by Kraig Strom, Certified Financial Planner Practitioner and Chartered Financial Consultant
Certain key types of trusts can be powerful tools for protecting your assets and mitigating taxes when they are used appropriately. Charitable Remainder Trusts, Irrevocable Life Insurance Trusts, and Testamentary Trusts are among the methods we recommend for our clients under certain circumstances when creative strategies are needed to provide income, avoid high tax bills, and/or protect assets from potential creditors. Some people are under the mistaken belief that these types of trusts are only used by the super-rich, but that is not the case. These legal strategies can be enormously helpful to anyone if the situation is right, and many miss out because they aren’t aware of the potential benefits.
A Charitable Remainder Trust (CRT) is a gift of cash or property to an irrevocable trust. The donor receives income from the trust for a defined period or for life, and the remaining trust assets are given to one or more named charities (either public charities or private foundations, even a family foundation) at the end of the trust term. It’s useful for converting a highly appreciated asset like real estate or stocks into lifetime income while avoiding capital gains taxes now and estate taxes in the future. Here’s an example from our practice to show how it can work.
A Southern California couple started buying single-family homes as rental properties around a local university about 25 years ago. At the time, the university was fairly small and not that well known. The properties were cheap, but their location meant that they were constantly rented and provided a good investment cash flow. Over time, however, the profile of the university grew, the community expanded, and the value of the properties skyrocketed.
In the meantime, the couple’s children had established successful careers and moved out of state. The couple wanted to retire out of California, but the prospect of the tax hit they would take if they sold the properties outright kept them tied to the area. A CRT allowed them to donate the properties to the trust, receiving a tax deduction and avoiding capital gains tax. The trust then sold the property with no tax and reinvested the value of that real estate portfolio. The parents now have an income stream that no longer ties them to California or the responsibilities of landlords, which they can enjoy in their retirement years.
An Irrevocable Life Insurance Trust (ILIT) is a life insurance trust that owns term or permanent life insurance on the grantor(s). This removes the death benefit of those policies from the estate, passing them on to the beneficiaries without estate taxes. This type of trust can be and often is used in conjunction with a CRT, as illustrated by our California couple.
In their case, their kids were well established and didn’t need the full value of the real estate asset that was designated to go to charity. However, the parents didn’t want to disinherit their children completely. They used some of the income generated by the CRT to create an ILIT to be able to pass down wealth to their children while shielding it from estate taxes and potential creditor attacks. (It’s important to note that the proceeds from a life insurance policy not protected by an asset-protected life insurance trust are considered part of your taxable estate.)
Another family we worked with had amassed a life insurance portfolio with $5 million in benefits for their children, but it was all exposed to potential creditor claims and taxes because it had not been protected yet. We were able to help them get an ILIT in place to ensure the full benefit went to their kids.
A Testamentary Trust is a trust established in accordance with the instructions given in a will. It allows a trustee to manage assets on behalf of a beneficiary or beneficiaries of the trust. This is a way of giving a beneficiary the benefit of the named asset without the risk of a creditor going after it. This can come into play if, for example, those inheriting are doctors, lawyers, or other high-risk professions, or if they have an ex-spouse who might try to claim their inheritance if they receive it directly.
These explanations only scratch the surface of what can be done with Charitable Remainder Trusts, Irrevocable Life Insurance Trusts, and Testamentary Trusts, and when they might be appropriate for your estate plan. Because every situation is different, there is no one right answer for everyone. At BarthCalderon, we work with each client individually to devise a custom legal strategy to mitigate or eliminate estate taxes, protect your wealth and income, and ensure your assets are distributed as you wish when you’re gone. To find out more about trusts and our estate planning services, contact us here.