End­ing Bad Trust Ad­vice

Much of the lat­est in­struc­tion is overly sim­plis­tic and can do a dis­ser­vice to clients. Here’s a guide to giv­ing bet­ter guid­ance.

Financial Planning - - CONTENTS - BY MARTIN M. SHENKMAN

Much of the lat­est guid­ance is too sim­plis­tic.

Many ad­vi­sors rec­om­mend that clients set up trusts for their chil­dren or grand­chil­dren to take ad­van­tage of the new large es­tate­tax ex­emp­tions. But some of the ad­vice given may be out­dated, or overly sim­plis­tic. To help their clients plan bet­ter, ad­vi­sors first must iden­tify how goals might be dif­fer­ent to­day be­cause of the tax over­haul. Ad­vi­sors may want to note the fol­low­ing: The cur­rent es­tate, gift and GST tax ex­emp­tion is a whop­ping $11.8 mil­lion, but that amount will be halved in 2026, so clients should try to use this strat­egy as much as pos­si­ble be­fore then. Us­ing the ex­emp­tion re­quires the client to make a gift that re­moves funds from the client’s es­tate (in tax par­lance, this is a com­pleted gift). Does the client need ac­cess to the as­sets they have given away? Without ac­cess, many clients will be un­com­fort­able mak­ing large gifts. Con­sult with the client’s es­tate plan­ner and CPA to de­ter­mine if the client would ben­e­fit from us­ing tra­di­tional grantor trusts (the client sets up the trust and pays the in­come tax) or non-grantor trusts (the trust, not the client, pays in­come tax on trust in­come). Some plans, such as those in­volv­ing life in­sur­ance, are best held in grantor trusts. Other plans may seek to cir­cum­vent the in­come tax re­stric­tions in the new law — for ex­am­ple, to max­i­mize char­i­ta­ble con­tri­bu­tion de­duc­tions, sal­vage state and lo­cal tax de­duc­tions on real prop­erty or in­crease the 20% de­duc­tion for passthrough busi­ness en­ti­ties, un­der new Tax Code Sec­tion 199A. Those strate­gies re­quire the use of non-grantor trusts. This dis­tinc­tion be­tween grantor and non-grantor trusts is crit­i­cal, as it re­quires dif­fer­ent pro­vi­sions. Ad­vi­sors need to un­der­stand the na­ture of the trust’s struc­ture, as it af­fects not only in­come tax plan­ning but also as­set lo­ca­tion de­ci­sions. Achiev­ing any of those goals can be com­pli­cated, and do­ing so re­quires fine-tun­ing in the prepa­ra­tion of the plan and trust doc­u­ments. Too many ar­ti­cles about plan­ning fol­low­ing the 2017 tax law have glossed over all of this. While ad­vi­sors don’t need to be ex­perts in all the nu­ances, many are ac­tive par­tic­i­pants in the tax plan­ning process, and they need to have some un­der­stand­ing of the nu­ances. If mak­ing a com­pleted gift sounds in­con­sis­tent with pre­serv­ing the client’s ac­cess

to those funds, be ad­vised that it re­ally isn’t. It just re­quires care­ful plan­ning and draft­ing. Don’t ad­vise the client to gift out­right to an heir, as that pro­vides no pro­tec­tion or ac­cess. In­stead, have the client gift to a trust to pro­tect the heir and as­sure the client ac­cess.

The ING Trust

A com­mon non-grantor trust plan is the in­ten­tion­ally non-grantor trust, or ING trust. These trusts have been used by high-in­come tax­pay­ers to shift cer­tain in­come out of a high-tax state. ING trusts may re­main great for ul­tra­high-net-worth tax­pay­ers who have used their es­tate tax ex­emp­tions. But for most wealthy tax­pay­ers, se­cur­ing ex­emp­tions be­fore they de­cline by half in 2026 may be the best strat­egy. These tax­pay­ers need a dif­fer­ent type of ING trust than the uber-wealthy use. If an ING ap­proach is used, it must be fun­da­men­tally dif­fer­ent from all tra­di­tional ING trusts, which were in­com­plete gifts (and thus, did not use the ex­emp­tion), so trans­fers con­sti­tute com­pleted gifts that use the ex­emp­tion be­fore it de­clines. Oth­er­wise, a fun­da­men­tal goal of plan­ning will be lost. When a client’s at­tor­ney rec­om­mends a type of trust, plan­ners need to truly un­der­stand the na­ture of that trust.

