Trusts FAQ
What are some of the different types of trust tools available?
Credit Shelter Trust
A Credit Shelter Trust (also referred to as a bypass trust, "B" Trust, or a
family trust) is a popular estate planning tool used to help protect assets
from successive estate taxes. Credit Shelter Trust provisions may be inserted
into a Will or into a Revocable Living Trust. While current laws permit an
unlimited amount of assets and property to pass to a surviving spouse tax free,
transfers to children and other beneficiaries valued in excess of the applicable
exclusion amount ($5,000,000 in 2011-2012) may be subject to federal estate
taxes. A couple taking advantage of a credit shelter trust generally arranges
for certain assets to pass into a trust for the benefit of a surviving spouse,
rather than passing all assets directly to the spouse. This trust, which would
not be considered part of the surviving spouse's estate, may pay the surviving
spouse income for life and then upon his or her death may pass to a
beneficiary, such as a child, free of estate taxes if under the applicable
exclusion amount (with the appreciation of the trust assets also passing tax
free). In addition, the gross estate of the surviving spouse, upon his or her
death, could also pass to the same beneficiary, and up to $5,000,000 (according
to federal estate tax laws for 2011-2012) would be free of estate taxes.
WHILE READING THE EXAMPLE BELOW, PLEASE NOTE: The Tax Relief, Unemployment Insurance Reauthorization
and Job Creation Act of 2010 passed by the U.S. Congress on December 17, 2010
allows each individual to transfer up to $5M at death federal estate tax free,
or $10M per couple. The tax rate for estates above $10M is a flat rate of 35%.
Furthermore, the Act allows a surviving spouse to add to their deceased spouses
exemption amount to their own exemption (which is called "portability").
Portability, in some cases, eliminates the need for complex estate planning
(i.e., the use of Credit Shelter Trust language in the estate planning
documents) designed to bypass federal estate taxes, which was commonplace prior
to the new law. Under the old federal estate tax laws, the exemptions were not
portable, meaning that the first exemption was lost without proper estate
planning through the use of Credit Shelter Trusts.
Using a Credit Shelter Trust as described below
still has great estate planning benefits despite the addition of portability
into the federal estate tax regime including:
§ The
Act is set to expire Dec. 31, 2012, unless congress acts to extend it.
Therefore, it is uncertain whether portability will be available after that
date. Due to the uncertainty, most large estates still choose to include Credit
Shelter Trust language in their will or trust, so that a Credit Shelter Trust
could be funded on the first spouse's death if necessary to avoid Federal
Estate Taxes. If portability expires, the exemption amount will be reduced to
$1M per person and the tax rate will increase to 35% which could have disastrous
consequences for estates that decide against placing Credit Shelter Trust
language in their estate planning documents.
§ Portability
only applies to Federal Estate Taxes and not state inheritance taxes.
Therefore, Credit Shelter Trusts are still a common technique to utilize both
spouses $1M Tennessee Inheritance Tax exclusion.
§ Appreciation
of the assets placed within a Credit Shelter Trust on the first spouse's death
will not be subject to estate taxes, whereas, appreciation of assets passed
directly to a surviving spouse via portability will be subject to estate taxes
upon the second spouse death.
§ Non
tax benefits of a Credit Shelter Trust: asset protection, professional
management of assets, and preservation of assets for children.
Example:
Credit
Shelter Trust Utilized for Federal Estate Tax Purposes
Husband and wife have combined assets worth $10 million.
Although they like the idea estate tax exemption portability in the new federal
estate tax laws and the simplicity of the concept, they want to create a
flexible estate plan that will preserve both of their $5 million federal estate
tax exemptions even if portability expires sometime in the future. The husband
dies devising his $5 million of assets in the estate to his wife (with the
assumption that husband and wife each own half of the estates assets- your
attorney can advise you on the best way to split the estate so that the trust
may be fully funded). His Will or Revocable Living Trust contains a
discretionary Credit Shelter Trust provision which states that upon his death
his wife is given the power to disclaim all or a portion of the husband's
estate and fund a Credit Shelter Trust with an amount that she chooses, up to
the Applicable Exclusion Amount for federal estate taxes ($5M in 2011-2012). The wife chooses to place $5 million
into the Credit Shelter Trust upon the husband's death which fully funds the
trust up to the Applicable Exclusion Amount. The wife now has $5 million in the
Credit Shelter Trust which will she will benefit from during her lifetime and $5
million in her own estate. The trust income is distributed to the wife to
provide for her the health, education, maintenance, and support during her
lifetime and then passes to the children upon her death. The wife can also receive principal
from the trust annually in an amount which is the greater of $5,000 or 5% of
the trust property. When the wife dies at a later date the children inherit the
$5 million in the Credit Shelter trust, which passes outside of the wife's
estate, free of federal estate tax.
