Which Trust and Why

By Brian Begalke, CPA,  Tax Accountant, Tax Services

A tax series on how setting up the correct trust and drafting the right agreement can save you and your family headaches in the future.    

Part One: Why it is import to come up with a game plan before you set up your trust and make any elections.

Nobody likes paying taxes. Nobody enjoys cutting that check to the treasury, or seeing their paycheck shrink due to withholding. We all have worked hard for the money we earn each year, and as we continue to work and save it is important to see what we have earned holds and retains value.  You have probably heard in the past from a family member, friend, co-worker, and of course, your attorney that you should protect all the financial assets you have worked so hard to earn by setting up a trust.  And instinctively you generally, say “Yes, that’s a great idea, I need to get around to that.” And yes, you do. But be wary, there is a lot of decisions and unexpected surprises that can occur when setting up a trust. Trusts are not the same and the terms and agreements you place in the trust can have severe tax or financial consequences down the road for you or those you choose to benefit.

The goal of a trust is to protect what you have earned and maximize your assets for your beneficiaries or your own future, so it important you eliminate any financial risks or additional costs. Proper planning can limit transfer taxes and financial loss. Many individuals who set up trusts often do not realize that their trusts may no longer meet their needs and can affect the beneficiaries of the trust in an unsatisfactory manner. It can be very beneficial to revisit a trust agreement already established and can save you or your beneficiaries from tax surprises in the future.

Trusts are very useful for a variety of reason besides a simple investment management strategy. Trusts can be used for the following:

·         Protection from creditors, including divorcing spouses

·         Protect beneficiaries from their own financial shortcomings

·         Protection of one generation from another

·         Preservation of an estate for children of prior marriages

·         And, of course, preservation of funds from wealth transfer taxes

It is important to consider these goals when setting up a trust and prioritize which are the most important to you. At times it is advantageous to set up several trusts to accomplish your goals. When setting up your trust agreement is essential that you understand what the purpose of your trust is, otherwise you can make this mistake of missing out on the correct protection, tax advantages, and financial opportunities.

Determining the purpose of your trusts can be difficult when you don’t understand how trusts can work in your favor and what needs to be accomplished. Some specific items you need to consider at times before you start setting your goals and purpose are the following:

1.       Who should manage the trust and my assets as the trustee?

a.       Should it be primarily for financial management and gains?

b.      Should it be an individual I trust or someone who can maximize my assets?

c.       Should it be a family member who can further determine where my wealth is distributed?

d.      Should I have multiple trustees or even a board to make future financial decisions?

2.       Who do I want to benefit?  

a.       Who is involved in my children? My grandchildren? My children and grandchildren? My siblings?

– This item generally has the largest impact how you set up each trust agreement.

b.      Do I want to use this trust for charitable organizations?

3.       How should I distribute the income to the beneficiaries?

a.       How much?

b.      How often?

c.       Until what age?

d.      Starting at what age?

e.      Are the distributions mandatory or upon stipulation?

f.        And all the other “What ifs”?

4.       When do I want trust to become funded and dissolve?

a.       At my death?

b.      During my lifetime and afterwards?

c.       After my spouses death?

d.      Do I want to plan for an event such as a college, a wedding, or retirement?

5.       How much money should be placed each trust?

a.       Is it financially beneficial to even place my assets in a trust?

b.      How much do I plan on leaving to my descendants?

As you can see there are a lot of scenarios that you must consider when drafting a trust agreement. It is important to get these items set in stone and really planned out thoroughly before taking the next steps in choosing what type of trust and what planning strategies you want to take advantage of. When the information above changes of if you over look any items above you may regret the choices you made when setting up your trust.

Once these factors above help you find the true purpose of your trust that is when the tax and financial planning strategies can start to take place. You can apply your plan and purpose to the trust instruments that provide the benefits listed above and properly avoid any tax surprises.  You can start making decisions like should I establish a living trust (operated during your lifetime) or a testamentary trust (funded at your death)?

In this series I will start to address the different trusts that are available and how the scenarios above as well as many others affect each trust. I will go through the tax planning advantages and consequences associated with each trust and how they can be used appropriately.

It is very difficult for one to understand and consider all possible rules, restrictions, and possibilities relating to trust taxation and estate planning. If you have any questions, or if you would like to discuss your unique situation, please contact us at info@bkl-cpa.com or 847+866+6800.