As mentioned in the August 3rd post, there are many different reasons that individuals create a trust. It is imperative at the attorney meeting that you are clear about what you are trying to accomplish.
Some trusts are created during the life of the grantor and some at death. For example, if you die with minor children, oftentimes, the assets that you have left to them go into a trust. An adult manages the assets until the child reaches the age of majority. In some states, that age is 18 and in other states, that age is 21. In NYS, where I am writing this from the age of majority is 21. With this type of trust, there is generally no trust document created until the parent’s death. The will indicates that the assets are meant to go into a trust. The guardian of the children is often named as the trustee of the trust. You can elect to have one person raise the children and a different person responsible for the finances if you feel that no one person has both skills.
This type of “will trust” is often also called a testamentary trust. It is an irrevocable trust since it arises when the death of the grantor occurs. If that parent dies after the child reaches the age of majority, the trust is never created. The assets go directly to the child unless another portion of the will directs them to be distributed differently.
A second type of testamentary trust created by a will is to minimize estate taxes when there are significant marital assets. Generally, a trust is created when the first individual in a couple dies. Rather than all the assets automatically transitioning to a spouse, some are placed into a trust. Whatever assets are placed into the trust do not become part of the estate of the surviving spouse.
Consider if a couple has an estate worth 8 million dollars. Right now, the exclusion to avoid estate taxes is $11 million, so there would be no tax due. However, that exclusion has fluctuated from $1 million to the current $11 million. If the wife dies and leaves everything to the husband, he now has an $8 million estate. If the exclusion were lowered to $5 million, he would owe taxes. If the wife instead puts part or all her $4 million estate into a testamentary trust, it does not belong to the husband. The husband can have access to the income and elect to take principal out of the trust, but it does not belong to him.
The assets of his wife would not be included in his estate. Once he dies, his estate assets are passed onto whomever he named as a beneficiary(ies). The wife’s assets pass to whomever she named as the beneficiary(ies) in the trust. This type of trust can also work well in some cases when dealing with blended families as a result of 2nd marriages. It can make sure that the children of both spouses get a share instead of only the children of the 2nd to person to die.
Often, when there is a special needs child, a trust is created as part of a will. If the special needs child receives government services due to the impairment, these services may be lost if the child were to receive an inheritance. For example, if the child is on Medicaid insurance, there is the possibility that the insurance would be lost until the inheritance is spent. By placing the child’s assets into a trust for them, they are not owned by the child, and there would be no loss of benefits. The trustee of the trust would provide disbursements from the trust to pay for extras for the child.
The execution of the will creates testamentary trusts. It may be for estate tax purposes. It may be because there are minor children. Sometimes parents are concerned that even though their children have reached the age of majority that they are not “grown-up” enough to handle an inheritance. The parent may be concerned about spendthrift children. In this case, the will may direct a trust to be created and the trust makes distributions based on certain ages or the achievement of certain events. The trust may allow for a dollar amount or percentage of the assets to be distributed at age 25, at age 30 and age 50, for example. The requirements of the trust may say that a distribution is allowed upon graduation from college to purchase a house, upon getting married, upon having a child. The grantor or the parent determines the situations under which distributions can be made.
There are several types of trusts that are set up before the death of a grantor. As previously mentioned, this may be a means of avoiding the probate process. This is the sole purpose of a revocable trust. This may be a means of protecting assets or avoiding having assets be part of an estate.
Life insurance trusts were quite popular for a time. A trust was created and a life insurance policy was put into the trust. Most often, the death benefit was expected to be used to pay for estate taxes upon the grantor’s death. This could be critical when there are illiquid assets in an estate, such as a farm or a closely held business. The value of that business or farm might create an estate tax liability, but there is no intention of selling that asset upon death. A life insurance policy was purchased so that the death benefit could pay the estate taxes without forcing that liquidation. With the higher $11 million estate exemption and now the ability to pay estate taxes over several years due to the illiquidity, these trusts are less popular today.
Protection of assets against long term care expenses remains a popular reason for setting up a trust. This type of trust is called an Asset Protection Trust. This is an irrevocable trust – to have this protection, the grantor can no longer own the asset nor control it. A trust document is written and assets must be re-titled or re-registered in the name of the trust so that they no longer owned by the grantor. After five years, the assets are considered fully protected. If the grantor needed long term care, either as home care or in a nursing home, these funds are not required to be used for care.
The income from the trust assets is still be required to be used for care. The individual’s income, such as pensions or Social Security, is still required to be used for the expenses of care. Once the non-trust assets or non-protected assets are used up, the individual would become a ward of the state. Medicaid would generally pay the difference between the income received by the individual and the monthly billed amount. If this is a married couple, the individual still in the home gets to keep a portion of the income to allow them to pay for their personal expenses.
There are pros and cons to an Asset Protection Trust. The grantor loses access to the assets put into the trust. If the individual remains healthy and at home, they may need some of those funds for living expenses. If there are no assets to pay for care, the individual may be forced into a nursing home, not of their choosing. If you are expecting the state to pay, your ability to choose your facility is significantly reduced. In some states, a hospital stay is required to get placed in a nursing home if the state is paying for your care. Many assets already have a protective wrapper around them, which means your needs for an Asset Protection Trust may be non-existent. If you do need to enter a nursing home, have an Asset Protection Trust, and are beyond the 5-year waiting period, it does mean you have assets that will be able to pass onto your heirs.
The actual trust document needs to be created by an attorney. As financial planners, we can help you determine if you need a trust and help you walk through the different types of trusts and the purposes they serve. The key is knowing what you want to accomplish to determine if a trust can meet that need.