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Irrevocable trusts are an incredibly powerful estate planning and asset protection tool. Even better, in the hands of an expert estate planning attorney, they are adaptable to most circumstances. Included below is a very incomplete guide to some common forms of irrevocable trusts.
Irrevocable trusts are commonly used for tax planning, helping you to eliminate or minimize certain estate taxes. This is a tremendous benefit, but in order to take advantage of the benefits irrevocable trusts offer, you sacrifice your ability to change your mind about how to use the assets you place in the trusts: they are, as the name suggests, irrevocable.
Beyond tax planning, irrevocable trusts are often used to shield assets from third parties. For instance, assets placed in an irrevocable trusts are typically judgment proof, meaning that a creditor who gains a judgment against you could not access the assets you’ve placed in an irrevocable trust.
Finally, irrevocable trusts are commonly employed to limit who has access to the trust assets, and how those trust assets may be used.
QTIP stands for Qualified Terminable Interest Property trust – a little less fluffy than the cotton bud of the same name. The main aim here is to protect assets and offer consistent security while also ensuring a controlled and predictable use of the trust assets. The QTIP is more structured than some other options, which may or may not be suitable for your requirements. Because a QTIP trust provides an income interest in the assets of the trust for his or her life, they are often used to provide certain payments (for instance, the interest accrued on assets in the trust) to a spouse without diminishing the overall value of the trust assets. By doing so, the spouse is provided income from the trust while preserving the trust assets for the ultimate beneficiaries – children or grandchildren, etc. For example, QTIP trusts are particularly useful in planning for a spouse who is not well equipped to make complex financial decisions or in situations where you want to lock in specific beneficiaries after your spouse passes.
Despite the fact that a QTIP trust may be drafted to provide very little to the surviving spouse, they can still qualify for the unlimited marital deduction for estate tax purposes if a QTIP election is made on the decedent spouse’s estate tax return. In fact, you can even choose to make the election for certain assets in the QTIP trust, but not others. This allows the fiduciary of the estate to do estate tax planning and maximize both the federal and Pennsylvania estate tax exemptions.
It is important to note that because some QTIP trusts may provide for principal distributions, they are not necessarily protected for Medicaid purposes. Medicaid can be applied for to cover the cost of long-term care services not otherwise covered by Medicare and Secondary or Supplemental Health Insurance. To be eligible for Medicaid, an applicant must have limited resources. The Medicaid regulations provide that any trust in which a beneficiary is entitled to principal, other than a validly created Supplemental Needs Trust, is considered an available resource to a Medicaid applicant.
A Spousal Limited Access Trust (SLAT) is an irrevocable trust created for the benefit of a spouse, with the objective of minimizing federal estate tax due on the donor spouse’s death. Although many clients want to take advantage of the historically high federal estate exemption, they shy away at transferring assets out of their estates for fear they may need the money at a later date. The SLAT largely eliminates this apprehension. Although the grantor is gifting away assets, the beneficiary spouse is entitled to income and principal distributions from the trust – thereby giving the grantor spouse indirect access to the trust. Although the spouse is the primary beneficiary, other family members can be included as beneficiaries. The grantor controls who the ultimate beneficiary is upon the donor spouse’s death.
SLATs are grantor trusts so the grantor pays all income tax on trust assets. This allows greater appreciation of principal, which is excluded from both spouses’ estate. If drafted correctly, SLATs also provide asset protection so that the assets are not reachable by creditors of the donor or beneficiary spouse. To avoid complications from a divorce, a SLAT can be drafted so that the beneficiary spouse is defined as the donor’s current spouse.
A Bypass Trust – also commonly called a Credit Shelter Trust – is meant to shield assets from estate taxes. Specifically, a Bypass Trust preserves a deceased person’s estate tax credit and generational tax exemption, while also sheltering the trust assets from the surviving spouse’s creditors and potential future spouses. On the death of your surviving spouse, the remaining assets of your estate remain tax-free for named beneficiaries of the trust.
The basic concept of the AB Trust is a bit more complicated than most irrevocable trusts, but the fundamentals aren’t hard: a married couple create a revocable living trust, which will split into two separate trusts at the time that the first partner passes. This initial trust provides the typical benefits of an RLT and after the passing of the first spouse, the trust is split and the resulting trusts are designed to shield as much of your assets as possible from taxation.
