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Trust Planning 101

I once had an estate tax expert tell me he never wanted to own assets - he just wanted to benefit from them. 

What he was getting at was the use of trusts in an estate plan.

A trust is a legal entity almost like a personal corporation that is used to manage assets.

When used properly, trusts can allow assets to be exempt from estate taxes, protected from creditors and can be off limits in the event of a divorce. Obviously, benefits of this nature can be immensely beneficial to your heirs.

In general, a will determines how your probate assets are distributed upon your death.

If a person dies in 2012 they can leave up to $5 million at death without incurring estate taxes. Although most people approach this as a death-only event, these asset transfer limits also apply to gifts made during your lifetime, which opens up many opportunities.

Generally, the most common trust for a husband and wife is a Bypass (or Credit Shelter) Trust. For example, assume husband and wife have a $10-million estate and the husband dies this year. The bypass trust gets funded after the husband's death and allows $5 million of the $10-million- joint estate to be placed in trust for the remainder of the wife's lifetime.

The wife is the beneficiary of the bypass trust and can be the trustee of the trust. The trustee is the decision maker and the one who is legally obligated to see that the trust rules are properly followed.

The wife, as beneficiary, can withdraw all of the income produced from the bypass trust for any reason and can spend the principal for items which typically fall under the categories of health, education, maintenance and support.

The bypass trust is not exposed to estate taxes in the beneficiary's estate or to the beneficiary's creditors. Because it is no longer exposed to estate taxes in this generation it can grow quite large with only income taxes being assessed.

Once the beneficiary dies, the assets of the bypass trust are distributed either outright or into other trusts for subsequent beneficiaries.

To further compliment an estate plan the bypass trust is many times partnered with a Generation Skipping Trust. The name itself is a bit confusing since the assets in this trust do not necessarily "skip" anyone - they just have the ability to do so.

Functionally, the only one who is skipped is the IRS for estate tax purposes. Anyone can leave up to $5 million into a GST to collectively benefit many people.

As such, a husband and wife each can leave up to $5 million combined in a generation skipping manner.

A parent who establishes a GST can effectively leave money in a protected manner for children, grandchildren and even great-grandchildren.

Given this, the GST is a very effective tool to manage and protect wealth for multiple generations.

As with the bypass trust, the GST is protected from creditors as well as ex-spouses (in the event of divorce). Furthermore, these assets can be protected from estate taxes for multiple generations.

Additionally, the beneficiary can access the principal of the trust for health, education, maintenance and support items.

One final comment on the GST is that it does not have to be funded only at death. For instance, if a husband and wife are actively gifting to a child outright, they can modify their plan to make the gifts to a GST for the child's benefit.

By managing gifting in this manner the parents reduce their estate, pass wealth to their child and the child has the protection afforded by the GST.

Furthermore, while the parents are gifting into the GST, the parents can serve as trustee of the child's trust effectively giving the parents tremendous control over the gifted assets and the management of the GST itself.

Dave Sather is a Victoria Certified Financial Planner and owner of Sather Financial Group. His column, Money Matters, publishes every other week.

Originally published Tuesday , March 13, 2012

Victoria Advocate