Twenty-three years ago, I was a 24-year-old financial planner trying to make a name for myself. One of the ways I accomplished this was to create my own radio show, "Brent Welch Talks Money." It was a way for me to get my name out to the community to connect who I was with what I did.
One day, I asked the most prominent estate planning attorney in La Crosse, Wis., John Bosshard, JD, to be a guest on the show. The late Attorney Bosshard said all trusts can fit into four boxes. He said, "Picture in your mind a window with four panes. In the upper left window pane write the word, 'Revocable.' In the upper right, 'Irrevocable.' In the lower left write, 'Living,' and the lower right, 'Testamentary.' You have just categorized every single trust known to mankind."
Trust types
Trusts can be adjustable or permanent, written to spring into effectiveness during your lifetime (Living Trusts) or after you die (Testamentary Trusts).
Wills are different from trusts because trusts hold ownership of assets while wills simply direct assets. A Revocable Living Trust (RLT) is by far the most popular estate planning trust our clients use. The second most popular trusts are testamentary irrevocable trusts, such as a Credit Shelter Trust (CST). These trusts are designed to become effective upon a person's death and are used to segregate assets to a separate account titled in its own name and given trust ID # to tie it to its own tax return. Because CSTs need to file a separate income tax return, they may be used to create a wall of protection from excess taxes and creditors.
Asset protection
Your client can't pay taxes on an asset he doesn't own. By reregistering assets into the name of an irrevocable trust, he can transfer ownership and taxation to the trust entity. By understanding that the IRS taxes assets according to the assets ownership form, he can shift ownership of his assets through gifting strategies to irrevocable living trust.
Be careful to understand that the tax rate of an irrevocable trust escalates to the highest marginal bracket at very low income levels. With 2010 tax rates for a person filing a joint return as a married person, the 35% marginal rate occurs at incomes over $373,650. For irrevocable trusts the highest marginal rate of 35% starts at only $11,200 of taxable income.
Grantors and their advisors need to use tax-efficient, tax-deferred and tax-free investments to avoid the high expenses of trust taxation. Advisors would be wise to suggest the use of life insurance, tax-free bonds or growth investments like stocks or ETFs to defer taxation and help keep taxes as low as possible.
Supplemental Needs Trust
Imagine a trust that provides supplemental income during a client's life to assist him in his health, education and welfare when he needs it most. Imagine that this Supplemental Needs Trust (SNT) helps him but isn't considered his asset for Title 19 planning purposes. Imagine having principal and interest available for living expenses by not being considered the owner of such a trust. How would that appeal to your client?
Picture this scenario: John gave $100,000 to his two children, Jake and Lauren. Jake and Lauren didn't want to lose the gift or be responsible for the creditor risks of what that gift represented. So they decided to set up a SNT to hold the gift in trust for John. Jake and Lauren become the grantors and the co-trustees of the trust for John, the income beneficiary.
The SNT files its own income tax return and pays taxes at the highest trust level. This trust could be invested into municipal bonds, growth stocks, or cash-rich, investment-grade life insurance. A combination of such assets should be considered for short-term, intermediate and long-term needs of the income beneficiary. Using tax-free muni-bonds for short-term needs, high-quality blue chip stocks for intermediate needs and the cash-rich, investment-grade life insurance for the long-term needs may be a consideration for such a trust.
Bottom line
Asset protection strategies require the orchestration of concepts surrounding ownership, tax-deferred growth IRC sec 7702 and tax-free death benefits IRC sec 101.
Work hard for your clients to help them accomplish their objectives by using methods described in the IRC as legal, proven asset protection strategies. No one has a patriotic duty to pay more than the law demands.
Brent Welch, CFP, ChFC, CLU, is founder and managing member of Welshire Capital, LLC. Reach him at www.welshirecapital.com.
