Understanding irrevocable trusts

What is a “trust” and why would I need one?

A living trust (also called an inter-vivos trust) is funded with assets during your lifetime and can be a useful tool to minimize an estate for New York State estate tax purposes. Living trusts can be revocable or irrevocable. In truth, even irrevocable trusts are not completely irrevocable, but are more inflexible, as they can be amended, modified, or revoked with the consent of all of the adult beneficiaries.

The current federal estate tax exemption is $5.34 million and will annually adjust for inflation. The New York State estate tax exemption was recently amended and is now $2.065 million, and will also be annually adjusted. However, whereas New York once did not have a gift tax, now New York State will “add back” gifts made within three years of death into a decedent’s gross estate.

Aside from taxes, there are other incentives to create a trust. Maintaining assets in a trust rather than in your individual name helps to avoid probate, a court process that is required in order to transfer assets from the name of someone who has died into the estate, where it can be distributed to the heirs. A trust can also help minimize disputes among your heirs, particularly if you intend to disinherit one of your children. It can also help control your assets seamlessly if you are incapacitated or when you die. And, in the case of second marriages, a trust can insure that you can leave assets for the benefit of your second (or third) spouse during the spouse’s lifetime, while protecting those assets and ensuring that they will be left to your children (and not the spouse’s children) when he or she dies.

Trusts can be tailored to meet a client’s specific objectives. Not all trusts are the same and there is no one-size-fits-all trust. Here is a brief explanation of some types of trusts that are commonly used:

2503 (c) Trust: This is a minor’s trust for the benefit of minor children. The trust by its terms must terminate when the beneficiary reaches the age of 18 or 21. This trust is preferable to making gifts to an Uniform Transfer to Minors Account or an Uniform Gift to Minors Account account as it can protect assets from creditors. Furthermore, the investment opportunities are unlimited.

Inter-vivos Bypass-Credit Shelter Trust: This is the same type of trust that is included in a last will and testament for a spouse and descendants, only it is created during the donor’s lifetime. If funded now, the transferred amount and all the appreciation will escape gift and estate tax. Another added bonus — the spouse can be both a beneficiary and a co-trustee.

Health Education Expense Trust: A “Heet” is used to pay beneficiaries’ health and education costs. Both contributions to the trust and distributions from the trust will be tax-free. This is a good option for people inclined to gift money who have already exhausted their generation-skipping tax exemption.

Intentionally Defective Grantor Trust: This trust is created for the benefit of descendants and others, but may also include the donor’s spouse. It can be drafted for the donor to pay the annual income tax for the trust without that payment being considered an additional gift. The benefit is that the trust principal appreciates and grows faster outside the donor’s estate.

Life Insurance Trust: This is created to avoid estate tax on insurance proceeds at the insured’s death. The common misconception is that life insurance is “tax free.” Whole life insurance policies are income tax free, but whole and term policies are not estate tax-free. They are taxable if the insured and decedent has an “incident of ownership” in the policy. If a trust owns the policy, the insured no longer has an incident of ownership in the policy. Annual payments to the trust will qualify for the annual exclusion and can be used to pay insurance premiums.

Supplemental Needs Trust: These are trusts created for disabled beneficiaries. Assets transferred to this trust is not counted as an asset of the beneficiary and therefore, does not render the beneficiary ineligible for Supplemental Security Income or Medicaid. When the beneficiary dies, the trust proceeds are payable to the donor’s named beneficiaries.

Retirement Trusts: These trust are drafted to receive required minimum distributions and additional principal from retirement funds. There are very specific IRS rules for naming a trust as a beneficiary of qualified funds. If drafted correctly, the trust can preserve the ability to stretch out the IRA payments over the beneficiary’s life expectancy and name alternate beneficiaries upon the primary beneficiary’s death.

Alison Arden Besunder is the founding attorney of the law firm of Arden Besunder P.C., where she assists new and not-so-new parents with their estate planning needs. Her firm assists clients in Manhattan, Brooklyn, Queens, Nassau, and Suffolk Counties. You can find Alison Besunder on Twitter @estatetrustplan and on her website at www.besunderlaw.com.