For many people, estate planning can seem like a complex and intimidating process. With so many nuances in state and federal laws, it can be difficult to understand the tax implications associated with estate planning decisions.
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If you’re putting together an estate plan, there are a few key questions you’ll need to answer. Here are 10 of the most important questions to ask yourself (or your estate planning attorney) to ensure that your plan is complete and effective.
As you think about your future, it’s important to start thinking about your estate plan. This includes making decisions about your healthcare and who will make those decisions for you in the event of incapacity.
Many people may not realize that charitable planning intersects with estate and business succession planning. Combining a charitable strategy and the sale of a business is a great way for owners to minimize taxes and provide equity for the next phase of their lives.
Charitable remainder trusts were authorized by the 1969 Tax Relief Act. Since then, they have become common vehicles for charitable giving. High-net-worth and middle-class individuals look to the various forms of charitable trusts as a way to give more to their favorite charities while benefiting from tax deductions. In many cases, charitable trusts can even allow a person to make a charitable gift they might not otherwise be able or inclined to make.
By implementing a complementary charitable planning strategy, a business owner can:
- Reduce and possibly eliminate income, capital gains, and transfer taxes;
- Preserve wealth;
- Generate a reliable stream of income; and
- Protect assets from creditors.
Charitable Trusts come in two forms: Lead Trusts and Remainder Trusts. In both cases, the donor makes a gift to the trust. The trust makes regular payments for a period of time, then distributes the remainder at the end of the term.
How Do Charitable Lead Trusts Work?
A Charitable Lead Trust (“CLT”) provides a stream of income to one or more charities as the “lead” beneficiary. The trust can be set for a specific term of years or for the life of a person. After the income stream ends, the remaining balance will be distributed to other beneficiaries, like spouses, children, or other loved ones. For more information about trusts, grantors, and beneficiaries, see What is a Trust?
When establishing a Charitable Lead Trust, the grantor pays gift tax on the expected final distribution to family members. This is calculated by using the § 7520 interest rate in effect at the time of creation. If the trust assets grow at a higher rate than the § 7520 rate, the additional growth passes to the grantor’s family without any estate tax due. In other words, the grantor will pay less overall estate tax while donating to a meaningful cause.
How Do Charitable Remainder Trusts Work?
A Charitable Remainder Trust (“CRT”) provides a stream of income to one or more individual beneficiaries, while preserving its remaining balance for charity. Similar to the CLT, the CRT can be set for a term of years (up to 20 years for the CRT) or for the lifetime of an individual. After the income stream ends, the remaining balance of the CRT will be distributed to one or more qualifying charities. Then, the grantor will receive deductions for federal income, gift, and estate tax purposes.1
In order to qualify for these tax deductions, the CRT must pass the IRS’ 5% probability of exhaustion test—there must be less than a 5% chance the trust will pay out its entire principal to the individual beneficiaries using the IRS discount rate.
In the year the grantor creates the CRT, he or she also receives an immediate income tax deduction that is equal to the present value of the expected gift to charities. Generally, the grantor names himself or herself, if not the spouse, as the income beneficiary of the trust, in which case there are no gift tax issues.
Grantors of CRTs must choose between two forms of income streams: Unitrusts or Annuity Trusts.
To be designated as a beneficiary of a Charitable Lead Trust or Charitable Remainder Trust, the charity must qualify under section 170(c) of the Internal Revenue Code (IRC). Qualifying charities generally include 501(c)(3) organizations, but are not limited to churches, synagogues, religious organizations, civil defense organizations, fraternal societies, and other organizations that operate solely for religious, charitable, educational, scientific, or literary purposes. (IRC 170(c))
If the named charity loses its qualification under section 170(c), an alternate charity can be selected. The grantor may name alternate or successor charities and beneficiaries during the creation of the trust. However, the grantor may also leave the remainder beneficiary “open” by reserving the power to designate a successor beneficiary or charity after the trust’s formation.
