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One of my favorite Disney movies is Cinderella. I like the story because I am a pushover for happily ever after endings and at times I think it could be nice to have a fairy godmother make things right. Additionally, as an estate planning advisor, the fairy tale reminds me of how important it is to plan in order to avoid Cinderella’s father’s mistakes. With proper estate planning and an understanding of the use of trusts in an estate plan, magic isn’t necessary to implement a meaningful transfer of wealth to loved ones. If Cinderella’s father could do it all over again, he should have considered the following.

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Should Cinderella have inherited her father’s wealth directly or in a trust?

An inheritance can be given directly to a beneficiary who has attained the legal age of adulthood or it can be held in a trust, an arrangement whereby a third party (‘the trustee”) holds and manages the trust assets on behalf of the beneficiary.

When a beneficiary receives an inheritance outright and free of trust, the beneficiary will be responsible for managing the money by themselves or for hiring a professional to invest the monies on their behalf. Even for those who are accustomed to handling their own finances, suddenly having greater wealth may be overwhelming. Even the most conservative person may spend in ways that are not in their immediate best interest.

Alternatively, when assets are inherited through a trust, the beneficiary will receive distributions over a period of time in accordance with the terms of the trust.

Using a trust as a vehicle to transfer wealth can have the following benefits:

Provide asset protection. Generally, the assets in an irrevocable trust cannot be used to satisfy a court judgment against the beneficiary and are not marital assets to be shared with a spouse in the event of a divorce.

Promote privacy and confidentiality. Assets held in an individual’s name at death may go through probate, the court proceedings through which the assets are distributed in accordance with the terms of a will or by the laws of intestacy. Probate matters are public records. Since trust assets are typically not part of the beneficiary’s probate estate, trust assets will likely remain private and confidential.

Protect beneficiaries from poor financial decisions and encourage or discourage certain behaviors. Using inherited funds to purchase Lamborghinis or to enable a child to postpone working may not be what you had in mind when you provided a financial legacy to your heirs. Trusts can include provisions limiting distributions for certain types of expenditures.

Encourage professional investment management. Management of financial investments takes effort. Years of sound financial planning can sometimes be destroyed by a few ill-timed decisions. Trustees often employ third party professionals to help fulfill their investment responsibilities.

Preserve assets for future generations and minimize transfer taxes. Under California law, trusts can be drafted to last for about ninety years and the value of assets in such trusts may be excluded from a beneficiary’s gross estate thereby creating the possibility of avoiding estate and generation skipping taxes for several generations.

Despite these advantages, it is important to remember that irrevocable trusts are separate taxable entities that require care and maintenance. The trustees must file the proper forms with the IRS and the tax rates for irrevocable trusts are normally higher than the rates for individuals. Trustees also can charge a fee which will be payable from trust assets.

Who should have acted as Cinderella’s trustee?

Deciding who should act as trustee of the trust is an important decision and may have significant implications to your beneficiaries. A trustee can be a family member, trusted friend, corporate trustee, or in many circumstances, the beneficiary can act as their own trustee. You may wish to choose a single trustee or name co-trustees to have a checks and balance system for the trust.

The trustee has many fiduciary responsibilities, including to: (1) Identify and protect the trust assets and maintain the books and records of the trust for its term; (2) invest and manage the trust assets in a way that is in the best interests of the current and future beneficiaries; (3) distribute the income and principal of the trust as the trust document provides; and (4) communicate with beneficiaries as to the terms of the trust and requests for distributions and prepare annual tax filings.

What should the term of Cinderella’s trust have been and the ages and/or standards of distribution?

A trust can last for a beneficiary’s lifetime or can terminate based on certain life events or ages of distribution. If a trust is to terminate during a beneficiary’s lifetime, distributions may be staggered so that the beneficiary is given the opportunity to manage the assets that are distributed. If the beneficiary makes poor choices with the funds distributed, there may still be additional funds remaining for their benefit.

Should an irrevocable trust have been formed for Cinderella and funded in part during her father’s lifetime?

If you have more than sufficient assets to meet your needs during your lifetime, you may wish to consider making lifetime gifts to children and creating an irrevocable trust for a child to hold the gifted assets. During your lifetime, you can make “annual exclusion gifts” (the $14,000 you can give someone each year without having to file a gift tax return or pay a gift tax) or you can also make “taxable gifts” (gifts that exceed the annual exclusion amount). While lifetime taxable gifts may not be subject to gift tax because of the lifetime gift tax exemption ($5,450,000 in 2016), the aggregate of these lifetime gifts (at their gift tax value) will be included in your taxable estate when you die. However, the post-gift future appreciation and income earned on the gifted assets will not be in included in your taxable estate.

If Cinderella had a lifetime trust, who should have been responsible for payment of income taxes on the trust income?

A trust created for another person during the creator’s lifetime can be designed so that the trust assets will not be included in the creator’s estate for estate tax purposes but all of the income earned on the assets will be taxed to the creator during his lifetime. In these cases, the income will remain in the trust for the benefit of the beneficiary and the payment of income taxes is a tax free gift to the trust’s beneficiary. This technique is commonly referred to as an intentionally defective grantor trust.

What If Cinderella’s father had named her as a beneficiary in other areas of his estate plan?

When trusts are used as part of a wealth transfer strategy, beneficiary designations for retirement accounts and life insurance need to be reviewed to ensure that there is coordination among the beneficiaries of the different components of an estate plan.

In the real world we can’t rely on fairy godmothers to make things work out for our loved ones after we pass away. However, we can still hope for happily ever after endings by engaging in thoughtful planning including using trusts as part of a comprehensive estate plan.

If you would like to learn more about using trusts in your estate plan, please contact one of your B|O|S service team professionals. We at B|O|S are ready to work with you, your attorney and tax professionals on the merits and specifics of these and other investment and financial planning options.

Please read important estate planning disclosures here.

Filed under: Estate Planning

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