post

Securing Your Family’s Future Using Inheritance Trusts: Part 1

PART 1: Inheritance Trusts and How They Work

The key to estate planning is understanding clients’ goals for the process. Generally, as a primary overarching goal, clients cite their desire to maintain their assets for as long as possible as a safety net protecting themselves and their loved ones from both anticipated and unforeseen threats and challenges. Nothing worries parents more than a creditor or divorcing spouse depriving their loved ones of the assets they worked so hard to pass on. Given this goal, it shouldn’t be any surprise that in our practice, once clients understand how Inheritance Trusts work, they choose to leave their estates to their loved ones by such trusts over 90% of the time.

Inheritance trusts have been with us for many years, primarily to manage funds for minors and others who would otherwise have trouble maintaining them. The basic idea was originally to separate management from benefit to protect the benefits for as long as necessary. The modern “wrinkle” has been the recognition that, by making the capable beneficiary the manager (i.e., the trustee) and by maintaining the trust in place, the protections and safety net remain in place for as long as possible without significant loss of beneficiary control or enjoyment.

In this installment, we describe Inheritance Trusts and explain how they work. To do so, however, we first have to review some basics:

The Law Underpinning our Use of Trusts

Trust law has developed over hundreds of years as an outgrowth of our laws of property and judicial support of fundamental fairness (equity). Under our law of property, the bundle of rights held by an owner includes the right to transfer his property in the manner he chooses. The law of equity will support and enforce such transfer as long as the transfer does not violate a paramount principle of public policy. In particular, the law grants primacy to the intent of the transferor in transferring his property, regardless of whether he transfers his entire bundle of rights in the property to one or more persons or whether he chooses to parcel out different rights in the property to different persons. Such differing rights could include the right to control how and/or how long property is used in a particular fashion, the right to receive the benefits of the property as so utilized, and the rights to transfer the property in the future and to administer the proceeds of such future transfer. This potential, indeed likelihood, for court enforcement of the transferor’s intent is the fundamental “glue” that underpins the use of trusts.

A trust is really nothing more than a transfer of property that separates the owner’s bundle of rights in the property at the time of transfer. In the case of an Inheritance Trust, that separation generally occurs after someone’s death, most likely, when a beneficiary might otherwise have inherited the property outright from the decedent.

What is a trust?

A trust is a court enforceable relationship established by a property owner when he transfers property to someone who will thereafter own and use the property according to a set of instructions that binds the new “owner” as to what he can or cannot do with the assets subject to those instructions. This relationship generally involves three types of parties: the original owner who is called a “settlor” or “Trustmaker”, a “Trustee” who will thereafter own the property and put it to use, and a “Beneficiary” who will now or at some time in the future enjoy the benefits of the property while it is owned by the Trustee. (Please note that although the words, “Trustmaker”, “Trustee”, and “Beneficiary”, are used here in the singular, there may be more than one Trustmaker, Trustee, and/or Beneficiary; and a person may simultaneously hold one or more of these capacities with respect to any trust.)

The Trustmaker is the party who establishes the trust by transferring property to the Trustee and by creating the instructions (i.e., in a will or trust agreement) that control that property in the Trustee’s hands. The Trustee is the party who actually has title to the trust property and who carries out the instructions. As the name suggests, the Beneficiary is the person who is intended to benefit from the trust assets and the Trustmaker’s instructions. It is the Trustee’s legal fiduciary duty to carry out the Trustmaker’s instructions for the benefit of the Beneficiary. If he or she fails to do so, the Trustee’s personal wealth is subject to court order to rectify any breaches of the terms of the trust (i.e., the Trustmaker’s intent).

If the Trustmaker retains the right to take back the property initially transferred to the Trustee or to change the instructions that control that property in the Trustee’s hands, the trust is called a “revocable trust”. If the Trustmaker expressly fails to retain or no longer has such rights (e.g. by reason of his death), the trust is called an “irrevocable trust”. Additional distinctions exist depending on when the trust is created: If the owner/Trustmaker establishes a trust during his lifetime, the trust is called a “lifetime”, “living”, or “inter vivos” trust. If the trust is created after the owner/Trustmaker’s death (e.g., a trust created under the Trustmaker’s will), the trust is generally styled as a “testamentary” trust. Absent express language in the trust document to the contrary, a Maryland lifetime or living trust is deemed to be a revocable trust. Since the Trustmaker is no longer alive to change his instructions, a testamentary trust will be irrevocable unless a court finds that the Trustmaker’s instructions (intent) have become impossible to achieve or that a unanimously agreed upon modification of trust terms is not inconsistent with a material purpose of the trust.

