Using a Trust to Preserve Wealth

Estate Planning is the only pillar of financial planning that is focused exclusively on the improvement of others’ lives. It’s no wonder, then, why legacy is often discussed in conjunction with the logistics of your end-of-life decisions and planning. While often considered an uncomfortable topic to broach, careful planning can make a significant difference in the lives of those whom you love most.

While certainly not for everyone, certain trust arrangements can help preserve and protect wealth that you have worked hard to accumulate, preserve, and protect during your lifetime for the next generation. We will explore two such arrangements in which a trust can carry that work on for you when you are no longer able to do so yourself.

Irrevocable Life Insurance Trust (ILIT)

As the name implies, an ILIT is used to hold a life insurance policy, commonly with the intent of reducing estate taxes. By being irrevocable, which means that the arrangement cannot be controlled nor changed after the trust is written and funded with the life insurance policy, the assets in the trust are not counted in the gross estate of the grantor. Therefore, the assets in the trust avoid estate taxes.

ILITs can be a great tool for families or individuals with an ultra-high net worth that would otherwise be subject to estate taxes upon death. The trust’s insurance policy death benefit can essentially replace money that had been spent during the grantor’s lifetime, thus allowing the estate to preserve value. Furthermore, if the estate is itself subject to estate taxes, the ILIT’s policy proceeds could be used to provide liquidity to pay that tax, again, helping to preserve the estate’s assets.

A specific application of the ILIT strategy involves the protection of and control over illiquid assets included in the estate of a deceased grantor. Examples here could include a family-owned business or a farm with farmland. A family-owned business could experience major disruption or have to close its doors if an estate tax requires a sale to cover. Valuable farmland cannot be spent to pay a tax, so heirs could otherwise be forced to sell a substantial portion of the land only to turn the proceeds over to the government in the form of estate tax. In each of these and similar scenarios, an ILIT can be used in the Estate Plan to provide liquidity so that the estate’s assets can be retained while still covering the estate taxes due.

Marital Bypass Trust

Sometimes also referred to as an A-B Trust or a Credit Shelter Trust, a Marital Bypass Trust is used by wealthy married couples to minimize Federal estate taxes or even eliminate them in some cases. The way this arrangement works is that assets are held together while both spouses are living. Upon the death of the first spouse, the trust is split into two separate trusts:

• The A Trust: The surviving spouse retains full control and use of their half of the assets within the A Trust.
• The B Trust: The deceased spouse’s share of the trust becomes an irrevocable bypass trust. The Federal estate tax exemption amount is applied to trust assets to reduce or even eliminate the estate taxes from this portion of the estate. However, this trust may still include some provision of income to the surviving spouse (but that definition cannot be altered).

Upon the death of the surviving spouse, both trusts disburse their assets to the trust beneficiaries according to each separate spouse’s wishes as they had originally directed.

There are several distinct advantages of a Marital Bypass Trust:

• Estate taxes can be reduced or even eliminated in some cases.
• Assets in the bypass trust are protected from the surviving spouse’s creditors (hence, the name, Credit Shelter Trust) due to the irrevocable status of that trust upon the death of the first spouse.
• Each spouse can separately direct how their portion of the trust assets will be disbursed to beneficiaries, which can be particularly helpful for blended families or unique circumstances.
• With income still provided to the surviving spouse from the bypass trust despite not being their own asset, a good balance of income (from ½ of the assets) and control (from the other ½ of the assets) can easily be achieved.

A Word About Costs

ILIT, Marital Bypass Trust, and other complex estate planning strategies can prove rather costly to create, implement, and administer, so adequate estate assets would generally be required to validate the use of these strategies. Even then, some individuals may desire to pay higher costs for the complexity in order to retain some amount of control over assets for future generations. There is no one-size-fits-all approach, so your individual goals and circumstances should be considered with the benefits weighed against the costs to determine an optimal course of action.

The McKinley Carter Difference

While our advisors do not practice law and do not write Estate Planning documents, we are well-educated and equipped to help you find possible solutions to obstacles or financial blindspots that you may not even know exist. With our deep bench of expertise and extensive professional networks, we are happy to collaborate with estate attorneys to ensure your needs are met — from the simple to the complex.

As complex and uncomfortable as the estate planning process can be, a well-crafted and executed plan — guided by trusted fiduciaries — can become a blessing that outlives you for many generations to come.