Over the past several years, there has been a noticeable uptick in the use of trusts as a planning tool for many of my clients. There are a range of uses for trusts and this narrative will serve as a primer for those clients who have objectives where trusts might serve as a solution. Please note that I am not a lawyer and this discussion should only serve as a catalyst to contact a qualified estate planning attorney.

Before examining benefits, a clear line of distinction must be drawn between revocable and irrevocable trusts. As its name suggests, revocable trusts can be terminated anytime during the grantor's lifetime. The trust is not a separate tax entity and income is taxed to the grantor as if they owned it directly. Revocable trusts attempt to achieve several objectives. First, management of the trust assets can continue if the grantor becomes disabled. Second, flexibility is maintained by retaining the right to name individuals or trust companies who may be located out of state as well as the ability to change beneficiaries. Third, privacy of trust assets is maintained since they are not subject to public disclosure. Fourth, the trust assets are not subject to probate. Finally, trust assets are available to pay estate expenses associated with the death of the grantor without waiting for a probate decree.

While irrevocable trusts have some drawbacks, they are offset by significant benefits. An irrevocable trust is a separate tax entity. In fact, most often it has its own tax identification number. Income at the trust level may be subject to very onerous taxes with only $12,300 of taxable income subject to the maximum tax bracket of 39.6%. The grantor of the trust may not terminate it without the consent of the beneficiaries or a court order. Despite these restrictions, irrevocable trusts can be quite advantageous. Benefits include creditor protection, exclusion from estate taxes and the shifting of income from the grantor to the trust that may result in lowering the individual tax bracket.

Early in my career, estate thresholds were at much lower levels than the current federal exemption of $5.43 million per individual. Furthermore, the highly beneficial portability of the unused portion of the deceased spouse's federal estate tax exclusion to the surviving spouse was not permitted. As a result, many modest estates were subject to federal estate taxes. The establishment of a credit shelter or so-called A-B Marital Trust was often devised to maximize exemptions for both spouses. While its use to minimize federal estate taxes has since been diminished, it still has utility in reducing state estate taxes. For example, in Massachusetts, the estate tax exclusion for each individual is $1,000,000. Between life insurance death benefits, the equity in many homes and the value of retirement plans, this threshold is often easily exceeded. The proper application of a credit shelter trust can ensure that each spouse maximizes this exclusion and minimizes state estate taxes.

With divorce rates hovering at around 50%, many couples in second marriages with children from a first marriage will often employ the use of a Qualified Terminable Interest Property (QTIP) Trust. The assets in this trust qualify for the unlimited marital deduction and achieve two objectives. First, trust income is used for the benefit of the surviving spouse during their lifetime. However, the surviving spouse does not own the assets and cannot sell or give them away. As a result, a second objective can be achieved upon the death of the surviving spouse where beneficiaries named in the trust, generally the children from the grantor's spouse's first marriage, receive the trust assets in tact.

For those clients with sizable estates that are subject to federal estate taxes and wish to fund a vehicle that does not inflate the estate and can be used to pay the estate tax, the use of an Irrevocable Life Insurance Trust (ILIT) is as relevant today as ever. By using the annual gift tax exclusion of $14,000 and, perhaps, a portion of the lifetime gift tax exclusion to pay the premium, the grantor purchases a life insurance policy that is owned by the trust and the trust is also the beneficiary. All death benefits are excluded from the estate and can be used to pay estate taxes and create a tax free legacy for heirs.

The most common types of trusts I currently encounter are Medicaid Trusts. With nursing home costs skyrocketing and the desire of individuals to protect their hard earned assets for their family, the use of these trusts has grown exponentially. They are irrevocable trusts designed to protect assets from a state lien in the event the grantor requests state assistance while confined in a nursing home. Two important requirements must be met to insulate trust assets from a lien - assets must have been transferred to the trusts for at least 60 months prior to applying for Medicaid and the Medicaid applicant must not be named as a trust beneficiary. However, the grantor may receive income earned from the trust assets, select and remove trustees and change beneficiaries.

As many of my clients age and become concerned about the long term care of disabled children with a chronic illness, the use of Supplemental Needs or Special Needs Trusts have become more prevalent. The funds in this trust are non countable assets as it applies to qualifying for government benefits and generates supplemental benefits above and beyond what the government provides. The trust must be irrevocable and established before the beneficiary reaches age 65.

While the use of trusts to minimize or eliminate estate taxes has declined, the aging population and their concern about the protection and distribution of assets for their family has increased dramatically. With proper and timely design, trusts can be an excellent tool to accomplish an assortment of estate planning objectives. In all cases, you should consult with your estate planning attorney to determine if a trust makes sense for you.


Clifford L. Caplan, CFP®, AIF®

In the News: In the June 12th edition of the Wall Street Journal in an article titled "Turning Savings into Steady Income", I commented on the pros and cons of using managed payout accounts for steady income during retirement.