Trusts can be the linchpin of a solid estate plan. But it’s important to remember that you can’t just set up a trust and forget about it. It’s a good idea to periodically review how your trusts are working, to make sure you and your family are getting the full benefit of them. Not doing so can be costly!
Here are just a few things to consider, and some common mistakes to avoid:
► Is your trustee still the best person for the job? If your trust arrangement allows you to change the trustee, you should periodically give some thought to whether the person you’ve selected is still the best choice.
Picking a trustee is difficult, because trustees typically wear two hats: They must invest and manage the trust assets in order to maximize their value, and they must distribute them according to the terms of the trust and the wishes of the grantor.
The problem is that people who are good at investing and managing money are not always good at being sensitive to family needs, and vice-versa. That’s why some people who create trusts name two trustees – one who is in charge of investments (perhaps even a professional or trust company), and one who is in charge of distributions (such as a family member). This can sometimes be a good solution if no one person is ideally suited to do both jobs.
►Does the trust actually own what it’s supposed to? Sometimes people create an excellent trust plan, but forget to change the title to certain assets so that the trust actually owns or controls them.
If a trust is supposed to hold real estate, life insurance, shares of stock, retirement or bank accounts, family business units, etc., does it in fact do so? Changing the title to the assets can be complicated, but if it’s not done properly, the trust won’t work as intended. And if the assets have changed in any way over time, this needs to be reviewed as well.
► How are the trust’s bills being paid? In most cases, the trustee’s fees and other ongoing expenses should be paid out of the trust itself. But be careful – many trust companies will automatically send the bill to the person who set up the trust.
If the trust grantor pays the fees, this could cause problems. For instance, the payments might be considered a gift to the trust, which could potentially trigger the need to file a gift tax return or even pay additional taxes. Things can get even more complicated if the fees are paid by someone other than the grantor.
If a trust was set up in part for asset protection purposes, then paying bills from the wrong account could even undermine the purpose of the trust. As an example, suppose you’ve created a trust for an heir so that the assets will be protected in case the heir gets divorced. If the income tax triggered by the trust is paid out of jointly owned marital property, this could mean that the trust assets will no longer be sheltered in a divorce.
The same is true if trust assets and marital assets are combined or commingled in various ways.
► Are you coordinating distributions to minimize taxes? Many trusts are set up such that if they pay out income, the beneficiary pays the income tax, and if they don’t, the trust pays the income tax. The problem is that, under current tax laws, the rules for trusts and individuals are very different.
For instance, in 2015, individuals pay the highest tax rate only if they have income over $413,200 for single filers, and $464,850 if they’re married and filing jointly. But trusts pay the highest rate if they have income over a mere $12,300! So even if a trust doesn’t earn all that much income, it can be hit with high tax rates.
Making smart distributions, especially to beneficiaries who are in a lower tax bracket, can save both federal and state taxes as well as minimize the 3.8% surtax on investment income.
Many people now have their estate planner, investment advisor and accountant work together each year on a plan to minimize both income and capital gains taxes while furthering the non-tax purposes of the trust.
► Are you missing a chance to lock in GRAT gains? A “grantor retained annuity trust” is a short-term trust designed to hold rapidly appreciating assets. The idea is that the trust eventually pays the grantor back the full original value of the assets plus interest (so no gift tax is owed), and any appreciation beyond that goes to the beneficiaries – tax-free.
If you have a GRAT and the assets have indeed appreciated, you might want to buy the assets back from the trust now at their current value. This locks in the gains for the beneficiaries.
If the assets decline in value in the future, you’ll have done your heirs a big favor and you’ll also have reduced your taxable estate. If the assets continue to increase in value but you leave them to your heirs in your will, your heirs will still escape having to pay capital gains tax on the appreciation.
You could also buy the assets back, lock in the gains, and then put them into a new GRAT.
This is something that many people might want to consider given the stock market’s gains over the past six years.