USE OF TRUSTS
USE OF TRUSTS
1. REASONS TO USE A TRUST
There are two main reasons to use a trust:
• to save taxes by making the trust property available to a beneficiary but in such a way that it will not be taxed in his or her estate at his or her later death;
• to provide for management of trust property when you don’t want the beneficiary to have complete control over it.
Example of Tax Savings
• If a decedent leaves a bequest directly to a beneficiary without a trust, what is left will be taxed in that beneficiary’s estate at his death. If the bequest is left in trust for the beneficiary, it will be available to the beneficiary during his or her life but what remains at the beneficiary’s death may escape estate tax in the beneficiary’s estate and pass on to the next generation of beneficiaries undiminished.
Examples of Management
These are some situations where a trust might be desirable for management regardless of tax savings:
• beneficiary is not capable of handling financial affairs by reason of age or illness;
• donor doesn’t trust beneficiary’s financial judgment;
• beneficiary does not want to be involved in day to day asset management;
• donor wishes to provide some protection of the assets against beneficiary’s creditors, divorces, etc;
• donor does not want surviving spouse to have complete control because of possibility of remarriage; the spouse may also feel more comfortable without complete control of the assets in the event of remarriage–won’t have to make hard choices between children and the second spouse and may lessen the need for a prenuptial agreement.
2. WHAT IS INVOLVED IN THE MANAGEMENT OF A TRUST
“Management” of a trust involves four primary functions:
• making discretionary decisions as to how much to distribute to beneficiaries, payment of beneficiaries’ bills where appropriate and periodic consultation with the beneficiaries concerning their financial needs;
• custody of trust assets, including collection of dividends and interest, stock splits and other capital changes and preparation of trust accounts;
• tax planning and tax return preparation (trusts file annual income tax returns just as individuals do);
• making investment decisions.
You may not be able to think of one person or entity with the ability to perform all four of these management functions. For instance, your broker or financial planner may be a great investor, but he or she may not be the person you want to be making discretionary decisions concerning distributions to your family. The one function that only a trustee may perform is the first one. The trustee can hire others to perform the last three management functions, although he remains responsible for overseeing them.
3. WHO MAY BE TRUSTEE
There are three main possibilities for choice of trustees:
• the beneficiary himself or herself;
• a family member or friend;
• a professional trustee.
A key function of the trustee is to make the decision whether principal should be distributed to the beneficiary. The beneficiary will have to ask the trustee for a distribution and explain why it is needed. Therefore the trustee must be someone the beneficiary is comfortable with in that situation. In some cases it may be appropriate to have a family member and a professional trustee serving together.
4. TRUST DISTRIBUTION STANDARD - AT WHAT LEVEL IS THE BENEFICIARY TO BE SUPPORTED?
Once you have decided to use a trust and have chosen trustees, you must make the further decision as to the level at which the beneficiaries are to be supported. This is determined in part by the anticipated size of the trust. It may also be determined by the level of support, if any, you are providing to the beneficiary during your life, the level of support the beneficiary has come to depend on.
Example 1 - The trust is only to save taxes by keeping what is left at the beneficiary’s death out of the beneficiary’s estate.
The donor's thinking: I am only using the trust to save estate taxes on the death of the beneficiary and protect the assets from the beneficiary’s creditors, and to the extent I can, in case of divorce. I want the beneficiary to be able to use up the trust during his life if he wants to, and would like the trust written so the trustees can generally give him what he asks for.
Example 2 - The beneficiary is well off on his own.
The donor's thinking: I would like the beneficiary to have the trust income (which I know might only be 1%-3% of the value of the trust annually), and I want the trust principal to be there for him if he has setbacks and needs it. Otherwise, I would like the trust principal preserved so that it can grow and ultimately go to the beneficiary’s children.
Example 3 - The beneficiary is not well off and not good at managing money.
The donor's thinking: the beneficiary is not well off and not good at managing his finances. I would like him to receive an amount equal to 3% of the value of the trust each year which I hope will improve his standard of living, but without exhausting the trust during his lifetime. I would like principal to be otherwise conserved and only used for medical emergencies, for the education of his children, for a vacation every few years in addition to those he can afford himself and, in case of financial reversals, to keep him at the standard of living he achieved at my death with his own funds, plus the 3% distributions.
Example 4 - Continue support given during life and a little more.
The donor's thinking: I have been helping the beneficiary by giving him money on a regular basis. I would like the trustees to distribute the same amounts to him after my death and also pay new expenses he may have for the education of his children, medical expenses and similar necessities. Other than that, I would like the principal preserved.
Example 5 - Leave it up to the trustees.
The donor's thinking: I want to give as much flexibility as possible to my trustees and don’t want to limit them to any standard which a beneficiary could enforce in court. I am confident that the trustees I have chosen will do what I would do and I do not wish to give those trustees any specific directives. When the particular trustees I have in mind die or retire, I am also content to give this complete discretion to whoever their successors are.