February 24, 2017: Trusts have been viewed in the past mostly as vehicles that avoid or minimize estate taxes. However, now with married couples having close to an $11 million exemption from such taxes, let alone the new Washington DC administration’s likelihood of repealing the federal estate tax, trusts that offer other advantages take the spotlight.
Trusts are now being created to optimize both (i) income tax deferral and minimization and (ii) asset protection for both the person creating the trust and his or her spouse and other family members. Risks to a family member’s or trust creator’s financial nest egg can be very significant when a creditor uses the legal system to challenge a person’s actions that in hindsight contributed to someone else’s detriment, holding the profit-maker financially accountable.
In light of this, trusts that are artfully crafted to build a legal protective barrier around one’s nest egg of hard-earned accumulated wealth, coupled with income tax optimizing provisions, can be the best investment one makes in a lifetime.
One of a number of examples to be highlighted here is the “stretch IRA” trust. For starters, the US Supreme Court has ruled that if a family member inherits an IRA, it may not be protected from creditors (such as in a lawsuit or bankruptcy) in the absence of having a properly designed trust hold the IRA proceeds. Furthermore, “stretch” provisions in the IRA trust allow a maximum deferral of any income taxation of any IRA payouts, whereas dollars to doughnuts, any existing typical trust will not have this specific design feature built in.
I would be remiss however to not at least mention here that the Senate Committee on Finance voted 26-0 in September to remove this type of stretch planning as an option to the extent IRAs exceed $450,000 for a non-spouse beneficiary. Be therefore on notice that this stretch benefit could disappear in future legislation, causing the IRA to be taxable over an accelerated five-year period. This may be an easy revenue generator to help with looming federal deficits. Creating a stretch IRA trust today however has better odds of being grandfathered into the now-existing more favorable tax environment that could remain protective even in future post-legislative-change years.
Another trust example is an asset protection trust (under the laws of one of 17 or so states in the US or in a significant number of offshore jurisdictions) that also includes (i) lower-income-tax bracket shifting provisions, (ii) provisions allowing a higher “tax basis” (i.e., lower or no capital gain tax) on assets contributed by one person to the trust, and/or (iii) applications of favorable law that allow for the above-mentioned higher tax basis for both the contributor and his or her spouse.