The wife also devises all of her $5 million estate to the children which
also passes free of federal estate tax due to her Applicable Exclusion Amount
($5M in 2011-2012). With the addition of a Credit Shelter Trust provision in
their Will or Revocable Living Trust, this family is able to avoid $1,750,000
of federal estate taxes. If the wife were to outlive the husband by several
years, the growth inside the trust would also pass estate tax free to the
heirs. For larger estates, assets invested wisely inside the Credit Shelter
Trust could lead to hundreds of thousands or even millions more dollars passing
to heirs free from federal estate taxes. (This example assumes that
portability of the $5M federal estate tax exemption has expired post Dec. 31,
2012. This example does not take into consideration the TN Inheritance Tax that
is assessed on estates over $1M).
To effectively reduce or eliminate federal estate taxes, a Credit Shelter trust
must follow certain rules laid out by the IRS. Let's suppose your will sets up
a Credit Shelter Trust for your husband, and you die first. In order to keep
the trust from being subject to estate tax when your husband dies, your will
must place the following conditions on the trust:
§
You must limit your husband's power to access the trust
during his lifetime - Your husband must not have an unrestricted right to
withdraw principal. However, you can give him the right to withdraw principal
to provide for his health, education, maintenance, or support, and you can also
give him the right to withdraw up to $5,000 of principal per year for any
purpose, or 5% of the total principal, whichever is greater. You can also give
him the right to all of the interest and dividends earned in the trust each
year, and you can appoint him trustee. As trustee, he would have discretion to decide whether principal
is needed for his "maintenance" or "support". Thus, this condition is
ultimately quite flexible.
§
You must limit your husband's power to distribute trust
assets upon his death - Except as provided above, your husband cannot have the
right to give the trust assets to himself, his creditors, his estate, or his
estate's creditors. You can, however, give him the right to name in his will
specific persons who will succeed to the trust upon his death. For example, you
could authorize him to leave the trust to any of your nieces and nephews, or to
divide it as he pleases among your children. Alternately, you can specify who
gets the trust next and leave him no discretion.
A
Credit Shelter Trust can be utilized as a testamentary trust in a Will or it
may be created by placing specific language within a Revocable Living Trust
document. In either case, it is a powerful estate planning tool which allows a
husband and wife to use both of their estate tax exclusions to pass more of
their assets to their beneficiaries tax free.
QTIP Trust
The entire value of an estate passing to a surviving spouse
receives a marital deduction from estate taxes if the surviving spouse is a
U.S. citizen and if the property passing to the surviving spouse is not a
"terminable interest". If the property passes to the surviving spouse as a
terminable interest, then the transfer does not qualify for the marital
deduction unless technical requirements are met. A terminable interest is an
interest which will terminate or fail on the lapse of time or the occurrence or
failure to occur of a contingency. An interest which passes from the decedent
to any other person other than their surviving spouse and such other person
enjoys the interest after the termination of the spouses interest, is a
terminable interest. For example, leaving property to a surviving spouse which
terminates if the spouse remarries is a terminable interest. An exception to
the terminable interest rules is a Qualified Terminable Interest Trust (QTIP).
