchase half as much life insurance as he or she would own personally and still get the same after-tax insurance benefit for his or her beneficiaries. Or he or she could double the amount of the coverage passing to his or her beneficiaries without paying a dime more of premium."

What is the downside of establishing an irrevocable life insurance trust?

While establishing an irrevocable life insurance trust can provide you with several benefits, the trusts have their disadvantages. Some people consider these trusts too complicated and expensive to establish and maintain. They donít care much about controlling the proceeds from their life insurance policy, even if it means allowing the Internal Revenue Service to keep up to 55% of the money. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "Other individuals are concerned about the loss of control over the terms of the irrevocable life insurance trustís provisions and the inability to use the cash value of the life insurance. These people want to ensure that if tax laws change or their circumstances change, they can exercise some kind of control over the trust and its terms. Although the cost to create and maintain these trusts is but a small fraction of the eventual tax savings that will pass to their children and grandchildren, some people do not feel comfortable using this technique."

How does an irrevocable life insurance trust pay the insurance premium?

Typically, the premiums for life insurance held by an irrevocable life insurance trust are paid from annual gifts made to the trust by the person who establishes it. Crummey demand powers are used to preserve the tax-free gift exclusion for gifts of a present interest up to $10,000 per beneficiary.

Who should I pick as the trustee of my irrevocable life insurance trust?

When youíre deciding whom to name as the trustee of your irrevocable life insurance trust, you should automatically scratch both your name and the name of your spouse from the list. According to "Wealth Enhancement and Preservation" (The Institute Inc., Denver, Colo.), "It is very clear under tax law that you should not be the trustee of an irrevocable life insurance trust that you set up. The trustee probably should not be your spouse either. Many planners suggest that a good trustee for an irrevocable life insurance trust might be the local bank trust department. Bank trust departments deal with irrevocable trusts on a regular basis, as do accountants. Because of the technical nature involved in the administration of an irrevocable life insurance trust, it may not be a good idea to use individuals as your trustees unless they are extremely well versed and competent to handle the technicalities involved."

How do I transfer my group life insurance policy to an irrevocable life insurance trust in order to avoid estate taxes?

Many workers have a group life insurance policy through their employer. By placing these policies in an irrevocable life insurance trust, you can keep the proceeds out of your estate when you die and thus guarantee that the benefits will be free from the federal estate tax than can top 50%. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver, Colo.), "The transfer is made by preparing an assignment which irrevocably assigns all your rights under the group policy to your irrevocable trust. This would include your rights to ownership, your rights to change the beneficiaries, and your rights to convert the policy to a permanent form of insurance. This change of ownership should be documented and forwarded to the insurance company for its acknowledgment. The insurance company may have a form that is appropriate for your use. "However, it may be necessary to use your attorney. If any identification documentation is required (i.e. ownership certificates, etc.), this documentation should be reissued by the insurance company in the name of the irrevocable trust. "Some group policies include provisions prohibiting assignment of employeesí rights. If you find yourself in this situation, you should contact the insurance company and ask that it waive this prohibition; this usually requires the written consent of the insurance company and your employer."

Is there a way to have access to the cash value of life insurance owned in an irrevocable life insurance trust?

The cash value of a life insurance policy held within an irrevocable life insurance trust generally canít be touched. But using a special "split-dollar" arrangement can make the cash accessible. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver, Colo.), "A significant problem with purchasing life insurance in an irrevocable trust is that the cash value of the life insurance owned by the trust will be outside the reach of the trust maker during his or her lifetime. "A family split-dollar arrangement structures the ownership of the life insurance policy so that the insurance coverage is owned and held by the irrevocable life insurance trust, and the cash value or investment component of the policy is held separately by the trust makerís spouse without causing the insurance death benefit to be included in the makerís estate for federal estate tax planning purposes."

What is a living trust?

A living trust is a trust you create while you are still alive. You can serve as the trustee to keep control of the assets placed in the trust. But you should also name someone to succeed you when you die or if you become incapacitated. The primary goal of a living trust, sometimes called an inter vivos trust, is to transfer property outside the probate process while retaining control over it. With careful planning, creating certain types of trusts can also provide important tax advantages for you and your heirs.

