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- Dennis & Jaylynn L.

DIFFERENT TRUSTS

August 2002 - By Eden Rose Brown J.D. Attorney and Counsellor at Law

As one of the most powerful estate-planning tools available, trusts can ensure that your estate will be distributed as you wish while shielding your assets from taxes and fees.

There are dozens of different types of trusts. Here are four situations in which trusts make a great deal of sense…

1. Provide for a new spouse but protect children from a prior marriage.

Many clients in this situation want to provide support for their current spouse. Upon the death of that spouse, however, they want their assets passed to their children from a previous marriage. To ensure this, ask your estate planner to include a Qualified-Terminable Interest Property Trust (Q-Tip) in your estate plan. If you die without a Q-Tip, your surviving spouse could leave your estate to anyone he or she chooses – which may not be your children!

How a Q-TIP trust works: Rather than inheriting your assets when you die, your spouse receives the income (and certain distributions of principal, if you desire) that the trust generates. The income must be distributed at least annually, and the money in the trust can be invested at the discretion of the trustees… preferably your spouse and another person.

For a Q-TIP trust to be effective, your spouse must be the only one who receives any income from the trust during his or her lifetime. Upon the spouse’s death, the value of the remaining assets in the Q-TIP trust is taxable in the spouse’s estate. These assets, net of taxes, are then typically divided into equal shares for the children of your prior marriage.

2. Ensure your assets and care will be managed if you become incompetent.

To ensure your affairs will be handled by someone whom you trust, without costly and intrusive court proceedings, set up a revocable living trust. Such as a trust can hold title (ownership) of your assets and direct where your assets will go when you die so that these assets avoid probate. You can amend or revoke the trust whenever you want. With the onset of incapacity, a panel of selected loved ones can meet with your personal physician and determine whether you are able to effectively manage your personal and financial affairs. If this disability panel deems you incapacitated, a disability trustee (many times two co-trustees), steps into your shoes and begins managing your personal and financial affairs as directed in your trust.

A well-drafted living trust is considerably more effective than a power of attorney because it lets you include comprehensive details and arrangements – such as instructions regarding your physical care (your desire to remain in your house instead of a nursing home, favorite activities, hobbies and foods, grooming requirements, etc.) that would be inappropriate or ineffective in other legal documents. Wills take effect at death and provide no instruction during incapacity. Accepting a Power of Attorney is discretionary – no one is required to accept it and many institutions routinely deny powers granted under a power of attorney. A trustee, on the other hand, holds one the highest authorities granted under the law and controls the title to your assets; the agent under a power of attorney does not.

3. Guarantee that large sums of money will be kept out of your estate.

Many people own substantial life insurance policies. What they don’t realize is that when they die, their estate will suddenly be worth much more. If an individual’s estate is worth more than $1,000,000 ($600,000 in Oregon) or a couple’s estate is worth more than $2.0 million ($1.2 million in Oregon), estate taxes will be owed.

Avoid these estate taxes by setting up an irrevocable life insurance trust and transferring all ownership rights in the insurance to the trust. When you die, the trust –not your estate—is the beneficiary of the life insurance policy. As a result, the value of the life insurance policy is excluded from your estate for tax purposes. In addition, when the insurance proceeds are paid out, the money can be retained in accordance with the principles and guidelines you established in the trust, ensuring professional management and protecting the inheritance from divorce, creditors, lawsuits and poor judgment.

Other benefit: A life insurance trust is often used to purchase a second-to-die policy that pays the estate tax upon the death of the second spouse. This type of policy is cheaper than those that pay off when one person dies – and it solves the problem of covering what could be a heavy tax bill.

4. You want to cut taxes and create a tax shelter for your surviving spouse.

Setting up a credit shelter trust, also called a bypass trust, accomplishes two objectives: (1) It keeps assets out of the estate of a surviving spouse, thereby sparing your spouse a heavy tax burden, and (2) It still gives a surviving spouse substantial access to the assets.

The trust uses the applicable credit, which exempts up to $1 million from federal estate tax in the estate of the first spouse to die and completely bypasses the estate of the second to die.

Under this concept, the surviving spouse gets income and principal distributions from the trust according to IRS-approved ascertainable standards. The standards set a defined limit that cannot be exceeded – but allow your spouse funds for health, education, maintenance and support.

By using this standard, the spouse’s ability to use the money is limited just enough to prevent the trust assets from being taxed in his or her estate, while still providing the spouse with adequate support and protection.