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From
E. Frederick
Petersen III |
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The
Petersen Law Firm
One Corporate Center
10451 Mill Run Circle;
Suite 400
Owings Mills, MD 21117
(443) 392-2585
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I have over 20
years of experience helping my clients develop and enhance
their estate plans by incorporating up-to-date wealth
preservation techniques.
Contact me to learn how the New STANDALONE IRA TRUST can
benefit your clients! |
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Volume 1,
Issue 3 |
| Understanding
the Significance of Trusts |
This
issue of The Wealth Advisor addresses a topic that
is important to many Americans yet is sometimes
misunderstood - trusts. In the right circumstances,
trusts can provide significant advantages to those
who utilize them, particularly in protecting trust
assets from the creditors of beneficiaries.
Admittedly this can be a complex topic, but you see
its implications in the headlines every day. This
newsletter attempts to simplify the subject and
explain the general protection trusts provide for
their creator (the "trust maker") as well as the
trust beneficiaries. Given the numerous types of
trusts, this newsletter explores only the most
common varieties. We encourage you to seek the
counsel of your wealth planning team if you have
questions about the application of these concepts to
your specific situation, or if you have questions
about specific types of trusts.
Revocable vs. Irrevocable Trusts
There are two basic types of trusts: revocable
trusts and irrevocable trusts. Perhaps the most
common type of trust is revocable trusts (aka
revocable living trusts, inter vivos trusts or
living trusts). As their name implies, revocable
trusts are fully revocable at the request of the
trust maker. Thus, assets transferred (or "funded")
to a revocable trust remain within the control of
the trust maker; the trust maker (or trust makers if
it is a joint revocable trust) can simply revoke the
trust and have the assets returned. Alternatively,
irrevocable trusts, as their name implies, are not
revocable by the trust maker(s).
Revocable Living Trusts
As is discussed more below, revocable trusts do not
provide asset protection for the trust maker(s).
However, revocable trusts can be advantageous to the
extent the trust maker(s) transfer property to the
trust during lifetime.
Planning Tip: Revocable trusts
can be excellent vehicles for disability
planning, privacy, and probate avoidance.
However, a revocable trust controls only that
property affirmatively transferred to the trust.
Absent such transfer, a revocable trust may not
control disposition of property as the trust
maker intends. Also, with revocable trusts and
wills, it is important to coordinate property
passing pursuant to contract (for example, by
beneficiary designation for retirement plans and
life insurance).
Asset Protection for the Trust Maker
The goal of asset protection planning is to insulate
assets that would otherwise be subject to the claims
of creditors. Typically, a creditor can reach any
assets owned by a debtor. Conversely, a creditor
cannot reach assets not owned by the debtor. This is
where trusts come into play.
Planning Tip: The right types
of trusts can insulate assets from creditors
because the trust owns the assets, not the
debtor.
As a
general rule, if a trust maker creates an
irrevocable trust and is a beneficiary of the trust,
assets transferred to the trust are not protected
from the trust maker's creditors. This general rule
applies whether or not the transfer was done to
defraud an existing creditor or creditors.
Until fairly recently, the only way to remain a
beneficiary of a trust and get protection against
creditors for the trust assets was to establish the
trust outside the United States in a favorable
jurisdiction. This can be an expensive proposition.
However, the laws of a handful of states (including
Alaska, Delaware, Nevada, Rhode Island, South
Dakota, and Utah) now permit what are commonly known
as domestic asset protection trusts. Under the laws
of these few states, a trust maker can transfer
assets to an irrevocable trust and the trust maker
can be a trust beneficiary, yet trust assets can be
protected from the trust maker's creditors to the
extent distributions can only be made within the
discretion of an independent trustee. Note that this
will not work when the transfer was done to defraud
or hinder a creditor or creditors. In that case, the
trust will not protect the assets from those
creditors.
Planning Tip: A handful of
states permit what are commonly known as
domestic asset protection trusts.
Given this
insulation, asset protection planning often involves
transferring assets to one or more types of
irrevocable trusts. As long as the transfer is not
done to defraud creditors, the courts will typically
respect the transfers and the trust assets can be
protected from creditors.
Planning Tip: If you are
concerned about personal asset protection but
are unwilling to give up a beneficial interest
to protect your assets from creditors, consider
a domestic asset protection trust or even a
trust established under the laws of a foreign
country.
Asset Protection for Trust Beneficiaries
A revocable trust provides no asset protection for
the trust maker during his or her life. Upon the
death of the trust maker, however, or upon the death
of the first spouse to die if it is a joint trust,
the trust becomes irrevocable as to the deceased
trust maker's property and can provide asset
protection for the beneficiaries, with two important
caveats.