What is a revocable living trust?

A revocable living trust is a trust that you create while keeping the right to modify it at any time. For example, you could replace the trustee, change the beneficiaries, or dissolve the trust completely whenever you so desired. With a revocable living trust, you are allowed to transfer as much property as you want to the trust without owing any gift tax. When you die, the property can bypass the probate process and instead can go directly to the person or people you have chosen to receive it. A revocable living trust, however, is not a tax shelter. It wonít reduce the income tax you owe while youíre still alive and it wonít reduce the inheritance taxes that may be due when you die. If you want a trust that provides such benefits, you should consider forming an irrevocable living trust or another type of trust.

What are the primary differences between a revocable living trust and an irrevocable living trust?

A living trust is a written agreement established while you are alive. You typically name yourself as the trustee of your trust, and another person-typically a relative, friend, lawyer or bank trust department-as a successor trustee to distribute the trustís assets if you die, or to act on your behalf if you become incapacitated. A revocable trust means the person who establishes it can change the terms of the trust at a later date if desired. An irrevocable trust, once established, cannot be changed. Setting up an íirrevocableí trust has tax advantages but they are rarely used since most people donít like to set up something they canít change later.

Do living trusts lock up your assets?

You may or may not be able to get back the assets you place into a living trust. It primarily depends on whether you choose a revocable living trust or an irrevocable trust. If you choose a revocable living trust, you are free to modify the trust or even dissolve it whenever you wish. This includes the power to place your assets into the trust and remove them later. If you instead choose an irrevocable living trust, the assets you place in the trust cannot be moved until you die. Irrevocable trusts can provide some important tax benefits that revocable trusts do not, but you have to give up some flexibility in order to obtain them.

Whatís the purpose of naming a successor trustee in my living trust?

When you create a trustee for your living trust, you obviously must name a trustee for it. However, you should also designate a successor trustee. A living trust is a written agreement that is established while you are alive (thus the name ílivingí). Typically you name yourself as the trustee of your own trust and someone else (relative, friend, lawyer or bank trust department) to be the successor trustee. This successor trustee can distribute the assets in the trust if you die but also can act on your behalf if you become ill and are unable to manage your own affairs.

Will my beneficiaries have to pay estate taxes or go through probate if I set up a living trust?

A revocable living trust allows you to "self-probate" your assets while you are alive and competent. The funding or retitling component of the revocable living trust process allows you, as the trust maker, to transfer your assets into your trust and consequently avoid the probate process. Whether forming a trust will reduce your estate taxes will largely depend on the type of living trust that you choose to create. If you form a revocable living trust, you can move assets in and out of the trust anytime you wish, but you will not reduce your taxes. If you choose an irrevocable trust, the assets you put in the trust will have to stay there, but the trust may provide you with tax advantages.

Can I set up a trust for my children inside my own living trust?

If you form a living trust, you can also put other trusts inside of it. Doing so can be especially useful if you have children and want to control when they get access to the money you will leave them when you die. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "You can even set up the children's trust in your own living trust. That will avoid probate as well as court guardianship proceedings-and you get to determine at what age your kids are entitled to receive the money. (You may decide to withhold the funds from them until well beyond age 18.)"

Can setting up a living trust provide any privacy protection for my estate?

When you form a living trust, you are also ensuring that the assets you leave behind when you die-and how you want those assets distributed-do not become open for all the world to see. Assets held in a trust are not a matter of public record when you die. With a will, the amount of your estate and the terms of the will are a matter of public record.

Should I name my revocable living trust as beneficiary of my IRA?