Lo­ca­tion Mat­ters

When clients set up a new trust, re­mem­ber to ask: What state has been rec­om­mended for the trust? Is it the client’s home state? In many cases, the type of plan­ning the client needs will re­quire that the trust be formed in what is called a “trust friendly” ju­ris­dic­tion. There are about 17 states, of which Alaska, Delaware, Ne­vada and South Dakota are the most pop­u­lar, that per­mit clients to set up a trust and be a ben­e­fi­ciary of that trust, yet also have the trust as­sets re­moved from their es­tate. This type of trust might be war­ranted for a sin­gle client who wants to as­sure ac­cess to as­sets trans­ferred by us­ing a self-set­tled do­mes­tic as­set pro­tec­tion trust. ING trusts also need to be formed in these states in or­der to work. If a client wants to save state in­come tax, form­ing a trust in (or mov­ing an ex­ist­ing trust to) a no-tax state may be es­sen­tial to the plan. Form­ing a trust in a state other than the client’s home state will of­ten re­quire nam­ing an in­sti­tu­tional trus­tee in that friend­lier state. Plan­ners should not de­ter such plan­ning for fear of un­der­min­ing their client re­la­tion­ship. Rather, ad­vi­sors should es­tab­lish re­la­tion­ships with purely ad­min­is­tra­tive trust com­pa­nies based in the bet­ter trust states, so their clients can get the best plan­ning without cre­at­ing un­nec­es­sary com­pli­ca­tions or com­pe­ti­tion for the ad­vi­sor. Trusts should also of­ten have a trust pro­tec­tor to pro­vide flex­i­bil­ity. This might in­clude the power to change in­sti­tu­tional trustees and states where the trust is gov­erned and ad­min­is­tered. Other per­sons might be given the power to add a ben­e­fi­ciary or loan the client money from the trust. But be care­ful, as these may char­ac­ter­ize the trust as a grantor trust for in­come tax pur­poses (which in some cases is not de­sir­able). There are also dif­fer­ent views as to whether the trust pro­tec­tor should act in a fidu­ciary ca­pac­ity (with the level of re­spon­si­bil­ity of a trus­tee) or not. If some­one is act­ing in a fidu­ciary ca­pac­ity, they may not be able to add a new ben­e­fi­ciary, for ex­am­ple, as that might di­lute the in­ter­ests of the ben­e­fi­cia­ries to whom they have a duty of loy­alty. While ad­vi­sors do not need to be ex­perts in all these mat­ters, they should at least ask ques­tions to be sure the at­tor­ney has con­sid­ered these is­sues. Given the cur­rent high es­tate tax ex­emp­tions, many clients might ben­e­fit from trusts that are cre­ated to last for­ever or at least for a very long time. The client’s gen­er­a­tion-skip­ping trans­fer ex­emp­tion should also be al­lo­cated to pro­tect gifts to the trust. This can keep the trust as­sets out­side the es­tate tax sys­tem for many gen­er­a­tions to come.

More Strate­gies Than Ever Be­fore

Over­all, there are more vari­a­tions of trusts than ever be­fore, which means clients and their fam­i­lies have more strate­gies from which they can ben­e­fit. That said, the ex­pan­sion of these op­tions has also in­creased the com­plex­ity of trusts as plan­ning tools, and iden­ti­fy­ing the best op­tion for clients is not al­ways an easy task. Plan­ners should re­main proac­tively in­volved in the es­tate and trust plan­ning process to en­sure that a client’s plan does not merely re­cy­cle older trust strate­gies. Ad­vi­sors and their clients should take ad­van­tage of the lat­est op­tions to build a tai­lored plan suited to mod­ern times.

For many clients, trusts should be cre­ated to last for­ever, or at least for a very long time.

Plan­ners should re­main proac­tively in­volved in the es­tate and trust plan­ning process to en­sure that a client’s plan does not merely re­cy­cle older trust strate­gies.

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