Julius Giarmarco

Using Trusts to Protect Heirs

In general, the primary beneficiary has all the rights, benefits and control over the trust property that a person would have with outright ownership – in addition to tax, creditor and divorce protection not available with outright ownership.

Estate planners use trusts to protect beneficiaries from their inability, their disability, their creditors and their predators. Included under “creditors” are the IRS and divorced spouses. More sophisticated estate planners generally create multi-generational dynasty trusts for their clients’ descendants that are (1) estate tax protected, (2) creditor protected and (3) divorce protected – while at the same time allowing the primary beneficiary to control the trust as the trustee.

These trusts are sometimes referred to as “beneficiary-controlled” trusts. Following are the design features of the typical beneficiary-controlled trust:

1. The donor (i.e., parent or grandparent) is the grantor of the Trust.
2. The child and his/her descendants are the beneficiaries of the Trust. However, the child is the “primary” beneficiary of the Trust during his/her lifetime and, therefore, the child’s needs take priority over the needs of his/her descendants.
3. The Trust has two trustees – the primary beneficiary as the investment trustee, and an independent trustee as the distribution trustee. The independent trustee can be the primary beneficiary’s friend, trusted advisor or bank.
4. The primary beneficiary has the power to remove and replace the independent trustee from time to time, thereby maintaining the beneficiary controlled feature of this trust design, so long as the replacement trustee is not a “related or subordinate party” as defined in IRS § 672(c).
5. The trustees can provide the beneficiaries with income and principal as needed for health, education, maintenance and support.
6. The trust agreement allows the trustees to purchase assets for the primary beneficiary’s use and enjoyment (with remuneration) such as vacation homes, artwork, jewelry, etc.
7. The primary beneficiary can be given a broad non-general power of appointment during life and/or at death in favor of anyone other than the primary beneficiary, his/her creditors, his/her estate, or the creditors of his/her estate.
8. At the primary beneficiary’s death, the assets remaining in trust pass to his/her children (i.e., the grantor’s grandchildren), in equal shares, but in further trust. At such time, the grandchild becomes the primary beneficiary of his/her separate trust, which now benefits the grandchild and the grandchild’s descendants. To the extent of the grantor’s generation skipping tax exemption, there would be no generation skipping taxes due.

The beneficiary-controlled trust is gaining popularity among estate planners. Beneficiary-controlled trusts can be created at death as part of the grantor’s living trust, or can be used in irrevocable trusts, including irrevocable life insurance trusts. In addition, trusts created during the grantor’s lifetime can be designed as so-called “grantor” trusts. With such trusts, the grantor is responsible for paying the trust’s income taxes. Thus, the trust grows income “tax free”. In essence, the grantor’s payment of the trust’s income taxes is a tax-free gift to the beneficiaries of the trust. In short, a beneficiary-controlled trust should be considered whenever it is worthwhile to protect beneficiaries from creditors, divorcing spouses and estate taxes.

THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.

Article Tags: Estate Planners, Primary Beneficiary, Independent Trustee, Primary Beneficiary’s

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