Four Reasons to Consider a Trust to Protect Your Assets

Nest EggFrom: Andrew H. Friedman

For many years, trusts have been the province of the wealthy, mysterious vehicles used to escape taxes and preserve assets for future generations. And for couples with joint assets approaching or exceeding $10.68 million — the current gift and estate tax exemption amount — a comprehensive estate plan that incorporates trusts is crucial for minimizing estate taxes.

More recently, however, families with assets well below this threshold are using trusts to help them protect assets from creditors, manage and grow assets for future generations, and ensure that their assets ultimately are distributed in accordance with their wishes to their heirs.

In setting up a trust, an individual appoints a trustee (an individual, a corporate trust company, or both) to act as a surrogate to manage and distribute assets in accordance with his or her wishes when (i) the individual later is not able to do so directly (due to, for instance, death, disability, incapacity, or geographic unavailability) or (ii) the individual wishes to shield the assets from possible later creditors. The individual sets out instructions in a trust document and appoints a trustee to act in his or her absence on his or her behalf. In this way, the trust ensures the ongoing preservation, protection, and control of assets.

Let’s consider some of the situations in which a trust can help someone control, protect, and preserve assets and address philanthropic goals.

 

Allocating assets among family members. Individuals often are concerned about leaving assets outright before heirs are ready to handle them. A child could dissipate assets too quickly, or lose assets in a later divorce. A spouse might remarry into a blended family. By placing assets in a trust, an individual can ensure that the assets are later distributed among family members in the time and manner intended.

Children: Suppose you have children who are young or irresponsible and might squander assets they receive outright. You can instruct your trustee when to distribute income and principal to each child. Such instructions can be based on age or on a specified accomplishment (e.g., college graduation). In this manner, you can seek to influence your children’s behavior even after your death.

Future generations: Suppose you wish to ensure that your assets remain available for future generations of your family, and that intervening generations do not squander assets to the detriment of generations that follow. For instance, if assets are left to a son, he might later give them to his wife, either voluntarily or in a later divorce, rather than leave them to your grandchildren. A dynasty trust ensures that each generation will receive sufficient income to live but be unable to divert remaining assets from future generations.

Surviving spouse: Suppose you want to preserve your assets for your offspring in the event you predecease your spouse. If you leave your assets to your spouse outright, he or she will have the power to determine their later distribution, perhaps giving them to a prior or later spouse’s offspring. By putting the assets in trust and providing for distributions to your spouse to maintain lifestyle, you can ensure that remaining assets go solely to your children. This planning can be particularly important if you have children from a prior marriage.

Education: An education trust can set aside assets to be used solely for educating or your children or grandchildren.

Special needs child: A special needs trust can be used to provide funds for an incapacitated child after the parent is no longer able to do so.

 

Provide for professional management. Individuals might be concerned that their heirs’ lack of financial sophistication – or the heirs’ divergent interests and needs — will preclude the effective management of the assets. A trust allows an individual to ensure that assets continue to be managed properly and to grow.

Incapacity: A trust can ensure that your assets are managed properly and your family’s financial needs are met in the event you suddenly become incapacitated. By specifying elements of incapacity in the trust document, your family typically can avoid a lengthy court proceeding. Providing for a smooth transition in the event of incapacity is particularly important for non-financial assets, such as real estate or a family business, where ongoing management is crucial.

Unsophisticated investors: Suppose your surviving spouse and/or your children are not sophisticated investors and will have difficulty managing assets to provide a reasonable return. By placing assets in trust, you can provide broad instructions as to how the assets are to be invested and identify a professional financial advisor to manage them.

Squabbling heirs: Often heirs cannot agree on how to manage a family asset, such as a home or business. By putting the asset in a trust, you can appoint a trustee to manage the asset and distribute income to your heirs per your instructions, helping to preserve family unity.

Shifting fiduciary duty: Naming one of your children to administer assets for all your children could expose the managing child to a suit by the others for breach of fiduciary duty if they do not approve of his or her actions. Naming a professional manager alleviates this concern by shifting the management duties away from a family member.

 

Preserve assets. Individuals in certain professions or businesses often are concerned that they might lose assets to creditors rather than preserve the assets for family members. Assets held in trust frequently are beyond the reach of creditors, allowing the assets to be preserved for heirs.