A QTIP Trust provision included in a will or revocable trust based plan allows
the testator to leave property for the benefit of the surviving spouse during
their lifetime while maintaining control over where the property goes after the
surviving spouse's death. If properly drafted, a QTIP election will be made by
the decedent's executor and the QTIP will qualify for the estate tax marital
deduction. The following technical rules apply: 1) the surviving spouse must
receive all of the income from the trust during their lifetime, payable at
least annually; 2) no person including the spouse can appoint the income to
anyone other than the spouse during the spouse's lifetime; 3) the QTIP property
is included in the surviving spouses taxable estate when they die; 4) QTIP
treatment must be elected by the executor of the estate upon the testator's
death. A QTIP trust can be a good option where spouses are in a second or third
marriage. For example, the surviving spouse is provided with income from the
trust for life and when they die the first spouse's children from their first
marriage receive the remainder of the trust. If the first spouse is concerned
that their surviving spouse could disinherit their children, then a QTIP trust
can be useful. This type of trust offers many advantages, however, the testator
should keep in mind that the surviving spouse looses control over the assets
placed into the trust (though they are still entitled to income from the trust)
which could be problematic if the surviving spouse will need the property
outright for standard of living and cash flow purposes. Additionally, the
surviving spouse is more likely to exercise their spousal elective share rights
before the QTIP trust is created.
Irrevocable Life Insurance Trust (ILIT)
Typically, the proceeds from any life insurance policy owned by you are
included in your estate for estate tax purposes (though they are not part of
your "probate" estate). An Irrevocable Life Insurance Trust, commonly called an
ILIT, is a unique legal document which helps keep the proceeds of a life
insurance policy outside of the estate and thus potentially free of estate tax
and income tax. The ILIT is a legal entity that becomes operational while
one is still living. The trust becomes the owner of the life insurance
previously owned or of a new policy purchased in the trust's name.
Because the policy is owned by this legally independent trust, you would not be
the legal owner of the proceeds, which therefore are not included in your
taxable estate. Below are some of
the potential advantages and disadvantages of using an ILIT:
Pros:
§
Removes life insurance proceeds from your taxable
estate
§
Provides tax-free liquidity to your estate
§
Preserves real estate, family business or other
illiquid assets
§
Uses life insurance proceeds in coordination with
charitable gifting in order to replace assets given to a charity
§
Increases the size of an estate
§
Maximizes inheritance while minimizing taxes paid to
the federal and state governments
Cons:
§
ILIT's can be somewhat costly to create and maintain.
Costs include attorney's fees for drafting the trust, and annual professional
trustee fees charged for drafting the required Crummey letters to the
beneficiaries, paying the insurance premiums, and acting as trustee.
§
Transferring funds to the trustee to pay the insurance
premiums often takes up your entire annual gift tax exclusion of $13,000 per
individual which limits your gift giving ability.
§
If you are transferring an existing life insurance
policy into an ILIT and die within 3 years of the transfer, the death benefit
funds from the policy will be included in your taxable estate.
§
Permanence and Loss of Control: the assets are no
longer the owners once they place them in the ILIT, furthermore the trust is
irrevocable.
There are two ways to establish and fund an ILIT. The first, and best, way
to do this is by establishing the ILIT first, and then allowing the ILIT to
purchase the life insurance. The second method is by establishing an ILIT and
contributing an existing life insurance policy to the ILIT.
Establishing the ILIT first is preferable, because doing so will allow you
to avoid any gift tax on the initial funding of the trust. Also, when existing insurance policies
are transferred into an ILIT the benefits will be included in your taxable
estate if you die within three (3) years of the transfer. You, as the Settlor,
make contributions to the ILIT. The trustee then takes the contributions and
uses them to pay the premiums on the life insurance policy. In order to avoid
gift tax on the contribution to the ILIT, the trust agreement must be properly
drafted, and several technical steps must be followed. The policy premiums are typically paid
by the Settlor in a manner that avoids gift taxes by use of the annual gift tax
exclusion (currently $13,000 per year).
If you have an existing policy, you may establish your Irrevocable Life
Insurance Trust and contribute the existing policy to the ILIT. Doing so will
result in a taxable gift, although you may use part of your lifetime gift tax
credit (currently $5 million) to avoid paying any gift tax on the transfer. The
amount of the gift will depend on whether it is a term or whole life policy.