Choose Wisely: The Importance of Selecting the Right Trustee
Given the complexity and longevity involved with a Charitable Trust, one of the most important decisions a donor can make is selecting a trustee. A corporate trustee can be completely objective, which is an important quality when there are—or may be—contentious family members. A corporate trustee has no vested interest in the income or the remainder of the trust and is in the best position to balance the interests of the various parties. Corporate trustees also have expertise in taxation and investments. There are other benefits as well:
• Professional asset management
• Legal proficiency to administer terms of trust
• Regulated entity; oversight & accountability
• Legal duty to act in clients’ best interest
• Perpetual appointment
• Capital & insurance
For more information about corporate trustees, see How To Choose a Trustee: 4 Key Considerations.
Members Trust Company as Trustee of a Charitable Trust
Founded in 1987 by America’s Credit Unions for credit unions, their members and the general public, Members Trust Company is the first national trust and investment firm providing financial stewardship, investment management, and trust services for both credit union and non-credit union accounts.
With our Main Street values comes Wall Street experience…without the ego or exorbitant fees. Our team of fiduciary administrators are highly credentialed and experienced. Our team of investment professionals hold the highest Chartered Financial Analyst® designation and have been continually recognized in the industry as subject matter experts in trust and investment solutions, big and small.
To speak with someone about Charitable Trusts, call us at (888) 727-9191 or visit https://memberstrust.com/contact.
External sources: (1992) Hoisington, W. The Truth About Charitable Remainder Trusts (How To Separate The Help From The Hype). The Tax Lawyer.1
Trust services provided by Members Trust Company, a federal thrift regulated by the Office of the Comptroller of the Currency. Trust and Investment products are not NCUA/NCUSIF/FDIC insured. May lose value. No financial institution guarantee. Not a deposit of any financial institution. This is for informational purposes only and is not intended to provide legal or tax advice regarding your situation. For legal or tax advice, please consult your attorney and/or accountant.
A trust is a legal document that allows a third party, or trustee, to handle your assets in the event of death or incapacity.
Why do people set up trusts?
People set up trusts to help manage their assets during their lifetime and after death. In the event of death, trusts make sure that your beneficiaries receive your assets according to your wishes. They can assist you in caring for dependents that may struggle with financial inexperience, addiction, or illness. In the event of incapacity, they also ensure that you get the type of care you need.
Who is involved in a trust?
A grantor is a person or institution that has assets and creates a trust.
A trustee is appointed by the grantor to manage the trust for a beneficiary or beneficiaries. The grantor can choose a corporate trustee, relative, or other person to manage the trust. (See How to Choose A Trustee). If the trustee is a financial institution, a trust officer will be assigned to administer the trust account. Trustees should have the expertise, time, and objectivity to properly manage your assets.
A beneficiary is a person or institution that receives distributions of trust assets. Beneficiaries can be children, spouses, other relatives, charities, or any other entity named by the grantor.
Benefits of a Trust:
- Control – Trusts allow you to set specific guidelines about the management of your assets. For example, you can set parameters so distributions only take place when your beneficiary:
- Turns 18
- Enrolls in college
- Graduates from a rehabilitation program
- Uses them to fund expenses related to health, education, maintenance and support (“HEMS”)
HEMS is a standard often used in trust documents to define when certain distributions are appropriate for the beneficiary. Some examples of HEMS include:
- Health – Medical expenses, surgeries, hospitalizations, rehabilitation treatments, therapies, gym memberships, health screenings, eye or dental exams, and alternative medical treatments.
- Education – Tuition for college or technical school, career training, books, study abroad programs, and school supplies.
- Maintenance and Support – Rent or mortgage payments, insurance, updates to housing, groceries, property taxes, and other types of reasonable support.
If your beneficiary needs help managing money, you can decide to limit how much money they receive each year. You can also customize distributions for charitable organizations, universities, or any other institution named as beneficiary.
