It should come as no surprise to advisors that wealthy clients are attuned to recent political rumblings about taxing the transfer of wealth.
The experienced advisor knows that adjusting long-term financial strategies based on changes in political rhetoric – no matter what side of the aisle it comes from – is hardly the right path to protecting and distributing wealth.
Clients who have worked hard may believe that all the challenges that come with building wealth have been met, yet they are uncertain about how to protect assets up until the time to transfer them to a family member or a worthy cause.
It may seem wildly counter-intuitive that disbursing an estate requires more than the will to “do the right thing.” Advisors should know that ensuring a legacy in a controlled, thoughtful and efficient way takes more than just right thinking. It requires the right tools.
For that, many investors should turn to a long-established but often under-utilized tool – the trust.
The conversation around the taxing of wealth transfers is inevitable, and the fundamentals of trusts, including the transfer of assets while at lower values, remain a tremendous tool for advisors and clients.
Currently, trusts are often under-utilized for a couple of primary reasons. Many clients hear an advisor use the word “trust,” and believe they are vehicles for the super-affluent, moving money from one generation to another.
Trusts also often require frank discussions and the expertise of more than just a single advisor – a team that might include an advisor, tax expert and attorney, for example. All advisors should have established relationships with outside expertise, or the willingness to work well with other professionals.
It is also easy for an advisor to forget that, for the client, a discussion of trusts is by its very nature a discussion about mortality, a discussion we all are normally anxious to avoid.
Clients may also confuse trusts with wills. Trusts often transfer assets while the benefactor is living and, in many cases, maintaining some control of the asset(s). A will can contain a testamentary trust, but with or without a trust component, a will does not transfer assets until death and has none of the living benefits of what is called an “inter vivos” trust, also known as a living trust.
While mortality and legacies may be uncomfortable discussions, trusts offer very real advantages as instruments of outcomes-based, long-term planning.
Control: A trust allows a person to determine who gets an asset, when they get it, and under what conditions.
Legacy Protection: A trust can protect an asset from creditors or others who might attempt to get control of an asset.
Privacy: A trust is not part of any public record, let alone Twitter fodder.
Probate Savings: The costs and delays associated with many asset transfers upon the death of a benefactor come as a real surprise to many beneficiaries. A trust helps to avoid those issues.
Estate Tax Savings: A trust may bring real savings, as well as a level of certainty, to future estate taxes.
Transfer Tax Advantage: Another tax argument that adds urgency to establishing a trust is the matter of transfer taxes. Under current law, most assets transferred at a current transfer tax rate will be exempted or taxed at that rate and then allowed to appreciate in value without further tax obligation as long as the transfer tax and exemption rates remain constant.
Once a client sees the advantages of establishing a trust there are often questions about what can, or should, go into a trust.
The most common items include more liquid assets like stocks, bonds or other paper investments.
Life insurance and annuities are also common components of trusts, with life insurance policies offering very favorable tax advantages to both benefactor and eventual beneficiaries.
Jewelry, antiques and artwork of assessed value can also be part of a trust, as can real estate.
A family business that has undergone a valuation process can also be a trust component but the best advisors will always suggest that the transfer of a business should also include some serious, devoted and realistic succession planning.
Potential Trust Beneficiaries
Family Trusts: The most common types of trusts name spouses or children as beneficiaries. They are hardly all the same. Some marital trusts, for example, are designed merely to shelter assets while others can provide income for a spouse while preserving assets for future generations.
Grandchildren Trusts: There are family trusts that can be created to transfer assets to grandchildren. Rather than transferring an asset to children and then on to grandchildren – and being taxed twice – a generation-skipping trust may often be taxed only once.
Special Needs Trusts: A special needs trust allows a person to care for a special needs child, for instance, without jeopardizing eligibility for programs like Medicaid. The long-term costs of a person with special needs can easily exhaust the fortunes of all but the wealthiest.
Charitable Trusts: It is increasingly common for benefactors to establish legacy contributions to charitable causes while maintaining some control of the asset, or receiving tax advantages based on the value of the donation. There are a wide variety of charitable remainder trusts and charitable lead trusts and that planning process should encompass both the needs of the benefactor and the eventual beneficiary.
Revocable or Irrevocable
A revocable trust does not remove assets from the benefactor and the beneficiary can be changed at any time. A revocable trust does not normally have the same array of tax advantages as an irrevocable trust.
An irrevocable trust transfers assets from the benefactor to the trust and, eventually, to the beneficiary. Irrevocable trusts are designed to save on current taxation, as well as reducing the size of the benefactor’s taxable estate.
Are irrevocable trusts really irrevocable? It depends on both circumstances and geography. Some states allow ‘decanting,’ or the transfer of assets from one trust to another without penalty. Other trusts include a ‘rewrite provision’ and allow for the appointment of a ‘trust protector’ who can alter terms of the trust.
While there are lots of resources for information on establishing trusts, it would be a client mistake to assume that there is a “one size fits all” model that you simply plug into.
A respected, experienced and currently informed advisor who is familiar with a family’s story, goals and the legacy the client would like to establish is a great start. The advisor needs access to the ideal financial components of a healthy trust and the ability to coordinate a small team with the right expertise.
There is one piece of advisor advice that does cover anyone who has been thinking about establishing a trust for a long time: Life doesn’t afford that many opportunities at legacy building. This is one of them.
Thomas F. Commito is an advanced sales attorney for Lincoln Financial Distributors.