First, the assets must remain in the trust to
provide ongoing asset protection. In other words,
once the trustee distributes the assets to a
beneficiary, those assets are no longer protected
and can be attached by that beneficiary's creditors.
If the beneficiary is married, the distributed
assets may also be subject to the spouse's
creditor(s), or they may be available to the former
spouse upon divorce.
Planning Tip: Trusts for the
lifetime of the beneficiaries provide prolonged
asset protection for the trust assets. Lifetime
trusts also permit your financial advisor to
continue to invest the trust assets as you
instruct, which can help ensure that trust
returns are sufficient to meet your planning
objectives.
The second
caveat follows logically from the first: the more
rights the beneficiary has with respect to
compelling trust distributions, the less asset
protection the trust provides. Generally, a creditor
"steps into the shoes" of the debtor and can
exercise any rights of the debtor. Thus, if a
beneficiary has the right to compel a distribution
from a trust, so too can a creditor compel a
distribution from that trust.
Planning Tip: The more rights a
beneficiary has to compel distributions from a
trust, the less protection that trust provides
for that beneficiary.
Therefore,
where asset protection is a significant concern, it
is important that the trust maker not give the
beneficiary the right to automatic distributions. A
creditor will simply salivate in anticipation of
each distribution. Instead, consider discretionary
distributions by an independent trustee.
Planning Tip: Consider a
professional fiduciary to make distributions
from an asset protection trust. Trusts that give
beneficiaries no rights to compel a
distribution, but rather give complete
discretion to an independent trustee, provide
the highest degree of asset protection.
Lastly,
with divorce rates at or exceeding 50% nationally,
the likelihood of divorce is quite high. By keeping
assets in trust, the trust maker can ensure that the
trust assets do not go to a former son-in-law or
daughter-in-law, or their bloodline.
Irrevocable Life Insurance Trusts
With the exception of domestic asset protection
trusts discussed above, a transfer to an irrevocable
trust can protect the assets from creditors only if
the trust maker is not a beneficiary of the trust.
One of the most common types of irrevocable trust is
the irrevocable life insurance trust, also known as
a wealth replacement trust.
Under the laws of many states, creditors can access
the cash value of life insurance. But even if state
law protects the cash value from creditors, at
death, the death proceeds of life insurance owned by
you are includible in your gross estate for estate
tax purposes. Insureds can avoid both of these
adverse results by having an irrevocable life
insurance trust own the insurance policy and also be
its beneficiary. The dispositive provisions of this
trust typically mirror the provisions of the trust
maker's revocable living trust or will. And while
this trust is irrevocable, as with any irrevocable
trust, the trust terms can grant an independent
trust protector significant flexibility to modify
the terms of the trust to account for unanticipated
future developments.
Planning Tip: In addition to
providing asset protection for the insurance or
other assets held in trust, irrevocable life
insurance trusts can eliminate estate tax and
protect beneficiaries in the event of divorce.
If the
trust maker is concerned about accessing the cash
value of the insurance during lifetime, the trust
can give the trustee the power to make loans to the
trust maker during lifetime or the power to make
distributions to the trust maker's spouse during the
spouse's lifetime. Even with these provisions, the
life insurance proceeds will not be included in the
trust maker's estate for estate tax purposes.
Planning Tip: With a properly
drafted trust, the trust maker can access cash
value through policy loans.
Irrevocable
life insurance trusts can be individual trusts
(which typically own an individual policy on the
trust maker's life) or they can be joint trusts
created by a husband and wife (which typically own a
survivorship policy on both lives).
Planning Tip: Since federal
estate tax is typically not due until the death
of the second spouse to die, trust makers often
use a joint trust owning a survivorship policy
for estate tax liquidity purposes. However, a
joint trust limits the trust makers' access to
the cash value during lifetime. In these
circumstances, consider an individual trust with
the non-maker spouse as beneficiary.
Conclusion
You can protect your assets from creditors by
placing them in a well-drafted trust, and you can
protect your beneficiaries from claims of creditors
and predators by keeping those assets in trust over
the beneficiary's lifetime. By working together with
your other wealth planning professionals, we can
ensure that your planning meets your unique goals
and objectives.
To comply with the U.S. Treasury regulations, we
must inform you that (i) any U.S. federal tax advice
contained in this newsletter was not intended or
written to be used, and cannot be used, by any
person for the purpose of avoiding U.S. federal tax
penalties that may be imposed on such person and
(ii) each taxpayer should seek advice from their tax
advisor based on the taxpayer's particular
circumstances. |
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