Creditor protection: Suppose you are a professional (such as a doctor) who might be sued for alleged mistakes. Or you are concerned that your business operations could expose you to financial risk in the event of an economic downturn. By placing your assets in trust before the actions giving rise to a suit or downturn occur, you can shield the assets from future creditors.

Children: Suppose your child has incurred significant debt, or you are concerned your child may do so in the future. Assets placed in trust for the child’s benefit are kept out of the reach of creditors seeking to collect on debts the child has incurred. A trusteed IRA program is designed to provide the same protection for your qualified assets.

Divorce protection: Placing assets in trust in some circumstances may shield the assets from split upon a later divorce property settlement.

 

Facilitate philanthropy. Individuals might wish to donate the bulk of their assets to a charity, but still provide needed income for family members and heirs. A charitable trust can accomplish these goals.

• Suppose you want to ensure that a portion of your assets goes to a charity, either during your life or upon your death (or both), while still providing income to you or your dependents. You can achieve this result by putting your assets in a charitable trust. Properly structured, a charitable trust also can provide immediate benefits, such as an income tax deduction for contributions to charity, and tax-free growth for future investment income.

 

Revocable vs. Irrevocable Trusts

A trust can be either “revocable” or “irrevocable”. An individual placing assets in an irrevocable trust cannot later reclaim the assets or make significant changes to their disposition. Thus, the donor must be comfortable with the arrangement at the time assets are placed in the trust. In contrast, a revocable trust can be changed at any time as long as the individual setting up the trust is alive and healthy. Upon the individual’s death or incapacity, the trust becomes irrevocable.

Which trust makes sense depends on the particular situation. Many individuals prefer the flexibility of the revocable trust. However, an irrevocable trust often is necessary for certain functions, such as estate tax minimization or asset protection. 

In choosing the type of trust, there are other considerations to keep in mind: 

State taxes. For purposes of applying their state inheritance tax, some states have adopted – or have suggested they will adopt — a gift tax exemption amount below the federal exemption of $5.34 million. Thus it is important to consider state tax consequences before undertaking any gift or estate plan. For states with lower exemptions, use of an irrevocable trust can help minimize state taxes.

Tax on trust income. Investment income earned within a revocable trust typically is taxed at the donor’s tax rate. Virtually all investment income earned within most irrevocable trusts, however, is taxed at the highest tax rate. Taking into account all surtaxes, that tax rate currently is 23.8% on dividend income and long-term capital gains and 43.4% on other types of investment income. To achieve both estate tax and income tax efficiencies an irrevocable trust should invest in assets that generate income exempt from tax or taxed at low rates. For this reason, life insurance can be a good investment within an irrevocable trust. When investing trust assets, a professional management strategy that seeks to enhance after-tax return by balancing investment and tax considerations is exceedingly important.

Stepped-up basis. In most cases, when a donor gifts an appreciated asset to an individual or an irrevocable trust during his or her lifetime, the recipient assumes the donor’s basis in that asset. Thus, the recipient will be taxed on any appreciation when the asset is later sold. By way of contrast, most assets transferred at death (including through a revocable trust) receive a “stepped-up” basis, relieving the heir of income tax on existing appreciation upon a later sale. Thus, the benefits of placing assets in an irrevocable trust during life must be balanced against the additional income tax a recipient might pay when the gifted asset is later sold.

Choosing between an irrevocable and revocable trust can be critical depending on the circumstances. For this reason (and others, including tax minimization and effective creditor protection), it is important to consult with a qualified attorney when establishing a trust, gifting assets, or considering any of the techniques described in this paper. Individuals establishing trusts also should retain a qualified professional fiduciary to assist in managing and administering the trust and directing the investment of trust assets.

 

Conclusion

A comprehensive estate plan, which typically involves the use of trusts, is crucial for couples with joint assets approaching or exceeding $10 million. But trusts also are important for couples or individuals with fewer assets, allowing them to protect assets from creditors, manage and grow the assets effectively, and distribute the assets to heirs or charities in accordance with their wishes when they are no longer able to do so themselves.

 

 

Andrew H. Friedman is the Principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He speaks regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. He may be reached at www.TheWashingtonUpdate.com.

Neither the author of this paper, nor any law firm with which the author may be associated, is providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

 

Copyright Andrew H. Friedman 2014. Reprinted by permission. All rights reserved.