If you have created a revocable living trust, you can name the trust as the beneficiary of your Individual Retirement Account. However, it may make more sense to use the trust only as a secondary, or "back-up," beneficiary-especially if you are married. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "In many cases, it is preferable to name a spouse or some other designated beneficiary as the primary beneficiary of your IRA. You can then name your revocable living trust as the contingent, or secondary, beneficiary. By using this succession of beneficiaries for your IRA, your spouse will have the spousal elections that are available upon the death of the IRA owner. If the owner and spousal beneficiary are killed in a common accident, then the revocable living trust can serve as a receptacle for the IRA proceeds." In other words, naming your spouse or other beneficiary as heir to your IRA can provide the beneficiary with more flexibility in choosing how the accountís assets will be used after youíre are gone.

What are by-pass trusts?

A by-pass trust is a trust that is created by your will when you die. If you create a by-pass trust, you can structure it so that someone -- usually your spouse -- benefits from the trust during his or her lifetime while the principal is held in trust for your children or other beneficiaries. Under this type of arrangement, your spouse or other designee would get the income generated by the assets you placed inside the trust. Your spouse could draw up to 5% of the trustís assets or $5,000 a year, whichever is greater. If your spouse doesnít need the money, it could simply stay in the trust and continue to grow. And even if the value of the trust mushroomed by the time your spouse dies, no federal estate tax would be due because the value of the trust -- for tax purposes, at least -- would have been set at the time of your death.

What is a dynasty trust?

A dynasty trust is an irrevocable trust that allows rich people to avoid paying multiple estate taxes on property they want to pass to different generations of their descendants. For example, a grandmother could establish a dynasty trust for her son and her sonís descendants. The trust could be created while grandmother was still alive, or upon her death.

What are family trusts?

A family trust is a trust that has been established for the purpose of passing assets to children or other heirs rather than to a surviving spouse. A lifetime, or inter vivos, family trust is a common technique used to avoid probate. A trust holds assets so that when you die, those assets will not be considered part of your estate for probate and possible estate tax purposes. A trust agreement permits you to set aside assets for the ultimate benefit of another person, called the beneficiary. In some cases, the beneficiary will receive income from the trust assets for life, while in other cases, he or she will receive principal from the trust. A family trust can be revocable or irrevocable. You may change or cancel a revocable trust whenever you wish. On the other hand, be very certain before you set up an irrevocable trust. Once established, it cannot be altered or canceled.

What is a generation-skipping trust?

A generation-skipping trust is a handy tool to use if you want to leave assets to your grandchildren. In general, you can use a generation-skipping trust to leave up to $1 million without getting hit with a 55 percent generation-skipping tax. The transfers are subject to federal gift or estate taxes, but they can be fully or partially offset by the estate tax exemption equivalent, which is $675,000 in 2001. Generation-skipping trusts are especially tricky to structure, so be careful and get the help of a qualified attorney and tax specialist.

What is the purpose of a generation-skipping trust?

A generation-skipping trust is a trust you can create to benefit your grandchildren or their descendents. As long as the assets in the trust are $1 million or less, the transfer will usually be exempt from the generation-skipping tax, or GST. If you and your spouse each create a generation-skipping trust, you can each transfer $1 million and avoid the tax. If you transfer more than $1 million, the IRS could levy a GST as high as 55 percent-in addition to any estate or gift taxes that might be due when the trust is created. Generation-skipping trusts are especially tricky to properly structure, so be careful and get the help of a qualified attorney and tax specialist.

What does a management trust do for a limited partnership?

A management trust is a rarely used type of trust that is created solely to avoid the problems that can occur when the general partner of a limited partnership dies or becomes mentally incapacitated. By forming a management trust, partnership investors can provide for continuance of the partnership without the need for liquidation or court proceedings.

What is a marital trust?

Under current tax codes, you can transfer all of your estate to your surviving spouse without having to pay federal estate taxes by using the unlimited marital deduction. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "To take advantage of the unlimited marital deduction, you can provide in a will or trust that, upon your death, all your assets are to be distributed outright and free of trust to your spouse, or you can provide that all your assets will be transferred into a trust for your spouseís benefit during his or her lifetime. This type of trust is commonly referred to as a "marital trust." An outright distribution to your spouse or a distribution in a marital trust for the benefit of your spouse will defer the assessment of a federal estate tax against your assets until the subsequent death of your spouse." Itís also worth noting that marital trusts are extremely flexible, allowing you and your spouse plenty of leeway to mold it however you wish. If youíre married, forming a marital trust now can provide you or your spouse with some important tax breaks when one of you dies.

