Using the Beneficiary Controlled Trust

What is a Beneficiary Controlled Trust?

A Beneficiary Controlled Trust is an estate or gift tax planning technique where parents leave property to their children in a trust rather than outright.  As the name implies, the child-beneficiary is the trustee of the trust.  Thus, the Beneficiary Controlled Trust.

Why are estate planners and their clients increasingly using Beneficiary Controlled Trusts?

It is easier to explain why, if we first understand that there are essentially two methods to leave property to the typical child, excluding those that are irresponsible, etc., they are:

• Outright to the child
• In a trust for the child where the child is the trustee

As we are assuming that there are only two methods to leave the property, we need to compare them against one another.

What are the factors used in the comparison?

We start by listing the things that a beneficiary can do when the property is left outright and free of trust with how those same things included in a Beneficiary Controlled Trust.

What can an owner of property do with the property?

There is actually a fairly limited number of things, they can do, they are:

• Give the property away
• Leave the property to anyone they want
• Use the property without paying for the use
• Sell the property
• Destroy the property
• Lose the property to a creditor
• Lose the property to a divorcing spouse

Do I understand correctly that you are now going to compare the ability of the beneficiary-trustee of a Beneficiary Controlled Trust to do the same things that an outright beneficiary could do?

Yes, that is exactly correct.  Let’s see what the comparison shows:

• Give the property away:  The beneficiary-trustee of a Beneficiary Controlled Trust may be given the power to make gifts of the property in the trust to anyone other than the beneficiary or the creditors of the beneficiary.  In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust.  We’ll give this an Equal rating.
• Leave the Property to anyone they want:  The beneficiary-trustee may be given the power to leave the property to anyone other than the beneficiary’s estate, creditors of the beneficiary, or the creditors of the beneficiary’s estate.  In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust.  We’ll give this an Equal rating.
• Use the property without paying for the use:  The beneficiary-trustee of the Beneficiary Controlled Trust may be authorized to use the property of the trust without paying for the use.  In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust.  We’ll give this an Equal rating.
• Sell the property:  The beneficiary-trustee may be given the power to sell the property and reinvest the proceeds.  In essence, the Beneficiary Controlled Trust is identical to the outright bequest free of trust.  We’ll give this an Equal rating.
• Destroy the property:  The beneficiary-trustee may not be given the power to destroy the property.  The Beneficiary Controlled Trust provides more property protection than an outright bequest.  We’ll give the Trust a Superior Protection rating.
• Lose the property to a creditor:  The Beneficiary Controlled Trust may be prepared in such a manner that creditors of the beneficiary-trustee may not attach assets held in the Beneficiary Controlled Trust.  The Beneficiary Controlled Trust provides better creditor protection. We’ll give the Trust a Superior Protection rating.
• Lose the property to a divorcing spouse:  The Beneficiary Controlled Trust can be prepared such that a divorcing spouse has little or no rights to the Beneficiary Controlled Trust’s property.  The Beneficiary Controlled Trust provides  better asset protection.  We’ll give the Trust a Superior Protection rating.

Now, let’s see how the Beneficiary Controlled Trust did in the item by item comparison:

Give the property away	EQUAL RATING
Leave the property to anyone they want	EQUAL RATING
Use the property without paying for the use	EQUAL RATING
Sell the property	EQUAL RATING
Destroy the property	SUPERIOR PROTECTION
Lose the property to a creditor	SUPERIOR PROTECTION
Lose the property to a divorcing spouse	SUPERIOR PROTECTION

Since the Beneficiary Controlled Trust is so far superior to outright bequests, why doesn’t everyone use them?

The primary reason is many estate planning practitioners are simply not familiar with the technique.  In addition, some clients simply do not want, what they perceive to be, “complicated estate plans.”

Are Beneficiary Controlled Trusts complicated?

No, they are not. An easy comparison is the Family or Credit Shelter Trust that holds the estate tax free amount for the first spouse to die.  An annual tax return is due and accounting and monitoring must be done.  However, it seems to me that the benefits provided by the Beneficiary Controlled Trust far outweigh the additional costs after the surviving spouse has died.