Upon your death, the trustee of the ILIT files the claim for the death
benefits. The insurance company issues the check to the ILIT, and the policy
proceeds are excluded from your gross estate. The terms of the ILIT should
allow the trustee to make loans to, or purchase assets from, your estate. This
provides liquidity to the estate for payment of any estate taxes, and prevents
a forced sale of assets which may be illiquid or your heirs do not wish to
sell.
Example: John has an estate which totals $2
million. He will not owe any federal estate taxes under the 2011-2012
Applicable Exclusion Amount ($5 million). However, Tennessee inheritance taxes
must be paid on all estate assets over $1 million. Therefore, $1 million of his
estate will be taxed by the state at an estimated tax rate of 9.5% for a tax
burden of $83,400. Assuming that
half of John's taxable estate is the death benefit in his life insurance policy
($1million out of the $2 million total), John could avoid paying any Tennessee
Inheritance taxes by transferring the insurance policy into the Irrevocable
Life Insurance Trust. Upon his
death, the trust, as the owner and beneficiary of the policy, will collect the
life insurance death benefit proceeds from the insurance company and distribute
them to the named beneficiary. In
this scenario, John's estate would be able to avoid paying the Tennessee
Department of Revenue $83,400 and this money could be used to benefit one of
his family members, a friend, or a charitable organization instead.
Charitable Remainder Trust (CRT)
A charitable remainder trust can be a highly effective financial and estate
planning tool. This irrevocable
trust provides an income stream to the donor or to other non-charitable
beneficiaries for life or for a term of years and pays the remainder interest
in the trust to one or more qualified charitable organizations. A CRT can be
either inter vivos or testamentary in nature, but typically they are created
inter vivos (during the donor's lifetime). An inter vivos CRT is created by a
written irrevocable trust agreement executed by the donor and the trustee
during the donor's lifetime. A
testamentary CRT is created by the donors will or revocable living trust. The advantages of a CRT are as follows:
1) allows the grantor to avoid capital gains taxes on highly appreciated
assets; 2) donor or donor's beneficiaries receive an income stream based on the
full, fair market value (FMV) of those assets; 3) donor is able to claim an
immediate charitable deduction on his or her income tax return; 4) the contributed assets are removed from the donor's estate,
so there is no estate tax liability on such assets and the donors lifetime
unified estate/gift tax exemption is not reduced as a result of making the
gift; and 5) the trust assets ultimately benefit the charity(ies) chosen
by the donor. There are two
primary types of charitable remainder trusts- charitable remainder annuity
trusts (CRAT's) and charitable remainder unitrusts (CRUT's).
§ Charitable
Remainder Annuity Trust (CRAT) - The annuity trust pays a fixed dollar amount
to the donor or other non charitable beneficiaries each year, regardless of how
the value of the trust may change.
The fixed dollar amount is based upon a fixed percentage of the initial
value of the trust property. An annuity trust may last for a term of years (not
to exceed 20) or for the lifetime of the income beneficiary. The income payout
from a CRAT to the donor must be at least 5% but no more than 50% of the
initial value of the assets transferred to the CRAT. The CRAT has one basic
form - a fixed dollar amount.
§ Charitable
Remainder Unitrust (CRUT) - The unitrust pays the donor or other non charitable
beneficiaries a fixed percentage of the value of the trust property as is
revalued each year. Also, unlike
an annuity trust which may not accept further contributions beyond the initial
funding, additional contributions may be made to a unitrust (assuming it is
created inter vivos). The income payout from a CRUT to the donor must be at
least 5% of the annual value of the assets in the CRUT. The CRUT has 4 configurations:
(a)
The standard fixed percentage CRUT pays a fixed percentage of
the value of the trust assets, revalued annually.
(b)
The net income CRUT pays the fixed percentage, or all of the
income earned, whichever is less.
(c)
The NIMCRUT pays the fixed percentage, or all of the earned
income, whichever is less, with a make-up provision which allows payment
shortfalls in early years to be made up in later years. The NIMCRUT is the most
flexible of the 4 CRUT configurations.
(d)
The flip CRUT first pays the fixed percentage, or all of the
income earned, whichever is less, and then upon the occurrence of a specified
event, flips or changes to a standard fixed percentage CRUT.
A charitable trust may be funded with a gift of cash,
securities, real property or closely held business interests.
