Trusts: A Crucial Component of Estate Planning

In the intricate world of estate planning, trusts play a vital role in ensuring financial stability and protection for individuals and their heirs. As an accountant, understanding the nuances of trusts is essential to provide comprehensive advice to your clients.

Trusts as a Vehicle for Financial Protection

Financial planner Barbara Bilello aptly compares estate planning to a car, with the estate plan serving as the body and investment management as the engine. Just as a car’s body offers protection, a well-structured estate plan, including trusts, shields assets from taxes and probate court complications. This analogy underscores the importance of trusts in safeguarding clients’ wealth.

The Tax Cuts and Jobs Act and Its Implications

With the higher estate-tax exemptions under the Tax Cuts and Jobs Act of 2017 set to expire at the end of next year, there is a pressing need for clients to consider setting aside assets in trusts. This move can significantly reduce the taxable portion of their estate, providing a financial cushion for their heirs.

Record-High Estate Tax Exemptions Scheduled to Sunset

Current estate tax exemption rates are at a historic high, allowing individuals to transfer $13.61 million and married couples $27.22 million tax-free. However, these exemptions are scheduled to sunset on December 31, 2025, reverting to approximately $7 million per individual, adjusted for inflation. Planning in advance is key to taking advantage of these opportunities and avoiding donor remorse.

The High Cost of Rushed Planning

Current exclusion levels represent a significant opportunity. However, in similarly fluctuating tax environments, we have observed some families acting precipitously as deadlines approached. Here are a few examples of potential planning missteps:

Liquidity Issues: Completing a gift to an irrevocable trust with liquid assets due to time pressures can result in insufficient liquidity later in life.

Growth Stock Gifts: Gifting company stock to a trust that later saw unexpected, spectacular growth without modeling alternative tools can lead to restricted access to the funds.

Retirement Assets: Gifting retirement assets to a trust without a complete understanding of the structure can result in more restricted access and control than anticipated.

Types of Trusts and Their Tax Benefits

Understanding the various types of trusts and their specific benefits is crucial for any financial advisor. Here are some key trusts that can be instrumental in estate planning:

Spousal Lifetime Annuity Trust (SLAT): This trust allows couples to shield up to $13.61 million from estate taxes, offering a safety net if one partner passes away. It provides financial security for the surviving spouse while minimizing estate taxes.

Bypass Trust: Also known as a credit shelter trust or marital disclaimer trust, it helps in preserving the estate tax exemption for both spouses. This trust allows the first spouse to pass assets to the trust without incurring estate taxes, and upon the second spouse's death, the remaining assets can be passed to heirs with reduced tax liability.

Charitable Remainder Trust: Ideal for clients looking to maximize deductions through donations, this trust provides both tax benefits and philanthropic satisfaction. It allows individuals to donate assets to a charity while receiving a partial tax deduction and a stream of income for a specified period.

Qualified Personal Residence Trust (QPRT): This trust removes the family home from the estate, significantly reducing gift taxes. The grantor can live in the home for a predetermined number of years, after which the residence passes to the beneficiaries, usually at a lower tax cost.

Irrevocable Life Insurance Trust (ILIT): It ensures that life insurance proceeds go to heirs tax-free, providing financial security without the burden of estate taxes. The trust owns the life insurance policy, keeping the proceeds out of the taxable estate.

Special Needs Trust: This trust supports dependents with disabilities or poor money management skills, ensuring their financial needs are met without jeopardizing their benefits. It provides for the beneficiary's needs while preserving eligibility for government assistance programs.

Navigating State-Specific Rules

One critical aspect of trust planning is understanding the state-specific rules that govern trusts and estates. Clients may fall under different categories, such as "small estate," which can impact whether they need a trust to avoid probate. The probate process can be lengthy and exposes the decedent’s life to potential claims from family members, making trusts an attractive option. In some states, probate can take several years and involve significant legal fees, making trusts a more efficient way to transfer assets.

Revocable vs. Irrevocable Trusts

Choosing between a revocable and irrevocable trust is a fundamental decision in estate planning. While a revocable trust offers flexibility and the ability to make changes during the grantor's lifetime, an irrevocable trust provides permanent tax and creditor protection. Clients must weigh these options based on their financial goals and needs. A revocable trust can be altered or dissolved, making it suitable for those who anticipate changes in their financial situation or family dynamics. Conversely, an irrevocable trust, once established, cannot be easily modified, providing a more secure asset protection strategy.

Collaborating with Estate Attorneys

Given the complexities involved in trust planning, collaboration with an estate attorney is indispensable. Advisors should ensure a seamless relationship with trusted attorneys to provide clients with accurate and comprehensive estate planning services. This collaboration helps maintain attorney-client privilege and ensures that the advisor remains in a supportive, rather than a controlling, role. Estate attorneys can draft the necessary legal documents, offer advice on the most suitable trust structures, and ensure compliance with state and federal laws.

Continuous Learning and Staying Informed

The field of estate planning is ever-evolving, marked by the convergence of tax and financial planning services. Continuous learning and staying informed about the latest developments are crucial for advisors to differentiate themselves and offer valuable insights to clients. Keeping abreast of changes in tax laws, estate planning techniques, and trust administration practices allows accountants to provide informed and effective advice.

Trusts are a powerful tool in the arsenal of estate planning, providing essential protection and tax benefits. As accountants, it’s our responsibility to guide clients through the complexities of trust planning, ensuring their financial legacy is preserved and passed on seamlessly. At D'Alessio, Tocci & Pell, LLP, we have experts in international taxation, estates, and trusts, and we maintain strong partnerships with leading estate attorneys to assist our clients in achieving their estate planning goals. Our comprehensive approach ensures that clients receive the best possible advice and support in managing their estates and trusts.