Successor Trustee? Tips on Avoiding Potential Liability

To help you avoid personal liability in connection when serving as trustee, follow three rules:

1. Document all transactions, including any reasons for making or not making distributions. While you may perceive the risk of getting sued as low, you cannot ignore the possibility. When you are acting as a trustee and are essentially in control of someone else's assets, you can easily become the focus of any anger or frustration that beneficiaries may feel.



2. Keep beneficiaries well informed of trust business. Be friendly and cooperative. It is much more difficult to sue someone with whom you have a good relationship. Maintain carefully documented files. Seek advice from experts.



3. Consider the dynamics of a lawsuit against a trustee. Judges and juries alike tend to have more sympathy for the party who appears to be “right.” If you have sloppy records (or have none), or if you have not sought help when you came up against something beyond your expertise, or if you have not provided beneficiaries with information that you should have, you will not be given the benefit of the doubt.

No NC Highway Use Tax for transfer into a Living Trust

The North Carolina General Assembly recently passed a law to clarify that the Highway Use Tax does not apply on a transfer of a motor vehicle to a Revocable Living Trust. The new law became effective July 17, 2010.

How to Sign Documents as Trustee

When signing anything on behalf of the trust, always sign as “[Your Name], Trustee.” By signing as Trustee, you will not be personally liable for that action as long as that action is within the scope of your authority under the trust. If the trustee does not sign as “trustee” and the contract does not specifically exclude liability, then a trustee is personally liable on contracts entered into in the trustee’s fiduciary capacity in the course of the administration of the trust estate. Whenever you sign any document on behalf of the trust, always sign as “[Your Name], Trustee.”

Don’t both spouses automatically receive the $1,000,000 applicable exclusion amount for a total exemption of $2.0 million in 2011 without doing anything?

No!  In order for married couples to fully utilize both spouse’s applicable exclusion amount of $1,000,000 in 2011 (assuming no new estate tax legislation), a plan must be in place.  Unless they want to give assets to someone other than each other, their estate planning documents, whether in a will or a trust, must plan for the creation of a credit shelter trust at the first spouse’s death. Because clients do not know which spouse will be the first to die, both spouse’s plans should provide for the utilization of such tax credit shelter trusts. Many spouses believe that such credits would be given automatically, sheltering $2.0 million assets in 2011.


In reality, when one spouse provides in a will or trust to leave everything to the surviving spouse outright, then the first spouse to die does not use their $1,000,000 exemption, but instead places everything in the potential taxable estate of the surviving spouse. There is no tax at the first death due to the unlimited marital deduction. However, at the second death there will only be $1,000,000 that can pass without tax. The amount of assets above the exemption will be taxed at a rate of up to 55%. In order for both spouses to provide for each other and receive their own $1,000,000 exemption, they must plan to do so in a will or trust.

HIPAA

The HIPAA (Health Insurance Portability and Accountability Act) regulations require that every patient sign another consent form, which gives providers permission to use and disclose a patient's protected health information for the purpose of treatment, payment and health care operations. If patients refuse to sign this consent form, providers are not required to treat them in most cases. In fact, it probably would be next to impossible for a caregiver to do so without having access to critical facts about the patients' condition. Your estate planning documents including your powers of attorney and your revocable living trust should include provisions to address the HIPAA requirements and allow those you have chosen to permit disclosure of your health care information.

How does divorce affect your trust?

By: Patrick D. Newton:  If you set up a revocable trust for your self that has provisions in it for your spouse, including naming the spouse as a current or successor trustee, those provisions are revoked upon divorce.  This default rule could be changed in the trust document itself, but generally would not be.

As for an irrevocable trust, the Grantor's divorce from a spouse who is a beneficiary, or a trustee, does not impact the irrevocable trust at all.  This general rule could also be drafted around.  Typically, if you are creating an irrevocable trust for your spouse, you will want to include language that will deem the spouse as deceased upon divorce. 

