• Transfer your property smoothly to your heirs
• Provide for loved ones who need help and guidance
• Minimize estate taxes
• Plan for the day when you are not capable of managing your affairs
• Keep the details of your estate private
Trusts. There are several types of trusts that can help you meet estate planning goals that may not be met by leaving your assets outright to your heirs. Let’s take a look at a few such goals and how a trust may help.
Say you are in a second marriage with children from a prior marriage. You want your assets to provide support to your spouse after your death, but you ultimately want them to pass to your children. If you leave your assets outright to your spouse, your spouse can leave those assets to whoever he or she chooses. By transferring your assets to a qualified terminable interest property (QTIP) trust, your spouse is entitled to the income from the trust, but cannot change the trust’s beneficiaries. After your spouse dies, the assets remaining in the trust are transferred to the beneficiaries you chose.
Say you have a special needs child. If you leave assets outright to your child, your gift may make your child ineligible to receive government benefits, such as Supplemental Security Income (SSI) and Medicaid, that are based on financial need. You can preserve your child’s eligibility for these programs by leaving your assets to a special needs trust instead. The trustee you name can use the money from the trust to supplement the services provided by the government programs. This might include vacations, entertainment, or computers.
Or say you have concerns about your heirs’ ability to manage your assets after you are gone. Leaving them to a trust allows you to name a trustee to manage them for the benefit of your heirs.
The bottom line is that when you want to exert extra control over how your assets are managed or distributed, trusts are typically the way to go.
Minimize estate taxes. Let’s get a few things clear about estate taxes right up front. First, most estates will not have to pay estate taxes, thanks to the estate tax exemption which allows a certain amount of property to pass free of estate taxes. (The federal estate tax exemption amount is $5.25 million in 2013; ask your estate planning advisor for your state’s current exemption amount.) Second, if you are married, you can generally leave your spouse an unlimited amount of property without it being subject to estate taxes. Third, if the value of your estate exceeds the amount you can exempt from estate taxes and you are leaving it to someone other than your spouse, a good chunk of your estate may go to paying the estate taxes on it. Certain estate planning tools may help minimize those taxes.
Irrevocable trusts. Several types of irrevocable trusts offer the potential for reduced estate or gift taxes. Let’s take a look at one that may help you transfer your home to your children at a reduced gift tax cost.
With a qualified personal residence trust (QPRT), you transfer ownership of your home to the trust for a period of years, during which time you may continue to live in the home. At the end of the period, ownership of the home is transferred to the trust’s beneficiaries, who are typically your children. When your home enters the trust, it is removed from your estate and is subject to gift tax. The good news is that the IRS allows the value of your home to be discounted for gift tax purposes because your children will not be able to take possession of the gift for years. If you do not outlive the period of the trust, the home’s fair market value is added back into your estate for estate tax purposes. If you do outlive the period and wish to continue living in the home, you can lease it from your children.
Before creating an irrevocable trust, it is important to keep in mind that this type of trust cannot easily be changed or revoked.
Family limited partnerships. A family limited partnership (FLP) may also help you minimize estate and gift taxes.
Here’s a simplified version of how an FLP generally works. You set up a limited partnership, with yourself as general partner and your children as limited partners. As the general partner, you control the partnership. You transfer assets to the FLP in exchange for partnership interests, some of which you give to your limited partners. These gifts reduce the value of your estate. Because the limited partners are limited in their ability to manage the FLP assets or sell their interests to outsiders, the interests that you give them are valued less highly for gift tax purposes than if you had given the assets outright to your children. Plus, the income that your children receive from their interests is not subject to the gift tax.
An FLP must have a valid business purpose and not simply be used to minimize estate and gift taxes. Your estate planning advisor can tell you more.
Irrevocable life insurance trusts. The proceeds from life insurance policies are frequently used to pay estate taxes so that assets in the estate do not have to be sold to pay the taxes. However, if you own the policy on your life, the proceeds will be part of your estate and subject to estate taxes—the very thing you are trying to avoid.
If your estate will be subject to estate taxes, it is generally a good idea to have an irrevocable life insurance trust own the policy on your life so that the proceeds are not part of your estate.
You can either transfer an existing life insurance policy to the trust or have the trust purchase a new policy on your life. If you transfer an existing policy, you must survive the transfer by at least three years for the proceeds to be excluded from your estate.
Strategic giving. If you expect that your estate will be subject to estate taxes, you may want to give some of it away during your lifetime.
You can give up to $14,000 (the annual gift tax exclusion for 2013) to as many people as you choose this year without your gift being subject to the federal gift tax or reducing the amount that can later be exempted from estate taxes. If you are married, you can double that amount if your spouse agrees to split the gifts with you.
Donations that you make to qualified organizations, such as charities, religious organizations, and non-profit schools, reduce your estate and are generally tax-deductible. Charitable remainder trusts and similar arrangements allow you to make a gift to charity, claim a charitable deduction for part of your gift, reduce your taxable estate, and generate a stream of income for yourself.
Which tools are right for you?
This is a question for your tax, financial, and legal advisors. They can help you select the appropriate tools and craft an estate plan that is right for you.