Example: Husband and Wife have highly appreciated assets such as stocks that are subject to capital gains taxes if sold. So they transfer the stock to the charitable trust and take an immediate tax deduction for the gift. Up to 50% of the couples gross income is deductable which can be taken out over a period of years. Husband and Wife will receive income for a specified time or for their lifetime. Not to mention that the amount used to fund the trust is taken out of the couple's estate for estate tax purposes.
Donors must realize that the property donated to the Charitable Trust will ultimately pass to the qualified charitable organization and not to the donor's family. However, and ILIT can be used with a Charitable Trust as a tax free wealth replacement tool. Basically, when the Charitable Trust pays income to the donor, the donor gifts all or part of the income to the ILIT to pay the premiums on the life insurance policy. In a nutshell, by combining the CRT and the ILIT, the donor makes a meaningful gift to charity and replaces the gift with an inheritance to the donor's family using life insurance.
Charitable
Lead Trust (CLT)
A
Charitable Lead Trust provides an income stream to one or more qualified
charitable organizations for the life of a natural person or for a term of
years with the remainder interest being paid to the donor or other non
charitable beneficiaries. A CLT is
primarily used by individuals who wish to benefit a charity first, with the
property ultimately passing to family members at reduced tax rates. A CLT is an irrevocable trust which may
be an annuity trust or a unitrust.
A CLAT pays the charity a fixed dollar amount based upon a fixed
percentage of the initial value of the property. A CLUT pays the charity a fixed percentage of the value of
the trust property as is revalued each year. The donor may make additional contributions to the CLUT but
not to the CLAT.
Special Needs Trusts
Planning is not optional for parents of children with
special needs. It is crucial to
ensure that the child will have the ordinary comforts of life that are not
provided by government assistance.
A special needs trust is frequently the most effective way to provide
security and quality of life for a special needs individual. A special needs trust is a legal
arrangement where a trustee holds and distributes trust assets for a
beneficiary who has special needs in a manner that protects the special needs
child's eligibility for government provided food, clothing, and shelter benefits
via Supplemental Security Income and Medicaid. The special needs trust provides supplemental assistance for
needs not already covered by government programs. A family member can often act as the trustee and use their
discretion to distribute or not distribute assets for the supplemental needs of
the special needs individual. Upon
the death of the special needs individual, the trust assets would go to the
individual's family members, friends, or perhaps a charity. The only
alternatives to a special needs trust are 1) leaving nothing to the child (see
Bequeathing To Other Family Members below), 2) creating a trust that does not
contain specific Special Needs Trust language (which causes the child to lose
public benefits), or 3) leaving an outright inheritance to the child which
disqualifies them for public benefits. None of the above are good options when
compared to a Special Needs Trust. As an estate planning attorney who has a
sister with special needs, Michael L. Smith is uniquely qualified to assist
families with the legal and personal issues associated with special needs
planning.
Bequeathing To Other Family Members
While it might seem like a good idea simply to
leave a set amount of money to your disabled child's sibling or other close
relative, with the understanding that the money will be spent on the disabled
child, this often backfires:
§
The money can fall prey to judgments or divorce
settlements against the relative, or can be lost in bankruptcy
§
The relative can't be legally forced to use the money
to benefit the disabled person
§
The relative to whom the money is left may be taxed at
a higher rate than the disabled child or a trust
§
Should the relative die before the disabled child, the
money would go to his or her heirs
A special needs trust avoids these potential
problems without putting an emotional strain on family relations. Monthly SSI
benefits can be spent on food, clothing and shelter. The special needs trust
money can then go to pay for virtually any expense not met by public or private
agencies such as:
§
Medical and dental expenses not otherwise provided for
§
Education
§
Training
§
Rehabilitation
§
Transportation (including the purchase of a vehicle)
§
Life insurance premiums
§
Computer equipment and electronics
§
Recreation
§
Vacations and airline tickets
§
Summer camp
Choosing a Trustee
Anyone other than the child with
special needs can serve as the trustee. The choice of trustee is one of the
most important considerations that the family will face. The trustee will be
responsible for custody of the trust assets as well as determining when to
distribution funds for the benefit of the child.