- Protection During Incapacity – Incapacity planning, addresses your needs if you lose the ability to make decisions for yourself due to accident or illness. Wills have no power until you pass away, but trusts can help in the event that you cannot make your own decisions. Both are essential for a comprehensive estate plan. If you set up a revocable trust, you serve as your own trustee unless you become incapacitated. Then, your designated successor, or back-up, trustee steps into your shoes and manages your assets, makes distributions, and ensures you receive the care you set in the document terms. To create an incapacity plan for assets outside of the trust, consider naming a power of attorney to act on your behalf.
- Tax Benefits – Depending on the status of the grantors (married, single, etc.), the value of the estate, and the terms of the trust, grantors may reduce or eliminate estate taxes.
- Avoid Probate – Trust assets are not subject to probate. Probate is the court process of administering a person’s estate after death. Probate typically involves significant time and money – heirs may need to pay attorney fees, taxes, or estate debts while they wait for the settlement.
- Privacy – Trusts provide privacy for grantors and beneficiaries. Probates are part of public record, so anyone can find information about estate assets – including their value and who received them. Details of wills become public record, while trusts remain privately administered.
What are the Different Types of Trusts?
- Revocable Trusts – A revocable trust, or a living trust, is created during the lifetime of the grantor and can be modified or revoked. If your circumstances or wishes change, it is flexible and can be amended or redrafted at any time. The grantor serves as trustee during his or her lifetime, maintaining control over all assets; however, the grantor must name a successor trustee in the event of incapacity or death. Upon incapacity or death, the revocable trust becomes irrevocable.
- Irrevocable Trusts – An irrevocable trust cannot be revoked after creation. Generally, the terms cannot be modified.
- Charitable Trusts – A charitable trust is created to provide distributions to one or more qualifying charities under 170(c) of the Internal Revenue Code, including but not limited to:
- Religious organizations
- Civil defense organizations
- Fraternal societies
A Charitable Lead Trust names one or more charities as the primary beneficiary to receive distributions. A Charitable Remainder Trust provides some distributions to other beneficiaries, like children or spouses, while preserving a balance for charity.
- Special Needs Trust – A special needs trust is created for a beneficiary to receive financial support, without disqualifying the beneficiary from government benefits, like Supplemental Security Income or Medicaid.
- Spendthrift Trust – A spendthrift trust is created to limit beneficiary access to trust funds, giving the trustee full authority over distributions. Often, beneficiaries are unable to control their spending. The grantor can help the trustee make decisions about distributions by adding the HEMS standard to the document.
- QTIP Trust – A QTIP trust is created to provide for the surviving spouse, while also saving remaining assets for future generations; it protects biological children from potential disinheritance.
What Can You Put in a Trust?
Assets can include more than your financial savings; they can include your home, business, or personal property.
- Financial Assets
- Checking and savings accounts
- Non-retirement investment accounts
- Notes payable to you
- Real Estate
- Farms or ranches
- Agriculture, including crops and livestock
- Commercial properties
- Personal Property
- Computers or other electronic devices
- Other Assets
- Patents or copyrights
- Small business interests (stock in a closely held organization, partnership interests, or limited liability company shares)
- Oil, gas, and mineral interests
After you decide which valuable assets to include, you can choose who will receive distributions and set parameters for management and administration.
In preparing for the future, trusts can be an essential part of your long-term financial plan. It’s important to meet with a qualified estate planning attorney or trust officer about how to best protect your assets and beneficiaries.
Trust services provided by Members Trust Company, a federal thrift regulated by the Office of the Comptroller of the Currency. Trust and Investment products are not NCUA/NCUSIF/FDIC insured. May lose value including the possible loss of principal. No financial institution guarantee. Not a deposit of any financial institution. This is for informational purposes only and is not intended to provide legal or tax advice regarding your situation. For legal or tax advice, please consult your attorney and/or accountant.