It was all hands on deck last year as the fiscal cliff pushed billions of dollars into irrevocable trusts. Here is where advisors can lay off the panic button and get back to adding long-term value.
The big question in the trust community this year really boils down to what the industry does for an encore.
On the one hand, recurring threats to increase the reach of the federal estate tax have gotten upper-middle-class families as eager to shield their property as the truly rich.
But on the other, most of the assets have already flown, leaving many advisors who rode the trust wave to ask what’s next.
This is actually a big opportunity for those who can switch gears from helping people create trusts to the heavy lifting of keeping those vehicles properly, says top attorney John O. McManus.
He still preaches the importance of those families who have not yet transferred their estates into an irrevocable trust – as he notes, the assets should continue to appreciate – but those who already have are often at a loss.
“I always explain to my clients that the creation of a trust shouldn’t be viewed as a box to check,” he says. “Rather than setting up the trust and moving on, new planning ideas can be continually implemented that utilize the trust as a leading instrument to accomplish one’s financial mission.”
Here’s the checklist he’s giving fellow advisors to consider when it comes to managing an existing irrevocable trust:
1. Are all trust accounts, real property owned by trust, and life insurance policies held in trust correctly titled?
a. While estate planning and, in particular, trusts set the framework for a successful wealth transfer, you must fund the trust and accounts must be titled in the proper manner.
b. By operation of law, accounts first move according to titling. The difference between a “tenants in common” ownership of an asset and “joint with rights of survivorship” can change the ability to properly fund trusts contemplated in your planning work.
c. Be sure that all beneficiary and owner designations for home and life insurance plans also are set to reflect the trust as owner.
2. How does the tax basis of an asset and its projected future growth affect future planning? What future swaps of assets might you consider?
a. Giving away a low-basis asset may incur a capital gains tax in the future if the trust decides to sell the asset.
b. The government gives all assets in the decedent’s estate a step-up in basis. This could be a useful strategy for certain assets. Swapping out low-basis items to take advantage of the step up in basis might make most sense.
3. How do we avoid common filing and reporting errors, especially payment of income taxes? If it’s a grantor trust, do we file an income tax return?
a. For almost all of the trusts we have created, the grantor will pick up the income earned by the trust on his or her own personal income tax return. This way the trust assets will be further preserved.
b. Even though the grantor pays the income tax, it is a good idea to file a tax return for the trust the first year that it exists to create a record with the IRS.
c. When filing gift tax returns for assets gifted to trust, be certain to elect to take advantage of the generation-skipping tax exemption amount.
4. Now that the trust is funded, what post-funding strategies can be employed to impact the trust to better meet your goals?
a. In addition to swapping assets as mentioned above, the trust can make loans, hold notes and invest in ways that can be beneficial to the grantor.
b. The trust can buy and sell assets, and make purchases such as buying life insurance, private equity or hedge fund commitments.
5. If you have not used the full exemption amount ($5.25MM), should you consider making additional gifts now to further “freeze” the estate?
a. With the exemption amount set to adjust for inflation each year, there is additional opportunity to preserve assets outside of your estate and protect any future growth.
b. In early budget talks, President Obama has once again picked up the discussion of lower exemption amounts and higher tax rates. With the end of the Bush era tax cuts, the president may feel that he has a firm enough footing to reduce the exemption.
6. If your life insurance has been transferred to trust, are you properly maintaining the trust to address annual payments?
a. If the policy was not initially purchased directly by the trust, be sure that the new owner and beneficiary designations are changed to reflect the trust ownership. Often a Trust Certification is also required. This is a short form that the insurance company will provide.
b. Life insurance trusts require a non-interest bearing checking account from which premium payments can be made.
c. Annual Crummey notices must be sent to beneficiaries of the life insurance policy. This is a short formulaic letter that informs the beneficiaries that a “present interest gift” has been made to the trust, for instance, to cover premium cost.
7. When and why should you transfer a trust to an asset-protected state? What states are most favorable?
a. States that allow levels of asset protection often permit the grantor, through a power of appointment, some access to the assets in trust.
b. Alaska, Delaware, Nevada and South Dakota are the states with the most favorable asset protection laws.
8. When should you consider an institutional trustee? What are the pros and cons? When an individual is named as trustee, does he know his responsibilities?
a. An institutional trustee may be needed for trusts sitused in a state other than the state of residence of the grantor. If a New York resident wants to have her trust in South Dakota for asset protection purposes, an institutional trustee will be needed.
b. We often recommend the spouse serve as trustee, but in instances where no such close relation exists, or where there is likely to be some level of disagreement, the formality of the institutional trustee can be helpful.
9. When your trust owns your primary residence, how should you cover expenses, insurance and titling? If you are the occupying tenant, is there a formalized lease agreement?
a. One good way to ensure there is a paper trail to indicate to the IRS that the residence is, in fact, owned by the trust, is to create a formal lease. The satisfaction demanded of the lease could be set to equal the carrying costs: maintenance, property tax, etc. This way the grantor can cover those costs and still reside in the home.
b. If the trustee of the trust that owns the home is the spouse, it is the spouse’s prerogative to allow whoever she wants to live in the house with her. A lease structure can only help in this case, but may not be essential.
10. How should you make distributions when the family business or other corporate entity (LLC, partnership, etc.) is owned by a trust? Are two transactions necessary?
a. For asset protection purposes, it is important to operate these entities as legitimate businesses with income passing into accounts in the name of such entities, expenses paid from such accounts, and otherwise abiding by the provisions of the company’s operating agreement.
b. If an asset held inside the LLC, partnership etc. earns income, that money could be held in an account in the name of the LLC, partnership etc. Another option is that it could be released to an account in the name of the trust, which is the member or partner. Once in a trust account, such cash may be invested, distributed to beneficiaries or otherwise managed in accordance with the trust agreement.