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Trusts

A trust has many serious advantages over a will.  Trusts avoid probate and can be designed to minimize present and future tax burdens. 

A trust is an instrument that allows property by one party to be held by another.  A trust is created by a grantor who places assets in the trust.  The grantor sets the terms by which trust assets are managed and distributed by a trustee.  The income and principal of the trust are distributed by the trustee.  The grantor designates the beneficiaries of the trust who will receive the benefit of the trust. 

Trusts are revocable or irrevocable.  You can change or revoke a revocable trust.  You cannot revoke or otherwise modify an irrevocable trust. 

Revocable Trust 

The living trust is very useful in estate planning.  The living trust is revocable, which means the trust can be cancelled and the assets taken back at any time.  A living trust helps avoid the cost and delay of probate and can be changed or modified at any time.  It can keep assets safe in the event of incapacity and provide instructions to the trustee how trust property should be managed.  A living trust can pass assets on to your beneficiaries immediately upon your death, or designate that distributions be made over time.  Living trusts can even be used to protect the interests of beneficiaries against creditors.

Without a revocable living trust, the court will distribute assets under a will.  This can be time-consuming and creates an unnecessary expense.  Probate costs are generally not necessary and can seriously delay estate distribution.  A living trust circumvents the probate process and immediately transfers assets to the beneficiaries.

Trusts can be beneficial in that they can designate funds to be used for a specific purpose, avoid probate, and help retain privacy.  There are several different types of living trusts with various benefits. 

Irrevocable Trust

Irrevocable trusts have a number of specific applications, and can also be used for asset protection.  Once assets are in the trust they will be outside the grantors control and can no longer be reclaimed.  Assets in an irrevocable trust cannot be within the grantors control.

For an irrevocable trust to protect assets from creditors the grantor must relinquish control, beneficial interest, and avoid restrictions such as fraudulent transfer.  The trust will be set aside if the grantor retains de facto control over the trust.  In order to protect the trust from creditors, the grantor cannot manage the trust or have rights as a beneficiary otherwise assets in the trust may still be within reach of creditors.

An irrevocable trust can be utilized when you are creating an estate plan which gifts the assets of the trust to your beneficiaries.  Even then, you must be certain you will not need the assets in the trust for future financial security.  If you are sure you will not need the assets, the irrevocable trust is a great device to achieve the goal of distributing assets to your beneficiaries at a future time.

Whether you transfer your assets to the trust within your lifetime or upon your death, the one difference between a revocable and an irrevocable trust funded within your lifetime is that the revocable trust won't protect you as the grantor.  Moreover, assets in your revocable trust are included in your taxable estate.  Assets transferred to an irrevocable trust are excluded from your taxable estate after a statutory period.

Important Trust Provisions

For a trust to fully safeguard your beneficiaries' interest in the trust assets, you need the right trust provisions. 

The trust must successfully prevent the creditors of beneficiaries from claiming their share of the trust principal or income.  The provisions must stop the creditor from asserting the right of a beneficiary or exercise powers that would forfeit the protection of a beneficiary.

Anti-alienation (spendthrift provision) - This provision protects trust assets from the creditors of a beneficiary. The anti-alienation clause prohibits the trustee from transferring the trust assets to anyone other than the beneficiaries.  This includes the trust beneficiaries' creditors.  The spendthrift or anti- alienation clause expressly prevents others from claiming the rights of a beneficiary.  Including the right to receive trust principal or income distributions

Distribution Discretion - Another important clause is to grant distribution discretion in the trustee.  The discretionary clause gives your trustee the right to withhold income and principal distributions that would be payable to the beneficiaries.  This discretionary clause allows the trustee rather than the beneficiary to have control over distribution of trust assets.  Spendthrift and discretionary clauses protect trust assets from your beneficiaries' creditors. 

Sprinkling Provision – The sprinkling provision further allows the trustee to have discretion over distributions.The trustee can then modify trust distributions through this sprinkling provision.  The trustee can retain the principal and income for the duration of the trust.  The trustee determines what each beneficiary will receive, and when.  The trust grantor would specify criteria for the trustee to follow when making distributions.

Irrevocable Children's Trust 

An irrevocable children's trust (ICT) can reduce taxes and provide protection.  Property that transferred to a children's trust cannot be seized by creditors and it won't be included in your taxable estate.  Income from the trust would be taxed at the children's lower income tax rates. 

The one disadvantage with the children's trust is that when the child reaches 21, they can demand trust assets.  Since it is an irrevocable trust, the grantor cannot withhold distributions from the trust.  You cannot prevent your child from receiving the assets that are then owned by the trust.  When creating a trust for a child it will also make sense to consider the Dynasty trust.

Irrevocable Life Insurance Trusts

Life insurance is a very important asset.  Life insurance can pay for your estate taxes and provide money for you loved ones.  If you own a large life insurance policy, title your insurance policy to an irrevocable life insurance trust (ILIT). An ILIT is specifically designed to own life insurance.  The ILIT has a trustee and beneficiaries similar to other trusts.

The ILIT then owns your insurance policy.  The trust becomes the insurance policy beneficiary.  At death, the insurer pays the ILIT trustee, who would follow the trust instructions and distribute the proceeds to the beneficiaries. 

Policy premiums must be directly paid from the trust.  You cannot directly pay the premiums or you'll lose both the trust's tax benefits and creditor protection.  The ILIT is irrevocable.  It protects the policy's cash value, death proceeds, and distributions from the trust to the beneficiaries.  Policy proceeds won't be included in your taxable estate, nor subject to estate taxes.

The ILIT allows for more control over policy distributions than insurance owned by you personally.  When you personally own insurance, your insurance company directly pays the named beneficiaries when you die.  An ILIT not only lets you control who receives the proceeds, but also how and when the policy proceeds will be distributed.  You can direct your trustee to pay your beneficiaries over a period of months or years and add spendthrift, anti-alienation, discretionary distribution, and other protective provisions to protect the insurance proceeds from your beneficiaries' creditors.

Dynasty Trusts

A trust can have the added benefit of safeguarding assets left to beneficiaries and can make it possible to protect an inheritance from future financial and legal problems.  Depending on the size of the estate, trusts can be created to protect assets for children and even grandchildren.  A dynasty trust can function to protect trust assets from your beneficiaries' creditors long after the death of the grantor.

Charitable Remainder Trusts

Gifting your assets to charity may seem an extreme way to gain creditor-protection, however, our tax laws allow you to give away your property to charity, achieve protection, and use these same assets to generate income for you during your lifetime.  

For protection, and the tax benefits from gifting assets, the Charitable Remainder Trust (CRT) can be an effective entity structure.  As the grantor, you select a tax-exempt charity as the beneficiary of your irrevocable trust.  When you create and fund the CRT, you make a charitable donation and can claim an immediate tax deduction for the value of the assets contributed to the trust.  Although you have gifted the principal, you would be the income beneficiary. 

Over your lifetime, the trust will pay a fixed annual income.  This creates a tax deduction and future income from the donated assets.

Medicaid Trusts 

Nursing home costs can impoverish you as quickly as a lawsuit.  Hence, the Medicaid trust.  This special purpose trust shelters assets so the grantor can qualify for Medicaid to pay their nursing home costs.  Medicaid trusts, of course, chiefly interest those who prefer to leave their money to their children rather than spend it on their own long-term care. 

A Medicaid trust, unlike other irrevocable trusts, the grantor can be the income beneficiary.  Their children or spouse would be the residual beneficiaries.  The grantor can receive income from the trust to the maximum amount allowed by Medicaid.  This allows the grantor to qualify for Medicaid nursing home assistance.

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