The assets that are diverted into the A trust is the set of assets that you cannot shelter from tax. The B Trust holds those that are protected. This means that you can make appropriate payments on liable assets but still provide plenty of financial protection. The A Trust works much like a Marital Trust or QTIP Trust, whereas the B Trust could be a Bypass Trust. Once both parties in AB Trusts have passed on, the trusts merge once again. This merger allows you to provide for your descendants. It is a lot to consider, but also a comprehensive approach that can support many loved ones over time.
Forever is a term you might not expect to see when dealing with legal matters and documentation. There is usually some exemption or end date to a plan where ongoing protection may diminish with time. This uncertainty could be off-putting for those keen to provide support for multiple generations to come. However, Dynasty Trusts can provide that long-term, multi-generation support you are after.
The assets placed into this trust are sheltered from a range of taxes that may otherwise transfer across generations. This means you won’t burden grandchildren with losses through gift tax, estate tax, or generation-skipping transfer tax. These funds and protections also continue to stay in place following a divorce or lawsuits, just in case relationships turn a little sour over the decades. If you are adamant about your money staying within your family for as long as possible, this could be for you. It is one of the best ways to say “I will support you forever” and actually mean it.
An Education Trust provides monetary support for specific beneficiaries purely for educational purposes. The money could go towards paying costs over the year, either large sums to cover all fees or accommodation costs each year or something smaller for textbooks or other living costs. You may also decide to incentivize the pay-outs based on achievements. That way your child or grandchild doesn’t just assume they are getting X amount of money when he or she turns 18. They could get some money for achieving acceptance to college, scheduled payments at the start of the academic year, and maybe an extra sum for graduating. However you set them up, Education Trusts can make pursuing a college or post-graduate education possible in an age where the total cost of schooling grows more absurd by the day.
An Intentionally Defective Grantor Trust (IDGT) places assets outside the grantor’s estate for inheritance tax purposes but is drafted so that income generated from the trust is taxable to the grantor. An IDGT allows the grantor to gift or sell assets to the trust and any appreciation grows tax free. Payment of income tax by the grantor allows the trust principal to grow and is not considered an additional gift to the beneficiaries.
Instead of using a portion of his or her estate tax exemption, the grantor can sell assets to the intentionally defective grantor trust in exchange for an interest-bearing promissory note. The grantor must first gift the trust with enough “seed” money so that the trust can afford to purchase the grantor’s assets. Since the IDGT is a grantor trust, the sale is not a taxable event. The note, if still existent at grantor’s death, further reduces the grantor’s taxable estate.
An important consideration when choosing a trust for you or your family is the range of assets included. Some trusts allow for various funds and assets to pass over for greater protection, while others are much more specific. The QPRT is one of the latter as it is the Qualified Personal Residence Trust. As the name suggests, this is all about focusing on your home. You can instruct advisors to remove the value of your home from your estate to limit estate taxation in the future.
This option is one to consider carefully as while you can still live in the property, the home is handed over to the trust. There is also the fact that the irrevocable nature of the trust freezes the value of the home at the time of transfer. This freeze is great if you expect the value to decline. The QPRT is a more niche example. But, it could help those whose biggest asset is their home, and that don’t want a more complex trust in place.
A Medicaid Qualifying Trust an irrevocable trust that protects assets from the exorbitant cost of long-term care. This type of trust is structured so that the grantor and spouse can have income generated from the trust, but have no access to the principal in the trust. The grantor can retain the right to live in any house included in the trust, to replace the trustee at any time with anyone other than the grantor or spouse, and change the ultimate beneficiaries. Any assets placed in such a trust is not a countable resource for Medicaid long term care purposes.
If we’re honest, the lion’s share of estate planning focuses on our family. For many of us, our pets are beloved members of the family and there are specific pet trusts you can utilize to ensure proper care for your pets. The trust is designed to cover any expense that might arise when providing care for the covered animals. This means that dogs and cats can maintain the same level of comfort and care and there are no concerns about future healthcare costs. Whatever the animal or circumstance, a Pet Trust lets new owners take them on with a little more peace of mind.
As their name indicates, irrevocable trusts must be done properly the first time and should not be something you attempt without the aid of a skilled estate planning attorney. If you think irrevocable trusts should be a part of your estate plan, please schedule your Estate Planning Strategy Session below.