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Dec 07, 2017

Trusts and Their Tax Considerations

By Heather Kelly

In our current political environment, there has been a lot of chatter about potential reform to our existing tax laws, including the possible repeal of the estate tax and the generation-skipping transfer tax. These specific tax regulations generally apply to high net worth individuals in this context defined as usually defined as people who have $5+ million or couples with $10+ million of assets) and their repeal would result in significant tax savings for assets passed on to kids and future generations.

Given this possibility, some financial advisers and planners to high net worth individuals are devising strategies that would take advantage of these tax reforms if they should occur. In my opinion, if is the operable word in that sentence. At this point, no one can predict what, if any, changes will pass in Congress, and how and when they might be implemented if changes were made.

In addition, consider this: let’s assume that a newly retired individual is 60 years old. According to actuarial tables, that individual could reasonably expect to live 24 more years, meaning he/she could experience six more presidential elections. And as we know, each new administration proposes their own revisions to the tax code.

My point is, as it pertains to taxes, nothing is written in stone and nothing is forever. Therefore, I think it is wise for individuals who wish to pass on their wealth to their heirs (and potentially future heirs) to construct an estate framework that precisely determines how they would like their family to receive an inheritance – with some consideration of current tax laws but not strictly because of them.

Of course, depending on the aims and intentions that high net worth individuals might have for distribution of their wealth to family members, there are several existing lawful structures that can be utilized to facilitate their goals. Typically, this involves the creation of a trust and depending on an individual’s needs and preferences, there are many different kinds of trusts which can be created.

I’d like to briefly describe two kinds of trusts – an Irrevocable Life Insurance Trust (ILIT) and a Generation-Skipping Trust (GST).

Irrevocable Life Insurance Trust(ILIT)

Most people are unaware that, under certain circumstances, the IRS can designate the proceeds from their life insurance policies to be part of their estate for tax purposes when they pass on. However, there are ways around this particular regulation. One option is to form an Irrevocable Life Insurance Trust which will take ownership of the policy.

Typically, an ILIT is designated as the insurance policy's owner and beneficiary. Your life insurance proceeds are transferred to the ILIT and they are held in trust for the beneficiaries you've designated. Using trusts can also help you control how proceeds are distributed. For example, if the proceeds are intended for a younger child you can control how much and at what ages or occurrences he/she will receive payments from the trust rather than a lump sum.

However, there are some stipulations with regard to this type of trust. First, the trust must be irrevocable, which means once the trust is funded, you are obliged to step aside. You are not permitted to serve as a trustee and in relinquishing that right, you are unable to make any changes to the trust or dissolve it. However, you are entitled to appoint your adult children, a friend, an attorney, or even a financial institution to serve as trustee in your stead.

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Generation-Skipping Trust (GST)

Some high net worth individuals would like a portion of their estate to benefit their grandchildren and even future generations beyond them. In order to accomplish this, a Generation-Skipping Trust can be effective.

In this kind of trust, an individual’s assets are passed down to their grandchildren, not their children. In doing so, the children are skipped from receiving the assets, thereby avoiding the estate taxes that could apply if the assets were included in the children’s estate.

In this scenario, it is generally assumed that the children will be sufficiently taken care of by other assets from an estate. Typically, only a portion of an estate’s assets are transferred to a Generation-Skipping Trust.

Generally speaking, high net worth individuals create trusts for a variety of reasons. Some people wish to specifically designate who will benefit from their estate and how they will receive the proceeds. Others might be more concerned with leaving a legacy – being remembered by future generations. But the trusts discussed here are also created as a way to minimize inheritance taxes while also accomplishing these objectives. These strategies, rules and regulations surrounding trust creation can be very complicated and complex.

For high net worth individuals, it is advisable to have a team of professionals who will carefully and thoroughly implement and administer all the rules and regulations involving the trust, as well as advising them on how to take advantage of any and all existing tax laws.

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