MoneyWatch

Athena financial & insurance services, inc.

Registered Investment Advisors
Text Box: A few weeks back in an article entitled “Trusts With a Twist” we examined some of the more unusual types of trusts used for specialized situations. This week we take a closer look at the more traditional type of trust instruments. Most of the time my clients tell me that when they pass on they want their children and grandchildren to inherit the hard-earned assets they’ve spent a lifetime accumulating. Without proper planning, though, their sweat and tears might help fill government tax coffers instead of grandson Bobby’s college fund. What a trust can help you do is maximize inheritance, minimize death taxes and eliminate probate fees. To understand the benefits of a trust, let's put the estate tax into perspective. When a person dies, the value of his or her total estate is determined for estate tax purposes. The estate tax is then computed on the taxable estate by applying a rate schedule that ranges from 18% to 46%. Then, various credits are applied to limit the amount of estate tax that has to be paid. First, each person qualifies for a flat credit to be subtracted from his or her estate tax liability. In 2006, this credit ($780,800) is equivalent to excluding the first $2 million from the decedent's taxable estate. Also, spouses are allowed an unlimited spousal exclusion—so no estate tax need be levied when the first spouse dies. Therefore, in the simplest case in which a single person dies in 2006 with an estate worth $2 million or less, no estate taxes will be due. What if your estate is greater than the credit? For a single person who dies in 2006 with a $2.5 million estate and a fully available credit, the federal estate tax bill would be $230,000 ($1,010,800 in estate tax less the full credit of $780,800). For married couples it gets a bit more complicated. Let’s say a married couple has an estate of $4.5 million. Because of the unlimited marital deduction no tax would be due when the first spouse dies provided everything was left to the surviving spouse. But when the surviving spouse dies (assuming the estate size remained at $4.5 million) the estate tax bill to the heirs would be a hefty $1,150,000. Enter something called a “Bypass Trust”. To minimize taxes on the overall estate, a couple establishes a revocable living trust containing a provision for a bypass trust (sometimes called a credit shelter, or exemption trust) which comes into existence following the death of the first spouse. Then, assets equal to the estate tax credit equivalent (currently $2 million) are transferred into the bypass trust with the balance going to the spouse. At this point, the bypass trust becomes its own entity, is irrevocable and requires its own income tax return. Typically, the assets of the bypass trust are available for the health and welfare of the surviving spouse, only passing to subsequent beneficiaries following the second death. Under this arrangement the couple is now able to shelter $4 million for the heirs which is the combined value of each spouse’s exemption. In our example, now the estate will pay only $230,000 in estate taxes after the surviving spouse dies, a savings to the heirs of $920,000. But trusts can include other significant provisions which can prove beneficial to your heirs. A spendthrift provision is a clause which prevents the creditors of your heirs from attaching the assets of the trust or forcing the trustee to make payment directly to the creditor; the creditor must wait until the trustee distributes a payment or trust assets to the beneficiary and then pursue collection. Trusts can also be written in such a way to make sure that only your children or grandchildren—not the people they marry—ultimately inherit your assets.▲

Use of traditional trusts...

Volume 17, Issue 19

October 2, 2006

Estate Planning Instruments