What is a qualified minor's trust?

A qualified minor's trust is an irrevocable trust you establish for the benefit of a minor. Because it is irrevocable, it cannot be altered or canceled once established. Assets placed into an irrevocable minor's trust are permanently removed from your estate and transferred to the trust. The trust becomes a separate taxable entity that pays taxes on the income and capital gains it generates. Therefore, when you die, the appreciation of those assets is not considered part of your estate and thus avoids estate taxes. Trusts are useful if you want your assets held separately for your young children. Upon your death, the trustee must report expenditures annually to a judge. If the trustee and the guardian of your children differ, this requirement acts as a check against the guardian's running off with your children's inheritance.

What is a testamentary trust?

A testamentary trust, sometimes called a death trust, is part of any last will and testament. A testamentary trust does not take effect until the person who made the will dies. As a result, the testamentary trust does not automatically prevent your assets from passing through probate or administration.

What is a qualified personal residence trust?

A qualified personal residence trust is an irrevocable trust created for the purpose of selling a personal residence to family members. It can be used to sell a vacation home to a family member, as well. Say you want to sell your home to your daughter. You could place your home in the trust, along with a limited amount of cash to maintain the house. You would decide how long you want the trust to last-five years, 10 years, whatever-and you could continue living in the property. When the term of the trust expires, ownership of the home would automatically pass to your daughter. You could continue living there as long as you paid a fair market rent for the property. The attractiveness of this trust results from the favorable gift tax valuation rules which apply when the trust is first created. When you transfer your ownership of the home to the trust, youíre making an immediate gift of the value of the "remainder interest " in the trust-in other words, the future interest that will pass to your daughter. Although youíll have to use the Internal Revenue Serviceís actuarial tables to determine this value, you can manipulate the outcome through a combination of a favorable appraisal and proper selection of the number of years the trust will last.

Are there cautions that should be heeded when considering a qualified personal residence trust?

While a qualified personal residence trust can provide some important tax and estate planning advantages, it also involves some pitfalls. Perhaps the biggest potential tax problem is the way the Internal Revenue Service will value your home if you die before the term of the trust has expired. If that happens, the home will be brought back into your estate at its value on the date of your death. So the tax benefits you had hoped to reap when you first created the trust will be wiped out.

 

What is an irrevocable trust and what are its tax advantages?

When you create a trust, you decide whether the trust will be revocable or irrevocable. A revocable trust can be changed or even dissolved by you at any time. An irrevocable trust, however, can never be changed. The assets you put into it must stay there. Beneficiaries cannot be added or deleted. And the only way to change the trustee is for that person to die or agree to resign. Why, then, choose to make your trust irrevocable? For tax advantages. An irrevocable trust or the beneficiary of the trust pays the income taxes on what its assets earn. When you die, the trust property is not part of your estate and will not be subject to death taxes. Conversely, revocable trusts offer no tax benefits at all. If you want lots of flexibility, make your trust revocable. But if you want tax breaks, you must forgo flexibility and form an irrevocable trust instead. -- Kenneth J. Strauss

What is Crummey demand power and how does it affect gift taxes?

Crummey demand power is an important tool in planning gift taxes. This power permits all transfers to a trust to qualify for the $10,000 gift tax exclusion even if the trust benefits are delayed into the future. The term "Crummey" comes from E. Clifford Crummey, whose court case resulted in the approval of the demand right technique.

Is the transfer of property into a trust subject to gift tax?

