A trust is a device to enable the holding of the legal title of assets. Trust provisions are tailored to the grantor’s needs, providing instructions to the Trustee regarding investment, management, and distribution of the assets within the trust.
Trusts can serve a variety of purposes, including:
- conserving assets for beneficiaries;
- designation of a third party to management investments;
- avoidance of guardianship proceedings for property transfers to minors and incapacitated persons; and
- tax savings (depending on the type of trust).
There are two categories of Trusts:
- inter vivos, (created during lifetime of grantor), and
- Testamentary (created under the Will).
Inter vivos trusts can be revocable or irrevocable.
Testamentary trusts come into existence and become irrevocable at the time of the decedent's death.
There are a variety of specialized trusts including:
- credit-shelter trust;
- qualified personal residence trust (QPRT);
- QTIP or qualified terminable interest property trust;
- irrevocable life insurance trust (ILIT);
- charitable remainder/lead trust (CRAT, CRUT, CLAT, CLUT);
- dynasty trust (DAPT);
- special needs/supplemental needs trust (SNT); and
- pet trust.
This type of trust is used for married couples and typically holds an amount up to the federal estate tax exemption amount (which for 2018 is $10 million (to be adjusted for inflation from a base year of 2010), and the rest of the estate passes to the spouse tax-free. Once the assets are placed in the credit-shelter trust, it shields appreciation from federal estate tax.
This type of trust can remove the value of the grantor’s residence or vacation home from his estate. The grantor can continue to live in the dwelling and maintain full control, during the period of time specified in the trust. The “period of time” is key, as the grantor must outlive the term of the trust-otherwise the full value of the home is included in the grantor’s estate. Planned correctly, the grantor can gift the dwelling to his heirs (valued significantly less than present-day value- longer trust term equates to less value of the gift for tax purposes), outlive the trust term, and continue to live in the residence if desired, paying fair-market value rent to the beneficiaries, thus removing more assets from the grantor’s estate.
This trust is useful for families with children from different marriages, and is typically combined with a credit-shelter trust. The surviving spouse will receive income from the QTIP, and the remainder will pass to the grantor’s heirs at the death of the surviving spouse. The assets in the QTIP will be treated as part of the surviving spouse’s estate, and pass estate-tax free to the grantor’s heirs. This trust can ensure that the grantor’s wealth passes to his own children.
This trust removes life insurance from the grantor’s taxable estate, can help pay estate costs and provide heirs with liquid assets. This is particularly useful if the grantor owns business. The heirs can use the life insurance proceeds for the operating costs of the business after the grantor’s death, until the business is sold or distributed.
Charitable Remainder Trust
This is an irrevocable trust that pays income to non-charity beneficiaries for life (or fixed term) and the remainder interest is paid to charities. The trust will pay no income tax and the grantor receives estate, gift and income tax deductions.
Charitable Lead Trust
This is similar to the Charitable Remainder Trust, except the charity receives payments for a set term, and the remainder interest is passed either to the grantor or his heirs. Income tax depends on the structure of the trust.
Dynasty Trust/Domestic Asset Trust Protection
This type of trust keeps assets in trust for an extended period of time, possibly in perpetuity. The basic structure of a Domestic Asset Protection Trust (DAPT) allows the grantor to receive income and discretionary principal distributions, provides asset protection from creditors, spouses and lawsuits and gives the grantor some control over the investment management through the directed trust structure.
South Dakota has one of the most progressive DAPT statutes in US. There is short look back period (2 years) under fraudulent conveyance statute. There is a total privacy seal that forbids the release of trust information to the public. The fear of placing property in an irrevocable trust is removed with flexible modification/reformation provisions. In a Dynasty Trust (a trust that lives on forever), the trust assets avoid federal taxation. South Dakota does not have income tax therefore undistributed trust income can grow free of state income tax. Pennsylvania cannot tax the grantor or beneficiaries on any undistributed trust income retained in South Dakota trust.
Benefits individuals/businesses that hold assets with significant appreciation (i.e. low cost basis closely held stock) by avoiding state capital gains; individuals with a net worth of over $5.49 million; and individuals who need creditor protection (professionals, athletes, businesses, and families).
A special needs/supplemental needs trust can be stand-alone or testamentary. The purpose of this trust is to provide for a beneficiary’s needs not covered by government benefits (i.e. Medicaid/Medical Assistance).
This trust is typically created by a parent/guardian or court, funded with the disabled beneficiary’s assets, used solely for the beneficiary, and the beneficiary must be under age 65. The trust assets are used to supplement (not take the place of) public benefits and at the beneficiary’s death, the remainder is distributed to the state to repay the public benefits given to the beneficiary.
This trust must be created with funds from someone other than the disabled beneficiary. Typically parents of disabled adult children will create this kind of trust. No payback provision to the state is required.