What are Benefits of Putting Money into a Trust?

For the average person, knowing how a revocable trust, irrevocable trust and testamentary trust work will help you start thinking of how a trust might help achieve your estate planning goals. A recent article from The Street, “3 Powerful Types of Trusts that Can Work for You,” provides a good foundation.

The Revocable Trust is one of the more flexible trusts. The person who creates the trust can change anything about the trust at any time. You may add or remove assets, beneficiaries or sell property owned by the trust. Most people who create these trusts, grantors, name themselves as the trustee, allowing themselves to use their property, even though it is owned in the trust.

A Revocable Trust needs to have a successor trustee to manage the assets in the trust for when the grantor dies or becomes incapacitated. The transfer of ownership of the trust and its assets from the grantor to the successor trustee is a way to protect assets in case of disability.

At death, a revocable trust becomes an Irrevocable Trust, which cannot be easily revoked or changed. The successor trustee follows the instructions in the trust document to manage assets and distribute assets.

The revocable trust provides flexibility. However, assets in a revocable trust are considered part of the taxable estate, which means they are subject to estate taxes (both federal and state) when the owner dies. A revocable trust does not offer any protection against creditors, nor will it shield assets from lawsuits.

If the revocable trust’s owner has any debts or legal settlements when they die, the court could award funds from the value of the trust and beneficiaries will only receive what’s left.

A Testamentary Trust is a trust created in connection with instructions contained in a last will and testament. A good example is a trust for a child outlining when assets will be distributed to them by the trustee and for what purposes the trustee is permitted to make the distribution. Funds in this kind of trust are usually used for health, education, maintenance and supports, often referred to as “HEMS.”

For families with relatively modest estates, a trust can be a valuable tool to protect children’s futures. Assets held in trust for the lifetime of a child are protected in the event of the child’s going through a divorce because the child’s inheritance is not subject to equitable distribution when not comingled.

Many people buy life insurance for their families, but they don’t always know that proceeds from the life insurance policy may be subject to estate taxes. An insurance trust, known as an ILIT (Irrevocable Life Insurance Trust) is a smart way to remove life insurance from your taxable estate.

Whether you can have an ILIT depends on policy ownership at the time of the insured’s death. In most cases, the insurance trust must be the owner and the insurance trust must be named as the beneficiary. If the trust is not drafted before the application for and purchase of the life insurance policy, it may be possible to transfer an existing policy to the trust. However, if this is done after the purchase, there may be some challenges and requirements. The owner must live more than three years after the transfer for the policy proceeds to be removed from the taxable estate.

Trusts may seem complex and overwhelming. However, an estate planning attorney will draft them properly and make sure that they are used appropriately to protect your assets and your family.

Reference: The Street (May 13, 2022) “3 Powerful Types of Trusts that Can Work for You”

Sometimes, Estate Tax Planning Can be a Challenge, Even for a Judge

Five and a half years into the case, the question of whether six life insurance policies at their cash surrender value should be included in the deceased woman’s taxable estate is one question, and the second is whether the estate is liable for the tax underpayment penalties. The policies were purchased for $30 million, reports Bloomberg Tax in the article “$30 Million Estate Tax Going To Be ‘Hard,’ Judge Says.”

The final ruling may also have an impact on the overall attractiveness of using this type of arrangement in estate planning. Known as a ‘split-dollar’ arrangement, this is an agreement between parties to split the cost and benefits of a life insurance policy, where a party paying premiums gets an interest in the payout.

The estate in this case is connected to a set of family businesses, described as the “Interstate Group,” accumulated over the decades after Arthur Morrissette began a moving company in 1943. Arthur’s surviving spouse Clara used her revocable trust to transfer $29.9 million to three trusts for the benefit of each of her three sons. That happened in 2006. The trusts then used the funds to make lump-sum payments for six permanent life insurance policies. Each son’s trust held a policy that insured the lives of the two other brothers.

The transactions were governed by split-dollar arrangements between Clara’s revocable trust and her son’s trusts. When an insured son died or an arrangement was terminated, Clara’s trust received either a policy’s cash surrender value or all of the premium payments on it, whichever was greater. If the policy remained in place until an insured son died, Clara’s payout would be taken out of the death benefit, and the son’s trusts would receive any remaining death benefit.

The first issue at trial was the motivation for setting up this type of split-dollar arrangement in the first place. In order to exclude the cash-surrender value of the life insurance policies from the taxable estate, tax rules require demonstration of a bona fide sale or business transactions. In other words, there needs to have been a significant non-tax reason for the arrangement to be put into place.

Attorneys representing the IRS said that the primary reason for the arrangements was to lower estate taxes, where having to wait to be repaid until the sons passed, lowered the present value of the rights Clara’s trust received in exchange for the $30 million.

One of the sons said that the family entered into the arrangement, so that money from a policy’s death benefit would help the surviving son buy each other’s shares at the time of their deaths, while also repaying their mother. He said that the policies paid a better return than the family was getting by putting the $40 million in investment accounts.

If the Morrissette’s argument about motivation prevails, the tax code also requires proof that Clara’s trust received something that was worth the $30 million that she put in. Experts debate what was the best real-world exchange with which to compare the split trust arrangements.

At the end of the trial, U.S. Tax Court Senior Judge Joseph Goeke said, “I look forward to your briefs, because for me this is going to be a hard case.”

This is a complex case, and estate planning attorneys will be watching it to learn if the split-dollar arrangement has a future.

Reference: Bloomberg Tax (October 14, 2019) “$30 Million Estate Tax Going To Be ‘Hard,’ Judge Says”