Gifts beyond a certain size transferred into a trust are subject to gift taxes. Current law permits each person to make an unlimited number of tax-free gifts per year, as long as gifts are not more than $10,000 each ($20,000 if a couple makes the gift). Gifts can be made to trusts and to charities, as well as to individuals. The gift tax rates, beginning at 18%, are the same as those of the estate tax. A gift tax return generally must be filed if the amount transferred into a trust exceeds $10,000. Married couples who consent to "split" gifts of over $10,000 but up to $20,000 must report the gifts to the IRS, although no gift tax is due under the annual exclusion. However, for gifts to a trust to qualify for the annual exclusion, they must be considered gifts of a present interest. Gifts of a future interest do not qualify for the annual exclusion. Although the facts and circumstances establishing a present interest can be complicated, this means whether an individual receiving the gift can currently utilize the gifts and its benefits or it is deferred until some future date and time. If there is deferral of the use of the gift, it does not qualify for the annual exclusion. Ė Jim Martin

How can I calculate the tax deduction I could take by creating a charitable remainder trust?

Creating a charitable remainder trust (CRT) can provide some important tax deductions, but you will likely need the help of a CPA, tax attorney or other specialist to calculate them. According to "The Truth About Money" (Georgetown University Press, Washington, D.C.), "Your tax deduction is based on a complex formula involving the value of the trustís assets, the annual income youíre to receive, and how long youíre to receive it. The IRS publishes tables determining these figures. Also, there are limits on tax deductions for charitable gifts and the Alternative Minimum Tax could apply if your gift involves appreciated property." -- Robert K. Doyle, CPA, PFS

Will my beneficiaries have to pay estate taxes or go through probate if I set up a living trust?

A revocable living trust allows you to "self-probate" your assets while you are alive and competent. The funding or retitling component of the revocable living trust process allows you, as the trust maker, to transfer your assets into your trust and consequently avoid the probate process. Whether forming a trust will reduce your estate taxes will largely depend on the type of living trust that you choose to create. If you form a revocable living trust, you can move assets in and out of the trust anytime you wish, but you will not reduce your taxes. If you choose an irrevocable trust, the assets you put in the trust will have to stay there, but the trust may provide you with tax advantages.

How do I transfer my group life insurance policy to an irrevocable life insurance trust in order to avoid estate taxes?

Many workers have a group life insurance policy through their employer. By placing these policies in an irrevocable life insurance trust, you can keep the proceeds out of your estate when you die and thus guarantee that the benefits will be free from the federal estate tax than can top 50%. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver, Colo.), "The transfer is made by preparing an assignment which irrevocably assigns all your rights under the group policy to your irrevocable trust. This would include your rights to ownership, your rights to change the beneficiaries, and your rights to convert the policy to a permanent form of insurance. This change of ownership should be documented and forwarded to the insurance company for its acknowledgment. The insurance company may have a form that is appropriate for your use. "However, it may be necessary to use your attorney. If any identification documentation is required (i.e. ownership certificates, etc.), this documentation should be reissued by the insurance company in the name of the irrevocable trust. "Some group policies include provisions prohibiting assignment of employeesí rights. If you find yourself in this situation, you should contact the insurance company and ask that it waive this prohibition; this usually requires the written consent of the insurance company and your employer."

 

What are the duties of the trustee of a trust?

If you are the trustee of a trust, your primary job is to administer the trust in the best interest of the beneficiaries while keeping the wishes of the grantor. According to "The Wall Street Journal Guide to Planning Your Financial Future" (Lightbulb Press Inc., New York), here are four of a trusteeís key responsibilities: 1. Manage trust assets to grow and produce income. This may require close supervision and ongoing decisions about what to buy and sell. It also means keeping accurate records. 2. Get the trust a tax identification number and insure that trust taxes are paid. 3. Distribute assets following the terms of the trust. The more discretion the trust provides about the payout terms, the more responsibilities the trustee has. 4. Oversee the final distribution of assets to the beneficiaries, if the trustee is still serving when the trust ends. Itís also worth noting that if you become trustee of a revocable trust because the person who set it up is dead or is no longer capable of making decisions, you may also find yourself acting as a guardian or conservator. This means you would have to handle living and health care arrangements as well as financial matters.

What criteria should I use in selecting a trustee for a trust?

