Benefits and Risks of Using Trusts to Transfer Wealth | Balentine (2024)

We all have a natural human tendency to avoid thinking about our mortality, and as a result, many of us procrastinate about estate planning. As a colleague once said, “Nobody wakes up in the morning saying, ‘Hey, today is a good day to establish a trust.’”

Yet trusts are a proven tool for achieving goals across generations. Thoughtful and strategic trust planning in consultation with trusted advisors can help you maximize the benefits and minimize the potential risks of setting up a trust.

Benefits of Using Trusts

Benefit #1: Support People you Love

Once you acquire significant wealth and assets, it’s natural to start wondering, “What happens to my wealth after I am gone?”

Trusts let you control how your financial legacy is used and provide long-term support for individuals about whom you care deeply. They are a mechanism for transferring wealth and helping children use their inheritance responsibly.

As part of their estate planning, many high-net-worth individuals establish testamentary trusts, a type of trust that gets triggered upon death. This type of trust complements the provisions of a will and can be used to anticipate unthinkable questions, such as:

• If a freak accident or illness cuts your life short, should your assets be distributed immediately or over time to multiple children?
• If your young children become orphaned, who gets custody?
• Do you want to set limits on how a surviving spouse can use inherited money?

Through a trust, you can anticipate and retain control over a wide range of eventualities. For example, perhaps a beloved niece has a special need that requires ongoing medical treatment. You can set up a trust that will provide for her ongoing comfort and care. Or perhaps you foresee the possibility that your spouse might remarry. Under a testamentary trust, you could support your spouse with a standard of living as appropriate, but prevent your hard-earned money being given away to a new family to the exclusion of your own children. In other scenarios, testamentary trusts can be used to delay a child’s access to wealth, to provide perpetual care of a special-needs individual, or to manage the affairs of loved ones with chronic addiction or handicaps.

Benefit #2: Reduce Taxes

Trusts are like swiss army knives and can be used in various ways to reduce a taxable estate. If you can leverage trusts to reduce tax impact, the return can far exceed the return garnered from capital markets.

Example: Let’s say current law allows you to bequeath $11.4 million tax-free, but you have $10 million in total assets plus a $5 million personal life insurance policy. Together these total $15 million and place almost $4 million over the tax-free threshold. Here are two potential trust-based strategies:

• A specific type of trust known as an irrevocable life insurance trust (more commonly referred to as an ILIT) could be used to effectively exclude a life insurance policy from the estate. Your beneficiaries will still receive proceeds from the policy, but that income is no longer considered taxable as part of your estate. Using an ILIT in this example could exclude nearly $4 million in insurance proceeds from your estate. With a prevailing estate tax rate of 40%, this exclusion would generate a savings of $1.6 million for your heirs!
• Another type of trust, known as a credit shelter trust (or family trust) can be used to avoid taxation all the way down to the grandchildren. This trust works in combination with unused lifetime estate tax exemption amounts and generation-skipping transfer tax (GSTT) exemption amounts, and it is typically structured upon the death of the first spouse. Potentially, the full amount eligible for estate tax exemption ($11.4MM, as noted earlier in this example) could be placed into a credit shelter trust. In this scenario, the surviving spouse maintains certain income rights to that money during their lifetime, and upon their death, remaining assets transfer to the remaining beneficiaries, free of estate tax and GST tax! (This strategy can be especially beneficial when the assets are expected to appreciate significantly over the surviving spouse’s lifetime. However, income taxes could become an issue. Assets owned by a credit shelter trust do not receive a step-up in basis upon death of the surviving spouse. Due to the compression of the capital gains rates and the estate tax rate (as currently written), it’s worth asking your tax advisor to calculate if the step-up in basis will be more valuable.)

