Most of our estate planning clients want the same thing: for their assets to pass to the people they love. For our clients with children, this typically means they ultimately want to benefit their descendants (i.e., their children, grandchildren, great-grandchildren, and so on). This article discusses one of the fundamental ways that you can accomplish this goal – by leaving your assets to your descendants in trust.
What is a trust?
A trust is a legal arrangement in which one individual, the trustee, manages assets for the benefit of another, the beneficiary. The trustee owes a fiduciary duty to the beneficiary – i.e., he must act in the beneficiary’s best interest, not his own. Trusts are usually established and governed by a will or other written instrument known as the trust instrument.
The trustee decides how trust assets are deployed. He determines which of the beneficiary’s needs and wants should be supported by the trust – e.g., should the trust pay for the beneficiary’s housing costs, college tuition, new car, etc. Funds not expended for the beneficiary are invested at the direction of the trustee and preserved for the future.
At the beneficiary’s death, any assets remaining in the trust are distributed in accordance with the trust instrument.
What are the benefits?
Trusts can solve many problems. The following are some of the most common reasons that our clients incorporate trusts in their estate planning:
Protection from poor decisions. Some children are simply too young and/or immature to wisely manage significant assets. Others suffer from addiction or are developmentally or intellectually limited. A trust allows someone else to manage the inherited wealth so that it is responsibly applied, invested prudently, and hopefully lasts longer.
Protection from creditors. Inherited assets that remain in trust are generally protected from a beneficiary’s creditors.
Protection from spouses. Inherited assets are generally protected from spousal claims in divorce. And as mentioned above, on a beneficiary’s death, trust assets are distributed in accordance with the trust instrument – i.e., you can ensure that your grandchildren, not the “in-laws,” are the ultimately beneficiaries of your assets.
Minimize Estate Tax. With increased Maryland and federal estate tax exemptions, estate tax minimization is a lesser concern for most clients. However, if one of your descendants is wealthy enough to be subject to estate tax on his or her own assets, a trust for assets you leave can be a useful tax avoidance device.
What are the burdens?
Like everything, trusts come with their share of negatives. The following are some common drawbacks:
Added complexity. It is obviously simpler to leave assets to descendants outright to do with as they please. The creation of a separate entity and appointment of a third party to manage an inheritance complicates both planning and administration.
Greater expense. A trust instrument must include instructions for the management of trust assets during the beneficiary’s lifetime, distribution at the beneficiary’s death, trustee succession and investment powers, and an array of technical provisions to ensure that the desired benefits are recognized. Therefore, a will that establishes trusts for descendants is more time consuming and thus slightly more expensive to draft. After a trust is established, an annual income tax return must be filed, legal questions may arise that incur attorneys’ fees, and trustees can seek compensation.
Income tax considerations. As discussed above, estate tax exclusion can be a beneficial feature of trusts. But the corollary loss of step up in cost basis can cause unpleasant capital gains tax consequences. This negative generally outweighs the positive in today’s high estate tax exemption environment. Also, trusts generally pay income tax at higher rates than individuals. A though explanations of the tax related pros/cons of trusts is beyond the scope of this article. If you have specific questions on this topic, please contact us.
Conclusion
Are trusts appropriate for your descendants? It should be no surprise that a lawyer’s answer to this question is “it depends, contact us to discuss further.” We have developed simple and practical ways to maximize the benefits of trusts, minimize the burdens and permit flexibility where appropriate. In other words, our clients’ families often enjoy the advantages of trusts without much pain. That said, a more thorough discussion is warranted to ensure that you make the best decision for your family.
Thank you for taking the time to read, and feel free to Contact us with comments or to discuss your situation further.