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Give the Advantages of Trusts
I'll give you a choice.
I'll give or leave you $1,000,000 (remember, this is all
hypothetical for illustration purposes only!).
You can have it in your own pocket. At your death, it will be
subject to estate tax. If you have marital problems, your spouse
may have a claim on it. If you run into financial troubles, your
creditors can go after it. If your kid has an accident while
driving your car, the injured parties can go after that money.
Alternatively, I'll put it in trust. It's not yours. It can pass
tax-free at your death. Your creditors can't get at it. If you
have financial losses, it's there to give you a fresh start.
Which would you prefer? And which would you prefer to provide for
your beneficiaries?
Well, you may respond, granted that a trust doesn't have some of
the disadvantages (which you hadn't realized existed) of owning
the money directly, are the *benefits* comparable? It doesn't do
any good to keep the money away from IRS or creditors if it can't
be affirmatively used for the beneficiary.
Aside from a QTIP deducted by one spouse and included in the
survivor's estate, a trust created by A will only be included in
C's federal estate if C is given a general power of appointment.
No other restrictions on C's power are required for federal tax
purposes. A may want to put on other restrictions for non-tax
purposes (see Introduction to Trusts), but they are not required
to avoid taxation.
A beneficiary can have:
all the income for life (for various reasons discretion is
better);
principal as the trustee determines necessary for their health,
education, maintenance and support;
be, or have the right to name, the trustee who determines what is
necessary for their health, education, maintenance and support;
principal as the trustee determines necessary for their "best
interests";
have the right to name [including broad power to change, but not
be themselves] the trustee who determines what is necessary for
their or their dependents best interests;
have a "quasi-general" power of appointment -- a right in life or
at death to appoint to anyone other than themselves, their
estate, their creditors, or the creditors of their estate;
all of this without inclusion in their estate.
On the other hand, a trust could be created in which B, the
trustee, has complete discretion whether to pay any income or
principal to the beneficiary, with the beneficiary having no say
at all.
And these differences can be varied over time and circumstances.
Now let's look at the real-life practical consequences of giving
a beneficiary a "quasi-general" power of appointment and making
them trustee.
The trust will not be included in C's estate when he dies. It
will not be subject to the claims of his spouse upon divorce, and
it will not be subject to claims of his creditors.
Does he want a house? The trust can buy a house for him to live
in, still without putting it into his name.
In many cases, a beneficiary can benefit without ever taking a
dime from his trust. Think how much saving is done as protection
from a "rainy day". But how much more can you afford to spend,
how much can your living standard be increased, if you know
there's an umbrella in the closet?
Suppose C insists on getting money out of the trust, other than
regular distributions. She can appoint part or all of the trust
to another trust for Y (if it were outright, then Y would later
make a taxable gift), whom she trusts to then appoint to her. And
if she's hesitant about Y, she can appoint 10% to Y, and only
appoint the next 10% after Y has acted.
Remember that C can have a power to appoint to himself if it's
for his health, education, maintenance and support. Theoretically
if he exceeds those standards D can sue to stop him. Now suppose
D comes to C and says "Dad, grandpa A [or Mom, Dad] said that you
could use the trust for your health, education, maintenance and
support. I really don't think that includes monthly trips to
Acapulco."
To which C replies "you may be right, son. You might be able to
sue to stop me from that spending. Just remember that I decide
who gets what's left at my death. Now [assuming three children]
-- do you want 1/3 of the pie that's left after my trips, or none
of a large pie without trips?"
From this concept, you can play continuing variations. If, for
non-tax reasons, you want more restrictions on the beneficiary,
you can give those powers to outside trustees who can provide
similar benefits without giving control to the beneficiaries. And
the shadings are innumerable.
The real limitations are not legal but human. You cannot give a
beneficiary virtually unlimited control -- and try to restrict
them. Are you afraid they'll give some to their spouse rather
than their descendants (your descendants)? Then you have to tie
them up, restrict their powers of appointment, and face potential
resentment from them. If you want to go through that, there are
ways to find intervening points.
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