Averting Planning Disasters

Part 3 of a 4 part series

Provided by Ryan F. Barradas and Tim Young
Unknown Conditions Ahead

In our previous articles in this series we discussed the entrepreneur’s need for a decision-making process versus a planning process. Furthermore, we covered the fact that good decision-making is governed and grounded by gut instincts. So what prevents us from making decisions? What enables us to procrastinate and kick the proverbial can farther and farther down the road?

We often seek out or are offered help with succession and exit planning without a process to gain clarity on the following: the relational factors that are unique to closely held business, the operational needs of the company and a way to see all of this transpire numerically.  We believe the primary reason most plans never get off the ground is that they are driven by solutions or the technical aspects of sound planning.  Tax and legal advisors are attempting to solve the income and estate tax issues along with ownership succession matters.  The technical or tax tail begins to wag the dog.  Before you know it, you become overwhelmed with solutions that fail to address some of the basic needs that are at play in the back of your mind. Instinctually, you know there is more to the puzzle.

Below is a list of common reasons we see that most plans fail:

  • They ignore basic business issues – what does the business need in order to support the needs of all of the stakeholders?
  • They fail to address the “void” left by the involvement in business – passion can be channeled in other directions so long as there is comfort in leaving.
  • They fail to adequately address family financial security – When do you cross over the line from “I need more” to “I have enough”?
  • Too many moving parts (too complex) – the best plan isn’t the one with the most tax savings or looks the prettiest on paper. It’s the one you can implement, live with and maintain.
  • They don’t involve “the next generation” – what are the needs and desires of the next generation? What are their expectations?
  • They don’t involve “the key employees” – how are you going to get where you want to go unless you know your key employee’s goals, desires and expectations?
  • Professionals are conflicted out of representing multiple parties – when there are conflicting interests, tax and legal advisors are forced to serve one client.
  • Everyone wants to avoid confrontation – any business is successful due to its ability to avoid drama. However, some relational issues cannot continue to be swept under the rug.
  • They rely upon the owner(s) to drive implementation – this only lasts for a short while.  Once the owner’s primary duties suffer, progress halts.
  • There is no way to measure success.

 

Without a process to avert one or more of the above, smart people might move forward in planning for a little while, but when it comes time to execute, they back away from the table. There’s simply too much at stake with their wealth, their business and their relationships to risk faltering.

In our next article, we will define the components of a successful planning process to avoid the pitfalls above and describe how to get started.

Ryan Barradas (ryan@wealthpoint.net) and Tim Young (tim@wealthpoint.net) are co-founders and partners of WealthPoint, LLC in Phoenix, AZ.  WealthPoint is a nationally recognized firm focusing in the areas of succession, exit and wealth transfer planning for entrepreneurial family groups.

Plan For Decisions…Don’t Just Decide To Plan

Part 1 of a 4 part series

Provided by Ryan Barradas and Tim Young

Tough DecisionsWhat is succession and exit planning?  It’s a process that helps to facilitate one of two events and sometimes both.  First, it plans for the entrepreneur to eventually become financially independent of the operating asset as their primary source of cash flow.  Second, it could help the operating asset become independent of the entrepreneur as its primary driving force.  How can I walk away with enough cash or how can I get a competitive rate of return on my business asset? 

You will exit your business somehow, someday.  It can only happen in one of five ways: Death, Disability, Voluntary Sale, Retirement or Bankruptcy/Orderly Liquidation.  Regardless of your method of exit, in order to maximize your value and/or the likelihood the business will succeed you; the business must be managed as if it were for sale on any given day.  The same things that are common discounts at the time of transfer in a third party sale can sabotage an intra-family succession plan or sale to key employees.

As an entrepreneur, your big decisions are inseparable from who you are as a person. So your decision making is defined by your ability to arrive at unshakable gut instincts. You need a process that allows the subconscious layers of bias peel away and give rise to pinpoint wisdom about desired outcomes. You need to get to that place of instinctual decision-making you know and trust.

Without this level of clarity, you might move forward with planning for a little while, but when it comes time to execute, you’ll back away from the table. There’s simply too much at stake with your wealth, your business and your relationships to risk faltering.  This is why planning and decision making must bump up against objectives in all three realms: relational, operational and numerical.

