The Case for Making Gift Transfers in Trust -- Part II

Advantages and Disadvantages of Using Trusts

In Part I, we discussed why trusts were so popular in an era of high estate tax rates and relatively low exemptions by describing traditional planning using so-called "credit shelter" or "bypass" trusts to remove certain assets from estate tax exposure before those assets are distributed to children and other beneficiaries.

We introduced the idea that because most families today are not exposed to significant estate tax, trusts designed primarily for estate tax reduction have largely become superfluous.  Our premise, however, is that taxes are only one possible threat to your family's continued financial security.   Your family wealth represents all of those things you "value," because you have and will continue to act to gain and keep them.  These are not limited to financial or business assets, but also include those attributes and elements that often provide the foundation for their accumulation -- such as your ability to create value in a competitive marketplace, your skills, your developed talents, your ability to create and then actualize ideas, your reputation, the knowledge and wisdom accumulated by senior family members about life and business, your relationships, your network and your ability to enjoy and benefit from the financial wealth you have produced.

Remember that we focus on maximizing your personal experience of well-being (however you define that).   Where there are values, unfortunately, there are forces at play that exploit weaknesses and vulnerabilities in order to extract, unearned, the values you've created.  Modern estate planning has everything to do with protecting those values from confiscatory forces.

We also suggested that in an environment characterized by dramatic and rapid personal, social and economic change, retaining flexibility to adjust to changing circumstances, needs, interests and desires is worthwhile.

Yet, often it seems that flexibility and stability are mutually exclusive.  The reality, however, is that we can and should have both.  Indeed, one without the other is not really possible.

In the modern estate planner's arsenal, few tools are as simultaneously flexible and stable as the well-designed and drafted trust.

Property transferred by trust can confer significantly greater benefits than can be derived from property owned outright, not only with regard to tax savings but also from the claims of creditors, including an estranged spouse in a divorce context. From the beneficiary's perspective, it is difficult to envision any rights in property owned outright that cannot also be provided in a trust through proper drafting, particularly by the imaginative design of trustee powers, and powers of appointment.  This is not to suggest, however, that giving full control to a beneficiary is desirable in all cases.

There are a number of advantages of using a trust, though not all of them apply in every case:

a.       A trust can provide access to professional management in the event that beneficiaries are unwilling or unable to properly manage the property, to devote the time, energy and personal resources necessary to make their own investment decisions or to hire, monitor and review the activities of investment professionals.

b.       A trust can provide a buffer against impulsive or unwise financial decisions and the trustee can serve as a “reality check” on certain anticipated uses of funds.  Many individuals possess the remarkable capacity to be unreasonably influenced by others.

c.       Property transferred to a beneficiary in certain types of trusts can provide some protection in the event the beneficiary may become subject to a divorce proceeding or paternity/maternity suit.

d.       Property held in trust can provide protection to a beneficiary who may become subject to significant creditor claims, including creditors of a failed business, clients or patients in a professional liability suit or governmental creditors for unpaid taxes.

e.       The trust can be drafted to require that the trustee make certain distributions to the beneficiary.  Note that mandatory distributions are subject to the claims of the beneficiary's creditors, and, in most cases, there is no advantage to requiring that certain distributions be made.

f.       The trust can be drafted to permit a beneficiary who is also acting as trustee or a third party trustee to make distributions of income and principal to himself or to other current or future beneficiaries for various purposes, including health, education,  maintenance and support, as well as broader purposes, such as travel, luxuries, the ability to purchase a home (through a distribution the beneficiary of a down payment on a home or vacation residence) or start a business or enter into a profession.  To the extent a beneficiary has control over these distributions, she loses some ability to protect the trust assets from the claims of third party creditors or predators.

g.       The trust can be drafted to permit the trust to purchase assets for the use of the beneficiary rent free (without causing the foregone rent to be income taxable to the beneficiary or the property to become subject to the claims of creditors or predators).

In the third installment, we will provide an example of one family's use of trusts to protect and enhance the value of property transferred to children and grandchildren.

Article written by John R. Bedosky, partner at Hinman, Howard & Kattell, LLP.  To contact Mr. Bedosky please email jbedosky@hhk.com or call (607) 723-5341.

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