If you are creating an irrevocable trust to qualify for the unlimited marital deduction, you cannot have such a provision and also qualify for the marital deduction.  You could, however, terminate the spouse's role as a trustee, and you could arguably terminate any access to principal.  The income in a marital deduction trust must continue to be paid to the spouse for his or her lifetime.

Don't wait till you're old or rich for estate plan

Don't wait till you're old or rich for estate plan:  CHICAGO — Hiding thousands of dollars inside a book may be a clever way to foil burglars. But it’s less than ideal estate planning — especially when you don’t tell anyone what you’ve done.

Don't Make the Same Mistakes You've Seen in the Headlines

Now is the time to update your existing estate plan, or proceed with implementing a comprehensive estate plan. Why? First, we now know with certainty that the federal estate tax is not going away, and thus we should establish a plan that avoids or at least minimize this voluntary tax.

More importantly, if you don't you just might end up like the host of celebrities who have made the headlines recently because they either had no estate planning or because the planning they did have was woefully out of date or otherwise inadequate.

As the recent celebrity examples demonstrate, estate planning is not just about planning to avoid estate tax. Instead, estate planning is about accomplishing what is important to you and your family, like: passing values to your children and grandchildren; passing property in a way that creates a lasting legacy; and protecting your privacy.

Pending Changes to Federal Estate Tax Law: Does It Really Matter?

As we approach year-end we continue to hear scuttlebutt from Capitol Hill that Congress will enact some estate tax legislation before January 1, 2010. As you may recall, this is "necessary" because under current law we are scheduled to have no federal estate tax for those who pass in 2010. Note, however, that in 2010 the estate tax would be replaced with a system that would tax a greater number of Americans when they sell appreciated assets (like stocks and real estate) - a system that Congress tried once before, but it failed miserably!

The consensus from Washington, D.C. is that we will see a "patch" that simply extends current law through the end of 2010. What will happen then, however, is anyone's guess. The cynics suggest that because 2010 is an election year, both Republicans and Democrats may be encouraged to do nothing. If that happens, the current law will expire, and beginning January 1, 2011 we would revert to a $1 Million federal estate tax exemption and maximum estate tax rate of 55%.

While we don't know the details, the fact that we will have an estate tax means that we should all take steps to minimize or avoid it. In addition, more and more states are enacting separate state estate taxes (usually with much lower thresholds) as a way to generate revenue, so state estate tax will ensnarl many who do not plan to avoid it.

Celebrity Examples of What Not to Do with Your Estate Planning

When it comes to estate planning, it seems that folks generally fall into one of three broad categories: (1) those who have done no planning; (2) those who have done some (often inadequate) planning; and (3) those who have done good planning, but who should have it reviewed and possibly updated. The recent spate of celebrity cases that have been in the news lately serves as a pretty telling primer on these various categories. As you consider the lives and stories of these famous people, how do you stack up? You may find that this winter is a good time to revisit your estate planning to make sure your plan is as it should be.

Leaving It to Chance with No Planning

Steve McNair seemed to have it together. A Super Bowl quarterback, 3-time Pro Bowl selection, and one of football's most prolific passers, McNair was killed at the age of 36. Surely thinking that his whole life was ahead of him, McNair did no estate planning at all, leaving his substantial wealth (nearly $20 Million) to be argued over - publicly - in the Tennessee probate courts. His children, assuming they are given substantial shares of his estate, will not enjoy the gift their father could have given by providing a framework in which they could grow into their inheritance.

When McNair's children turn 18 - the legal age of majority in Tennessee - they will receive their inheritance outright; they will be free to do what they please with the money. Can you imagine turning an 18-year-old child loose with several million dollars?

Even if you don't have millions, do you want your loved ones to be able to do with their inheritance as they please, knowing that you can provide them with predictability and guidance to help them protect and preserve what you leave behind?

