Sometimes farm clients tell me that their estate planning issues are completely taken care of because they have a trust. I then try to explain to them that there are many different types of trusts and different trusts can have very different functions. I use the analogy of a person from the city who visits the farm. The city visitor usually goes to the barn and sees a “cow." The city visitor has no idea that there are a many different kinds of “cows” by age, gender and breed.
Living trust vs. testamentary trusts
There are two basic types of trusts: living trusts and testamentary trusts. A living trust is set up and funded during a person’s lifetime. A testamentary trust is set up in a will and established and funded only after the person’s death when the will goes into effect. A good example of a testamentary trust is the type of family or children’s trust typically found in a will for an individual who has minor children.
Revocable vs. irrevocable trusts
A revocable trust allows you to retain control of all the assets in the trust, and you are free to revoke or amend the terms of the trust at any time. In an irrevocable trust, the assets you contribute are no longer yours and you can’t make changes without the beneficiary’s consent. However, in an irrevocable trust, “a limited power of appointment” can be retained or given away. A limited power of appointment means the right to distribute property among a specified group or class of people.
Trusts for estate tax planning
Under current estate tax laws, you may transfer all of your assets upon death to your spouse tax free, which is typically referred to as the unlimited marital deduction. There is a certain type of trust called a Q-Tip trust which: 1) qualifies for the unlimited marital deduction; 2) gives a surviving spouse a lifetime interest in the trust; 3) but allows the grantor of the trust to name who the ultimate beneficiaries of the trust will be. This is type of trust is particularly helpful in second marriage situations with combined families.
Under current tax laws, an individual is allowed to pass a certain amount of his or her assets tax-free upon death, which is referred to as the applicable exclusion amount (AEA). The AEA amount for 2016 is $5,450,000. In a type of trust called a credit shelter the trust is funded using the deceased spouse’s AEA. However, the surviving spouse is allowed the income and principal of the trust. By funding a Credit Shelter Trust upon the first to die of a married couple, the surviving spouse is able to double his or her AEA.
Finally, a common trust to limit exposure to estate taxes is the ownership of life insurance policies by an irrevocable life insurance trust (ILIT). In an ILIT, the grantor gifts life insurance premiums to the beneficiaries of the ILIT. However, the life insurance cash value and death benefit are removed from the grantor’s estate for estate tax purposes.
Trusts for Asset Protection
More and more people are concerned about the cost of long-term care. However, people are hesitant to make outright gifts to their children in order to qualify for medical assistance.One option is the Medicaid Asset Protection Trust (MAPT). Known as an “income only” trust, the MAPT must name someone other than the grantor as the trustee and limits the grantor to income only from the trust. Also, transferring assets to a MAPT creates a penalty period that will affect you for five years after you transfer assets to the trust.
In summary, it surprises people that there are so many types of trusts. This article only names a few and there are many more types of trusts that apply to specific situations. Who knew that trusts and cows could be so complicated?
Schneider is an attorney in the ag law firm of Twohig Rietbrock Schneider & Halbach S.C. Call Schneider at 920-849-4999.