"To trust or not to trust, that is the question?"
OK, Hamlet didn't really say that, but may Americans do. The idea of setting up a trust and working through the legal language involved puts a number of Americans off of using this valuable planning tool. The real question lies in deciding if setting up a trust makes good legal and financial sense for you and your family.
This article is intended to demystify some of the basics of trusts: ■ what they are, ■ how they work, ■ how they can contribute to a successful retirement plan.
Trusts, like many other legal matters, are a complex topic where one size definitely doesn't fit all. Before you establish a trust (or enter into any other legally-binding arrangement), it's important to get personalized advice from an attorney or financial planner who's familiar with your particular situation. This article is not a substitute for personalized advice.
What is a Trust
A trust is a legal entity created to hold assets for the benefit of one or more individuals. These individuals are usually referred to as the beneficiaries of the trust. Most trusts are established by the people (usually referred to as (settlors, donors, or trustors) who will provide the assets that fund the trust (these are called the corpus). The terms and conditions governing the trust are normally set out in a written legal agreement officially called a declaration of trust. This names the individual responsible (the trustee) for managing the trust on behalf of the beneficiaries, and may also identify one or more successor trustees who will be responsible for administering the trust if the original trustee dies or becomes unable to serve.
Trusts can be established for almost any lawful purpose. For example, a parent might appoint a bank to hold a sum of money in trust for a child, with instructions to pay interest to the child, but to not release the original sum to the child, until they reach age 21. An individual might put money in a charitable trust so that a favorite charity could continue to receive interest income after the individual's death. Or, a person might choose to establish a trust as part of her estate planning, to make things easier for her family after her death.
How Trusts Work
One way to reduce the value of your estate is to put some or all of your assets in a trust. Once the trust has been set up and the funds transferred, the money no longer belongs to you and, therefore, is not part of your estate when you pass away. Your loved ones can succeed you as the beneficiaries of the trust without the worry of paying hefty estate taxes on the trust property. Please note, though, that you can also set up a trust with yourself as the primary beneficiary during your lifetime.
How a Trust Can Help You
Some people believe that only very wealthy individuals need trusts, or that having a will is enough. Unfortunately, it's not always that simple. If you die without a will, the probate court in the state where you live will divide your property among your surviving relatives - so much to a surviving spouse, so much to children and grandchildren, and so forth - based on established formulas that may or may not be consistent with the best interests of your family. But even if you have a will, your estate will still need to go through probate as the court reviews the will to ensure it is legal, and that your requests are carried out. Depending on where you live and how large or complex your estate is, probate can be expensive and take many months to complete. During that time it may be difficult for your loved ones to get access to the money they need to survive, and they may resent the lack of privacy inherent in the probate process.
Estate Tax Planning
Depending on the size of your estate, your heirs may be faced with a hefty estate tax if you put all of your assets through probate. In 2011 Congress allowed a $5 million per person estate tax exemption and at the same time raised the gift-tax exemption to $5million for $1million for individuals and to $10 million from $2 million for couples. So, people can give away that much without paying a penny in taxes. As reported by the Wall Street Journal, "the tax rate on gifts above those amounts fell to 35% from a scheduled 55%, a boon to the ultrawealthy people who want to give away even more money."
In 2012, the amount one individual can give another annually without incurring a gift tax remains at $13,000. However, the gift and estate tax exemptions are indexed for inflation, the $5 million lifetime gift and estate tax exemption limits has risen to $5.12 million, or $10.24 million per married couple. In 2013, the gift and estate tax exemptions are both scheduled to revert to $1 million and the top estate tax rate will revert to 55% unless Congress acts to change the law.
It is impossible to predict how Congress will adjust the estate taxes in the coming years. As a result, if you have a significant amount of money to leave to your loved ones, you may want to explore ways of shielding some, or all, of that money from federal estate taxes.
Setting up a trust may sound like a simple way to save your heirs some money, but creating a trust is not without cost and aggravation. Hiring an attorney to prepare a declaration of trust and related documents can cost hundreds of dollars, and professional trustees usually charge fees to manage the trust's assets and oversee the distribution of funds to the beneficiaries. It may be tempting to rely on a family member or friend to serve as trustee, but realize that choice also comes with its own risks. A trustee has a fiduciary responsibility to manage the trust and its assets, but amateur trustees may not have the necessary skills to properly fulfill that responsibility.
Once the trust is established, it needs to be funded, which means that the trustor must transfer assets from banks, stock accounts, etc. If the trust will own the trustor's home or other real estate, the deeds to those properties need to be changed and recorded. Also, trust administration is not a one-time event. Marriage, divorce, birth, death, illness, job loss and other life events can change the trustor's wishes, and make it necessary for trust documents to be changed and assets reallocated. Again, properly making these changes usually takes professional legal advice and can be fairly expensive.
Only you can decide if establishing a trust makes good sense for you. Factors such as your age, marital status, family circumstances, income level, desire for privacy, willingness to surrender control over some, or all, of your money, complexity of your estate and interest in minimizing estate taxes can all come into play. Every individual's situation is different, and needs to be considered on its own merits. Generally, however, an unmarried person under the age of 55 or 60 who's in good health and of moderate means might decide not to establish a trust, or at least not to do so for now. An older individual with greater wealth, minor children or grandchildren and health issues might conclude that setting up a trust makes good financial sense.
State laws govern the establishment and administration of trusts, and many varieties of trusts exist, each with its own advantages, disadvantages, and tax consequences. While you don't need a law degree to understand trusts, it's definitely a good idea to have a qualified estates attorney prepare the declaration of trust and any other relevant documents.