Inadequate, or "Do-It-Yourself" Planning

Studies indicate that nearly 70% of all Americans have done no estate planning at all. But even of those roughly 30% of people who have done some estate planning, many have done a very poor job, designing an estate plan that inadequately represents their wishes or worse, causes confusion, delays, and unmet expectations.

Heath Ledger had a will. It was a simple, three-page document created before he made his mark in the film industry and made his millions with his Oscar-nominated performance in the movie Brokeback Mountain. When he died at age 28, his estate and his family had far outgrown his inadequate estate plan. His will provided that his estate should be divided equally among Ledger's parents and his siblings, and failed to provide anything for his infant daughter. Although she will surely ultimately be provided for, by relying on a will (and a very deficient one), Ledger assured his family a legacy of confusion, frustration, and public litigation.

The worst offenders feeding this category are those who sell "one size fits none" form estate planning documents, either online or in stores. These folks sell documents to well-intentioned individuals who are proactive and motivated enough to do something about their estate plan. But the key to this mistake is that it approaches estate planning as a document transaction. Sure you get a "will" or a "trust" and some other documents, but do they really represent your goals? Will they properly instruct your family when they need to? As in Heath Ledger's case we may have only one chance to get estate planning right. Printing and signing documents without thoughtful legal help is a disaster waiting to happen.

Imagine that your child is getting married and you need a new suit. Will you go to the corner discount retailer and pull something off the sale rack? After all, they advertise "always the low price." You'll have a jacket, pants, the whole ensemble. But is that really the right solution for you on this special occasion? Isn't it more appropriate to see an expert who can learn about your tastes, your needs, your best features, and deliver what you really need, something you can be proud of?

By the same measure, buying documents - from a retailer or from an attorney - is not estate planning. Although estate planning requires documents to make a plan legally effective, the art of effective estate planning comes through professional, comprehensive advice that only focused and dedicated estate planning professionals can provide.

Outgrown Estate Plans

Now some time has passed since you bought that new suit for the special occasion. One grandchild, maybe two are born and things have changed. Maybe you've lost a few pounds (or, heaven forbid, gained a few!). What has happened to that nice suit? Sure it's a little musty, but never the worse for wear. But no matter how hard you try, it just doesn't fit like it used to.

Just like a finely tailored suit, an estate plan can get outgrown, too. The estate plan that you spent time, effort, and money to get just right will not automatically evolve as your life changes. Even when you have a great estate plan in place you must remain vigilant. The current battle over Michael Crichton's estate illustrates this point precisely.

Crichton was the creator of movie hits like Jurassic Park and the television series ER. Understanding the importance of sound estate planning to preserve peace of mind for his family, Crichton apparently had a robust estate plan in place. And then life changed.

Michael Crichton had prepared carefully, incorporating a premarital agreement with his fifth (and surviving) wife to make sure that he fully provided for his child from a previous marriage. However, Crichton and his wife were expecting a new baby when Crichton died unexpectedly late last year. Though he had apparently gone to great lengths in earlier planning, the fact that he failed to provide for his unborn child has cast a cloud of uncertainty over Crichton's estate. It appears that despite his earlier efforts, Michael Crichton is bound to leave a legacy of distress, uncertainty, and litigation for his family.

Unlike Heath Ledger and Michael Crichton, you may be certain that you will not have children later in life. But do you know with certainty that your loved ones will not become a spendthrift, develop a creditor problem (50% of marriages end in divorce), or receive government benefits such that an outright inheritance would result in disqualification of those benefits?

Where Do YOU Stand?

Although none of us like to embrace our mortality, as responsible adults we have to prepare ourselves and our families for the inevitable. Whether you're a millionaire or of more modest means, you want to leave a lasting legacy of family harmony, good memories, and caring protection for those you love. Estate planning can be challenging, and should never be done alone. Take the time to discuss your needs with a team of well-trained, attentive estate planning professionals now.

