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.
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 But some of the advice given may be outdated, or overly simplistic.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.
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.