Four powerful trusts that can help protect your assets

You want both to enjoy your wealth and to pass along as much as possible. Trusts can help.

06 Jun 2016

You may already know the basics about how trusts can help protect your estate from taxes while helping you control where your money goes. Most of these decisions will happen with you, your family and your Financial Advisor, but to help you begin to get a clearer understanding of how you can help protect your assets, here are four types of trusts and a general summary how they work.

1: An irrevocable gift trust. This type of trust can help you pass along assets to your beneficiaries and heirs while easing the tax burden they might face should the asset increase in value. Use this trust to pass on assets that you expect to appreciate. The value of the assets when you contribute them will count against your lifetime tax exemption ($5.45 million in 2016), but any appreciation won’t be subject to gift or estate taxes. “Say you have a closely held business in the start-up stage and you’re convinced it will have spectacular growth,” says David English, professor of law at the University of Missouri School of Law and vice-chair of the American Bar Association’s section of real property, trust and estate law. “You can freeze the value of that business on the date you put it in trust, and any appreciation of the business will escape federal estate tax.


Key takeaways

  • Trusts can help protect your assets from estate and inheritance taxes.
  • An irrevocable gift trust works well if you have assets that are likely to appreciate.
  • A qualified personal residence trust allows you to put your home in trust and still live in it for a specified number of years, which lets you pass it on to beneficiaries at a discounted value.
  • A grantor-retained annuity trust lets you transfer appreciation of assets to the next generation tax-free.
  • A dynasty or multi-generational trust may allow you to pass wealth to grandchildren free of tax, up to $5.45 million in 2016.

2: A qualified personal residence trust (QPRT). This type of trust can make it easier to pass down your home. A QPRT can hold your primary or secondary residence. Unlike most irrevocable trusts, a QPRT allows you to retain use of the asset. In this case, you’re entitled to live in the home for a certain number of years. At the end of the trust, the house passes to your beneficiaries at a much-discounted value, using up only a fraction of the gift tax exclusion you would have used had you given the house outright. In addition, you can continue to live in the house if you pay a fair rent to your beneficiaries, which allows you to pass even more tax-free wealth to them, because fair market rent is not a gift.

3: A grantor retained annuity trust (GRAT). A GRAT allows you to transfer appreciation of assets to the next generation tax-free. The assets you put in a GRAT will provide for a fixed yearly sum of money, called an annuity, paid to you for two or three years—the usual term for a GRAT. The payments are usually set up so that they equal the value of the property you contributed to the trust; the GRAT is then considered to be zeroed-out.

“If the investments in the GRAT perform well, you can potentially distribute significant amounts to your beneficiaries.” – Wilms

But if the assets appreciate in value, as described below there should be assets remaining at the end of the trust term, which your kids get free of tax. This works because the IRS assumes that the assets will grow at a certain rate of return, which in today’s low interest rate environment is about 2%. If the assets in the GRAT appreciate at a rate that exceeds that assumed rate of 2% return, your kids get the bounty clear of gift tax.

“This is a great time to fund a GRAT,” adds Erin Wilms, Head of Advanced Planning for UBS Financial Services Inc., “because the rate at which your assets must appreciate in order to accomplish wealth transfer is at historical lows. If the investments in the GRAT perform well, you can potentially distribute significant amounts to your beneficiaries. You may even be able to lock in the gain by substituting less volatile assets in the GRAT.”

4: A dynasty or multigenerational trust. A sizeable gift to your grandkids in your will could trigger the dreaded 40% generation skipping transfer (GST) tax in addition to a 40% estate tax. Instead, you can fund a dynasty or multi-generational trust with your federal gift and GST exemptions, which is $5.45 million in 2016. The gift incurs no tax when you give it. Generations from now, if the assets have grown manyfold, your grandkids and future heirs can enjoy your gift free of tax.

It takes a lot of planning to make sure that your money both serves your needs and provides for your family efficiently. Speak with your Financial Advisor to explore appropriate ways to move ahead with your financial goals, and of course, discuss these matters with your independent legal or tax adviser.