The trustee for a special needs trust for your
disabled child could be:
§
A trusted family member who is close to your child
§
A bank or other financial institution, who will take a
percentage of the trust assets for administering the trust
§
A team approach, with a financial planner and one or
more family members working together as a co-trustees, or a family member as
trustee with the ability to delegate the investment functions to a financial
advisor
§
A family friend such as special needs teacher close to
the child, or your family's minister
Special Needs Trust Requirements
To be effective, a special needs trust document:
§
Must have language that makes it impossible for your
disabled child to demand that the trust funds be distributed
§
Must give the trustee full discretion to spend the
trust assets as he or she sees fit
§
Must make it clear that the trust isn't intended to be
a basic support trust, but that the money is intended to be used solely to
supplement benefits that are otherwise available to your child
§
Should specify that the trust is to be administered so
that eligibility for public government assistance isn't jeopardized
§
Must be managed by a trustee other than the child with
special needs
Funding A Special Needs Trust
A special needs trust can be funded through a will or gifts from relatives and friends made directly to the trust instead of to your disabled child. Life insurance can be the most cost effective and efficient method for providing the funding necessary to establish the trust and provide for the child throughout their lifetime. It immediately places assets in the trust upon the deaths of the parents or insureds.
Letter of Intent
One way to be clear about what you intend for your
disabled child's future is to make a "Letter Of Intent" to be given to his or
her trustee at the time of your death. This document gives family members and
others the benefit of your knowledge about your child's capabilities, needs and
fears, and can be updated periodically.
A letter of intent can include:
§
Biographical info
§
Financial details
§
Medical history and needs
§
Social contacts
§
Any negative influences you'd like to guard against
§
Personality traits
§
Skills, hobbies and physical abilities
§
Goals your child is working toward
With a little planning, you can make your disabled
child's future much brighter.
Key Points:
§ In
order to qualify for the Social Security Administration's Supplemental Security
Income Benefits, ("SSI"), a disabled adult can't hold more than
$2,000 in assets, excluding a car and a home. SSI benefits must be spent on
food, clothing and shelter expenses.
§ Eligibility
for SSI makes a disabled person eligible for food stamps and Medicaid, which
pays medical expenses, nursing home care and mental health services.
§ As
these benefits add greatly to a disabled person's ability to care for him or
herself, you wouldn't want to give your disabled child property that would
disqualify him or her from receiving these benefits.
§ Special
Needs Trust the child money for expenses not met by public benefits.
§ Special
Needs Trust language is included in the parents will or revocable trust and the
trust is established upon the parent's death.
§ There
is no limit to the amount which can be placed in the Special Needs Trust.
Other
Estate Planning Trusts Tools
Various
other charitable planning tools may be considered depending on the unique needs
of the client. Additionally, there are many other irrevocable trust tools that
may be useful in specific situations. Using a trust can be an excellent method
of accomplishing your long term estate planning goals. As these trusts involve,
in some cases, complicated tax laws, you should consult with your tax and legal
professionals concerning your particular situation.
Do I need a Revocable Living Trust as opposed to a Will?
Typically the answer in Tennessee
is no. Some planners assert that everyone should have a living
trust, while others believe that a will is all most people need. Before you
make a decision, you should keep a few things in mind. First, the probate process in Tennessee
is relatively fast, relatively inexpensive, and is mostly private. Secondly, the creation and maintenance
of a living trust is more costly than creating a will (typically 2 to 4 times
the cost to create a Will based estate plan), although the cost of probate will
likely be avoided with a living trust.
There are several situations where a living trust could be the proper
estate planning tool, including:
§
You want to avoid the probate process altogether.
§ You
own real property in more than one state and you want to avoid ancillary
probate (property not owned in trust in other states will need to go through
the probate process in that state in order for title to pass according to your
will; although ancillary probate is often a fairly inexpensive and expedited
probate process).
§ You
want your assets to transfer automatically upon death, avoiding the delays of
the probate court (average probate in Tennessee last about 6 months, however,
challenges by the estates creditors are only available for 4 months when an
estate goes through probate).