If You Have a Living Trust, Be Sure to Fund It

Bob and Carol had a Living Trust, but neglected to retitle their assets as instructed by their attorney. The attorney even deeded their home to their trust, but they later sold the home and purchased another home in joint tenancy and not in the name of the trust. Bob died a few years ago, and on Carol's death, all of the assets were subject to probate and were part of her taxable estate. This defeated many of the reasons for having a Living Trust Estate Plan.

By not titling their assets in the name of their trust, they totally defeated their planning goals of avoiding probate and reducing estate taxes.

Moral: If you have a living trust, be sure to fund it with your assets by changing record title or beneficiary designations as instructed by your attorney. In our office we fully fund all of our trusts so you don't have to worry about it. We also conduct periodic plan reviews to determine that everything is working correctly and the assets are all properly titled.

Planning You Should Consider Now

These are difficult times. The "experts" now acknowledge that we are in a recession - and that we have been so for some time. Consumer confidence is low. As a result many of us are concerned, wondering what planning we should do now, if any.

For the vast majority of Americans, planning is not discretionary. These individuals continue to have - or perhaps for the first time have - personal concerns that they need to address now because these concerns are unrelated to the economy. In fact, some of these concerns may even be made worse by our current economic situation.

In addition, for anyone who may be subject to federal or state estate tax in the future, unusual circumstances have created a "perfect planning storm" that will not last long. This post addresses some of the planning needs unrelated to the economy and discusses strategies that create the biggest planning opportunities today.

Planning Needs Unrelated to the Economy

Many planning needs are unrelated to the economy. They include:

• Disability and retirement planning;
• Special needs planning;
• Beneficiary protection planning (for example, protection from divorce, creditors and/or perhaps the beneficiaries themselves); and
• Second marriage and "blended family" protection.

These planning needs are often more critical for those with fewer assets than for those with more wealth.
Disability Planning
According to the Family Caregiver Alliance and recent MetLife Mature Market Study, of those Americans currently age 65 and older:

• 43% will need nursing home care;
• 25% will spend more than a year in a nursing home;
• 9% will spend more than 5 years in a nursing home; and
• The average stay in a nursing home is more than 2.5 years.

Nursing home costs are increasing much faster than the inflation rate would imply. Thus, many of us quite appropriately are very worried about how we will pay for that kind of care if we need it.
Planning Tip: Careful consideration of how to pay for long-term care is critical for most individuals.
Also of concern to many people is who will provide long-term care and whether those caregivers will care for us in the way we desire. For many, there is a strong desire to stay at home as long as possible. For others, the companionship found in an assisted living facility makes that choice preferable. Still others need care that cannot be provided at home or only at a prohibitive cost. And, not surprisingly, these goals often change over time and with changing circumstances.
Planning Tip: A trust that sets forth your current, carefully thought-out disability objectives is the best way to ensure that your planning meets your personal goals and objectives.
Special Needs Planning
Special needs planning is another area unrelated to the economy. According to the 2002 U.S. census:

• 51.2 million people reported having a disability;
• 13-16% of families have a child with special needs;
• Autism occurs every 1 in 150 births and between 1 and 1.5 million Americans have an Autism spectrum disorder.

