Keep It in Trust
One of the most valuable presents that you can
ever give to your children and grandchildren, if you will be leaving
them a significant inheritance, is to leave it to them in the form of a
The trust is an enormously powerful asset
protection and tax planning tool, and should be used far more often than
If the trust is drafted as a
"spendthrift" trust, then as a general rule in almost every
state, the trust assets will not be subject to the claims of the
However, the key to using trusts for creditor
protection is understanding that the creditor protection generally
only applies to a trust set up for the benefit of a person by a third
party. If you set up a trust for yourself, your creditors will
be able to reach the trust assets just as though you still owned them
individually. Such a trust is called a "self-settled"
trust. The popular Living Trust is a type of self-settled trust.
While certain offshore jurisdictions allow you to
set up a trust for yourself that is exempt from creditors claims, and
some states, including Alaska, Nevada, and Missouri, have set up
statutory schemes that purport to provide the same benefit (but may not,
under the Full Faith and Credit Clause under the U.S. Constitution), the
general rule in the United States is that self-settled trusts don't
protect assets from your creditors.
So, in terms of creditor protection, by
establishing a trust, you are providing a benefit to your children and
grandchildren that they literally cannot provide for themselves.
A lot of people don't like trusts, based upon how
they are presented in the popular media. However, the
typical objections don't stand up to close scrutiny. Let's take a
Objection #1: I don't want my kids to
have to deal with some bank trustee in order to get their money.
If you don't want that, they don't have to.
Your child can serve as sole Trustee, if you wish,
and can have the ability to receive the trust income and to receive
principal from the trust based on an ascertainable standard relating to
health, education, maintenance and support.
If you don't want a child to serve as sole
Trustee, then there are an almost limitless number of alternatives
available. A trusted family member, friend, advisor or a trust
company can serve as sole Trustee or as Co-Trustee with the child.
The child can have the ability to replace the Co-Trustee under such
terms as you deem appropriate.
Objection #2: I was always told that
trusts are used to hold assets for my kids while they are minors or if
they are disabled or have other problems, such as substance abuse,
gambling, or a history of frivolous spending habits. My kids are (or
will be) responsible adults and I trust their ability to manage their
This is a commonplace view of trusts often seen in
the popular press. May I respectfully suggest that it is also
dead wrong. Certainly, trusts should be used in the
above situations, but the potential benefit does not end there. The
questions you should be asking in determining whether a trust is
Will my child ever be
divorced? Statistically, divorce is likely.
49% of all U.S. marriages end in divorce. Source: Human
Development Report, 1999, United Nations. While the law in
most states is that property received by inheritance, gift or bequest is
generally not considered marital property subject to division on
divorce, a growing minority of states do not follow this rule. And
in all 50 states, your child would have the burden of proof to show that
his or her inheritance was separate non-marital property - a major
problem if there has been any commingling of assets!
Will my child ever be
sued? According to published reports, the
average business owner or professional (doctor, dentist, lawyer,
accountant, etc.) can expect to be sued an average of six or seven times
during his or her lifetime. Any assets left to a child outright
will be subject to seizure by creditors to satisfy any judgment.
As already discussed, in almost every state, assets held in a
spendthrift trust established by a third party (i.e. you) will not be
subject to the child's creditors.
Will my child ever
become incapacitated in his or her lifetime? With
today's medical advances, more people are living longer. Stroke,
Alzheimer's disease, arteriosclerosis and other ailments affect the
ability to make sound financial and personal decisions, a fact well
known to unscrupulous persons who make their living from preying on the
elderly. Many older persons who had been financially secure have
been duped out of their lifesavings and had to spend the remainder of
their lives in poverty - a very sad and all too common story.
A trust for your children can be drafted to become
a "special needs" trust when your child becomes a senior
citizen so as to ensure that the assets are properly administered for
that child's needs and to permit qualification for Medicaid and other
public benefits, if necessary.
Will estate taxes be a
concern in my child's estate?
Any assets that you leave
outright to a child will be subject to federal estate taxes (if not
repealed) and any applicable state estate or inheritance taxes
upon the child's death. While your child can do estate planning to
avoid these taxes on his or her own, these techniques can be expensive
and generally require the child to relinquish access to and control of
assets to be effective.
To the extent that you leave
assets to a child in the form of a Dynasty Trust that is exempt from
generation skipping transfer tax by allocation of your GST exemption
(which is $5,340,000 in 2014), any undistributed trust assets will not
be subject to federal estate taxes upon the child's death, nor upon the
deaths of his or her own children, or grandchildren, or
great-grandchildren, for as long as the trust continues. Under a
new Florida law, a trust can last for as long as 360 years!
Even if the trust is not GST
tax-exempt, federal estate tax savings are possible. For example,
assume that a child dies childless, and that child's assets instead pass
to a brother or sister. If the child owned the assets outright,
they would be subject to estate taxes. If the assets were instead
held in the form of a trust that provided that federal estate taxes
would not apply except to the extent necessary to avoid the federal GST
tax, there would not be any estate taxes in this situation.
Objection #3: A trust is too
The major expenses with respect
to a trust are its set-up costs: the creation of the trust document and
initial funding. Once the trust is set up, assuming that the child
is the sole Trustee or that the Trustee serving is not charging a fee,
the only additional expense is the preparation of an additional income
tax form each year (IRS Form 1041).
If your estate plan provides
for trusts which provide for outright distribution at ages (e.g. 1/3 at
25, 1/3 at 30, 1/3 at 35) as is commonplace, you're paying for the
trust, but your children won't benefit from it because you directed it
to be dissolved!
The other answer to this
objection is too expensive as compared to what? Many successful
professional people pay enormous fees to set up and maintain offshore
asset protection trusts to shield their assets from creditors.
A garden-variety domestic spendthrift trust that you provide for your
children will provide at a fraction of the cost possibly better asset
protection than any offshore trust arrangement that they can set up for
Objection #4: Don't trusts have to
pay a lot of income taxes?
No - in fact, a trust can help your children save
A trust pays income taxes on its ordinary income
that is not distributed to a beneficiary using the trust tax rate tables
under Internal Revenue Code Section 1(e). These rates are very
compressed, and the highest marginal rate begins after the first few thousand dollars of income (39.6% rate on income over $12,150 in 2014). The capital gains rate for
trusts is currently capped at 20%, the same as with individuals.
However, to the extent that income is distributed
to a beneficiary, the beneficiary pays the tax at his or her own
By including a "sprinkling" power in the
trust document which permits the Trustee to "sprinkle" the
income among family members, the Trustee has some ability to choose
who pays the tax! Presumably the family member chosen will be the one
subject to the lowest combined marginal federal and state income tax
rate - a teenager without other significant income, for example.
In addition, a trust that you establish during
your lifetime may be designed to qualify as a "grantor" trust,
which means that you would pay the income taxes at your own marginal
rate on the trust assets just as though you still owned them personally.
This makes establishing the trust a "wash" for income tax
purposes and allows the trust assets to appreciate income-tax free,
increasing the amount that will pass estate- and gift-tax free to your
children. Under current law, your payment of the tax on the
trust's income is not considered an additional gift to the trust.
You may release the "grantor trust power" in the trust at any
time if you decide that you no longer wish to pay the income taxes on
Additional Note - Trust Protectors.
The Trust Protector is an individual or institution that you can name
that can have control over certain aspects of the trust that you desire
without actually serving as Trustee. This role is helpful under
many circumstances and can greatly add flexibility in trust