Types of Trusts

Testamentary trusts are created within a will, taking effect at death, controlling the eventual distribution of probate assets (single name assets controlled by the will). Testamentary trusts can hold assets in trust for the benefit of a surviving spouse and future heirs without subjecting the assets to estate and inheritance taxes at every generation. A testamentary trust provides continuing professional asset management by trusted advisors; ongoing care and support payments to your beneficiaries; special trust accounting for distributions to different types of beneficiaries (differentiating income and principal), generation skipping gift distributions, charitable income or remainder trusts, and many other estate planning purposes.

The originator (or grantor) of a revocable living trust maintains complete control over trust assets during life, while benefiting from professional asset management (that continues in the grantor’s behalf in the event of disability). At the grantor’s death, assets can stay in trust for the benefit of heirs or be immediately distributed free of probate costs (estate administration and legal fees) associated with an estate settlement distribution. In other words, living trusts contain their own ‘dispositive’ instructions, by-passing the will. Also, living trusts are private – not part of the public record, avoiding the delays of estate administration. Trust assets can pass directly to your heirs or remain in trust, outside of the will as instructed by the trust document, meeting the distinct, varying and ongoing needs of your beneficiaries.

Unique assets, such as real estate, closely held businesses, art and collectibles, precious metals, limited partnerships and other illiquid assets often make up significant percentages of estates that continue to have value for future generations. Individual trustees often lack the expertise to administer non-traditional assets (especially real estate and businesses). Corporate trustees typically prefer to reduce risk by immediately selling non-conventional assets in an effort to diversify the trust portfolio.

In ‘directed trust’ states such as Tennessee, trust grantors have maximum flexibility in naming specialty advisors in the management of unique assets. As a Tennessee chartered trust company, Counsel Trust (serving as a corporate trustee or co-trustee) supports and works seamlessly with grantor directed advisors enabling non-traditional trusts to maintain unique trust assets.

Irrevocable trusts set up during life are useful tools in removing taxable assets from your estate, while effectively controlling ultimate asset disposition to your beneficiaries. In directed trust states such as Tennessee, a ‘self directed’, asset protected irrevocable trust can be established to remove assets from the taxable estate while continuing to retain key grantor management and withdrawal powers. An added benefit in Tennessee, income can be compounded inside the trust, avoiding state fiduciary income tax for out of state grantors and or beneficiaries.

From an estate tax standpoint, if you are a married couple whose estate exceeds $11.2 million (the 2018 estate tax exemption), or are an individual with an estate over $5.6 million, you will have a federal estate and possibly a state inheritance tax problem. These tax issues are compounded if your illiquid assets such as a business, real estate or other unique asset dominates your estate’s total value, possibly forcing an unwanted sale after your estate has been drained of its liquid assets to pay taxes.

Another effective and flexible estate planning tool is to own life insurance in an irrevocable trust, (referred to as an ILIT). ILIT’s make sense because, first, life insurance death benefits paid to a properly designed irrevocable trust are estate and income tax free and are indirectly available to either loan to or purchase assets from the estate, providing much needed liquidity to pay estate taxes. Second, life insurance premiums paid during your life are removed from the estate, further reducing the eventual estate tax liability. Third, the tax-deferred rate of return on the premiums paid for certain types of policies can be quite compelling, even when you live well beyond normal life expectancy.

Example:   Consider a couple in their mid-60’s with a net taxable estate of $40 million – split evenly between liquid (cash, equities and bonds – $20 million) and illiquid (closely held business, real estate- the other $20, million) assets. Assuming no prior taxable gifts, and using the now portable, combined exemptions of $11.2 million and a federal estate tax rate of 40%, this couple would owe $11.5 million in federal estate taxes upon the death of the survivor in 2018.

In this scenario, much of the couple’s $20 million in liquid assets would be consumed to pay estate taxes and other settlement costs. An ILIT solves this liquidity bottleneck. Here is how it works: the couple sets up an irrevocable trust that is funded with income producing assets which are used to pay the insurance premiums; or is unfunded (dry trust) where periodic gifts are made by the grantor (under the Crummey trust provisions) to pay the premiums. Because the irrevocable trust is the owner and beneficiary of the life insurance policy, the death benefit is paid to the trust free of estate and income taxes.