Failure to properly plan for a person with special needs can have disastrous consequences, especially if the person is receiving government benefits.
Planning Tip: A Special Needs Trust that incorporates specific care provisions is a critical component of the planning necessary for a special needs person who needs ongoing support.
Planning Tip: Insurance on the lives of the parents or grandparents of a special needs person frequently funds the ongoing care of that special needs beneficiary.
Beneficiary Protection Planning
Protecting an inheritance from being lost in a divorce or to a beneficiary's creditors is a serious concern of many individuals. Many from the older generation fear that their children and grandchildren lack strong financial decision-making skills - and the potential for creditor attack or for beneficiary dissipation of an inheritance is greater during difficult economic times.
Also, divorce rates exceed 50% nationally. Many individuals express concern over their children and grandchildren divorcing - they don't want the assets they worked so hard to accumulate winding up in the hands of a former daughter-in-law, son-in law, etc. Since divorce rates increase in difficult economic times, this planning is even more important now than in better economic times.
Blended Family Planning
A higher divorce rate also leads to more second and subsequent marriages - each with a higher statistical probability of ending in another divorce. With blended families (in other words with potentially his, her, and their kids), it is critical that each parent's planning protect his or her children in the event that parent predeceases the subsequent spouse. Failure of blended-family parents to do this type of planning practically guarantees that somebody's kids will be disinherited or a messy probate will result.
Planning Tip: Carefully drafted estate plans protect beneficiaries from divorce, creditors and themselves. Such plans can also provide for children from prior marriages, which is often the only way to ensure that these beneficiaries actually receive any inheritance.
The "Perfect Storm" for Taxable Estate Tax Planning
Certainty as to the Federal Estate Tax
The prospect for a repeal of the federal estate tax in the foreseeable future is essentially zero and, in half the U.S. jurisdictions, there is also a state estate tax (which can apply if you own property in that state or move there). Nobody knows whether the Congress and President will agree to a new federal estate tax exemption amount (the amount an individual, with planning, can pass free of federal estate tax). Despite rumors from Capitol Hill, we also do not know what that new amount might be - especially in light of the federal spending developments of the past few months. If that spending leads to greatly increased inflation, many more individuals may face being subject to the federal estate tax. Because of the virtual certainty that we will continue to have an estate tax, many individuals must plan if they wish to avoid paying it.
As the U.S. Supreme Court said:

Anyone may so arrange his affairs that his taxes shall be as low as possible; he
is not bound to choose that pattern which will best pay the Treasury; there is
not even a patriotic duty to increase one's taxes. Therefore, if what was done
here was what was intended by [the statute], it is of no consequence that it was
all an elaborate scheme to get rid of [estate] taxes, as it certainly was.

For those who may be subject to federal or state estate tax, we are in a "perfect storm" that creates exceptional planning opportunities not likely to be seen again for many years. The factors that have come together to create this "perfect storm" are (a) reduced asset values; and (b) historically low interest rates.
Reduced Asset Values
Reduced values for stocks, real estate, businesses, etc., mean that individuals can transfer these assets for less today than they could have just a few months ago.
For example, if a particular stock you own declined from $100 per share to $80, now you can transfer 162.5 shares with a $13,000 annual gift tax exclusion (it went up from $12,000 on January 1, 2009) instead of 130 shares had it remained at $100. Married couples can give twice that amount, or $26,000 per person, per year. Typically, clients transfer this amount to children, grandchildren and other close family members.
In addition, reduced real estate and business values mean that you can transfer a larger percentage of these assets free of federal gift tax by taking advantage of your $1 million lifetime exemption from federal gift tax.
Planning Tip: At a minimum, if you are subject to federal or state estate tax, you should take advantage of the annual gift tax exclusion ($13,000 per person as of January 1, 2009) to transfer assets with reduced values to children, grandchildren and others. Ideally, you should make these gifts in trust to provide the beneficiaries protection from divorce, creditors, predators, and themselves.
Historically Low Interest Rates
The other piece to the "perfect storm" is today's historically low interest rates. The January 2009 Applicable Federal Rates (AFRs) - the "safe harbor" interest rates provided by the government for, among other things, loans among family members - are as follows:

• Short-term (not over 3 years): 0.81%
• Mid-term (over 3 but not over 9 years): 2.06%
• Long-term (over 9 years): 3.57%

February Rates are even lower. Due to a number of reasons, these low interest rates make many estate planning strategies even more attractive, including:

• Strategies that involve the use of loans at current interest rates; and
• Strategies that assume (as required by the IRS) that the assets you transfer will grow at current interest rates.

