Trusts can be a confusing concept. Even well-written and easy to understand descriptions can be abstract. The best way to understand them is to look at what they can accomplish. Part of the reason they are so difficult to understand is because they can be used for so many different purposes.
To get us started, here’s three examples of uses of trusts in Maryland.
Help Minimize Taxes
This is somewhat less of an issue in Maryland thanks to recent changes in the estate tax, but wealthy families might need some additional planning to help avoid the Maryland and Federal estate taxes. One possible way is an irrevocable life insurance trust. Normally, life insurance benefits are considered part of one’s taxable estate. In a life insurance trust, the trust itself owns the insurance policy. This way, the life insurance proceeds are never part of the estate and are not exposed to estate tax.
Example: Trevor is wealthy and expects to pay estate taxes. In order to pass on more of his wealth to his son Paul, he creates a life insurance trust and transfers enough assets for the trust to purchase a life insurance policy on his own life. He names his local Frederick bank as trustee. The trustee purchases a $5 million policy. When Trevor dies the life insurance policy pays the proceeds into the trust, and the trust distributes the funds to Paul. The life insurance proceeds are never part of Trevor’s estate and are free from estate tax.
Life insurance trusts must be irrevocable to be effective. This means they can’t be changed, so it is essentially giving the money away. The IRS imposes a “look back period,” meaning that assets placed into the trust within three years of death are still considered part of the estate. They are tricky to set up and are only for those facing significant estate tax liability.
Manage Property for Young Children
A trust can allow the management of the assets of a young child until the child is mature enough to handle the assets herself. A child cannot legally own more than a minimal amount of property without supervision. If a child inherits property, the property is placed into a guardianship, which is a difficult and cumbersome process that requires court supervision. A better option is to leave property to the child under the Maryland Uniform Transfers to Minors Act, where a custodian is appointed to manage the money without court involvement until the child turns 21. When the child turns 21, the child takes direct control of all the money.
Some parents are uncomfortable having a child own a large amount of money at 21. An even better option is to leave the property to the child in a trust, where the trustee will manage the money for the child until an age or condition specified in the trust.
Example: Randy and Carmella want to provide for their daughter, Sophia, if something happens to both of them. Randy and Carmella have a sizable estate and don’t think Sophia will have the maturity to handle a large amount when she turns 21. Randy and Carmella create a trust in their wills where Carmella’s brother will serve as trustee for Sophia’s inheritance. The trust is only created if Randy and Carmella both die before Sophia is 25. The trust gives the trustee broad authority to manage the assets and spend it on Sophia as he sees fit. The trust states that the trust will terminate and Sophia will receive what is left when she turns 25 or when she graduates from college, whichever comes first.
Provide for Children from a Previous Marriage
In Maryland, if a parent dies, the surviving parent becomes the guardian of the children and the children’s property. If the parents are divorced, this may not be ideal. The surviving parent may not be the best choice to manage the property of the child. A trust lets a parent choose the person to manage the property of the child.
Example: Victoria is happily married to Tom. Victoria has a young son, John, from a previous marriage to Joe. Tom acts like a father to John, but cannot adopt him because Joe will not consent. Joe has a drug problem and is no longer part of his son’s life. If Victoria dies, Joe would likely take custody of John. In order to prevent Joe from mismanaging John’s inheritance, Victoria sets up a trust where if she and Tom die, her sister would manage John’s property until John turns 21. This way, Joe does not have access to any of John’s money.
Trusts have many other applications in estate planning. Talk to an attorney experienced with them to see if you should include them in your estate plan.
Montefusco Estate Planning, LLC is an estate planning law firm in Frederick, MD. If you are interested in our services, contact us today. This information is written for the context of Maryland estate planning but is not legal advice for anyone. For more information, read our disclaimer.