When it comes to financial planning, what are your top priorities? For many, it's things like:
- Paying down debt.
- Making smart investments.
- Saving for retirement.
While your priorities may vary, chances are they pertain to the financial freedom you and your loved ones enjoy. But planning for your future doesn't end at retirement. If you’re at or approaching the later stages in life, you need to explore your options in:
- Asset management.
- Estate planning.
For doctors, establishing a trust is simply a must (if not multiple). For those who don't know where to start --- consider this your crash course.
A trust is a legal arrangement used to:
- Manage assets for the benefit of someone other than who created the trust.
- Efficiently distribute estates to heirs when the trust maker passes away.
It's important to understand that trusts are not just for the top one percent. Anyone with an estate should plan how to manage and distribute their assets in a clear, tax-efficient manner.
Creating a trust requires legal assistance. Whereas a will communicates your wishes, a trust is often needed to carry out those wishes. In fact, some experts even suggest using a trust in lieu of a will to handle disbursement of an estate after death.
All trusts requires three main parties to create, manage and distribute its assets.
- The grantor is the person who creates the trust. He or she has the authority to transfer property to the trust.
- The trustee is responsible for managing the property inside the trust according to its rules. The trustee can be an individual or corporation.
- The beneficiary is whoever receives benefits from the trust. There can be multiple beneficiaries, including nonprofits and charitable organizations.
The main objective of a trust is to control the distribution of a person’s wealth. After all, no one wants their lifelong earnings to go to waste after they’ve passed.
A trust allows you to specify exactly how you want your assets to be handled and cared for. You can dictate who receives the trust’s assets and when they receive them.
Trusts are also used to minimize tax obligations --- especially estate taxes. For federal estate taxes, this is not as great of a concern as it was in the past due to:
- The current state of tax laws today.
- The amount of wealth required to trigger federal estate taxes,
However, several states do impose their own estate and/or inheritance taxes. Some have a much lower threshold than the federal level.
Another planning strategy is to reduce the amount of a person’s estate by making gifts while they’re still living. Current tax law allows individuals and couples to "gift" up to a certain tax-free amount per recipient. There is also a lifetime exclusion for gifts to avoid gift taxes.
You can “gift” assets to a revocable trust if you want to:
- Make gifts up to exclusions...
- But don’t want to relinquish control of their assets before they die.
The grantor of the trust then dictates how to handle the assets.
All trusts fall into one of two basics categories:
- Revocable trusts.
- Irrevocable trusts.
The main difference between revocable and irrevocable trusts is control.
In a revocable trust, you maintain control and ownership over the trust and its assets while you're alive. You can alter the trust, remove property from it and even cancel it altogether. The trustee can be the same as the grantor.
On the other hand, irrevocable trust cannot be canceled or altered once it’s been created. The grantor is surrendering ownership and control of any property placed in the trust to its trustee. That means you cannot remove property from an irrevocable trust. The trustee also cannot be the same as the grantor.
Living trusts vs. testamentary trusts
Furthermore, every revocable or irrevocable trust is either living or testamentary.
The difference between the two is when the trust goes into effect. A living trust becomes effective immediately upon its creation. A testamentary trust does not become effective until after you pass away. You can create a testamentary trust within your will.
Both have their pros and cons.For example, a testamentary trust helps your heirs minimize or avoid estate taxes. This will also shield their inherited assets from creditors. But a living trust will keep your estate out of probate --- something a testamentary trust cannot do. This is often a lengthy, expensive and public process. When transferring assets, a testamentary trust will minimize time spent, fees and expenses, and public scrutiny.
That being said, here are five specific types of trusts, and what each allows you to do.
As its name implies, a charitable trust transfers some or all of the trust’s assets to one or more charities.This is where you spell out which specific organization(s) you wish to donate to.
These types of trusts are typically irrevocable. Some charitable trusts enable you to split trust assets between a charity and a separate beneficiary.
One example is a charitable lead trust. This allows you to designate:
- A set amount of the trust's assets to charity.
- The remainder of the trust’s assets to other beneficiaries.
It’s typically used as an estate planning tool to reduce the estate's value below estate tax levels.
A remainder trust is another common type of charitable trust. Under this arrangement, a designated charity (approved by the IRS) serves as the trustee. The charity pays you or a named beneficiary a regular stream of income from the trust assets. The remaining assets will be transferred to the charity either after a set number of years or upon your death.
Special needs trusts
A special needs trust allows you to take care of the needs of a special needs child or spouse. And it does so without jeopardizing their eligibility for government benefits.
Under Social Security guidelines, a special needs trust can provide benefits to a recipient if:
- The individual has no control over trust distributions.
- The individual has no authority to revoke the trust.
A special needs trust is necessary because an individual with a certain level of financial resources does not qualify for government disability benefits. This could happen if the special needs individual receives an inheritance or proceeds from an insurance policy.
By putting those assets inside a trust, the special needs person has no ownership rights. But the trust can ensure its assets provide the beneficiary care and living expenses in the event the person’s caregivers pass away.
Credit shelter trust
Also known as a bypass or family trust, this is another common tool used to avoid estate taxes. It allows you to capitalize on the tax-free transfer of assets to a spouse upon death. It also allows you to pass on your estate to your children without the burden of estate taxes.
To set it up bypass, include a provision in your will that transfers assets to a trust upon your death. The amount of those assets will be under the estate tax exemption amount. It will never be subject to estate taxes --- even if those assets grow in value. The rest of your estate then passes to your spouse tax-free.
Qualified terminable interest property trusts
This is a trust that provides income to a surviving spouse. Once the surviving spouse passes away, the remaining assets will pass on to other named beneficiaries. This type of trust is often used when a person divorces and remarries.
It allows the trust maker to:
- Transfer assets to your children over an extended period of time. This prevents them from inheriting all of your assets at once.
- Ensure that children receive fair treatment. This is especially important if you have been married more than once.
- Provide income for a surviving spouse. After he or she passes away, the remainder of your estate will go to other beneficiaries you name.
This type of trust allows you to transfer tax-free money to beneficiaries at least two generations below you, such as grandchildren. Generation-skipping trusts are also commonly referred to as dynasty trusts.
Every doctor needs a trust --- often times more than one. And the sooner you can prepare your estate, the better. In doing so, it important to understand:
- The basics of trusts, such as the parties and purposes involved.
- The pros and cons of various types of trusts, such as tax implications.
- How your estate fits into your financial planning needs.
Of course, there is much more to planning your estate than setting up a trust or two. That's why is essential to surround yourself with a dedicated team of financial professionals.
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Joel Palmer is a writer and personal finance expert who focuses on the mortgage, insurance, financial services, and technology industries. He spent the first 10 years of his career as a business and financial reporter.