Examples Of Inheritance Trusts

Let’s say you and your spouse would like to establish Inheritance Trusts for your two daughters after both your deaths. You and your spouse will first create a will or living trust as a Trustmaker. Each of these documents will contain instructions to establish trusts for your daughters together or for each of them and will transfer your property to the Trustees of those trusts after both of you have passed.

You believe your oldest daughter is already prepared to manage the assets transferred to her trust, so you name her as the trustee of her trust so that she can control that property and you give her discretion as to when she can distribute property income (or the trust property itself) to herself or her descendants.

You would like to see your younger daughter grow into her future role as Trustee, so you name her as a Co-Trustee of the trust (with her sister or another trusted family member or friend as the other Co-Trustee) until your younger daughter reaches a certain age (e.g., 30). At that time, the trust instructions say that she will become her trust’s sole Trustee. While your younger daughter serves as a Co-Trustee with the consent of her Co-Trustee required to make decisions, your trust instructions require the Co-Trustees to distribute certain amounts to her annually so that she can count on receiving those annual benefits.

Once each daughter becomes sole Trustee of her respective trust, each will act as caretaker of the inheritances and manage their investment until they are ready to pass them on to their own children and/or more remote descendants.

In the meantime, while her trust remains in existence, you state in the trust document for each daughter that no right to benefit from the trust may be transferred by any beneficiary as such, and no creditor of a beneficiary may attach trust property or any trust interest. Trust property will remain transferrable by the Trustee, but under Maryland law, “[a] creditor may not . . . reach or otherwise compel distribution of the beneficial interest of a beneficiary that is a trustee or the sole trustee of the trust, . . . except to the extent that the interest would be subject to the claim of the creditor were the beneficiary not acting as cotrustee or sole trustee of the trust.” Subject to certain limited public policy exceptions for unpaid taxes, child support, and alimony, each daughter’s interest in the trust and the trust property itself is therefore protected from claims by potential creditors.

Stay tuned for future installments

In future installments of this series about Inheritance Trusts, we will explain these and other benefits of using Inheritance Trusts in your planning. We will also explain the process of receiving an inheritance in trust, as well as titling trust assets, setting up trust accounts, and the obligations of Trustee-beneficiaries to their other or future beneficiaries.

If in the meantime you would like to speak with us about securing your own plans for the future, please give us a call at (410) 224-7800.

Download PDF Version

Read on to Part 2 »

post

Securing Your Family’s Future Using Inheritance Trusts: Part 2

PART 2: The Benefits of Using Inheritance Trusts

In part 1 of this series, we described Inheritance Trusts and how they can achieve clients’ desires to maintain their assets for as long as possible as a safety net protecting themselves and their loved ones from both anticipated and unforeseen threats and challenges. In this installment, we go over the particular benefits they offer at relatively little cost.

Benefits of Receiving Your Inheritance in Trust

There are three significant benefits to receiving your inheritance in trust rather than outright: (1) asset and creditor protection, (2) transfer (i.e., estate, gift, and GST) tax minimization, and (3) disability planning.

Asset Protection

As we discussed in Part 1 of this series, inheritances held in Inheritance Trusts are typically what are commonly referred to as “spendthrift” trusts. This term comes from the trust provisions that prevent a beneficiary from being able to pledge, assign, or otherwise anticipate their interest in the trust before he or she actually receives it. Because the beneficiary has no right to receive trust distributions ahead of the time when the Trustee (who may be the beneficiary himself but who acts in a fiduciary, as opposed to an individual, capacity) actually distributes them to him, the beneficiary’s creditors similarly cannot reach his trust interest until it is actually in his possession. As a result, his individual judgment creditors will not be able to reach the assets owned by the beneficiary’s Inheritance Trust unless they are creditors of the trustee (in his or her separate role as trustee) or creditors of a beneficiary with respect to alimony, child support, or taxes. In other words, the Inheritance Trusts’ assets are protected from lawsuit judgments against the beneficiary (or the beneficiary’s descendants or siblings).

Asset protection is important in a litigious society where the divorce rate hovers around 50%. The value of trust asset protection cannot be emphasized enough, especially since public policy generally makes it impossible for an individual to obtain this level of asset protection with respect to his or her personal assets. Spendthift trust creditor protection is made possible by the law’s view that, as long as he does not violate some important public policy in doing so, the manner in which a Trustmaker ties up his assets after death is his business and an entitlement resulting from his ownership of these assets in the first place. Spendthrift trusts are not deemed to be violative of public policy.