In order to do this, it must transform from the traditional planning process to a decision making process.  For advisors, we all love great planning processes. But for you the entrepreneur, the planning really happens in the background.  What you need is a process that allows you to make pinpoint decisions about desired outcomes.   Where am I today?  Where do I need to go? Who do I feel responsible for? Whose feelings do I need to be mindful of? What are the business and personal risks I want to mitigate? What’s my time frame?  Once you create well-defined macro goals, decision making becomes infinitely easier.  The latest “flavor of the month” or other crazy business idea no longer derails or distracts you from your long-term objectives if they don’t pass the test: Do they help me accomplish all or a majority of my macro goals?  If not, move on. 

In the remaining three parts of this four part series we will help you to understand how to create a culture of succession and address it on five levels (ownership, management, leadership, relationship, and cultural), address why most plans fail, and finally how to get a successful succession and exit planning process off the ground. 

Ryan Barradas (ryan@wealthpoint.net) and Tim Young (tim@wealthpoint.net) are co-founders and partners of WealthPoint, LLC in Phoenix, AZ.  WealthPoint is a nationally recognized firm focusing in the areas of succession, exit and wealth transfer planning for entrepreneurial family groups.

The Impact of Collaboration on Managing Your Affairs

When a family addresses their affairs, whether it’s a small change or a big decision, they’re in search of a quality result. Established families have inherent complexity in their affairs. The tax code, legal system, financial markets and various financial or insurance instruments are inextricably linked. Even if the family changes nothing, their past planning changes with the passing of time.

Let’s look at how advisory models traditionally rise to this momentous occasion for families. Historically, advisors in different professional disciplines working with a common family haven’t had an intentional model for frequent communication. This article suggests that not only is communication essential, it’s no longer enough. In today’s world, collaboration is the ideal advisory dynamic for affluent families.

Why is communication between your advisors essential?

A great advisory team has a central goal: to understand the family’s vision and carry that vision forward effectively and with integrity. To achieve this, advisors require a common starting point – a confirmation of the client’s vision. In order to act on the vision effectively, planning implementation has to be airtight. For any given decision a family makes, three to four advisors may need to touch the implementation to get it right. It would seem difficult to achieve effective implementation without a model for intentional communication. 

The difference between communication and collaboration

Communication is essential; however there is a deeper opportunity at hand for families – the opportunity to have a collaborative advisory team. Communication is more about the coordination of tasks; one person informing another about their actions. This passing of information back and forth is helpful, yet families can ask for more.

Collaboration, is defined by The American Heritage Dictonary as: to work together in joint intellectual effort. Consider the impact of having a truly collaborative advisory team. The team assesses the families’ challenges and opportunities and brings the necessary advisory strengths to the table to move the family forward. Advisors sit together at the table and brainstorm on a family’s behalf. Ideas are more innovative and more refined. Consensus builds confidence and momentum into the execution phase – for the advisors and the family.

How families can foster collaboration?

Two dynamics must be in play. Collaborative advisors assess their strengths and proactively invite additional talent to the table based on the family’s vision and goals. This requires self-confidence and confidence in their relationship with the family. 

Families must also play a role. Insist that your advisors collaborate. Consider bringing all of your advisors (tax, legal, financial, insurance) together for a social outing. Foster communication and relationship first. Then move into a more formal brainstorming process. Enlist assistance from the group in confirming your vision. Then draft some ground rules around how the professionals can move beyond communication and into collaboration on your behalf.

Spoiled Brat!

I read this Barron’s article today and thought we should discuss it.  Too much money rarely ruins kids, it’s too little character as we stated in our May 3rd, 2011 post. Character is the the foundation on which good responsible people are built.  Money or no money.  Money seems to only enhance the character that already exists.  Sure, education is crucial, actual experience is a must and communication is paramount.  But, we always have to turn to the number one ingredient for a good person and a good steward of wealth, CHARACTER!  Then we can build the other muscles that allow next generation heirs to carry on family values, businesses and wealth.

Reminds me of a quote from the late great coach John Wooden. “Be more concerned with your character than your reputation, because your character is who you really are and your reputation is merely what others think you are.” 

I found this an enjoyable read and I think you will too. Good ideas, great stories and some solid solutions. Enjoy!

Barrons.com – Goodbye, Family Fortune*

Are my heirs going to be good stewards of my wealth? Or just benefactors of it?

Too much money rarely ruins heirs, it’s too little character. However, you may want to set your legacy planning up to incent your heirs to lead productive and respectable lives. We help you make sure that your family values are not lost in the process. The establishment of a family mission statement and properly structured trusts can be set up to do just this – preserve family values and incent productive lifestyles. You can plan around the fear of creating “trust fund babies.”