For transfers made in January 2009, this rate is 2.4%.
I encourage you to contact your advisors to determine if one or more of these strategies is appropriate for you under the circumstances.
Conclusion
Despite these difficult economic times, there are many reasons why you should plan or update your planning now rather than wait until we have more economic certainty. Furthermore, in the current economic and political climate it is impossible to know which of us will be subject to federal (or state) estate tax in the future. We do know, however, that the federal estate tax is not going away. If you may be subject to estate tax, the current "perfect storm" creates a unique opportunity for the planning team to help you meet your goals and objectives.
To comply with the U.S. Treasury regulations, I hereby inform you that (i) any U.S. federal tax advice contained in this blog was not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (ii) each taxpayer should seek advice from their tax advisor based on the taxpayer's particular circumstances.

Understanding the Significance of Trusts

In the right circumstances, trusts can provide significant advantages to those who utilize them, particularly in protecting trust assets from the creditors of beneficiaries. Admittedly this can be a complex topic, but you see its implications in the headlines every day. Today’s post attempts to simplify the subject and explain the general protection trusts provide for their creator (the “trustmaker”) as well as the trust beneficiaries. Given the numerous types of trusts, I will only explore the most common varieties of Trusts. I encourage you to seek the counsel of your wealth planning team if you have questions about the application of these concepts to your specific situation, or if you have questions about specific types of trusts.

Revocable vs. Irrevocable Trusts

There are two basic types of trusts: revocable trusts and irrevocable trusts. Perhaps the most common type of trust is revocable trusts (aka revocable living trusts, inter vivos trusts or living trusts). As their name implies, revocable trusts are fully revocable at the request of the trust maker. Thus, assets transferred (or “funded”) to a revocable trust remain within the control of the trust maker; the trust maker (or trust makers if it is a joint revocable trust) can simply revoke the trust and have the assets returned. Alternatively, irrevocable trusts, as their name implies, are not revocable by the trust maker(s).

Revocable Living Trusts

As is discussed more below, revocable trusts do not provide asset protection for the trust maker(s). However, revocable trusts can be advantageous to the extent the trust maker(s) transfer property to the trust during lifetime.

Planning Tip: Revocable trusts can be excellent vehicles for disability planning, privacy, and probate avoidance. However, a revocable trust controls only that property affirmatively transferred to the trust. Absent such transfer, a revocable trust may not control disposition of property as the trust maker intends. Also, with revocable trusts and wills, it is important to coordinate property passing pursuant to contract (for example, by beneficiary designation for retirement plans and life insurance).

Asset Protection for the Trust Maker

The goal of asset protection planning is to insulate assets that would otherwise be subject to the claims of creditors. Typically, a creditor can reach any assets owned by a debtor. Conversely, a creditor cannot reach assets not owned by the debtor. This is where trusts come into play.

Planning Tip: The right types of trusts can insulate assets from creditors because the trust owns the assets, not the debtor.

As a general rule, if a trust maker creates an irrevocable trust and is a beneficiary of the trust, assets transferred to the trust are not protected from the trust maker’s creditors. This general rule applies whether or not the transfer was done to defraud an existing creditor or creditors. Until fairly recently, the only way to remain a beneficiary of a trust and get protection against creditors for the trust assets was to establish the trust outside the United States in a favorable jurisdiction. This can be an expensive proposition. However, the laws of a handful of states (including Alaska, Delaware, Nevada, Rhode Island, South Dakota, and Utah) now permit what are commonly known as domestic asset protection trusts. Under the laws of these few states, a trust maker can transfer assets to an irrevocable trust and the trust maker can be a trust beneficiary, yet trust assets can be protected from the trust maker’s creditors to the extent distributions can only be made within the discretion of an independent trustee. Note that this will not work when the transfer was done to defraud or hinder a creditor or creditors. In that case, the trust will not protect the assets from those creditors.

Planning Tip: A handful of states permit what are commonly known as domestic asset protection trusts.

Given this insulation, asset protection planning often involves transferring assets to one or more types of irrevocable trusts. As long as the transfer is not done to defraud creditors, the courts will typically respect the transfers and the trust assets can be protected from creditors.

Planning Tip: If you are concerned about personal asset protection but are unwilling to give up a beneficial interest to protect your assets from creditors, consider a domestic asset protection trust or even a trust established under the laws of a foreign country.