Most trusts are set to terminate 80 or 100 years after the birth of the current youngest living child. However, some states have exceptionally favorable trust tax laws, such as no state income tax and no rule against perpetuities. (Current examples include Delaware, Tennessee, South Dakota, Nevada, and Alaska.) Because fiduciary law is ever changing, be sure to consult with your advisors on the latest trust nuances, tax pitfalls, and tax planning opportunities.

Benefit #3: Protect Your Family’s Privacy

Probate courts oversee the implementation of wills, and this process can be expensive and time consuming. Further, probate is public record, and reveals sensitive information to anyone who views the court documents. However, assets maintained in a trust automatically sidestep the probate process and avoid prying eyes.

High-profile individuals who put a premium on privacy sometimes put assets into a revocable living trust in order to shield details of those assets from public disclosure. For example, private residences can be held in a revocable living trust in order to exclude estate details and personal addresses from public record during probate. Otherwise, anyone can go to the probate court and see how much some celebrity left their child or how much money they had. As this type of trust is revocable, it can be dissolved later as needed.

Risks of Using Trusts

Risk #1: Overlooked Details

Trusts rely on complex legal documents and processes, so if those documents and processes are not completed or are not up-to-date, the trust itself will inevitably fall short of your goals.

Overlooking small details can undermine an otherwise elaborately planned trust.

For example, one couple worked closely with their estate attorney to plan the required trust documents. However, the couple didn’t realize they never finished signing all the paperwork. As a result, the “titling” was never executed to convey the assets. In other words, the assets were never legally transferred into the trust. That important oversight would have caused a big headache to the surviving spouse.

In another scenario, what happens if you craft airtight trust documents then you put those documents in the drawer, ten years pass, and you never review those documents? Outdated trust documents can easily lead to unfortunate surprises at probate. For example, perhaps during that decade you remarried, but the trust documents contain the first spouse’s name. Perhaps the person named as trustee has passed away.

Trusts can provide powerful protection when they are kept up-to-date, but can cause unforeseen outcomes if they are not checked and updated regularly.

Risk #2: Unintended Emotional Implications

While the financial benefits of trusts can be enormous, trusts have the potential to cause emotional friction when not planned or communicated effectively. Here are a few unfortunate potential scenarios:

• A financially struggling child is forbidden to tap any of their inheritance until they meet a certain age or educational criteria and comes to feel their parents betrayed them.
• Children cannot agree amicably how to share a joint asset left in trust, such as a country retreat, and so it falls into disrepair or tax delinquency.
• One sibling is shocked to discover that they alone must submit to drug testing to receive trust payouts, while the other siblings have no such stipulations.
• Children don’t learn the scope of their parent’s estate until probate—and are unprepared for their new responsibilities or tax burden—and become furious and resentful over family secrets.

By clearly explaining your decision-making process and why your trust was set up a certain way, you help prevent any emotional fallout later, once the trust’s specific provisions are revealed.

Transparency and communication go a long way to avoid ill will and bad feelings.

You also want to select a trustee who is capable of performing administrative responsibilities tactfully as well as competently, in order to help reduce potential misunderstandings and interpersonal conflict down the road.

Risk #3: Fear of the Process

Trust planning has the potential to get complicated so quickly that often people put up a wall. So, we recommend keeping it simple. Write out in bullet points what your intentions are and ask your estate planning attorney to draft documents that achieve those goals.

For simplicity, consider reviewing your trust and estate plan every three to five years and stair-stepping into only as much complexity as needed to achieve your goals as your circ*mstances evolve over time.

Are Trusts Right for You?

If you plan to sell a business or otherwise anticipate a sudden increase in liquidity or accumulation of assets, trusts should be front of mind during thoughtful financial planning. The benefits of trusts can be enormous, and with appropriate planning and regular document reviews, the risks can be minimized.

Whether or not trusts are right for you depends on your personal situation, financial objectives, tax objectives, and estate plan.

Contact your team of wealth protection advisors to identify trust opportunities suitable for your unique situation. Together, you can work holistically and customize an approach to trusts that will protect assets and achieve your family’s goals for future generations.