Future Transfer Tax Minimization

Inheritance Trusts also implement important estate and generation-skipping transfer tax planning. Under this type of planning, the assets in an Inheritance Trust will not be included in the beneficiary’s gross estate for federal or state estate tax purposes, no matter how much they grow in value. While the beneficiary can control the trust as its Trustee and has powers in this regard that are quite broad, those Trustee powers are by design insufficient under federal and state law to make them the functional equivalent of outright ownership. The same is true as to inherited rights as a trust beneficiary. As a result, while retained in the Inheritance Trust, the trust assets are not taxed for estate tax purposes as a part of beneficiaries’ respective taxable estates, and they can be passed on to the next generation (i.e., the Trustmaker’s descendants) without being subjected to estate tax.

An Inheritance Trust can be passed on to the next generation tax-free because it is exempt for the federal generation-skipping transfer tax (“GST Tax”). This is a tax equal to the federal estate tax that becomes payable when trust assets are distributed to beneficiaries more than one generation below the person in whose taxable estate the trust assets were last included. In essence, the federal GST Tax is designed to capture the estate tax that would have been payable from a generation where estate tax on trust assets is skipped. To limit the reach of this GST Tax on “smaller” estates, Congress allows an exemption from GST Tax for each individual taxpayer. Inheritance Trusts can be specifically designed to take advantage of all of the GST Tax exemptions of both the Trustmaker and the Trustmaker’s spouse. (The current GST Tax exemption available to a decedent is $5,450,000, but this amount will be indexed for future inflation. In the case of spouses, those exemptions can be doubled with careful planning). Unfortunately, unused GST Tax exemptions are not portable from a prior spouse to his survivor, so each spouse will need to use an estate plan utilizing Inheritance Trusts to take advantage of his or her GST Tax exemption.

Beneficiary Disability Planning

While a beneficiary is alive and able to manage his finances, he can serve as Trustee of the Inheritance Trust set up for his benefit. In addition, Inheritance Trusts often authorize the beneficiary to determine who will succeed him as Trustee when he is no longer willing or able to serve. To do so, the beneficiary will have to nominate a person, persons, or entity as Successor Trustee in a written document executed with the level of formality required in the trust instructions. If the beneficiary fails to nominate a successor trustee, the Trustee of the Inheritance Trust will be as the Trustmaker originally nominated in the trust by default. Please note that if a beneficiary wants his spouse to serve as Trustee of his Inheritance Trust if he cannot do so, he will usually need to create a writing that specifically makes this designation. To avoid complications of any potential divorce, a spouse is not generally otherwise named as a part of a line of succession.

In any event, if the beneficiary becomes disabled, management of his trust assets for his benefit is assured without court appointment of a guardian of his property or the ambiguities of enforcing a power of attorney.

 

In the final installment of this series about Inheritance Trusts, we will explain the process of receiving an inheritance in trust, as well as titling trust assets, setting up trust accounts, and the obligations of Trustee-beneficiaries to their other or future beneficiaries.

If in the meantime you would like to speak with us about securing your own plans for the future, please give us a call at (410) 224-7800.

Download PDF Version

Read on to Part 3 »

post

Securing Your Family’s Future Using Inheritance Trusts: Part 3

The Logistics of Inheritance Trusts

In parts 1 and 2 of this series, we described Inheritance Trusts and how they can achieve clients’ desires to maintain their assets for as long as possible as a safety net protecting themselves and their loved ones from both anticipated and unforeseen threats and challenges. In this installment, we go over the mechanics of setting up and operating an Inheritance Trust.

Titling Trust Assets and Setting Up Trust Accounts

When an Inheritance Trust is established, its Trustee (and in particular, a Trustee who is also a beneficiary of the trust) will need to keep inherited assets (as well as assets acquired in the future using the proceeds of these inherited assets) segregated from his personal assets. He does so by the titling of trust property and by using a separate trust taxpayer identification number.

Title to all newly inherited trust assets (and the proceeds of these inherited assets) should be kept in the name of the Inheritance Trust at all times. We prefer the following format for titling assets in the name of an Inheritance Trust:

“Gloria Sample Jones, Trustee of the Gloria Sample Jones Inheritance Trust under Article Twelve of the John Sample Living Trust dated December 24, 2008”

Obviously, each beneficiary Trustee would insert his or her name in this language and the particulars of the source document when titling inherited assets to his trust. However, to avoid future problems with banks and financial houses, it is important to use a title that references the document that states the authority for the trust, the trust administration provisions, as well as the source for Trustee powers and succession provisions.

Merging Separate Inheritance Trusts from Each Parent

Often, children of the same parents will technically receive an Inheritance Trust from each parent. To avoid having multiple trusts, the source document will generally have a merger clause allowing the Trustee to merge multiple trusts with the same beneficiaries and trust provisions. As such, the substantially identical trusts set up by each parent can be merged by having the Trustees sign what is known as a Trust Merger Agreement. Thus, two separate Inheritance Trusts (i.e., one received each parent) are consolidated into a single Inheritance Trust for the beneficiaries involved.