Asset Protection for Trust Beneficiaries

A revocable trust provides no asset protection for the trust maker during his or her life. Upon the death of the trust maker, however, or upon the death of the first spouse to die if it is a joint trust, the trust becomes irrevocable as to the deceased trust maker’s property and can provide asset protection for the beneficiaries, with two important caveats. First, the assets must remain in the trust to provide ongoing asset protection. In other words, once the trustee distributes the assets to a beneficiary, those assets are no longer protected and can be attached by that beneficiary’s creditors. If the beneficiary is married, the distributed assets may also be subject to the spouse’s creditor(s), or they may be available to the former spouse upon divorce.

Planning Tip: Trusts for the lifetime of the beneficiaries provide prolonged asset protection for the trust assets. Lifetime trusts also permit your financial advisor to continue to invest the trust assets as you instruct, which can help ensure that trust returns are sufficient to meet your planning objectives.

The second caveat follows logically from the first: the more rights the beneficiary has with respect to compelling trust distributions, the less asset protection the trust provides. Generally, a creditor “steps into the shoes” of the debtor and can exercise any rights of the debtor. Thus, if a beneficiary has the right to compel a distribution from a trust, so too can a creditor compel a
distribution from that trust.

Planning Tip: The more rights a beneficiary has to compel distributions from a trust, the less protection that trust provides for that beneficiary.
Therefore, where asset protection is a significant concern, it is important that the trust maker not give the beneficiary the right to automatic distributions. A creditor will simply salivate in anticipation of each distribution. Instead, consider discretionary distributions by an independent trustee.

Planning Tip: Consider a professional fiduciary to make distributions from an asset protection trust. Trusts that give beneficiaries no rights to compel a distribution, but rather give complete discretion to an independent trustee, provide the highest degree of asset protection.

Lastly, with divorce rates at or exceeding 50% nationally, the likelihood of divorce is quite high. By keeping assets in trust, the trust maker can ensure that the trust assets do not go to a former son-in-law or daughter-in-law, or their bloodline.

Irrevocable Life Insurance Trusts

With the exception of domestic asset protection trusts discussed above, a transfer to an irrevocable trust can protect the assets from creditors only if the trust maker is not a beneficiary of the trust. One of the most common types of irrevocable trust is the irrevocable life insurance trust, also known as a wealth replacement trust. Under the laws of many states, creditors can access the cash value of life insurance. But even if state law protects the cash value from creditors, at death, the death proceeds of life insurance owned by you are includible in your gross estate for estate tax purposes. Insureds can avoid both of these adverse results by having an irrevocable life insurance trust own the insurance policy and also be its beneficiary. The dispositive provisions of this trust typically mirror the provisions of the trust maker’s revocable living trust or will. And while this trust is irrevocable, as with any irrevocable trust, the trust terms can grant an independent trust protector significant flexibility to modify the terms of the trust to account for unanticipated future developments.

Planning Tip: In addition to providing asset protection for the insurance or other assets held in trust, irrevocable life insurance trusts can eliminate estate tax and protect beneficiaries in the event of divorce.

If the trust maker is concerned about accessing the cash value of the insurance during lifetime, the trust can give the trustee the power to make loans to the trust maker during lifetime or the power to make distributions to the trust maker’s spouse during the spouse’s lifetime. Even with these provisions, the life insurance proceeds will not be included in the trust maker’s estate for estate tax purposes.

Planning Tip: With a properly drafted trust, the trust maker can access cash value through policy loans.

Irrevocable life insurance trusts can be individual trusts (which typically own an individual policy on the trust maker’s life) or they can be joint trusts created by a husband and wife (which typically own a survivorship policy on both lives).

Planning Tip: Since federal estate tax is typically not due until the death of the second spouse to die, trust makers often use a joint trust owning a survivorship policy for estate tax liquidity purposes. However, a joint trust limits the trust makers’ access to the cash value during lifetime. In these circumstances, consider an individual trust with the non-maker spouse as beneficiary.