The ABCs of Trust Planning

Estate Planning, like many specialty fields, has a language all its own.  For professionals involved in the field, short hand acronyms for various planning techniques are well-known and understood.  For the individuals and families seeking estate planning advice, however, it can leave your head spinning.

Fortunately, once explained, many of these techniques are fairly easy to understand and extremely helpful in achieving your estate planning goals.  This is especially true of a group of “alphabet soup” trusts that are common techniques used by most estate planners.

This is not exhaustive list of trusts or estate planning techniques, but these are some of the more commonly used trusts:

Charitable Lead Trusts (CLT)

How it works: The Grantor (the person who creates and funds the trust) contributes property to the trust and gives a charity or other exempt entity an income interest for a term of years.  Upon the end of the trust term, the remaining property passes to the Grantor’s descendants or other named beneficiaries.

Benefits: The Grantor receives a charitable deduction based on the present value of the income stream and the contributed property is removed from the Grantor’s taxable estate.

Charitable Remainder Trusts (CRT)

How it works: A CRT works exactly like a CLT except the beneficiaries are reversed.  The Grantor or a member of the Grantor’s family receives an income interest for a term of years.  At the end of trust term, the remaining property passes to a charity or exempt organization.

Benefits: The Grantor receives a charitable deduction based on the present value of the remainder interest and the contributed assets are removed from his or her taxable estate.

Grantor Retained Annuity Trusts (GRAT)

How it works: The Grantor contributes property to a trust and receives an annuity interest for a term of years.  At the end of the trust term, the property passes to the Grantor’s descendants or other beneficiaries.

Benefits:  By using the present value of the property and the Section 7520 interest rate, the value of the gift made by the Grantor is zero for gift tax purposes.  The remainder beneficiaries receive the remaining property without the Grantor incurring any gift tax.

Intentionally Defective Grantor Trusts (IDGT)

How it works:  By retaining certain powers over the trust (for example, the power to substitute trust property), a trust is considered a pass through for income tax purposes.  The grantor, rather than the trust, pays any income tax attributable to the trust property.

Benefits:  The income tax rates for individuals are typically more favorable than the tax rates for trusts.  Additionally, the Grantor reduces his taxable estate by paying taxes on the trust income.  IDGTs are often used in sales transactions between the Grantor and the Trust, which also allows the property to pass without estate or gift tax.

Irrevocable Life Insurance Trusts (ILIT)

How it works:  The Grantor contributes cash or cash equivalents to the trust which are used to purchase life insurance on the Grantor’s life.   Each year, the Grantor makes additional contributions to pay the premiums on the life insurance.  Upon the Grantor’s death, the death benefit of the policy(ies) is paid to the Trust.

Benefits:  The proceeds of the life insurance policy(ies) are outside the Grantor’s estate for estate tax purposes.  Additionally, the proceeds may be used to pay any estate taxes due on the Grantor’s estate and allows the Grantor’s estate to avoid liquidating assets such as real estate or business interests.

Qualified Personal Residence Trusts (QPRT)

How it works: The Grantor contributes his or her residence to the trust and retains the right to reside in it for a term of years. At the end of the trust term, the residence passes to the remainder beneficiaries, typically the Grantor’s descendants.

Benefits: Upon the contribution of the residence, the property is removed from the Grantor’s taxable estate.  The value of the gift made by the Grantor is reduced by the value of his or her interest in the residence during the initial trust term.

Each of these trusts is not without its disadvantages and complications.  Unless they are properly drafted and administered, the benefits discussed above may be thwarted.  Despite this, for those looking to reduce their taxes, to pass property to their descendants and/or make a charitable gift, they are well worth diving into the ‘alphabet soup’ to find the right transaction for you.

Please contact info@levyestatelaw.com for more information about these and other trust transactions.

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