Utilizing the Assets of An Inheritance Trust

In order to provide the asset protection and tax benefits described in Part 2 of this series, there need to exist certain technical restrictions on beneficiary Trustee access to an Inheritance Trust’s property. However, beneficiary Trustees need not feel particularly limited by these restrictions because these provisions are purposefully drafted to be as expansive as possible without causing tax effect. The beneficiary Trustee will generally have complete authority as to the investment of trust property and broad authority as to when to make distributions.

A Trustee of an Inheritance Trust may make distributions of trust property to trust beneficiaries (including himself) for their education, health, maintenance or support. These terms have very broad meanings as demonstrated below:

Education

Includes payments for tuition, fees, books, supplies, living expenses, travel and reasonable spending money related to private pre-school, kindergarten, elementary school, middle school, college preparatory high school, undergraduate college, graduate college, and vocational, professional, or other specialized training

Health

Includes payments for medical services, prescription/over-the-counter drugs, and/or medical equipment, and, in general, anything directly promotive of the good health of trust beneficiaries

Maintenance or Support

Includes payments to keep the beneficiaries living in the manner that is reasonable given the amount of funds which can be devoted to this purpose, i.e., anything reasonably required to maintain the beneficiary’s lifestyle. (In addition, Trustees are often given the discretion when and whether to take the beneficiary’s other resources into consideration in making such lifestyle maintenance distributions.)

The principal limitation here is that Inheritance Trust assets may not be used to benefit persons or entities other than those persons who are currently the beneficiaries designated by the Trustmaker.

Types of Property an Inheritance Trusts Can Own

In general and unless otherwise specified in the Trustmaker’s instructions, Inheritance Trusts may own any type of property that is readily available to the public, such as: real estate, farming/ranching businesses, stocks, bonds, commodities, options, metals, partnership interests, limited liability company interests, and other types of closely-held business interests. The limitations here are that the Trustee is obligated to the beneficiaries to invest prudently and to avoid self-dealing.

Inheritance Trusts may also own life insurance or annuity products. However, you should consult with an estate planning attorney prior to purchasing a life insurance or annuity product with an Inheritance Trust. Notwithstanding trust provisions, if the Trustee of a trust owns life insurance on his own life, that life insurance can be made taxable as a part of his estate.

Other Ongoing Trustee Duties

In addition to the duties discussed above, Trustees of Inheritance Trusts need to remember that they now have fiduciary duties to others to be responsible for many of the same tasks they would have been doing if they owned the property in their own name (rather than as Trustee of the Inheritance Trust), such as:

Insuring trust property against potential hazards/casualties;
Keeping records of the trust’s financial history; and
Filing annual federal and state income tax returns for the trust on April 15th of every year.

It is important to note that Inheritance Trusts will each be separate income taxpayers and will require their own respective income tax returns. To this end, Trustees need to use separate federal tax identification numbers for their trusts. Because trusts pay federal income tax based on very compressed tax brackets (in 2017, a trust’s undistributed income is taxed at 39.6% once that income totals only $12,500), Trustees will probably want to do some distribution planning to make sure that as much of this income as possible is taxed at lower rates available to trust beneficiaries.

Trusts currently written as a Maryland trust are also subject to Maryland income tax. However, beneficiary Trustees who reside outside of Maryland may change the taxing state if the trust is being administered outside of Maryland and was not created under the will of a Maryland resident. One of the first administrative activities a beneficiary Trustee might want to consider undertaking is an examination with a local accountant or attorney as to where it makes the most sense to have the trust taxed.

Finding Assistance

Much of this may seem new to you, but it is not “rocket science”. We are in business to help our clients plan their Inheritance Trusts and to help with their implementation and administration. If you would like to speak with us about achieving your goals for the future, please give us a call at (410) 224-7800.

Download PDF Version

post

Protect Your Family From Unforeseen Creditors

Caring for a loved one can be quite an undertaking for you and your family. In light of this, we want you to be prepared for circumstances such as debts accumulated from unforeseen creditors. Here at The Wright Firm, we provide guidance and resources to protect your loved one’s hard-earned assets from various unforeseeable creditors, including business creditors, tort creditors, divorce, and nursing home costs. Asset Preservation covers protected inheritance trusts, planning for Medicaid and long term care, and special needs trusts. To get started in protecting your assets for your loved ones, please call us at (410) 224-7800 or visit our website, thewrightfirm.net.