Trusts 101 part 8 – Benefits and estate taxes

In part 8 of our look at the use of various trusts by physicians, we examine specialized estate planning and estate tax avoidance trusts and how they can benefit physicians’ families.

We started our introduction to the use of trusts and their legal uses for asset protection and estate planning by physicians with some basic trust vocabulary and trust taxation issues before moving on to estate planning and other special purpose trusts. This week we introduce several common forms of specialized estate planning trusts that can help control how your family takes your assets in the most predictable and tax efficient way. In some cases, these may be a separate, stand-alone trust created to achieve a specific result or benefit a specific individual, in other cases they may just refer to specific drafting language and provisions that included in trust that is wider in scope.

Special Needs Trusts

Special needs trusts (SNTs) are irrevocable trusts created by one person for the benefit of another. SNTs are commonly used by the parents or other family members of those with special needs including significant physical and mental disabilities, substance abuse issues, or severe chronic or terminal illnesses.

The Trustee of the SNT makes discretionary distributions of trust assets for the permitted benefit of the beneficiaries. This discretionary language means that the beneficiaries have no specific right to a distribution or a specific amount of assets and as such, helps preserve their financial qualification for a variety of income and asset dependent government benefits that may include Social Security, disability, Medicare or Medicaid access and nursing home care, among others. Assets in an SNT are creditor protected from both the creditors of the Grantors that create and fund the trust and the beneficiaries of the trust, with the usual caveats*.

Generation Skipping Trusts (GST)

This is a tool most often used by high-net-worth individuals with both an estate tax exposure due to the size of their estate and a willingness to “skip” their immediate heirs and pass their assets on to their grandchildren, thereby legally avoiding the estate tax obligation that would otherwise have been due upon their death. I often see this strategy used when both the Grantors and their children are HNW and where the assets would likely be subject to estate taxes twice; first at the death of the Grantors and then again at the death of their own wealthy children who may also have an estate tax exposure, before the assets are passed on to the grandchildren. By skipping a generation with a specifically calculated portion of their estate, a Grantor can currently pass on nearly $12MM of their estate (or $24MM for a married couple). Any amount over that is taxed at the current estate tax rate, currently 40%.

This is an irrevocable trust that may provide creditor protection to the subject assets from the liabilities of both the Grantors and the beneficiaries. While the discussion often involves grandchildren, it can be used to transfer wealth to any beneficiary (often called a “skip person” in this scenario) regardless of their actual relationship to you (friend, niece, nephew, godchild, etc.) as long they qualify by age. They must be one generation away from you in age, which the I.R.S. defines as at least thirty-seven and a half years younger than you. A final bonus, while your children can’t have access to the assets transferred to the GST, they can have access to income distributions if the principal transferred into the trust remains intact and follow generation skipping transfer tax (GSST) rules.

Some GST distributions are even more heavily favored. As one article on the Intuit consumer education blog explains:

"Other gifts and transfers to skip persons qualify for an exclusion, including educational and medical expenses and health insurance. As long as the payments are made directly to the educational institution, medical facility, or insurer, these transfers avoid the gift and generation-skipping taxes. They also don't count toward the lifetime estate tax exemption or the annual gift tax exclusion."

As always, this can’t be taken as specific tax or legal advice, get expert help that fits your facts.

*The exception to virtually every creditor protection strategy, whether created by a transfer to an irrevocable trust, or by a specific statutory exemption, is the same. No strategy implemented to thwart an existing creditor or known liability is effective or legal. Asset Protection is always proactive.