May 16, 2024

Thoughtful Estate Planning Calls for Architectural Construction Plans in Advance of Drafting – Which Trust Structure Fits Your Stewardship Plan?

By Irene L. Nubla, Director, Tax & Business Services

Thoughtful Estate Planning Calls for Architectural Construction Plans in Advance of Drafting – Which Trust Structure Fits Your Stewardship Plan? Private Client Services

Constructing a sturdy and welcoming home worthy of the ages requires meticulous planning, thoughtful design, and great attention to detail. Each element from the foundation to the roof must work in harmony to create a lasting structure. Similarly, crafting an effective estate plan demands an equally strategic approach, where components like revocable trusts and irrevocable trusts are the building blocks that safeguard an individual’s legacy and protects generational wealth. Similarly, as an architect considers the uniqueness of the landscape and the needs of those who will inhabit a home, a quality estate plan must consider the individual financial situation, future goals, and family dynamics to ensure that the structure will stand the test of time.

Proper usage of a revocable or irrevocable trust must also be provided for to ensure assets are managed and passed on as intended – providing lasting security and honoring the trust creator’s wishes. Both a well-built home and a well-structured estate plan stand as testaments to the foresight and care invested in their creation. The most successful structures understand the timing of asset deployment as well as division.

Creating an effective estate plan that meets an individual’s goals and objectives can be complex and time-consuming. An individual, otherwise known as the grantor, may create a revocable living trust. By serving as the trustee, the grantor retains certain privileges allowing for possible beneficiary changes during their lifetime. The grantor in this situation can also designate or change when the distribution of the assets will occur as well as manage trust assets as if they were owned in their individual name. In this unique trust wrapper, the living trust acts as a mirror image of the individual where the grantor retains full control and ownership of the trust assets.

Additionally, a revocable living trust allows the grantor’s heirs to avoid probate and maintain overall discretion relating to asset type and value. A well-executed revocable living trust eliminates this time-consuming probate nightmare which can take months or years to resolve.

Irrevocable trusts are like revocable living trusts in that they are also set up by the grantor. However, there are meaningful differences that must be understood prior to execution. The trustee of an irrevocable trust is generally a third party, not the grantor. By transferring assets to the trustee of the irrevocable trust, the grantor effectively relinquishes full control and ownership to those assets. The disposition of the assets and the beneficiaries of the irrevocable trust cannot be revised by the grantor without a court order or the consent of the trust beneficiaries. This raises the obvious question: Why would anyone want to set up an irrevocable trust if the grantor has to give up control and ownership of the assets?

There are different types of irrevocable trusts with distinct purposes. An irrevocable trust should be carefully reviewed and analyzed to understand why a grantor would want to set up an irrevocable trust. Once an irrevocable trust is established, the grantor loses all control and ownership of the assets funded into the trust.

An irrevocable trust may be established to protect assets from creditors. When a person’s assets are transferred to the irrevocable asset protection trust, the trust acts as a shell against creditors. The assets inside the trust, unless distributed to the trust beneficiaries, are not subject to attachment by creditors. Creditors can include lawsuit judgments, ex-spouses in a divorce proceeding, unpaid medical providers, lender and credit card defaults. The timing in which the trust is established is critical because a court can undo your transfer of assets to the trust if there is evidence that the assets are intentionally transferred to defraud creditors.

A special needs trust holds title to property for a person with a disability without impacting public benefits eligibility. The trust provide support for the person with a disability, but it can also supplement various benefits received by this person from government assistance programs. This is an important factor because the person with a disability can still obtain government benefits. Therefore, this trust allows the beneficiary to continue receiving government assistance. The special needs trust acts as a supplement to meet the additional needs of the person such as housing, education, health, therapy, maintenance and other essential services.

Irrevocable trusts are sometimes created to manage the payment of estate taxes. Irrevocable life insurance trusts (ILIT) are set up by a grantor to provide for the payout of a life insurance policy in the event of death. An ILIT is established to own the life insurance policy. The life insurance premiums are deposited into an ILIT bank account. The trustee of the ILIT bank account remits the premium payments to the life insurance company. At the grantor’s death, the life insurance company pays out the life insurance policy to the ILIT.

The beneficiaries of the ILIT can then use the life insurance proceeds to pay estate taxes due. The life insurance proceeds are liquid unlike a house, vehicle, real property, or closely held family business. Therefore, it simplifies paying the estate tax when liquidity is not available.

An ILIT is a significant planning tool in an individual’s estate plan. Life insurance policies held in an individual’s name are included in an individual’s taxable estate. However, life insurance policies owned by an ILIT are not included in an individual’s taxable estate. If a life insurance payout is $1,000,000 and included in an individual’s taxable estate, the additional tax would be $400,000 ($1,000,000 x 40%). With an ILIT wrapper for the life insurance policy, the estate would save $400,000 in estate taxes, leaving more money in the hands of the heirs.

A charitable remainder trust (CRT) is an example of a philanthropic irrevocable trust. In a CRT, a grantor typically transfers appreciated assets, such as real property or securities, to the trust. The CRT will provide an income stream to the grantor and/or specified beneficiaries during their lifetime, with a subsequent payout to the charity. A CRT plays an important role in an individual’s estate and income tax planning. An individual avoids capital gains on the transfer of the appreciated assets to the charitable trust and may be eligible for an income tax deduction for the charitable contribution. The individual and charity both win because the individual and /or specified beneficiaries receive an income stream during their lifetime and the charity will receive the remaining assets.

Setting up an irrevocable trust requires careful planning considerations. While there are benefits, these trusts have their drawbacks. An estate plan where family assets are moved into trust, much like a house, must be resilient to the disturbances of life and law, adaptable to unforeseen events, and carefully tailored to shelter the legacy of its creator for generations to come. With a clear understanding of the various trust mechanisms and their strategic applications, one can establish a legacy that is as enduring and cherished as the home they reside in. Marcum’s Private Client Services team offers tailored solutions to help families manage their wealth, navigate complex tax landscapes, and ensure a lasting legacy through personalized estate planning and trust strategies.