Using Living Trusts in Your Estate Planning

If your estate is more than $3,500,000 today, there's a good chance that you will need to do some estate planning. Below that level of wealth, no federal estate tax will apply to your estate in most cases. The reason: A provision of the tax law called the "unified credit" permits any individual to pass up to $3,500,000 of property (starting in 2009) to others.

Once your assets exceed $3,500,000, however, you'll want to protect them from federal estate taxes that could devour as much as 45% of your taxable estate. Leaving everything outright to charity or your spouse can shelter your estate from taxes, but even those solutions may be fraught with complications.

For many people, trusts provide a better alternative. A trust (or trusts) can help reduce your overall estate-tax burden, often while achieving other goals as well.

A trust is an arrangement in which you transfer money or other assets to a trustee who holds the assets for the benefit of another party, the beneficiary.

Living Trusts

Trusts can take effect during your lifetime (a living trust) or at death (a testamentary trust). With an irrevocable living trust, you can make lifetime gifts to family members and thereby reduce the size of your taxable estate. Neither the value of the assets transferred to a qualifying living trust nor the future appreciation in those assets will be included in your gross estate for estate-tax purposes.

If lifetime gifts via a trust are made properly, gift taxes can be kept to a minimum or avoided completely. Living trusts can also be used to keep life insurance proceeds out of your gross estate or to make charitable gifts.

Marital Deduction Trusts

Federal tax law allows you to pass along any amount of assets to your spouse without estate taxation, under a provision known as the "unlimited marital deduction." However, your spouse may not wish, or may not be qualified, to manage those assets. Marital deduction trusts allow you to take advantage of the unlimited marital deduction while arranging for the management of your assets after your death. You can even use them to pass assets to your children or another party.

Example: You want to secure the marital deduction, but you also want to preserve the assets for your children. You can set up a trust in your will that provides a lifetime income for your spouse. The principal can be used to meet special needs your spouse may have. The remaining assets are passed to your children when your spouse dies. Your estate will qualify for the marital deduction even though your children are the ultimate trust beneficiaries.

Credit Shelter Trusts

The unlimited marital deduction alone can result in no taxes being paid when the first spouse dies. Yet, if you have a sizable estate, it may not prevent estate taxes at the death of the second spouse. Why? Because the full amount of the assets passed from one spouse to the other may be included in the second spouse's estate.

One way to avoid this pitfall is a credit shelter trust. The first spouse's will sets up a separate trust, one that contains assets equal in value to the unified credit (i.e., the $3.5 million of excludable estate value under federal tax law). This trust can provide for the second spouse while he or she is still living, but the trust property's will not be included in the surviving spouse's gross estate.

This article contains only a summary of the use of trusts in your estate-tax planning strategy. If we can help you in your individual situation, please call us.

Disclosures:

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