§ You
know that you will be moving to another state in the near future and you want
to make sure that your primary estate planning document is effective in other
states as well. Wills are state
specific documents and there is a chance that a will might not meet the
execution formalities required in the new state (although if a will is validly
created in the old state, it is generally accepted in the new state). However, the trust is not subject to
the same formality requirements of a will and offers mobility advantages to its
grantor.
For the large majority of Tennesseans, a Will based plan is the most
economical and efficient choice for their estate planning needs.
If life insurance proceeds are tax-free anyway, why do I need an ILIT?
While it is true that life insurance proceeds are not taxed as income, the proceeds of an insurance policy may be included in your gross estate for federal estate tax purposes. If you possess what the IRS terms "incidents of ownership" of the policy, the proceeds will be included in your gross estate and taxed accordingly. You possess any of these "incidents of ownership" if you are the owner of the policy, have the ability to change the policy's beneficiaries, can surrender, assign, or cancel the policy, borrow cash, surrender value, or otherwise pledge the policy, or if you own a majority of a corporation which is the owner of the policy. This list is not all-inclusive, but simply illustrates that simply purchasing a life insurance policy will not necessarily provide tax-free benefits to your heirs. Proper drafting, funding, and administration of an Irrevocable Life Insurance Trust will allow the full face value of the policy to benefit your heirs.
Can I be the trustee of my Irrevocable Life Insurance Trust?
No. Being the trustee of your own ILIT will cause the proceeds of the policy to be included in your gross estate. You also should not choose your spouse as the trustee if the trust is funded with a second to die life insurance policy. A trusted family member, accountant, attorney, or financial institution may be good choices as trustee of your ILIT.
How does a grantor choose a trustee?
The choice of a trustee is extremely important. The trustee owes beneficiaries a fiduciary duty to act in their best interests and usually receives compensation for trust management activities, so the grantor usually wants to make this decision personally. Many grantors choose family members or close friends due to personal confidence in those individuals, but others prefer professional trustee institutions (such as attorneys, trust companies, banks, or CPA’s) because of staff expertise. A grantor should consider the burden posed by the trust's administration, the compensation required by a trustee, and the particular needs of the trust. If a trustee is not specified in the trust document, then a court will appoint one, possibly choosing a trustee the grantor would not have chosen freely. Legally, it is not necessary to notify the trustee prior to creating a trust, but a trustee may decline his or her appointment. Therefore, the grantor should choose someone who is willing to take on the required responsibilities, and should inform them of their appointment. It is advisable to choose an alternate trustee in the event the original choice is unable or unwilling to accept the trust obligations when the trust commences. Grantors may choose multiple trustees to act together in managing trusts. Co-trustees must act unanimously unless the trust expressly allows division of responsibilities. A grantor may name himself or herself as trustee during his or her life. Additionally, a grantor may name one of the trust's beneficiaries as a trustee. The only impermissible combination is naming the same person as sole trustee and sole beneficiary, because this arrangement merges the legal ownership with the property benefits as in regular property ownership.
What are some of the fiduciary responsibilities owed by a trustee to the beneficiaries?
The trustee has several major duties, including:
§
Loyalty: The greatest duty is for the trustee to be loyal to
the beneficiaries. The trustee must administer the trust solely for the benefit
of the beneficiaries, and provide full disclosure of his or her dealings. The
trustee must deal fairly with the beneficiaries, and not manage the trust to
profit his or her own financial interests (i.e., by buying stock in a company the
trustee owns).
§
Administration: The trustee has a positive obligation to do what is
necessary for the good of the trust.
§
Productivity: If the purpose of the trust is to maximize assets
over time, the trustee owes a duty to make productive investments.
§
Earmark: The trustee must keep trust assets separate from all
other assets, including those of the trustee, and must clearly identify those
assets belonging to the trust in all dealings.
§
Account: The trustee must provide financial statements
regarding the state of the trust.
§
Nondelegation:
Because the trustee holds legal title, only the trustee may manage the trust. However, the trustee may delegate the
investment functions of the trust.
§
Diversification: If the trust involves investment of assets, the
trustee must diversify the trust's holdings as a prudent investor would do with
his or her own money.
Impartiality: The trustee must act for the benefit of the trust as a whole, and not
favor one beneficiary's interests over another's.