In establishing a trust, your toughest decision will be choosing an outside trustee. Someone has to be ready to step in if you or your spouse can no longer serve. Here are some criteria for selecting a trustee offered by Jane Bryant Quinn, author of "Making the Most of Your Money" (Prentice Hall). A dependable grown child will see to your welfare, but might have bad financial judgment. A business associate might be good at managing your money, but help himself to it. A bank has investment experience, wonít skip out or steal, and will handle the paperwork. But itís not cheap. And it may not go out of its way to keep you happy. Co-trustees often work well-a family member and a bank or investment advisor. In the end, you can only go for integrity and keep your fingers crossed. And, of course, provide a method for replacing a trustee whom the family doesnít like.

Can I change my mind about who I designate as a trustee of my trust?

A trustee is an independent manager who administers the trust you establish to make sure that your wishes are fulfilled. You may act as trustee yourself, or ask a relative, a trusted friend or business associate, a financial professional like a lawyer or an accountant, or an institution like a bank or a brokerage firm. A trust must be established with a formal, written, legal document. You can do this yourself, with the help of do-it-yourself books or software, or you can consult an attorney who specializes in estate planning. There are two types of trust: revocable and irrevocable. A revocable trust can be changed or even canceled at any time, so there would be no problem in changing the trustee. An irrevocable trust cannot be altered or canceled once it is established, so if you wish to retain the right to change the trustee, that right must be written into the trust document.

As the trustee of a deceased personís trust how can I make distributions without getting myself into trouble?

When you are named the trustee of someone elseís trust, you have to be extremely careful. You may be sued and held personally liable if you are negligent in the handling of the trustís assets and liabilities. According to "Legacy: Plan, Protect & Preserve Your Estate" (Esperti Peterson Institute Inc., Denver), "You must maintain accurate records regarding trust property, including additions of principal and income. Liabilities are even more critical because if an unexpected obligation pops up after you have distributed assets to the beneficiaries, it is difficult to retrieve the funds. You could become personally liable if you distributed funds without properly paying all creditors." To protect against these dangers, you might want to hold some of the trustís assets back for a year or more so the last of the bills can trickle in. Once youíre sure that all liabilities have been covered, itís safe to make final distributions to the beneficiaries.

Whatís the purpose of naming a successor trustee in my living trust?

When you create a trustee for your living trust, you obviously must name a trustee for it. However, you should also designate a successor trustee. A living trust is a written agreement that is established while you are alive (thus the name ílivingí). Typically you name yourself as the trustee of your own trust and someone else (relative, friend, lawyer or bank trust department) to be the successor trustee. This successor trustee can distribute the assets in the trust if you die but also can act on your behalf if you become ill and are unable to manage your own affairs.

Can I be my own trustee in a charitable remainder trust?

If you form a charitable remainder trust (CRT), you can name yourself the trustee if you want to be in charge of the trustís management. Or, if you want to sell assets whose value isnít easy to ascertain, you can name a special independent trustee to sell those assets and then become the sole trustee again after the sale is completed. According to the National Network of Estate Planners in Denver, most people "like to be in control of their assets and income; those who donít wish to manage their assets can certainly name professional trustees to administer their charitable remainder trusts. Alternatively, you can serve as trustee, assign investment responsibility to a bank or trust company, and retain the power, as trustee, to replace a company, if necessary."

Who should I pick as the trustee of my irrevocable life insurance trust?

When youíre deciding whom to name as the trustee of your irrevocable life insurance trust, you should automatically scratch both your name and the name of your spouse from the list. According to "Wealth Enhancement and Preservation" (The Institute Inc., Denver, Colo.), "It is very clear under tax law that you should not be the trustee of an irrevocable life insurance trust that you set up. The trustee probably should not be your spouse either. Many planners suggest that a good trustee for an irrevocable life insurance trust might be the local bank trust department. Bank trust departments deal with irrevocable trusts on a regular basis, as do accountants. Because of the technical nature involved in the administration of an irrevocable life insurance trust, it may not be a good idea to use individuals as your trustees unless they are extremely well versed and competent to handle the technicalities involved."

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