I’ve heard many people say that by establishing a trust, you will eliminate any estate taxes due. That is a false statement. However, trusts do simplify the transfer of your assets to your heirs, as well as establish whatever guidelines you want. For example, if you want to leave your grandchildren each a sizable amount of money, but believe that they will be too young to manage the money by themselves, you can put the money into trust where it can stay until they are old enough (which is an age that you determine). Or, you can ensure that your assets don’t pass directly to your family members by putting them into a trust.

Trusts are legal entities that function as corporations do. They may allow you to save on some estate taxes, as well as help minimize the amount of estate taxes paid. They allow you to continue to control your assets, both while you are living and after you have passed away. Plus, trusts can specify how the trust’s money can be spent. There are different types of trusts, including revocable, irrevocable, living and bypass trusts.

In some instances, trusts can take the tax burden off of an individual, who may be in a higher tax bracket, and shift it to the trust, or its  beneficiary. However, the government has sought to limit the amount of tax savings that can occur through trusts. For instance, the beneficiary of certain types of trusts must be at least 14 years of age, or else the income is taxed at the grantor’s (person who transfers the property into the trust) tax bracket. But, trusts may allow for a significant  estate  tax  savings by removing the property out of the grantor’s estate, much to the benefit of future generations, without incurring any federal estate taxes.

While setting up a trust, you will need to select who you will want to be your trustees. A trustee acts for the trust, and will be required to make any decisions regarding the trust. Many times, I have seen where it is advised that trustees be from a corporate setting (i.e., a trust company or bank that has been authorized to oversee the trust), but I feel that these third parties won’t understand your family and your wishes. It’s true that a trustee needs to be able to make impartial decisions, should have sound business knowledge, and should have some skill in investment and/or trust management. But it’s also important to have a family connection to your trust. Corporate trustees may charge a very high maintenance fee for their services, all the while not doing anything to benefit the trust. If you have a family member who is experienced with investments and business, and you trust that person, have him or her act as a trustee. If you don’t have anyone that has the experience, consider having a corporate trustee and a family member act as co trustees, so that one cannot make all the decisions.

Revocable and Irrevocable Trusts

When the grantor wishes to retain control over the assets placed in the trust, as well as the right to change, amend or even terminate the trust, the grantor creates a revocable trust. However, if that person wishes to waive those rights, he or she may create an irrevocable trust. In an irrevocable trust, the grantor not only gives up the right to the property in the trust, he or she also relinquishes the right to any income produced from those assets. Plus, if any of the grantor’s circumstances change, that person will be unable to alter the trust in any way.

Living Trusts

Living trusts may be either revocable or irrevocable, and are established during the grantor’s lifetime. In a revocable living trust, the grantor retains the rights to the property that is placed inside the trust, as if the grantor were still the owner in name of all the assets. The grantor is then taxed on any income that is produced by the trust’s assets. The major advantages to revocable living trusts are (1) the management continuity and the income stream are guaranteed to last beyond the death of the grantor, (2) any assets that have been placed in the trust won’t have to go through the probate process since the trust will continue to survive after the grantor has died, (3) the trustee is responsible for all management and investment decisions, and (4) all aspects of the living trust, including the amount of assets within the trust are private. Unlike the probate process, which is a matter of public record, the trust documents, named trustees and, all other parts of the trust will remain a private matter even after the death of the grantor. Disadvantages include the cost to set up the trust, as well as any management fees charged by the trustee. Plus, since the grantor still has control over the trust’s assets, they are included as part of the grantor’s estate, and may be subject to estate taxes upon the grantor’s death.

The advantages to setting up an irrevocable living trust are the same as for the revocable living trusts. Irrevocable trusts may also help reduce the amount of taxes paid by the grantor, since the property is not only removed from the grantor’s estate, any income from the assets is also removed. However, the disadvantages of an irrevocable living trust outnumber those of a revocable trust. First, the grantor loses the right to his or her property placed in the trust plus any income generated by these assets. Second, the grantor will not be able to make any changes to the trust, nor rescind it, once it has been established. Third, the grantor may be subject to gift tax on the assets placed in the trust, depending upon the assets’ value. And finally, the grantor will still be responsible for any fees charged to set up the trust, and perhaps, some management fees charged by the trustee. Usually, though, the trustee is paid directly from the trust.

Bypass Trusts

Bypass trusts are also known as marital or A/B trusts. Married couples who have an extensive net worth, and therefore need all the unified  credit  they  can get, establish them. Bypass trusts divide a couple’s assets so that each of them may claim the maximum unified credit  ($1 million in  2002 and increasing until  2010 when it is repealed). A bypass trust will help reduce, or even eliminate, estate taxes by passing the trust’s assets directly to the heirs, and thus, bypassing the surviving spouse’s estate. Normally, when one spouse dies, he or she bequeaths the entire estate to the other spouse. The surviving spouse doesn’t need to worry about estate taxes because assets inherited from a spouse aren’t subject to estate taxes. But, the deceased spouse hasn’t used their unified credit. When the surviving spouse dies, the beneficiaries will only be able to apply one unified credit, making the rest of the assets subject to estate taxes.

One way to make sure that the bypass trusts work is to make sure that each spouse has enough assets to maximize the benefit of the unified credit.  Sometimes this means retiling assets that are in one spouse’s name to the other spouse’s trust. One spouse may give the other spouse an unlimited amount of money without triggering any gift tax. So, if you find that your spouse has less money in his or her name, and his or her trust, give your spouce some of yours. The point of establishing bypass trusts is to maximize the unified credit for each of you.

For example, Matthew and Cynthia Client have a joint gross estate of $5 million. Both of them are in good health now, but are in their early 80s. Matthew has been worried that if one of them were to die soon, their estate would be hit with enormous estate taxes. They would like to establish A/B trusts to help reduce the amount of taxes their children will have to pay on their estate. Upon dividing their assets, Matthew discovers that he only has about $1.2 million in assets in his name, while Cynthia has $3.8 million. Since they want their trusts to be as equal as possible, Cynthia gives Matthew $1.3 million worth of assets, which he places into his trust. Now they both have trusts worth $2.5 million. Plus, they incurred no gift tax because they are married. As long as their assets don’t appreciate very rapidly, and providing they live past the year 2008, their heirs won’t be subject to a large amount of estate taxes. And, if they both were to pass away in the year 2010, none of their estate would be taxed.

Irrevocable Life Insurance Trusts

These are established to be the owner of your life insurance policy. Once you have passed away, the death benefit is paid to the trust and doesn’t become part of your estate. The proceeds can then be used to pay whatever estate taxes are due, or can be invested, with the interest going to benefit your heirs. This type of trust is best suited for those who have very large estates that would be subject to estate taxes.

Charitable Remainder Trust

This type of trust benefits the charity, or charities, of your choice. There are two major benefits to this trust. First, you (and possibly, your beneficiaries) can receive an annual income from the interest generated by the assets in the trust. Second, you can receive a tax deduction for the assets that you give each year to the trust. Then, after you (or your beneficiaries) pass away, the charity gets the principal.

There are other types of trusts, but these are the most commonly used and referred to. You may now know what type of trust you think you need, if any, but, no book can take the place of actually meeting with your attorney and financial advisor to determine what you need and what you should do. Be sure to consult with them prior to making these decisions.